By Adrian W. J. Kuah
At the heart of standard neoclassical economic theory stands homo economicus: rational man who acts independently to maximise his self-interest. And it does not require a great stretch of the imagination to describe the prototypical policymaker in more or less the same terms. Can the criticisms that behavioural economics have been levelling at orthodox economics also provide some insights into the public policy enterprise?
For years now, behavioural economics has been laying siege to the citadel of mainstream neoclassical economics, chipping away at its central foundation: that humans are independent, rational self-maximisers. Recent research, however, has shown that far from being the dispassionate calculator that is homo economicus, people engage in herding behaviour, do things out of habit, are motivated by things other than narrow self-interest, and are bad at the computations and forecasts on which they base their decisions.
While research has tended to focus on how people act in economic transactions, such as buying properties and investing in stocks, comparatively little work has been done on how policymakers really make policies. This neglect has been surprising, given that the prototypical policymaker is often viewed (not least by himself) as homo economicus par excellence. The suggestion that he might not be therefore casts the public policy enterprise in a radically new light.
The key insight from behavioural economics for the policy making process is the notion that people have two modes of thinking: a quicker, intuitive and reflexive mode, and a slower, analytical and reflective one. The former, of course, was encapsulated in Malcolm Gladwell’s Blink which has captured the public imagination. Behavioural research argues that the default mode of thinking, which is done with the least effort, is ‘blink’ thinking. To be sure, such snap decisions tend to serve people well when the problem at hand is straightforward, when information is complete, and where goals are well-defined. However, when problems become complex or are poorly-structured, when information is incomplete and ambiguous, and when goals are vague and shifting, paradoxically people rely even more on reflexive decision making even though it is the slower, more analytical mode of thinking that is called for. If policy problems are indeed becoming more complex, in increasingly uncertain environments, then policymakers would do well to recognise the need to overcome their natural pre-disposition to be cognitive misers, and to deliberately slow things down so that more reflective and analytical processes can take over. It may be that the policymaker’s ability to over-ride his intuitive urges will matter as much, if not more, than his intellectual capabilities.
But that is not all.
Going with the Crowd
The standard neoclassical model assumes that people carry out a rigorous and independent analysis of the options available to them before making a decision. The reality is that people often simply copy what other people do. Furthermore, people are particularly influenced by those whom they respect, like or who occupy positions of power and authority. Given the hierarchical nature of most, if not all, government ministries and agencies, the notion that policymakers are able to make independent, rational decisions is simply unrealistic.
Just as investors, both institutional and individual, exhibit ‘herding behaviour’, policy makers to varying degrees end up being hostage to the institutional imperative. Everywhere the symptoms of groupthink are as familiar as they are insidious: an illusion of invulnerability which gives rise to excessive risk-taking, collective rationalisation and self-validation, direct pressure on organisational members who hold dissenting views, and self-censorship.
Biases and Overconfidence
Another crucial insight from behavioural economics is that people often do things out of habit, with minimal or no cognitive effort. Indeed, psychologists have long accepted that how things have been done in the past greatly determines how things will be done in the future, and that significant willpower is required to break established habits and to form new ones. By contrast, neoclassical economics is strangely silent on how the role of biases, routines and habits play out in decision making. Given that policymakers inhabit organisations that run on standard operating procedures, there is a risk that organisational traditions and conservatism can, via a process of culturalisation and social osmosis, constrain and ultimately demoralise creative individuals entering public service.
The observation that investors hang onto their views too long and adjust them slowly and reluctantly in the face of new information can also explain the conservatism that is frequently seen in policy making. The processes of anchoring and slow adjustment – whereby people only change their views when there is undeniable evidence they were wrong, and then only change their views slowly – would explain policy failures not in terms of a deficiency in capabilities, but a reluctance to admit and address mistakes. The ‘sunk cost’ fallacy also partly explains the rarity of policy makers back-tracking on policies: people hold onto their views simply because so much time and effort went into forming them, even though those views turned out to be wrong. Furthermore, behavioural economics predicts that policymakers would tend to under-react in unstable environments with strong signals, and over-react in stable environments with weak signals. Hence, policy makers tend to miss points of inflexion in the socio-political and economic domains.
Finally, behavioural economics suggests that policymakers are prone to over-confidence. The sheer amount of information that goes into formulating a policy position seems to be driven by the logic that, if some information is good, then more clearly is better, and therefore the more confidence policymakers have in the accuracy of their forecasts and policies. There is, however, a crucial difference between confidence and accuracy. Research on how investors pick stocks or gamblers bet on horses do not bode well for information-hungry policy makers: while more information initially increases both confidence and accuracy, beyond a certain point accuracy simply plateaued even as people became recklessly over-confident. Furthermore, it is highly probable that given the cognitive limitations of even the best and the brightest, information is simply mis-analysed: relevant information is treated as irrelevant, and vice versa.
“You’re not as rational, independent and smart as you think you are”
These lessons from behavioural economics for policymakers make for stark and uncomfortable reading. However, by reflecting on such criticisms, policy makers can at least begin to identify and overcome the different cognitive biases, limitations and blind spots that they certainly are not immune to.
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Adrian W. J. Kuah is an Assistant Professor at the S. Rajaratnam School of International Studies (RSIS), Nanyang Technological University.
Picture by Andrew Loh.