Why Behavioral Economics Needs Behavioral Biology: Avoiding Arms Races

Yves here. As this post explains, Darwin’s ideas were much less….Darwinian…than they’ve been made out to be. Laypeople and behavioral economists often glorify competition when Darwin’s ideas were more nuanced.

Even though I imagine most will agree with the main point about arms races, I suspect some will dispute the examples. Does buying a more expensive suit really improve one’s chances in an interview, beyond meeting a certain minimum standard of attire? I’m also not sure the $100 ticket versus free ticket is a great example of sunk cost fallacy. Someone who paid $100 for a ticket is presumably a serious fan and is very much looking forward to the contest. Someone who got a free ticket is less likely to be devoted and therefore unlikely  to enjoy going as much.

By Robert H. Frank, the Henrietta Johnson Louis Professor of Management and Professor of Economics at Cornell’s Johnson Graduate School of Management and a Distinguished Senior Fellow at Demos. Twitter: @econnaturalis. Originally published at This View of Life

Following my first sabbatical—a two-year stint as a federal bureaucrat in Washington, DC—I resumed my teaching duties in Cornell’s department of economics in the fall of 1980. Shortly thereafter, I met Richard Thaler, who had started teaching economics in the university’s business school while I‘d been away. Over the next several years, he and I spent long hours in conversation about how our own observations of people’s behavior were often strikingly at odds with the predictions of standard economic theory.

Thaler had spent his own recent first sabbatical working with the Israeli psychologists Daniel Kahneman and Amos Tversky, both renowned for their pioneering work on systematic cognitive errors. Thaler’s 1980 article, “Toward a Positive Theory of Consumer Choice,”1 which drew on that work, is now widely viewed as the paper that launched behavioral economics, a vibrant new field that has focused largely on the intersection of cognitive psychology and economics. In October of 2017, Thaler was awarded the Nobel Prize in economics in recognition of that work.

In 1983, I taught the first undergraduate course ever offered in behavioral economics. Because few students had ever heard the term, my first challenge was to come up with a course title that might lure some to enroll.  In the end, I decided to call it “Departures from Rational Choice” (a decision I later regretted, because it triggered fruitless debates over the meaning of rationality). Naturally, there was no standard syllabus then.  After much deliberation, I decided to cover material under two broad headings: “Departures from Rational Choice with Regret,” and “Departures from Rational Choice without Regret.”

Under the first heading, I listed studies that document the many systematic cognitive errors to which most of us are prone.  For example, although standard rational choice models say that people will ignore sunk costs (costs that are beyond recovery at the moment of decision), such costs often influence choices in conspicuous ways. In one of Thaler’s celebrated examples, you’re about to depart for a sporting event at an arena 50 miles away when an unexpectedly heavy snowstorm begins.  If your ticket is nonrefundable, your decision of whether to stay home should not be influenced by the amount you paid for it. Yet a fan who paid $100 for his ticket is significantly more likely to make the dangerous drive than an equally avid fan who happened to receive his ticket for free.  The first fan is probably guilty of a cognitive error.  People typically seem to regret making such errors once they become aware of them.

Under my “…Without Regret” heading, I listed studies that describe departures from the predictions of standard rational choice models that people do not seem to regret. Consider an MBA student’s decision of how much to spend on an interview suit. The standard assumption in these models is that the primary determinants of the satisfaction provided by any good are its absolute attributes, but that’s clearly not true of the utility provided by an interview suit. If you’re one of several similarly qualified applicants who all want the same investment banking job, it’s strongly in your interest to look good when you show up for your interview. But looking good is an inherently relative concept.  It means looking better than other candidates. If they show up wearing $500 suits, you’ll be more likely to make a favorable first impression, and more likely to get a callback, if you show up in a $3,000 suit than if you show up in one costing only $300. Spending more is rational from the individual job seeker’s perspective, but irrational from the perspective of job seekers as a group.

Behavioral economics as it developed over the next decades did not follow the roadmap outlined in my syllabus. Instead, it has focused almost exclusively on behavior under my first heading, departures with regret. This work on cognitive errors has had an enormous impact on policy makers. Governments around the globe have been inspired by it to set up behavioral science advisory groups, popularly known as nudge units, to help citizens make better decisions. A UK study found that implementation of the British group’s recommendations had produced savings that exceeded the group’s costs by a factor of 20.2

Work that falls under my departures-without-regret heading has been far less extensive—so much so that an instructor putting together a syllabus for a behavioral economics course today might find the presence of that heading on my early-1980s syllabus somewhat puzzling.

