Behavior-based economics vs. the free market

Behavior-based economics vs. the free market
At the end of the 1960s, people were no longer interested in the idea of a free market society.
The “century of liberalism,” which ran from 1815 to 1914, came to an end with World War I, and the Great Depression forced governments of all political stripes to get involved in the economy and stop supporting free trade. The Second World War then caused a lot of damage and death all over the world. However, because the Soviets worked so hard to win, a lot of people came to realize that when ideologies clash, socialism can win out over other ways of organizing society.

Most voters in the few stable democratic societies with limited and representative governments, private property, and market-based economies had stopped believing in classical liberalism.

But at that time, a new liberalism was taking shape thanks to the work of a few original thinkers. Most people didn’t notice. Some of these thinkers, including many economists, would get together at the Mont Pelerin Society’s events and talk about their ideas.

Their work led to a better understanding of how spontaneous order happens. This understanding came from new ideas in economics, such as more nuanced ideas about how subjective economic value is, how little we know about the economy, and how economic activity is always changing. The Use of Knowledge in Society, written by Friedrich Hayek in 1945, is a good example of one of these contributions: The real economic problem isn’t how to divide up known resources to meet known needs. The real problem is how to coordinate the different kinds of knowledge that people have, which can’t be captured by statistics or any other database that could be “scientifically” used.

All those concepts had been lost from mainstream economics, along with lessons about man and society from Adam Smith’s The Theory of Moral Sentiments. The Wealth of Nations seemed to be the only source for classical economics. By the end of the 1800s, “Manchesterism,” a bad name for utilitarianism, had become linked to economics and, by extension, the liberal order. It took about a century for perfectionist ethics to come to be understood as a better justification for non-perfectionist politics1 and as a more rounded moral justification for freedom and responsibility, one proposed by Neo-Aristotelian philosophers inside and outside academia.

Last but not least, the development of new disciplines on the edge of traditional ones, like Law & Economics and Public Choice, gave us new ways to look at how people interact with each other. These new ways made us question the motives and abilities of political agents to “do good.” These changes gave us more reasons to believe that the best way to organize society to help people thrive is to make sure that everyone has the freedom and responsibility to do what they want.

“Critics and outright enemies of the open society haven’t missed the fact that neoliberals have been able to use advances in the social sciences to support social arrangements based on freedom and responsibility.”
Critics and outright enemies of the open society have taken note of how well neoliberals have been able to use advances in the social sciences to support social arrangements based on freedom and responsibility. Soon, there was a response.

Karel Vasak’s Third Generation Theory of Human Rights, published in 1977, was a clear attempt to challenge the idea that only individuals have rights.

2 This theory questioned any way to protect individual rights from being taken away by the group.

In the 1970s, Roberto Mangabeira Unger and others at Harvard came up with Critical Legal Studies. They said that the idea that the legal system exists to dole out justice is a myth. Rather, the legal system is an instrument of class exploitation and, therefore, it is perfectly acceptable to use the legal system as an instrument of political struggle by the left. After all, they say that the right has always done it.

In the field of economics, Behavioral Economics is a new field that goes against the core assumptions of the neoclassical synthesis. The neoclassical synthesis models assume that markets work best when economic agents act rationally and have all the information they need.

In the rest of this essay, I want to talk about how Behavioral Economics adds to our understanding of the liberal order.

To understand what this new field is all about, let’s look at the “Market Approach to Human Behavior” and “Behavioral Economics.” Both of these look at freedom and its limits. The latter suggests that, although humans are not irrational, they often need help to make accurate judgments and better decisions and, in some cases, policies and institutions must be used to provide that help. The first way of thinking says that government shouldn’t get in the way…. So, there is a lot at stake in the argument between these two points of view.

Behavioral economics wants to question the economic basis for individual freedom by arguing that sometimes people need to be limited in their freedom in order to improve welfare.

Were some of the issues brought to the modern economic debate by proponents of Behavioral Economics already present in classical economics as proposed by Adam Smith? The answer is in the affirmative, although some of those concerns were later lost by neoclassical economics. But the writings of Karl Brunner (1916–1989) show that mainstream economics has been trying to think about more realistic assumptions about human motivations and the limits of what economic agents know even before some of the recent research on economic behavior.

Also, if we look at the free market approach and compare it to Behavioral Economics, we can see that there are two camps. On the one hand, some people think that Behavioral Economics is a useful addition to the paradigm of economic rationality because it helps to make it more realistic.

Gary Becker, for example, wrote in 2007:

“Classical libertarianism doesn’t assume that people always make the right choices. Instead, it says that in the vast majority of situations, people make better choices for themselves than the government could. You don’t have to be a classical libertarian—I disagree with them on some things—to see that the literature behind libertarian paternalism doesn’t hurt the case for classical libertarianism. In fact, the case for classical libertarianism may be even stronger when the same things are said about government officials and intellectuals as well as the rest of us. 3
For others, the questions asked by behavioral economists are meant to show that economic agents don’t always act in a logical way.

Those who see Behavioral Economics as an addition to the paradigm of rational choice point to the line of research that simply expands the economic approach to fields of human action other than just economic activity and to the research that tries to explain how some behavior that at first seems irrational may actually be the result of rational choices.

But some of the conclusions that behavioral economists come to are based on claims that haven’t been proven and are meant to discredit the paradigm of rational choice, which, as was already said, is seen as a strong reason for free markets and free enterprise.

