Behavioural Economics and Social Protection Policy

Adam SmithOne Family Director of Policy & Programmes, Stuart Duffin, writes on the topic of behavioural economics and social protection policy.

Behavioural economics improves the realism of the psychological assumptions underlying economic theory, attempting to reunify psychology and economics in the process, and should lead to better predictions about economic behaviour and better policy prescriptions.

Because economics is the science of how resources are allocated by individuals and by collective institutions like firms and markets, the psychology of individual behaviour should underlie and inform economics, much as archaeology informs anthropology. However, economists routinely – and proudly – use models that are grossly inconsistent with findings from psychology. An alternative approach is behavioural economics, which seeks to use psychology to inform economics while maintaining the emphasis on mathematical structure that distinguishes economics from other social sciences.

Behavioural economics represents a reunification of psychology and economics. Early thinking about economics was shot through with psychological insight. For example, in his Theory of Moral Sentiments, Adam Smith described all the ways in which people care about the interests of others. In his later book, The Wealth of Nations, he suggests that people get dinner “not from the benevolence of the butcher, the brewer, or the baker” but “from the regard [of those agents] to their own interest”. The latter passage is one of the most famous in economics, whereas Smith’s earlier book on moral sentiments is ignored. Why?

The answer is that two trends led economics and psychology along different paths this century (although both were trying to make their disciplines more scientific). One trend was that theorists like Samuelson and Debreu worked hard at formalising economics mathematically, with physics as inspiration. Psychologists were also inspired by natural sciences – by experimental traditions rather than mathematical structure. As a result, to an economist, a theory is a body of mathematical tools and theorems. To a psychologist, a theory is a verbal construct or theme that organises experimental regularity.

This divergence in methods and ways of expressing knowledge pushed economics and psychology apart. A second trend kept the fields apart. In the 1940s, economists took up logical positivism with a special twist (called the “F twist” after its advocate, Milton Friedman). Because theories with patently false assumptions can make surprisingly accurate predictions, economic theories that assume that individual agents are highly rational and willful, judge probabilities accurately, and maximise their own wealth, might prove useful even though psychology shows that those assumptions are systematically false. The F twist allowed economists to ignore psychology. Many theorists also thought that relaxing rationality assumptions would inevitably lead to analytical intractability. Lived realities and new thinking have shown cases in which this is wrong.

A behavioural diagnosis and design process would provide a means of identifying and addressing key reasons that social protection policy in Ireland is not performing to expectation; uncover behavioural bottlenecks that are amenable to solution; and identify structural issues. The diagnosis process encourages Government to step back and examine multiple possible explanations for under-performance before embracing a particular theory or solution, thus improving the likelihood of success.