I continue to believe, however, that economic losses under the without-regret heading are larger by several orders of magnitude than those under the with-regret heading. Losses from without-regret departures are also substantially more stubborn—because, unlike losses resulting from cognitive errors, they cannot be remedied by unilateral individual action. Once someone learns that it is a mistake to take sunk costs into account, for example, it becomes possible to ignore them unilaterally. Collaboration with others isn’t required. But collective-action problems are a different matter. It is one thing for job candidates to recognize that all would be better off if everyone spent less on interview suits. But absent an enforceable agreement for all to cut back in tandem, each candidate’s best bet is to continue spending.

As behavioral economics continues to evolve, it would profit from adopting an even broader interdisciplinary perspective, drawing on the insights not just of economics and psychology, but also those of evolutionary biology. Traditional models of rational choice typically ignore what I view as Charles Darwin’s central insight—that life is graded on the curve. It’s not how strong, fast, or clever we are that matters, but rather how those traits compare with those of rivals. When context influences our ability to achieve important goals, as in the interview suit example, all bets regarding the efficacy of Adam Smith’s invisible hand are off.  Notwithstanding the uncritically enthusiastic pronouncements of many of Smith’s modern disciples, unbridled market forces often fail to channel the behavior of self-interested individuals for the common good. On the contrary, as Darwin saw clearly, individual incentives often lead to wasteful arms races.

The losses from these arms races are often epic in scale. One of the most robust findings from the large and contentious literature on the determinants of human well-being is that beyond a certain point—one that has long since been passed in the developed world—across-the-board increases in many forms of private consumption produce no measurable gains in health or life satisfaction.3 If all mansions were to double in size, for example, those living in them would be neither happier nor healthier than before. Existing research thus does not permit us to conclude with confidence that Americans were meaningfully better off in 2018 than in 2012, even though the inflation-adjusted total value of the nation’s goods and services was more than $2 trillion higher in 2018.

Now imagine that someone had possessed a magic wand that could have rearranged our 2012 spending patterns—say, by making the largest houses somewhat smaller, cutting expenditures on automobiles and interview suits, and reducing outlays on wedding receptions, coming-of-age parties, and the like. The resulting savings could have been spent to shorten the workweek by a few hours and provide an additional two weeks of vacation time for everyone. And more could have been spent to repair our decaying infrastructure.

Existing evidence leaves little doubt that expenditure shifts of this sort would have caused clear gains in well-being for 2012 Americans, gains that would enable us to say that Americans living in this rearranged version of 2012 would have been happier and healthier than actual Americans in 2018, even though those in the first group were $2 trillion poorer. Unless we are willing to deny the validity of that evidence, the clear implication is that our current spending patterns are wasting at least $2 trillion annually in the United States alone, a sum that almost surely dwarfs the losses caused by cognitive errors.

The things we buy are of course not the only choices that are influenced by others. As psychologists have long said, “It’s the situation, not the person.” When we see someone behave in a particular way, our impulse is to ask what sort of person would do such a thing. Psychologists say that’s the wrong way to think about it. The behavior we observe is more often driven by the social forces surrounding the actor than by traits of character and personality. Sometimes those forces influence us for ill, as when people who smoke lead their friends to take up the habit. But social influence can also be positive, as when time spent with friends who eat prudently and exercise regularly makes people more likely to adopt healthful lifestyles.

All this is uncontroversial. Also uncontroversial is that the causal arrows run in both directions—that the social environment is itself a consequence, in the aggregate, of our own choices. The smoking rate, for example, is just the number of us who smoke divided by our total number. But because the effect of any individual choice on the social environment is minuscule, people typically ignore that second causal pathway. Few express concern, for example, that their decision to smoke might make others more likely to do so.

Are there simple policy measures that would encourage us to consider how our choices affect social environments? Cigarette taxation provides an informative case study. Because nicotine is one of the most highly addictive substances, even large increases in the price of tobacco products typically produce only small reductions in consumption for those already addicted. And the initial declines in smoking rates were indeed modest in the 1980s when American regulators began imposing significant taxes on cigarettes and restrictions on where people could smoke. Yet a small proportion of smokers did quit soon after the taxes began, and higher prices also induced a modest number of others to refrain from starting. And because smoking is highly contagious, those initial responses launched a powerful dynamic. They induced still others to quit or refrain from starting, and in every succeeding year, rates continued to fall. The cumulative effect of these responses was dramatic: The adult smoking rate in the US is now less than one-third of what it was in the mid-1960s.