For example, behavioral economists talk about overconfidence, loss aversion, and (the lack of) self-control as three important types of behavioral bias. The question is not whether people ever show these biases. The question is whether the presence of these biases is enough to reject the idea of individual responsibility, which is based on the assumption that people act rationally. For example, some actions, like lack of self-control or “short-termism,” may be justified in situations where the time preferences of the specific agents may be skewed, such as soldiers in a war, terminally ill patients, people living in risky environments in general, etc.

But capitalism is criticized for more than just economic reasons based on how people act. Behavioural biases are also used as a basis for moral criticism of markets. In a 2013 piece, for example, Michael Sandel criticizes Dennis Robertson’s 1954 essay on What Does the Economist economize? by saying that it “ignores the possibility that our capacity for love and kindness might not shrink with use but grow with practice.” 4 His comment completely misses the point that Robertson and, before him, Adam Smith made, which is that market exchanges mean we don’t have to be friends with “the butcher, the brewer, and the baker” to get good services from them, so we can spend our limited time with people we care about, like family and friends. Adam Smith says this in The Theory of Moral Sentiments: “Society can exist among different men, like between different merchants, out of a sense of its usefulness, without any love or affection, and even if no one in it owes anyone anything or feels grateful to anyone else, it can still be kept going by a mercenary exchange of good services based on an agreed valuation.”

This (wrong) claim about how people act, which Sandel used to criticize the reasons why people would participate in markets if they had the chance, shows the power of these kinds of arguments and why leftists value them so much.

Both rational and irrational ways of thinking about behavioral biases meet in the debate over “nudging,” which is a design for public policy. This is the idea that the way people are given choices causes their behavior to change in predictable ways without the need for rules. I think it’s silly to think that corporate or government bureaucrats might have the public’s best interests in mind when they decide what “default” options will be available to the public. I also think it’s a silly idea to think that people would believe that.

Think about what Richard Thaler and Cass Sunstein say about saving for retirement in their book 2021 Nudge: The Final Edition. “Some people definitely save too little,” they said. First of all, this is the authors’ general opinion. They haven’t put themselves in the shoes of the people who make these decisions, but they do know that the problem is most common when an employer doesn’t offer a pension plan. But no one talks about why some employers have chosen not to offer pension plans. What did they do? To make sure that every employer who doesn’t offer a pension plan sets up a default so that their workers are automatically enrolled in a pension fund run by the government. This is on top of the money they pay into Social Security. If you asked me, I’d say that their discussion has nothing to do with a “inherent” tendency to not save enough for retirement. Most likely, the employees who didn’t have much money saved had better things to do with their money than put it in savings. For example, these workers may be investing in their children and hoping to get help from them in the future, or they may have some other kind of informal retirement plan. Also, Thaler and Sunstein’s book “Nudge” could make these actions less important (e.g. investing in the education of their children). In the end, it looks like their “solution” has everything to do with giving the government more control over more money.

Next, think about what Thaler and Sunstein say in the same book about organ donation rules and how to make more organs available for transplants without hurting people’s preferences. Their conclusion is that “defaults (positions) have a huge impact on the elicitation of preferences.” In plain English, this means that they can count on most people to agree to whatever people in positions of authority suggest to them, even if they wouldn’t do it on their own. This may be true, but it also assumes that people trust those in charge and believe they have their best interests in mind. Consider that. If an airline, phone company, or other company with a near-monopoly offered you a “deal,” would you assume that they are looking out for your best interests? I’m not sure about such an idea. So, “default” positions don’t help people find “what they really want.” Instead, they’re just more subtle ways of forcing people to do things they don’t want to do.

Lastly, think about what they said about “Saving the Planet.” They don’t like the fact that nudges to get people to save energy or even some regulations, like those that make appliances less efficient or cut the water flow in showers, aren’t enough to get people to really do what they want in terms of conservation. They think this is because of these behavioral biases so much that they had to give up any pretense of “libertarian paternalism” and just make the rules stricter. But that leaves out a lot of things. First, it’s possible that people don’t believe there is such a strong link between greenhouse gases and the temperature. Second, even if there is a link, we are not in a “climate crisis,” and there is no reason to risk our current well-being for things that might not happen for hundreds of years, if they happen at all. Lastly, they completely miss the point that if people are forced to use washing machines that don’t clean and showers that don’t pour enough water to meet their needs, they will find ways to get around those things if they can.

In the end, the contributions of behavioral economics to a better understanding of how the economy works would have to go through a lot of theoretical twists to be used as weapons against the liberal order. One way to limit the damage that could be done by such misuses is to call them what they are: ideological mystifications. Think about Daniel Kahneman’s Thinking, Fast and Slow, which came out in 2012.

“Freedom has a price, which is paid for by people who make bad decisions and by a society that feels like it has to help them.”
First, that famous author made a straw man out of the idea that the economic approach to human behavior assumes “perfect rationality.” Then, he ruled out the benefits of social arrangements based on freedom and responsibility by saying that real people are more complicated than what is assumed in economic models that are only used as guides.

See for more on these subjects.

Sendhil Mullainathan and Richard H. Thaler wrote a book called “Behavioral Economics.” A short dictionary of economics.
Podcast episode Richard Thaler talks about libertarian paternalism. EconTalk.
“The Success of Neoliberalism That No One Knows About,” by Scott Sumner. July 5, 2010, Library of Economics and Liberty
Neoliberalism as a whole can be seen as an intellectual effort to come up with new ideas that could convince “enough people” (as needed to support policies) that freedom and responsibility are the foundations of an open and prosperous society. In this way, a big part of what is now called “Behavioral Economics” could be seen as a reaction to neoliberalism, and it should be treated as such.

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