Robert Sugden’s The Community of Advantage: A Behavioural Economist’s Defence of the Market
There are few books critiquing behavioural economics that I find compelling. David Levine’s Is Behavioral Economics Doomed? attacks too many straw men. Gilles Saint-Paul’s The Tyranny of Utility: Behavioral Science and the Rise of Paternalism is more an attack of the normative foundations of economics than of behavioural science. And in most of Gerd Gigerenzer’s books, while making a strong case that many of the so-called “biases” are better described as good decision-making under uncertainty, Gigerenzer often extends his defence of human decision making too far.
In The Community of Advantage: A Behavioural Economist’s Defence of the Market, Robert Sugden finds a nice balance in his critique. Sugden starts by taking the evidence of behavioural anomalies seriously, reflecting his four decades working in the field. His critique focuses on how the behavioural research has been interpreted and used as part of the “nudge” movement to develop recommendations for the “planner”, “benevolent autocrat” or “choice architect”.
Sugden’s critique has two main thrusts. The first relates to how behavioural economists have interpreted the experimental evidence that our decisions don’t conform with rational choice theory. In the preface, Sugden writes:
I have to say that I have been surprised by the readiness of behavioural economists to interpret contraventions of rational choice theory as evidence of decision-making error. In the pioneering era of the 1980s and 1990s, this was exactly the interpretation of anomalies that mainstream economists typically favoured, and that we behavioural economists disputed. As some of us used to say, it is as if decision-makers are held to be at fault for failing to behave as the received theory predicts, rather than that theory being faulted for failing to make correct predictions.In particular, Sugden sees behavioural economists as having adopted an approach whereby they see people as having inner-preferences that conform with the rational choice model (“latent preferences”), contained within a “psychological shell”. This shell distorts our decisions through lack of attention, limited cognitive abilities and incomplete self control. As Sugden points out, this approach has almost no relationship with actual psychological processes, and it is questionable whether these latent preferences exist.
The second thrust of Sugden’s critique relates to how the behavioural findings have triggered a public policy response that is largely paternalistic. In the preface, he continues:
I have been less surprised, but still disappointed, by the willingness of behavioural economists to embrace paternalism. And I have felt increasingly uneasy that, in public discourse, ideas from behavioural welfare economics are appealing to a sensibility that is hostile to principles of economic freedom—principles that, for two and a half centuries, have been central to the liberal tradition of economics.Here Sugden undertakes the rather large task of seeking to displace the dominant normative basis of economics – utilitarianism – with “contractarianism”.
I’ll now cover each of these two arguments in the depth they deserve.
The concept of latent preferences
Decades of behavioural research have presented a challenge to neoclassical economics. Many of its underpinning assumptions about human preferences and decision making simply do not hold. So how can we reconcile the two?
Sugden makes the case that behavioural economists typically approach this problem by thinking of humans as rational beings wrapped in a layer of irrationality. (He draws heavily on his work with Gerardo Infante and Guilhem Lecouteux in Preference purification and the inner rational agent: A critique of the conventional wisdom of behavioural welfare economics (working paper pdf) in making this case.) Sugden pulls apart a number of the seminal papers on nudging, including Thaler and Sunstein’s Libertarian Paternalism (pdf) (the precursor to Nudge) and Colin Camerer, Samuel Issacharoff, George Loewenstein, Ted O’Donaghue, and Matthew Rabin’s Regulation for Conservatives (pdf), in arguing that there is this common approach. For each of them, the underlying “latent preferences” are the benchmark that against which utility is measured, with decisions that do not meet this criteria attributed to error.
Given this, the role of the planner (or “choice architect” as Thaler and Sunstein rebranded the planner in Nudge) is to try to reconstruct a person’s latent preferences. These latent preferences would have been revealed if they had not been affected by limitations of attention, information, cognitive ability or self-control. Sugden calls this reconstruction of latent preferences “preference purification”.
One of Sugden’s central points concerns whether preference purification is possible. For instance, it is only possible if the latent preferences are context independent.