Yet regulators did not invoke behavioral contagion as a rationale for cigarette taxation. Rather, they defended their restrictive measures by citing recent studies showing that exposure to second-hand smoke increased the incidence of serious illnesses among hapless bystanders. But the harm from such exposure, although real, is minuscule compared to the harm from actually being a smoker. By far the greater harm caused when someone becomes a smoker is the injury suffered by others thereby influenced to take up the habit. It’s a huge effect. One study estimated, for example, that when the proportion of smokers among a teen’s friends rose from 20 to 30 percent, she became 25 percent more likely to become or remain a smoker.

I use the term “behavioral externalities” to describe choices that affect social environments in these ways. Because social environments influence us so profoundly, both for good and ill, we have a powerful and legitimate interest in them. We would prefer to live in ones that bring out the best in us and to avoid those that harm our interests. Yet behavioral externalities have received virtually no serious attention from policy analysts, and it’s here that lie many of the most exciting opportunities for young researchers. Once you’ve been alerted to their existence, it quickly becomes apparent that behavioral externalities are ubiquitous.

Careful empirical studies have documented the importance of behavioral contagion in such diverse domains as, among many others, excessive drinking, sexual predation, cheating, bullying, obesity, greenhouse gas emissions, and compliance with public health directives. Research has tended to focus on negative peer influences, but there is also compelling evidence of positive influences. The adoption of rooftop solar panels, hybrid cars, and plant-based diets, for example, have all been shown to be highly contagious.4

By its focus on systematic cognitive errors, behavioral economics has greatly increased our understanding of why people’s choices often fail to match those predicted by traditional rational choice models. But our failure to take full advantage of existing opportunities owes less to such errors than to our embeddedness in complex social structures. As Darwin understood clearly, our fate depends not only on our own decisions and capabilities but also on those of rivals and partners. And that, in a nutshell, is the case for a broader and more inclusive behavioral economics, one that incorporates the rich insights of behavioral biology.

References:

[1] Richard H. Thaler, “Toward A Positive Theory of Consumer Choice,” Journal of Economic Behavior and Organization, 1 (1), March 1980: 39-60.

[2] The Economist, “Policy Makers Around the World are Embracing Behavioral Science,” May 18, 2017.

[3] For an extensive summary of that literature, see chapters 5 and 6 of Robert H. Frank, Luxury Fever, NY: The Free Press, 1999.

[4] For a review of the relevant studies, see Robert H. Frank, Under the Influence, Princeton: Princeton University Press, 2020.

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15 comments

  1. fresno dan

    I actually was offered a free ticket to a Baltimore Colts (way, way back). It was snowing and would have been 50 miles more or less from Washington DC. It was late season, they were way out of it, and no way I was sitting in the snow. I guess if they were in it and it was a pleasant fall day I would have went, but than I doubt I would have been offered a ticket. And the same thing happened with the Washington football team, except it was just really cold. And truth be told even back than I wasn’t much of a sports fan. And unlike baseball, a football game is much, much better viewed by TV.
    Now, I do order unfamiliar food at restaurants, and if I don’t like it I won’t eat it, AND I insist on paying for it (this results in who is more stubborn – me or the owner who won’t charge. I just incorporate the price into the tip). I like to try new things, and I don’t expect the business to subsidize my experiments in cuisine.

    Reply
  2. Carolinian

    Once you’ve been alerted to their existence, it quickly becomes apparent that behavioral externalities are ubiquitous.

    Or, to put it another way, once you’ve dropped a highly artificial economics frame for looking at the world one will realize the common sense position many learn through experience–to wit, people much or most of the time are not “rational” but governed by forces both instinctive and learned at an early age. It feels good to wear that expensive suit and look better than the others and therefore no need to overthink.

    Of course there’s one branch of the business world that has long understood this and that is advertising. It’s their Skinner Box and we just live in it with the “rewards” being not pigeon feed but irrational human motivators such sex, fear, competition. If some of us are allergic to advertising this could be the reason.

    Bottom line IMO, perhaps economics should be a branch of behavioral psychology–political science, definitely.

    Reply
  3. Tom Pfotzer

    This is a terrific article, Yves. Thanks very much for posting it.

    When I was a boy, my father took me for long walks, which were the pretext for long lectures. The theme of one such was “Whatever you have, has you”. My Dad’s main target was consumptive excess, but…over the years, I came to appreciate the maxim in a different context.

    Most of us don’t conduct regular referendums on our relationships. We don’t take out the clipboard, put up a three-column table (headings: Relationship, Plusses, Minuses) and fill it in, and then act according to the dictates of the data we just laid out.

    Note that in the above table, “relationship” can be with a person or a group. The “group” could be church, co-workers, community, etc.

