Study with the several resources on Docsity
Earn points by helping other students or get them with a premium plan
Prepare for your exams
Study with the several resources on Docsity
Earn points to download
Earn points by helping other students or get them with a premium plan
Community
Ask the community for help and clear up your study doubts
Discover the best universities in your country according to Docsity users
Free resources
Download our free guides on studying techniques, anxiety management strategies, and thesis advice from Docsity tutors
The insights from behavioral economics, a field that challenges the assumption of rational decision-making in economics. Behavioral development economics, a subfield of this research, focuses on economic development using psychologically realistic models. the historical context of behavioral economics, its connections to broader social sciences, and its implications for development economics.
What you will learn
Typology: Study notes
1 / 38
This page cannot be seen from the preview
Don't miss anything!
Public Disclosure Authorized
Public Disclosure Authorized
Public Disclosure Authorized
Public Disclosure Authorized
Produced by the Research Support Team
Abstract
The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent.
Policy Research Working Paper 8317
This paper is a product of the Macroeconomics and Growth Team, Development Research Group. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The authors may be contacted at khoff@worldbank.org.
A core insight from early behavioral economics is that much of human judgment and behavior is influenced by “fast thinking” that is intuitive, associative, and automatic; very little human thinking resembles the rational thinking that characterizes nized is that innate reliance on cognitive shortcuts means homo economicus. What is less well-recog- that cultural mental models—categories, concepts, social identities, narratives, and worldviews—profoundly influ- “toolkit” or “repertoire” of mental models that they use to^ ence judgment and behavior. Individuals have a cultural perceive and interpret a situation and construct a response.
Many researchers have connected cultural mental models to economic development, yet they rarely identify their research findings as “behavioral” economics. This research constitutes a second strand of behavioral economics that illuminates the tight interlinkages between preferences, culture, and institutions and points to new policy opportu- nities. It brings the discipline almost full circle back to 18th and 19th century perspectives. This essay cautions against decision making are squeezed into a rational actor model.^ strong reductionism in which sociological influences on
Table of Contents
From the earliest work in economics, many writers recognized that people are not always rational and that institutions and cultural contexts shape their character (Smith, 1982 [1759]; Hirschman, 1982). Yet with W.S. Jevons’ introduction of mathematical methods into economics and the creation of neoclassical theory in the 1870s, core research and much of the practice of economics adopted a different theory of the economic actor.^1 Neoclassical theory assumes an actor with unbounded rationality and exogenous preferences—he is called the rational actor. Neoclassical theory until the 1970s investigated economic activity independent of institutions (other than property rights) and independent of culture. Few economists believed that the theory accurately described how individuals made decisions. Instead, adopting neoclassical assumptions was widely accepted as the best means of modeling behavior in economic contexts. In many circles, invoking preference changes as an explanation for behavioral changes was condemned as bad science (Stigler and Becker, 1977, p. 89).
Development and growth economists could explain a lot with neoclassical theory, and powerfully so. Central neoclassical applications are capital accumulation and markets with information problems:
(^1) Throughout the 20 th^ century, prominent researchers directed attention to violations of rationality. Keynes discussed “animal spirits” and Simon detailed many aspects of “bounded rationality” (Keynes1937; Simon 1957). However, this work was often marginalized or ignored because there was little interest in building on a behavioral perspective that lacked a unifying theoretical core.
political influence could explain the differences across the former colonies in economic performance in the 20th^ century (a survey is Hoff, 2003): the initially richest areas—rich because of plantations and mines—were characterized by the highest levels of inequality and became the poorest in modern times. There was a “reversal of fortune”:
Research in the colonial origins of underdevelopment draws on a large sample of economies. But many questions about development cannot be studied across large samples. To make it possible in those cases to build cumulative knowledge, economic historians introduced an approach called “analytic narratives.” A theoretical model is built based on a specific historical problem. For example, Greif (1994) explains why the city-state of Genoa in the early medieval period established a rule of law to solve the problem of overseas agents behaving opportunistically during long-distance trade, whereas the Maghribis, who traded all over the Muslim Mediterranean world, did not. Although based on specific cases, models in analytic narratives generate testable hypotheses applicable to many cases (Bates et al., 1998).
