Methodenstreits between behavioural and neoclassical or keynesian economics
Methodenstreits between behavioural and neoclassical (or keynesian) economics Vladimir Avtonomov National Research University Higher School of Economics Moscow ov NRI IMEMO of the Russian Academy of Sciences Moscow
The tale of two canons • Methodenstreits in the history of economics seem to be focused on the degree of abstraction permissible in the economic science • There is an approach of differentiating between two canons of economic science according to the degree of abstraction (Erik Reinert)
The tale of two canons 2 • The First more abstract canon is deductivist, based on metaphors and models borrowed from natural sciences (such as equilibrium), uses a simple assumption of human motivation (homo oeconomicus). • The Second canon is less abstract, based on everyday experience, plurality of human motivation. It is inseparable from specific local and temporal contexts. Its main objective is to produce a useful economic theory
When does a MS come about? • MS emerge when in one of the canons there is a breakthrough: a new technique of analysis is invented and used ( marginal analysis, game theory/expected utility hypothesis in the first canon, or psychological and sociological methods in the second).
What happens during a MS? • 1/ Both canons tend to exaggerate their differences but this helps to draw general attention of scientific community to important methodological problems. • 2/ The dispute leads to a “victory” of one of the sides • 3/ Both sides take into account the position of their adversaries often using their instruments (progressive stage)
Mini-MS 1/ Simon against maximization • Instrument : case-studies in organisations • Challenged: neoclassical microeconomics (maximisation assumption) • Simon proposed a bounded rationality model (using the psychologial concept of aspiration level introduced by Kurt Lewin) as an alternative to full rationality with maximizing. • He described some algorithms (heuristics) of decision making which could be considered as optimizing decision. But these heristics did not approximate the global optimum.
Mini-MS 1 Stage 1 • Counterarguments: Neoclassical economists argued that taking into account the costs of acquiring information would make behavioural economics excessive. (Stigler, 1961). [Infinite regress] • Bounded rationality didn’t allow prediction of human behaviour, assuming it to be too volatile. [Ronald Heiner rather conclusively proved the opposite (Heiner, 1983)].
Mini-MS 1 Stage 2 • In general Simon’s challenge was not accepted by the mainstream economists. Simon received the Nobel prize in 1978 but in this rare case the Nobel prize seemed to be delivered ahead of time before the acception to the mainstream
Mini-MS 1 Stage 3 • Synthesis Simon’s ideas made their way into economic theory including its influential branches. • New institutional transaction costs economics of OLiver Williamson (already mainstream), • X-efficiency theory of Leibenstein, • evolutionary economics of Nelson and Winter, • 'cognitive economics' using networks and agentbased simulations
Mini MS 1 a between R. Lester and F. Machlup (marginalist controversy) • Instrument: the survey method • Challenged: the realisticness of neoclassical microeconomics • American Economic Review 1945 -1950
Mini MS 1 a Stage 1 • R. Lester conducted a survey of manufacturers which proved that they never used “equating at the margin” while deciding how many workers to hire and how much output to produce. • Fritz Machlup disproved Lester’s thesis about non-validity of neoclassical theory on methodological grounds (as if) later elaborated by M. Friedman
Mini Ms 1 a Stage 2 • Machlup was proclaimed the winner
Mini MS 1 a Stage 3 • Baumol’s and others’ theory of the firm with alternative goals
Mini-MS 2. Around incorporation of von Neuman/Morgenstern behavioural axioms in economics • Instrument: psychological experiments • Challenged: expected utility hypothesis • This Mini-MS evolved around two discoveries : game theory and expected utility theory on the side of the First Canon and psychological experiments on the side of the Second
Mini MS 2. 1. Stage 1 -2 -3 • in 1952 -1954 – the dispute between M. Allais and L. Savage. • Savage did not recognize his defeat but corrected his position (normative/decriptive)
Mini MS 2. 2 Stage 1 • 1970 -ies new psychologists’ reseach from the University of. Michigan: Slovic and Lichtenstein preference rev ersals • Counterarguments: laboratory experiments could not approximate the real economic behaviour. The important experiments by Grether and Plott (1979) who aspired to prove theses surprisingly proved the opposite: anomalies can’t be eliminated by perfection of experimental techniques.
Mini MS 2. 3. Stage 1 • The new real MS was observed in 1985 at the Conference in Chicago University organized by R. Hogarth and M. Reder. (“ The Behavioral Foundations of Economic Theory”, 1986).