    We’re not typically “allowed” or expected to assess the cultural context we operate within. Who dares to suggest that they might be wise enough to conduct a referendum on a culture? That’s pretty uppity. And groups are good at punishing/repressing any sort of introspection, right?

    These relationships “have” you just as much as you “have” them, to apply my Dad’s maxim. Those relationships exert a very considerable influence, and it’s just as often invisible to us, as we’re immersed in it. I’m not sure fish are that aware of the water they’re floating in, any more than we’re aware of the air we’re breathing. Culture is just on short step away from “air”.

    In my lifetime, I actually did do the clip-board thing. I’m sorry to report that, as I understand that it makes me appear somewhat ruthless. Ruthless or not, it was a rather painful process for all involved. You can well imagine.

    As the pain gradually subsided, the process resulted in a curious phenomenon. My velocity of emotional and intellectual growth actually increased a lot, as I wasn’t expending nearly so much effort keeping up appearances and fence-mending the inevitable issues which occur when one’s own trajectory diverges from the cultural context.

    That’s a lot of relationship-overhead that I no longer incur.

    We’re all aware that the culture we’re immersed in “has issues”. What if “fixing yourself” gets you cross-wise with the dominant culture? Some of you surely have that to contend with, given your proclivity to think for yourselves.

    So, what to do? Someday I’d like to read a book about running the “discard, get a new deal” process, so that next time I do this (in my next life, of course) I be able to do it more adroitly.

    For here and now, I say that solving the “arms race” problem may ultimately depend more on one’s ability to recruit (find) or evolve a new culture than it depends upon coping with other players who are happy with the game as it is.

    Reply
    1. jeremyg

      Myself and another used to have Relationship Meetings. We agreed the agenda the day before and sat comfortably. One chaired, the other did the minutes, in rotation. “Behavioural Externalities” would have been a useful category. Matters Arising was always the dog.

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    2. Equitable > Equal

      My father put it in a more humane way, without the need for a clipboard – ‘As you get older, you realise that it’s not worth spending time on people that you don’t feel good around’. Heuristics of course, but I think you’ll arrive at the same outcome in almost all cases.

      Reply
  4. David

    I suspect that in reality only economists (and even then a certain type of economist) ever believed that rational actor models were of any use anyway. When I studied economics aeons ago, it was explained to us that rational actor models were necessary as a simplifying assumption to enable any models to be constructed, but shouldn’t be confused with reality. At some point in the last few generations, that caveat seems to have been lost. It’s noticeable, of course, that all of the economic actors who actually had to sell things to people used models of completely irrational consumer behaviour: can anyone even begin to describe describe how people rationally choose perfumes, for example? In many ways, behavioural economics is not a new subject, but just the slow realisation by economists that the theoretical map is not the territory.

    But even dissident economists can’t entirely break the habit of trying to quantify everything. What about the suit example? Well, aside from the fact that an organisation that recruits on the basis of how expensive the candidates suits are (or appear to be) isn’t an organisation you’d want to work for, it’s hard to see why a rational employer would care about such things. If I were sitting on the other side of the table, I’d probably expect a minimum level of smartness, because that would imply both common courtesy and a degree of preparation and self-awareness, and beyond that, a shirt and tie that matched the suit. But that’s strictly entry-level stuff, and I’d hate to be in an organisation that made recruitment decisions based on such superficial judgements.

    Reply
    1. Thuto

      Re: expensive suits.

      I once spoke to a private banker and wealth manager about this and was told that as much as the bank he worked for wished they could make hiring decisions purely on smarts and aptitude, it’s the biases of the clients which herded them into this corner where admittedly shallow considerations such as expensive suits played into who was eventually hired. An expensive suit apparently put the clients at ease with who was managing their money, so the bank had no choice but to cater to this bias.

      He did add that if you were a strong candidate that happened to be style-challenged, an image consultant and a wardrobe makeover budget would be available to you.

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    2. Terry Flyn

      The problem that us economists who mixed with true mathematical psychologists realised was not rationality per se but the use of DETERMINISTIC models. Those lead to conclusions like transitivity: if A>B and B>C then A must >C right?

      Wrong. In a probabilistic world (assumed by math psych since the 1950s – successfully in so much prediction – McFadden & the BART for instance) humans can both often go for “what appears best” but often violate this. The math was proved by Yatchew & Grillisches in mid 1980s. Logit/probit models (used in epidemiology to model cure/fail, live/die, in economics, voting (Democrat/Republican etc) you MUST assume a LINK function (logit/probit usually) to turn a (0/1) outcome into some latent (unobserved) continuous value (say “propensity to be left wing”). Trouble is the likelihood function can’t separate means from variances – they’re perfectly confounded. So Stata/SPSS/whatever is solving for x (the mean) from xy=8 where y is the variance. See the problem?