5) Analytic narratives— Economic historians enlarged neoclassical theory by deductive rational choice modeling of large-scale historical phenomena. History influences the salience of the possible equilibrium outcomes and, therefore, which equilibrium is selected. Most work in NIE and analytic narratives retains rational choice theory while bringing social factors back into economic analysis. As the precision of empirical work in economics grew, it became increasingly clear that there remained much of importance that rational choice
theory could not explain. There were systematic violations of rational decision-making with large consequences for welfare, e.g ., underuse of fertilizer and under-responsiveness to free vaccination programs for children (Duflo, Kremer and Robinson, 2008, 2011; Banerjee et al., 2010). Esther Duflo put to herself and others the question: when naturally occurring data does not provide the evidence needed to answer a development question, why not implement an experiment (Parker, 2010)? To pursue their vision and advise governments on policy design in all its detail, Duflo and her colleagues founded a lab at MIT. They viewed randomized controlled trials (RCTs) in field experiments as the best way to learn how to promote economic development and reduce poverty. The Jameel Poverty Action Lab (JPAL), and many other organizations, as well, have undertaken RCTs in countries all over the world:
6) RCT-based project evaluations — This approach – in which individuals are randomly allocated to treatment and control groups – has been described as an effort to “transform…development economics, one experiment at a time… Because of the randomness, [treatment and control] groups, if large enough, will have the same complexion: the same mixture of old and young, happyand sad, and every other possible source of experimental confusion. If, at the end of the study, one group turns out to have changed—become wealthier, say—then you can be certain that the change is a result of the treatment...” (Parker, 2010) Deaton (2010) and other critics contend that RCT-based project evaluation will not lead to a better understanding of the development process. The success of a treatment may depend on many mechanisms. Which mechanisms are in place in which contexts is not learned from RCT- based project evaluation. The critics argue that it is necessary to go back to theory to build a cumulative research program in economic development. JPAL has indeed increased its use of “mechanism experiments,” which are RCTs to identify the behavioral mechanisms central to well-specified policy questions (Deaton, 2010; Jensen, Kling, and Mullainathan, 2011).
perspective that “take[s] it as obvious that individuals’ preferences are formed by society and that society, so to speak, exists within persons.”^2
For the first time, research across disciplines is producing rigorous evidence that context, history, and culture affect decision-making. New techniques have expanded the ability to infer causality from non-experimental data. Research findings are that preferences are influenced by social networks and experience and exposure through which individuals learn mental models (such as categories, identities, and narratives) that they use to process information. Myopic preferences can explain why the wrong types of leaders emerge and well-intentioned reformers fail to obtain legitimacy (Khemani, 2017). Table 1: Frameworks to explain economic development outcomes
(^2) Personal communication from the sociologist, Peter Hedstrom, cited in Fehr and Hoff (2011). An early survey of work on endogenous preferences is Bowles (1998). A history of behavioral economics isHeukelom (2014).
Focus on: Approach
Rational choicewith fixed preferences
Institutions Culture Empirical validationof individuals’ intentions
Yes No No No
Yes Yes Some authors, notothers No
Table 1 lists the approaches to development economics that we have discussed. The table makes it easy to see one of the themes of this essay: modern development economics has circled back to insights made in the 18th^ and 19th^ centuries about the limits on rationality and the impact of institutions and culture on preferences. With the obvious exception of ‘early economics,’ the approaches listed in Table 1 are alive and well today. Thus, development economics is fragmented, as it has always been. Even the individual approaches listed in Table 1 are fragmented. There is no agreement on what constitutes an institution nor, as we discuss later, on the degree to which culture (under various definitions) is a part of behavioral economics.
Today, the central focus of research and teaching in development economics is on micro- economics—market failures and RCT-based mechanism evaluations. Graduate students may read everything from the foundational works in neoclassical economics to research on the psychology of poverty. Many are steeped in instruction on RCTs. Within development economics, behavioral development economics is gaining momentum. It is producing a coherent set of principles to improve the design of development projects and policies. The first journal symposium on behavioral development economics was published in 2014 (in the Review of Income and Wealth). In 2015, Harvard University introduced a PhD-level course in behavioral development economics, and the World Bank presented the first book-length synthesis of work in this field (World Development Report 2015: Mind, Society, and Behavior ). Kremer and Rao (in progress) are writing the first Handbook survey, entitled “Behavioral Economics and Development.” Development practitioners have applied behavioral insights in many low- and middle-income countries and in poor communities of rich countries. Extended discussions of the successes of these interventions are Datta and Mullainathan (2012), Demeritt and Hoff (2015),
Within the field of development economics, the current generation of researchers has focused on empirics (Ray, 2008). At the Richard T. Ely lecture at the 2017 American Economic Association Annual Meeting, Duflo (2017) urged economists who are helping governments design new policies to act not only like scientists and engineers, but also like plumbers. Plumbers lay pipes and fix leaks and get things to work properly on the ground by adopting an experimental mindset. Economists who design policy need to recognize that humans are boundedly rational and are embedded in cultural contexts. Therefore, what worked “there” may not work “here.”
