Behavioral economics invades London, at least one economist resists

September 19, 2010

Here is good news to all those who oppose a lemmings approach to markets. A recent article by economist Paul Omerod in the Financial Times makes two interesting points about behavioral economics.

The first point is that the craze has crossed the Atlantic and now rules London.

The coalition government has talked up the benefits of behavioural economics. Early on it promised to shun “the bureaucratic levers of the past” and help “people to make better choices”. More recently a Downing Street “nudge unit” has been set up to examine how better information can change behaviour, and the economist Richard Thaler (who co-wrote the book Nudge) flew in last week to launch it.

The second and most important one is that behavioral economics offers a limited account of economic problems. It needs, according to Omerod, to be augmented by an understanding of social networks:

The government needs to show far more imagination. In particular, it must recognise how social networks can unlock the power of behavioural policy. Both mainstream and behavioural economics mistakenly assume that we act as autonomous individuals. But we do not: we are hugely influenced by the actions of others. The implications of this insight can be dramatic, with small initial changes delivering large final outcomes.

With David Stark, I have written at length on the limitations of a behavioral approach to markets. But for now, I’d like to take my hat off to an economist who demonstrates judgment. That’s is, who is humble enough to see the limits of his discipline — while wise enough to understand that the current alternative, behavioral economics, is just as limited.

My comeback to Omeron is, of course, that sociologists are beyond the point of explaining everything with recourse to social networks. As proponents of the social studies of finance know well, providing markets devices that make possible better forms of rough calculation (a socio-technical approach) is bound to be as beneficial as understanding how decision-making is embedded rather than purely individual.

3 Responses to “Behavioral economics invades London, at least one economist resists”

  1. yuvalmillo Says:

    Thanks for this, Daniel. I missed the piece at the FT (subscription is worthless when you have no time to read the issues…), but it is another signal in an increasingly long chain that shows that mainstream financial economics is finding itself (or parts of it do) in a rare moment of reflection. The tried and tested paradigms of EMH and the underpinning assumptions ‘failed to deliver’ during the crisis and now there is some search for new ways of explaining markets. Behavioural finance has been around for decades and contributed a lot, in my opinion, to enriching our understanding of markets. That said, understanding price discovery as a networked process is still at its infancy in economics (one exception is Sanjeev Goyal in Oxford) and it would be great to see these concepts developed. SSF, in addition, with its triad of devices, historical outlook and multiplicity of discourses can (and I believe will) be part of these efforts to develop a new paradigm for markets. Finally, we cannot talk about new and promising directions without mentioning Harrison Hong’s Social Interaction and Stock Market Participation, which can signal a breakthrough in financial economics.

  2. yuvalmillo Says:

    Is it Omerod or Omeron?

  3. danielbeunza Says:

    I disagree. It good to be intellectually generous. But granting intellectual merit to the paradigm that is most clearly counter to one’s own (sociology of finance) simply confuses readers and dis-spirits fellow sociologists.

    Behavioral finance is way over-rated. Far from illuminating actual market processes, behavioral economics explains what happens in the lab with undergraduates and then claims that something similar hopefully is taking place out there in the actual markets.

    What’s worse, the discipline is performative in that, by advocating for limited choice (we the academics know what’s best for the people) they are removing the incentive for market actors to engage in controversies and from devising new tools to help others make decisions.

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