      Stats programs normalise y=1 FOR ALL RESPONDENTS. Suppose some are “less inconsistent” (smaller y). Then x might be 16. You can’t aggregate their data until you’ve have standardised y across everyone. This is why so many epidemiology, economics and especially voting studies are wrong.

      “Fixes” like nudge are thought up. Anecdotally I was told what the top math psych people thought of the work of two top researchers…. They used to joke at conferences that the wrong one got the credit due to death..

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    3. ChrisPacific

      Yes, we often end up with a kind of circular reasoning whereby the efficient functioning of the market is the best way to achieve success, and success is measured in terms of market performance (GDP growth, for example). As the three paragraphs discussing the cost of arms races eloquently describe, much of this is outright contradicted by studies on what makes people happy and improves their wellbeing. But because economists implicitly assume (via their choice of success metrics) what they are trying to prove, namely that efficient functioning of the market is the optimal path to wellbeing, they cannot or will not see this.

      Reply
  5. Jokerstein

    Yves – Frank explicitly states that the hypothetical fan with the free ticket is equally avid, thus leveling the playing field in that respect:

    Yet a fan who paid $100 for his ticket is significantly more likely to make the dangerous drive than an equally avid fan who happened to receive his ticket for free.

    Reply
  6. fresno dan

    Just to throw it out there, who chooses their religion?
    Isn’t it really 99% irrationality and 1% rational?
    If I had been born in Iran, India, or China, I would have profoundly different outlooks on a whole slew of things despite my delusion that thought and logic determines my values and beliefs.
    https://awealthofcommonsense.com/2021/02/the-defining-trait-of-all-bubbles-the-willful-suspension-of-disbelief/
    Why is a Bitcoin valuable?
    And really, was Farrah Faucet all that?

    Reply
  7. Susan the other

    Socially organized by our illusions and delusions. That’s probably not good. All you need to make nonsense seem rational is a tiny bit of truth thrown in. In fact, wishful truth. That’s the essence of propaganda and we are all suckers for it. The question is, Why? Fight or flight? At this point in our evolution, when we are all looking at ourselves and wondering why we can’t make things work better, it might be good to not focus so much on behavioral externalities (those loose ends that advertisers latch on to by telling us to “be free”) but actual E.O. Wilson-type social biology. If our big behavioral template gave us clearer direction for discretionary behavior (externalities) it would probably eliminate our worst vulnerabilities to being manipulated by ads and other people’s externalities. I don’t think our society has this foundation. We are all just pushed and pulled by the wind.

    Reply
    1. Tom Pfotzer

      “Socially organized by our illusions and delusions.”

      And our genetics. My family has farm animals. They act – in many respects – like humans. Territorial, tribal (peck new people entering the group), status-seeking/defending, group-think, stealing, jealousy…a very significant component of our behaviors. Chix left our part of the Tree of Life a very long time ago – hundreds of millions of years back. Yet, there you see the behaviors. Horses, goats, dogs, even cats – all show the same set of behaviors as the chix and us. Just with less pretense and posturing. That’s what makes it so easy to spot.

      These issues we’re trying to overcome really run deep.

      Reply
      1. Rando

        As equally deep as our instinct for bonding and collaboration. Key may lie in ‘perceived threat/competition for resources’. Media and politicians keep us at constant rate of biochemical stress. Of course exploitation of workers and poverty = actual stress. But many in ‘developed worlds’ run on manufactured stress with brain chemistry unnecessarily activated into emergency animal defensiveness. If only our biology can stop being hacked by opportunists we would have a mighty fine and ancient body + instinct working toward collective good. Fine tuning needed though.

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  8. skippy

    Ugh … again …

    I’m firmly in the camp that sees ***behavioral*** economics[????] [Milgrams white coat] as a post marketing study that gets blinkered at onset with both its methodology and its base line.

    So what are we exactly observing and what methodology is being used to evaluate the veracity of data input – econometrics[????] based on wobbly notions about how humans respond in some highly top down ideological construct [neoliberalism] that seeks malleability over critical thinking or life experiences in the name of markets …. sigh those like Lars Syll take all this quasi, whatever it its, behind the shed and picks it apart from the sophist musings that got us all in this pickle and yet were treated to more homo economicus narrative frameworks ….

    Yet in quite corners these same people whisper about the next generation and the advances in knowledge and how the narrative will stick – problem solved … because markets …

    Reply

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