We next turn to the relationship between behavioral development economics and other social sciences with respect to “grand theory.” Behavioral development economics does not offer a new grand theory as an alternative to neoclassical theory. What it offers instead are realism-improving middle-range theories. Rabin (2013) calls them “PEEMS”—portable extensions of existing models. They incorporate features of psychology— e.g ., limited attention, limited will power, framing effects, salience (the details that leap out at you), loss aversion, social identity, and concern with fairness and morality— into an otherwise standard economic model that translates them into testable predictions. PEEMs address an inconsistency that Kenneth Arrow noted over 30 years ago:
[A]n economic theorist …toils for months to drive the optimal solution to some complex economic problem, and then blithely assumes that the agents in his model behave as if they are capable of solving the same problem. (Thaler, 2016, p. 162)
A few subfields of behavioral economics, with an example of a PEEM or middle-range theory in that field in parenthesis, are behavioral finance (prospect theory), behavioral macroeconomics
(present bias), behavioral game theory (limited strategic thinking), and behavioral law and economics (the availability heuristic). While an expressed need for mid-level generalizations is relatively new in economics, it has long propelled work in other social sciences. Robert Merton, one of the ‘founding fathers’ of modern sociology, penned an essay in 1949 titled “On Sociological Theories of the Middle- Range.” The essay was a reaction to scholars’ desire for a “total system of sociological theory,” which Merton argued offered “the same exhilarating challenge and the same small promise as those many philosophical systems which have fallen into deserved disuse” (p.453). He advocated “middle-range theory” firmly tethered to empirical data and hypothesis testing. Modern-day social theorists build on this idea (e.g., Hedstrom and Swedberg, 1998; Elster, 2007; Hedstrom and Ylikoski, 2010; an argument particular to development is Deaton, 2009). The behavioral sciences are converging on a shared view of the value of middle-range theory. Such theories do not match the scope and power of rational choice theory but are necessary for understanding many behaviors. They provide a framework within which policy tools are designed, as discussed later.
Many economists have been wary about treading into this territory. The concept of choice is very ingrained in economists’ thinking. One way of thinking about behavioral economics is that it tries to clarify the domain of choice. Choice is influenced by the context of decision making, over which the decision-maker has limited control, and by the categories, concepts, and narratives through which an individual processes information, over which he has limited awareness. We will later present four examples (on female labor force participation, civic culture, learning in education systems,, and gender attitudes) to illustrate how social constructs emerge and how they constrain or enable choice.
authors show that the prime has no effect. Many Strand 1 effects rely on culturally-specific mental architecture that is now being investigated as part of Strand 2 behavioral economics.
Whether fast thinking leads you automatically to, for example, overlook women for leadership roles, or to respond aggressively to an assertion of authority, depends on the experience and exposure you have had ( e.g., Alesina et al., 2013; Heller et al., 2017). “People think and feel and act in…ways that are shaped by particular patterns of historically derived meanings, practices, products and institutions” (DiMaggio and Markus, 2010, p. 348). Only some features of Strand 1 of behavioral economics, such as procrastination, are common to all known cultures. People universally do not meet the assumptions of homo economicus that preferences are consistent and fixed, but the mechanisms and manifestations of the departures are, in part, culturally specific.
Perception entails construction. The anthropologist Mary Douglas (1966, 45-46) writes that
Whatever we perceive is organised into patterns for which we, the perceivers, are largely responsible. Perceiving is not a matter of passively allowing an organ—say of sight or hearing—to receive a ready-made impression from without, like a palette receiving a spot of paint….As perceivers we select from all the stimuli falling on our senses only those which interest us, and our interests are governed by a pattern-making tendency, sometimes called schema [or equivalently, mental model]…In perceiving we are building, taking some cues and rejecting others. The most acceptable cues are those which fit most easily into the pattern that is being built up…Ambiguous ones tend to be treated as if they harmonised with the rest of the pattern. Discordant ones tend to be rejected...
