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.

A field experiment at LHR

At Heathrow Terminal 2, there is an escalator and a lift to take you from the Underground up to departures. The authorities have put a sign up:

TIME ON ESCALATOR 3 MINUTES

TIME ON LIFT 58 SECONDS

TAKE THE QUICK ROUTE – TAKE THE LIFT

Why has this happened?

1. Standard economics: the sign was a mistake. People already choose the optimal route. (Public choice theory: the sign was not a mistake but a deliberate conspiracy by the elevator company to wear out the lift and make money from replacements.)
2. Social preferences: the sign is a nudge to counter travellers' "lift aversion".
3. Social norms: there is a norm of taking the escalator. People really want to take the lift, but they are afraid what others will think of them.
4. Social heuristics: people mistakenly assume the escalator is faster, as it usually is in their experience. The sign corrects this.

This is a biased choice of example. In other situations, the first three explanations might be more plausible. Still, many lab experiments might be cases of 4, mistaken for cases of 2 or 3.

I first read the term "social heuristics" in this paper.

Behavioural should not be behaviourist

What differentiates behavioural economics from psychology? A common answer is "we are interested in behaviour".

For example, psychologists studying group identity might use a questionnaire measure, asking subjects "how proud are you to be in your group"? Economists, instead, would test whether they gave more money to their in-group. "Real choices have costs," goes the slogan.

Costly choices are a great experimental tool. But I had an epiphany recently, when a psychologist remarked that economists are using a theory psychologists gave up fifty years ago – behaviourism, the idea that you could ignore the mind and just study how stimuli affected behaviour.

Only studying behaviour makes sense as long as the mind has no "state". If stimulus X always causes behaviour Y, then we only need study Y.  But of course the mind has state: for example, our choices depend on our moods.

We need to study these states directly, so as to improve our theories by clarifying the links in their causal chains. Why are subjects more selfish if the game they are playing is labelled the "Wall Street game" rather than the "community game"? Maybe the market-oriented phrase puts subjects into a materially self-interested mindset. OK, so when does that happen in the real world? For an answer, we will need to measure this mindset directly and learn how it is induced.

This is doable. Yes, people may lie, or misinterpret their own behaviour; but psychologists have been devising valid, reliable questionnaire measures for decades. (FMRI data seems more easily accepted by economists than questionnaires, perhaps because it seems more like "hard" science – or because it is impressively expensive?) We can use these measures, or create similar ones of our own.

Without good theory, experimental economics risks becoming a pile of unorganized, uninterpretable results. For good theory, we need to open and study the black box of the mind.

Francis Drake on inequality

Sir Francis Drake, off the coast of America, addresses questions of socioeconomic inequality and integration.

External validity in experimental economics

Lab experimenters worry a lot about external validity. OK, we say, it happened in the lab, but would we see it in the real world? Answering this question, by connecting the lab and the field, is a good way to get published.

Most of these papers look at individual-level external validity. For example, were the same people who were trustworthy in a "trust game" lab experiment,  also more likely to (e.g.) repay microfinance loans? Were people who cheated in an "honesty game" (throwing a die and reporting the result where you got paid more for some results) also more likely to cheat by riding without a fare on public transport? *

Policy-makers, though, are probably more interested in external validity of treatments. For example, in the lab, people may be more cooperative if others can observe their behaviour. Will the same thing happen if we (e.g.) gave people badges when they made a charitable donation?

Individual-level and treatment-level validity need not be related. Perhaps the same people are generous in the lab and in real life; but a particular treatment only works in the special atmosphere of the laboratory. Conversely, even if lab behaviour does not reflect a stable underlying trait of individuals, a policy intervention may still affect it. Both questions are interesting but it is important to distinguish them. The real test of external validity is probably: does your policy intervention work?


* Marie Claire Villeval's paper, not online yet.

Update: Ro'i Zultan points me at Vernon Smith's 1981 paper:

What parallelism hypothesizes in micro-economy is that if institutions make a difference, it is because the rules make a difference, and if the rules make a difference, it is because incentives make a difference.

Political economy of the UK and Europe, January 2015: Doom and Gloom edition

This week I started a new job in the Department of Economics at the University of East Anglia. To celebrate, I will share my thoughts about the UK economy. As I am not a macroeconomist, these ideas are opinionated ramblings, not expert knowledge.

Florence, once at the heart of early capitalism, is now a tourist town, lying in state among its architectural heritage. Europe is making the same slow transition from a place where wealth is created to a place where it is spent. Better economic policy could slow but not stop this change, since the markets of Asia contain the majority of the world's population, including two massive polities: that is the customer base to start your business, if you want to conquer the world. Since the gains from better economic policy would be limited, we can predict that it will not be forthcoming. Europe will see some economic reform, perhaps even Thatcherite revolution in places, but not enough to clear the huge overhang of debt.

The UK is no exception to this story. It now has an economy driven by house prices, like a tropical island whose inhabitants give up fishing so as to sell their shacks to millionaires. The Conservative party's constituency is the homeowner, its policies are designed to shore up house prices, and the economic recovery to date is not based on real economic reform but on low taxes (unsustainably low given our debt) and a house price boom with the attending rise in consumption. The Labour party's constituency is the public sector: its policies may be more competent and responsible, but it is equally incapable of economic reform. Both parties have second rate leaders.

Institutions – the police, judiciary, local government and so on – need to be coordinated: this can happen either via political leadership, or by coordination through the informal networks we call the establishment. Unfortunately, we have a vacuum of political leadership, and the traditional establishment has collapsed. There are plenty of people in power, and they certainly know each other, but they have no shared values or mutual trust on which to act in concert, and they are equally untrusted by the man in the street. When institutions are not coordinated, they continue to function, but begin to work in a way that serves their own interests rather than that of the whole. This will increasingly happen here.

On the “high politics” side, the UK's decision to remain outside the Euro, while economically prudent, has cemented the Franco-German axis. I do not know whether the Eurozone will survive the next year in its current form. If it doesn't, then the UK is on the outside of a failing continent, which, like Italy in the 16th century, will be pulled apart by the surrounding larger powers (think the Cold War, but more chaotic). If it does, then the UK is on the outside of a strong regional player which will understandably make the rules to favour French and German capital, not UK financial capital. Neither is appealing, though the second is preferable.

I see I've ended up writing about politics not economics, but as politics determines economics, that's fine. Clearly this is not an optimistic view. I wish I could suggest policy solutions, but in political economy, notoriously, there is no actor to appeal to outside the system. The role of social science is sometimes just to help people understand and cope with ineluctable realities.