Tuesday, 22 September 2015

Experimental economics after the demolition job on theory

The front cover of Richard Thaler's autobiography Misbehaving shows a single bird, looking quizzically at a huge flock of birds who are all flying in the same direction. It's a metaphor for behavioural economics. The single bird is the lone behaviourist; the flock is the economic theorists who all think the same way. And indeed, the book is a story of conflicts in which standard economic theory and presuppositions turned out to be wrong.

Economic experiments started as critique. A typical experiment takes real humans and puts them into a situation designed to be as much as possible like an economic model. Payoffs are well-defined. Subjects know all about the experiment in advance. Play is anonymous - so there's no chance to "change the game" by, say, taking your partner out for a pint afterwards. None of this is anything like the real world. But, if economic theory doesn't even get it right in these situations, what hope does it have in the real world?

I happen to think that the critique has been successful. Sensible economists no longer take (e.g.) rational maximization of monetary payoffs, or Bayesian updating, as Gospel which somehow must be true. They accept that other things might happen.

Having performed this negative task, experimentalists have gone further. They want to build their own "behavioural" theories of how people do act. But now there is a problem.

Standard theory is a function from game forms to behaviour. Given such-and-such a set of players, payoffs, information sets and action spaces, Nash equilibrium predicts such and such behaviour from each player. If standard theory is right, then people in a lab experiment which implements a "game" in this way will behave exactly as the theory predicts. They don't, so standard theory is falsified. Fine.

But it does not follow that there is another theory, which also takes games forms as the input, and which will always correctly spit out people's behaviour. Indeed, we know that this does not work. For example, people behave very differently if you call a public goods game "the community game" or "the Wall Street game". But the game-theoretic description is unaltered by this label. There is no correct theory of behaviour which depends only on game forms.

Unfortunately, lab experimenters have blithely continued to write down game forms that correspond to real world situations; implement them in the lab; observe behaviour, perhaps building a model to predict it; and assume that this is what will happen in the real world. There is now a huge accumulation of such experiments. You can see them at any experimental conference.

There is no reason to believe this approach will work. Other things than actions, information and incentives matter. So mimicking actions, information and incentives in the lab does not guarantee people will behave the same way as in the real world.

This whole research programme has to stop. Then we can start designing experiments that will tell us about the real world. In particular, a first step is to think more carefully about the theory that makes any given laboratory experiment informative about the social phenomenon of interest. Such a theory is always needed. Psychology can be helpful here, because it opens the black box of the mind and tries to find how the subject perceives a given situation.

But my main point is: stop the mindless empiricism in economic lab experiments.