To illustrate the problem of context independence, Sugden asks us to consider Thaler and Sunstein’s famous cafeteria story. Imagine that the relevant prominence or ordering of food in a cafeteria affects people’s choices (and experimental evidence suggests that it does). The cafeteria director could place the fruit more prominently, with the cakes at the back, increasing purchases of fruit and “nudging” the customers to the healthy option.
Suppose the cake is at the front of the display. When the ordinary human “Joe” goes to the cafe, he selects the cake. If the fruit had been at the front, he would have selected the fruit. Has Joe made an error in his choice? We need to ask what his latent preference is. But suppose Joe is indifferent between cake and fruit. He is not misled by labelling or any false beliefs about the products or their effects on their health. He simply feels a desire to eat whatever is at the front of the display. What is the nature of the error?
To help answer this, imagine that SuperReasoner also goes to the cafe. SuperReasoner is just like Joe except that he “has the intelligence of Einstein, the memory of Deep Blue, and the self-control of Gandhi”. (Sugden borrows this combination of traits from Nudge). What happens when SuperReasoner encounters cake and fruit that vary in prominence? Since he is just like Joe, he is indifferent between the two. He also has the same feelings as Joe, so feels a desire to eat whatever is at the front. This is not a failing of intelligence, memory or self-control. There is no error. Rather, the latent preference itself is context dependent. But if latent preferences themselves are context dependent, how do you ever determine what a latent preference is? What is the right context?
When I first read this example, I was unclear how important it was. It was clear that Sugden had found a weakness in the latent preferences approach, but was this something practically important?
I think the answer to that question is yes, and it comes down to the disconnect between the latent preferences approach and the actual decision making processes of humans. Context independent latent preferences in many cases simply do not exist. They only come into existence in certain contexts. And whatever the psychological approach actually is, latent preferences in an inner shell isn’t it.
Even if there were an inner rational agent, advocates of the preference purification approach don’t attempt to understand or explain the decision making process of this inner agent. There is simply an assumption that there is some mode of latent reasoning that satisfies the economists’ principles of rationality, free from the imperfections created by the external psychological shell. (This is also a problem with rational choice theory. As Sugden writes “rational choice is not self-explanatory: if there are circumstances in which human beings behave in accordance with the theory of rational choice, that behaviour still requires a psychological explanation.”)
(As an aside that I won’t go further into today, Sugden and Sunstein continue this debate in a series of papers that are worth reading. See Sugden’s Do people really want to be nudged towards healthy lifestyles?, Sunstein’s response (pdf) and Sugdens rejoinder. Sugden’s rejoinder has another great example of the problems created by context dependent latent preferences that I’ll discuss in another post.)
Sugden does see that one possible defence of the latent preference approach is to define latent preferences as the preferences that this same person will endorse in independently definable circumstances. People will acknowledge these latent preferences even when a lack of self control (akrasia) leads them to act against their better judgment....MUCH MORE
Sunstein and Thaler draw on this interpretation in Nudge in their New Year’s resolution test. How many people vow to drink or smoke more when making their resolutions?
As Sugden points out, this is a context dependent preference. People are using the cue of the New Year to make their resolution. In the same way, if they decide later to have an extra glass of wine in a restaurant, they are responding to that particular context.
The issue then becomes which of these are the true preference. I presume Sunstein and Thaler would take the New Year’s resolution. Sugden is less sure....
Possibly also of interest:
Behavioral Finance at The World's First Stock Exchange
Nobel Laureate Richard H. Thaler on the End of Behavioral Finance
Investing: "Have the Behaviorists Gone Too Far?"
Nudge This: "The Internet of Things Will Be a Giant Persuasion Machine"
Nudge This: "Yes, You’re Irrational, and Yes, That’s OK"
Nudge This: "The Algorithmic Self"
Behavior: We Are More Rational Than Those who Try To 'Nudge' Us
Cass Sunstein and the The Storrs Lectures at Yale: Behavioral Economics and Paternalism