A cultural toolkit of concepts, categories, identities, narratives, and worldviews, allows people to “locate, perceive, identify, and label” events in the world around them (Goffman, 1974). A greater appreciation of the effects of culture on cognition has led scholars in sociology,
psychology, and anthropology to abandon the “entity” view of culture, in which culture determines a stable and consistent set of preferences, in favor of a dynamic view of culture as something that happens “in action” as individuals interpret a situation using a cultural “toolkit” or “repertoire” of concepts, categories, meanings, identities, and narratives and construct a response (Swidler 1986; DiMaggio 1997). In contrast, most modern economic work that takes culture into account adopts the entity view of culture. Behavioral economics is beginning to embrace the toolkit approach, as we discuss below.
The cognitive toolkits people use to assess situations and solve problems can affect institutional persistence and change. When members of a group share monolithic cultural experiences, the beliefs and attitudes associated with those experiences can become entrenched even as available information and technologies change; since attention and perception are shaped by an individuals’ limited experiences, and since beliefs themselves affect self-confidence and performance, “fictions” can be sustained in equilibrium, hampering societal development (Hoff and Stiglitz 2010). Individuals and culture are mutually constituted (Markus and Kitayama 2010), and culture and institutions interact and evolve in complementary ways (Alesina and Guiliano 2015). Thus culture, preferences, and institutions are all closely related (overviews from the perspective of behavioral economics are North, 1994; Fehr and Hoff, 2011; and Hoff and Stiglitz, 2016). North (1990, p. 8) discusses how culture’s effect on individual judgment can block development:
Incremental change comes from the perceptions of the entrepreneurs in political and economic organizations that they could do better by altering the existing institutional frameworks at some margin. But the perceptions crucially depend on both the information that the entrepreneurs receive and the way they perceive it. If political and economic markets were efficient (i.e., there were zero transaction costs), then the choices made would always be efficient. That is, the actors would always possess true models or if they initially possessed incorrect models, the information feedback would
In middle-income countries, there has been a rapid expansion of door-to-door sales of high- sweetened, low nutritional foods to poor people, expanding rates of obesity, diabetes, and undernourishment ( New York Times , Sept. 19, 2017, p. A1).
A book titled Nudge (Thaler and Sunstein, 2008) became “the spearhead of behavioral economics” ( The Economist, March 24, 2012). The authors define a nudge as a policy that changes behavior without substantially changing incentives or information. One way a nudge works is by changing how easy it is to choose a particular option and by giving immediate feedback that permits individuals to correct their mistakes. We use two examples to illustrate how a nudge can promote economic development.
There is often a high return to public investments in the poor, but relatively little is known about how to induce governments to increase such investments. The introduction of electronic voting technology in Brazil in 1998 showed that making it easier for voters to communicate their preferred choices greatly increased the voice of the poor by reducing the number of error-ridden votes, particularly by the less educated. The limited number of the devices available in 1998 meant that the electronic voting technology was introduced only in municipalities with more than a threshold number of voters, while the rest used paper ballots. Brazil requires all adult citizens to vote. Fujiwara (2015) identifies the impact of the machines by comparing outcomes for municipalities just above and just below the threshold. By reducing the number of error-ridden ballots that had to be thrown away, electronic balloting effectively enfranchised 11% of the voters. Political power in municipalities shifted to the Left. One of the things that legislators
could quickly affect was funding for health care, which is free in Brazil. Funding for public health care increased by 34% over eight years. The number of pregnant women receiving regular pre-natal care increased by 20 percent and the number of low-weight births decreased by 6%. As the World Bank Group (2015, 37) notes, “[t]his is a major development success, since newborn health, controlling for other factors, predicts lifetime health, education, and income.”
Poor education of disadvantaged students contributes to the intergenerational transmission of poverty. Better performance by their teachers can help children escape poverty as adults. The rational actor responds to incentive pay, but there is scant evidence that merit pay for teachers is effective. In a disadvantaged community near Chicago, Fryer et al. (2012) investigated how to amplify the effect of incentives. They ran a field experiment that involved 150 teachers of kindergarten through eighth grade in disadvantaged communities. The teachers were randomly assigned to a control group or one of the two treatment groups, which we will call ‘winners’ and ‘losers.’ The ‘winners’ worked under a traditional year-end bonus scheme, under which they could make up to $8,000 extra at year-end for strong performance of the students on year-end standardized tests. The ‘losers’ were given $4,000 at the beginning of the academic year and were told that at year-end, poor performers would have to return a portion and that the strongest performers would receive an additional bonus of up to $4,000. The ‘winners’ and ‘losers’ faced identical financial incentives. Only the framing of the incentive payments differed between the two groups.
