Behavioural Economics is one of the main drivers of modern economics but we have not spoken about how ideas from this field are relevant to current Irish economic conditions. This is not a blog just for specialists so I am going to try to give some jargon-free sentences on what behavioural economics is and why policy-makers should care. This is purely my own view having researched the area since 2001 and having lectured courses in TCD and UCD on the topic and they do not reflect any attempt at capturing the consensus opinion in this field. I feel very strongly of the view that the absence of an understanding of both psychology and of policy evaluation has damaged Irish policy and that a continued cynicism about the capacities of the Irish public sector to deliver innovative policy is leading many to stop trying to think of innovation. Behavioural Economics combined with rigorous policy design is a partial corrective to these tendencies.
Basically, behavioural economics focuses on the application of psychology to economic behaviour. Increasingly, it is focused on why people make decisions in key domains relevant to economic policy. A trend has been the development of the view that policies need to be designed rigorously with respect both to potential evaluation and with respect to actual psychological principles and that such policies should stand or fall on the basis of whether they work. A recent Economist article put this at the heart of the next ten years of economics arguing that the union of behavioural economics and policy evaluation represents the most dynamic tendency in economics. Just because the Economist says it, doesnt make it so, but we should give this work credence in thinking about a potential Irish recovery.
The most developed literature that can be applied in Ireland is the one on pensions. John McHale wrote a great piece a few years ago summarising some of the literature up to then on behavioural economics and pensions and its relevance to the Irish situation. It did not seem to have much of an influence on the debate, which is a shame. In general, financial decision making is the first area that really should be looked at if policy makers want to take behavioural economics seriously. Tax codes, legal codes, social welfare entitlements and so on are need to be gone through not just from the point of view of accounting waste. We need to look in depth at what financial incentives exist for people and how people interpret these financial incentives and whether people are disincentivised by the framing of these processes. Several experiments in the US are starting to show that simple questions of how instruments are framed, the cognitive complexity of application forms, the nature of the default setting can all have dramatic effects on behaviour. As pointed out by Akerlof and Shiller, the interaction of the psychology of financial decisions with the regulatory structure generates a lot of the negative effects seen on financial markets.
Secondly, behavioural economics is also focused on the outcomes of people’s decisions and, in general, is not wedded to the view that consumption is a good measure of people’s well-being. Focusing on well-being directly is increasingly a concern in behavioural economics. In particular, looking directly about how factors such as health, unemployment, aging and so on determine well-being is increasingly a guide to developing policy. The UK have taken seriously the idea that things like home foreclosure and unemployment are not just economic events but are also psychologically distressing and have been provided psychological therapy on a more wide ranging basis than before, based on recommendations from this literature. Several other policy ideas derive from looking closely at well-being and these should not be dismissed lightly and certainly not without some debate.
Thirdly, behavioural economics is increasingly focusing on actual policy experiments in real world contexts. My own opinion is that this is the prime way in which economics can positively impact recovery in Ireland. In particular, well-designed micro-policy experiments in areas such as health, financial decisions, based on sound principles about how people actually behave is the main thing we can take from this new literature. This does not necessarily mean more government intervention (it may mean less). However, it does mean far more active discussion of specific micro-level policies in areas such as education, training, innovation and so on. A focus purely on expenditure to the absence of actual outcomes and process is characterising a lot of the current debate and this is damaging.
Some recent popular works written by leaders in the field that people might be interested in if they want to understand the potential relevance of behavioural economics to current policy are linked below.