Approaches to Economic Science

Transcription

1 S.1 Approaches to Economic Science Part 3: The Economic Approach and its Limits (Module MW26.1) Prof. Dr. Andreas Freytag, PD Dr. M. Pasche Friedrich Schiller University Jena

2 S.2 The Economic Approach to Social Science and its Limits Outline: 1. The Economic Approach how economists look at social phenomena 1.1 The core criteria 1.2 Some examples 1.3 The liberal prejudice 1.4 Are there alternatives? 2. Limits of the Economic Approach 2.1 Methodological individualism, aggregation problem, and macroeconomics 2.2 Bounded rationality and irrational behavior

3 S.3 3. Critique to the economic approach How relevant? 3.1 Recap: Economic Approaches to Explain Social Behavior 3.2 Alternative Economic Approaches 3.3 Limit to the Economic Approach How to identify irrational behavior? When is exchange voluntary? Moral limits of markets Ch : Pasche; ch. 3: Freytag

4 S.4 Basic Literature: Becker, Gary S. (1976), The economic approach to human behavior. Chicago: University of Chicago Press. Frey, Bruno S. (1992), Economics as a science of human behaviour: towards a new social science paradigm. Boston: Kluwer. Kirchgässner, Gebhard (2008), Homo Oeconomicus: the economic model of individual behavior and its applications in economics and other social sciences. New York: Springer. MacKenzie, Richard B., Tullock, Gordon (1978), The new world of economics: Explorations into human experience. Homewood (Ill.): Irvin. Noteboom, Bart (2014), How Markets Work and Fail, and What to Make of Them. Cheltenham: Elgar. References to more specific literature can be found in the slide collection.

5 S.5 1. The Economic Approach Recall Lakatos Research Programme approach (part II): Core: basic concepts, normative ideas, theoretical assumptions which guide scientific research Belt: specific assumptions and theories which are developed from the core. In case of empirical conflicts the researcher looks for flaws in the belt and is, by doing so, thus immuifying the core against falsification. Does the economic approach exist? What about pluralism and competing research programmes (or paradigms ) in economics? In the following we will look at the research programme of a very broadly defined mainstream in economics.

6 S.6 1. The Economic Approach 1.1. The core criteria Methodological individualism Rational choice: Subjective utility Choices as instruments Rationality Voluntary exchange Equilibrium analysis

7 S.7 1. The Economic Approach 1.1. The core criteria Methodological individualism: Basic assumption: the starting point for an economic explanation is the individual level of decision making; all social phenomena could be derived from individual decisions. Opposite assumption: the starting point for explanations are collective ontological entities such like state, classes (Marx) or social systems (Luhmann).

8 S.8 1. The Economic Approach 1.1. The core criteria Collectivists argue that e.g. the worker class or the political party or the capital are acting entities, have a certain interest, a will, an intention etc. Individualists argue that only individuals have needs, interests, intentions etc., and collective phenomena appear as a result of self-organized exchange of individual decisions. Roots in liberal political philosophy of the 18th century: justification of something not based on authority but on rational arguments which can be proven by each individual (in philosophy and science as well as in politics and society). Collectivistic thinking might legitimate collective entities to express the individual needs and preferences instead of the individuals themselves (ranging from soft paternalism to dictatorship).

9 S.9 1. The Economic Approach 1.1. The core criteria What methodological individualism is not: No statement about the true nature of the individual (ontological individualism). It s just the methodological decision to choose the individual as the starting point of an explanation. Example: where do individual preferences come from (e.g. influenced by marketing/advertising, social norms, peer groups,...)? Might be interesting question, but the model works with the assumption of given preferences.

10 S The Economic Approach 1.1. The core criteria However: What happens if we have collective phenomena which cannot be derived from individual decisions (if the whole is more than the sum of its parts )? Or if a microfoundation of the macro phenomenon is pointless because the nexus between macro effect and micro calculus is weak or negligible? Will be discussed later on.