Mini MS 2 Stage 3 • On the one hand behavioural economists did their best to become more model-like (prospect theory of Kahneman and Tversky). In fact Tversky and Kahneman inherited Savage’s descriptive/ normative distinction. Normative theory is OK! They gave the descriptive one. • R. Thaler pointed in his works towards empirical correction of neoclassical consumer choice theory (disregarding opportunity costs, taking into account sunk costs etc. ) • The new behavioural economics unlike the old one (Simon) concentrated not on outright refutation but rather on weakening or correcting neoclassical assumptions which made them mainstream-compatible.
Mini MS 2 Stage 3 - Institutional synthesis: • Research programms in behavioral economics supported by Alfred Sloan and Russel Sage Foundations included prominent psychologists and econmists (Baumol, Schelling, Akerlof, Summers, Shleifer), • The new journal of AEA (Journal of Economic Perspectives opened with a series of Thaler’s articles on anomalies (14 articles were published in 1987 -1991). • С 1992 г – Behavioral Economics Roundtables (Akerlof, Blinder, Camerer, Elster, Kahneman, Loewenstein, Tversky, Thaler, Schelling, Schiller 4 Nobel prizes!) training programs for graduates –
Mini MS 2 Stage 3 • On the other hand, using experimental methods new rules were designed that allowed people to behave more rationally. (experimental economics of Vernon Smith). Smith (began in 1959) emphasized time and institutions required for a market to reach an equilibrium. Extending microeconomics through economics of information and technology of transactions. Smith studied not individuals but economic agents
Mini MS 2 Stage 3 • Neoclassical economists included psychological results in their theories (Arrow Risk perception in Psychology and Economics 1982).
MS 3 Katona against Keynesian orthodoxy • Instrument: social surveys • Challenged: Keynesian macroeconomics and macroforecasting • Katona opposed “aggregate causality” of Keynesian macroeconomics and argued that intervening psychological variables should be taken into account when analysing durable goods purchases. These variables are significantly affected by non-economic variables and could be explored by means of surveys used in sociology and social psychology
Mini MS 3 Stage 1 • Counterarguments: Katona’s psychological intervening variables could be “approximated away” by objective economic variables. Then consumer confidence can be modelled without any recourse to psychology. • • Katona’s reply was twofold: first intervening variables are affected also by non economic variables. Secondly: the subjective weights of different variables can be learnt only from respondents themselves.
Mini MS 3 Stage 2 -3 • The dispute over these matters (surveyed by Waerneryd, 1982) was rather long and ended as follows: survey method was maintained by its early practitioners in a rather narrow field eliciting consumer and business sentiment indexes for the purposes of business cycles forecasting. CIRET conferences. • Outside – not used
Mini MS 4 in finance • Instrument: statistical data and neuroeconomics • Challenged: efficient market hypothesis : prices on the financial markerts incorporated all relevant information. There couldn’t be such things as bubbles and one never could beat the market.
Mini Ms 4 Stage 1 • Anomalies in this case were already there before the EMH was formulated. One can just recall numerous instances of financial panics or J. M. Keynes’s chapters about financial markets in the General Theory • Richard Thaler in 1985 introduced ( in the article written with De Bondt) the term Behavioral Finance. Thaler and De Bondt using historical data proved that it was indeed profitable to buy underappreciated stocks • Robert Shiller (1981) who began by proving that since 1871 present value of dividends was highly stable but the stock prices were not
Mini MS 4 Stage 1 -2 • During the above mentioned Chicago conference Merton Miller was especially harsh in trying to suppress Behavioral Finance • Fama who at first argued that the more profitable stocks were simply more risky had to concede (in the article with French, 1992) that non risky stocks proved to be more profitable, though they proposed other measures of risk besides CAPM to save the EMH.
Mini MS 4 Stage 2 • Fama and Shiller were simultaniously awarded the Nobel prize – the draw!
Mini Ms 4 Stage 3 • Fama who didn’t accept behavioral movement used another strategy to explain the evident anomalies. He added to his models of financial markets a new economic actor – general public whose emotional and uninformed reactions could lead to apparently irrational behavior.
Mini MS 5 Thaler and Sunstein against Law and Economics • Challenged: Posner’s Law and Economics. Coase theorem • Endowment effects : loss aversion means that people evaluate gains and losses asymmetrically
Conclusions: some controversial progress • As a result of all this behavioral economists using economic models as reference points and modifying them somewhere ascended to the mainstream. • Behavioural economics spread its influence among new segments of economics: behavioural finance, behavioural game theory, behavioural law and economics, behavioural industrial organization, behavioural development economics and even behavioural macroeconomics. • experimental (psychological) methods were used to supplement and prove neoclassical theory in the long run (V. Smith) • mainstream economists adopted not the methods but some general assumptions of behavioural economics for instance the assumption of limited and asymmetrical information
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