11 S The Economic Approach 1.1. The core criteria Rational Choice: Utilitarism: Greatest happiness principle (Jeremy Bentham). Individuals seek for pleasurable choice consequences and try to avoid unpleasurable ones. Utility and methodological individualism: only the individual knows what is good for him/her. Individual behavior is guided by individual preferences (inside) and the choice opportunities and incentive schemes (outside). Beside preferences, also expectations are subjective (Bayesian approach). Axioms on a rational preference order guarantee that behavior can be represented as a maximization of expected utility (von Neumann/Morgenstern 1947).

12 S The Economic Approach 1.1. The core criteria Core The notion of preferences is very broad: could range from simple tastes for pizza to far-reaching internalized moral norms. The core concept doesn t say anything about the content of preferences. Belt specific assumption, e.g. pure self-interest. Adam Smith as well as John Stuart Mill: individual utility not only pecuniary, and behavior also shaped by moral convictions or moral sentiments.

13 S The Economic Approach 1.1. The core criteria Questions: Preferences about well-being of others (e.g. altruism). What does it mean if an altruist maximizes his utility? Do people really know what they want? Could preferences be manipulated? Where do preferences come from? The economic approach doesn t mind. It does not take utility as something what individuals consciously and intentionally maximize, they take it as a conceptual (normative) framework to consistently describe choice behavior from a rationality perspective.

14 S The Economic Approach 1.1. The core criteria Implication: Individual utilities are not comparable (incommensurable). One cannot simply add up individual utility functions to a collective one. Pareto criterion Disentangling allocative efficiency and distribution (in case of self-interest). What happens if individuals have other-regarding preferences? Distribution and efficiency cannot be disentangled!

15 S The Economic Approach 1.1. The core criteria Choices are instruments: Doing something in order to achieve a choice consequence. Preferences are about choice consequences. The choice as such does not have any intrinsic value. Problematic in case of discussing ethics, or acknowledging that individuals seem to have preferences about the procedure how choice consequences are achieved (e.g. procedural fairness).

16 S The Economic Approach 1.1. The core criteria Rationality: Assumption: if expected consequences of choice A are preferred to expected consequences of choice B then individual will choose A instead of B = behaves consistent with the preferences and beliefs. Thus the observable behavior reveals the underlying preferences (and beliefs). Substantive rationality, as the theory doesn t say anything about the psychological background and the specific procedures how decisions are made. It s just a consistency requirement. Not more, not less. Very restricted interpretation of rationalitas which had been understood in antique philosophy as the ability to critically deliberate, reflect, and justify what the individual is doing.

17 S The Economic Approach 1.1. The core criteria Voluntary exchange: Basic assumption: human interaction are exchange relationships. Being rational, individuals will establish and maintain relationships which are mutually beneficial. Thus, it is voluntary; there is no external coercion. This does not mean that there is total freedom : Social interaction requires (and is facilitated by) institutions which shape the behavior and make behavior more predictable and reliable. Indivduals can commit themselves to rules or make binding contracts which limit their future dispositions.

18 S The Economic Approach 1.1. The core criteria The existence of coercion is not denied: any sort of force or coercion has to be interpreted as a feature of the given choice set (or its limitations) some individuals have the power and incentive to limit other s choice set. Others might suffer from not being able to abandon these limitations because a revolution bears high costs and suffer from it s public good property.

19 1. The Economic Approach 1.1. The core criteria Equilibrium analysis: Economic theory analyses individual choice behavior and its social coordination (e.g. on markets). As rationality requires consistency with preferences and beliefs, explanation should not consider choice behavior which is based on systematic error. Instead, the starting point is an equilibrium where rational dispositions and their voluntary exchange are internally consistent. Claims about what happens outside the equilibrium still presumes the idea of an equilibrium! An equilibrium is not necessarily a static situation. Also growth paths, cyclical behavior or even more complex dynamics could be equilibrium phenomena. Evolutionary models which consider permanent and not predictable changes of the conditions can only make pattern preditions. Once when they are formalized in terms of mathematical models, an equilibrium analysis is again an unavoidable part of the model. S.19

20 S The Economic Approach 1.2. Some Examples The research field of economists is not just the economy! Economists deal with all social phenomena where the economic methodology could be applied to. Microeconomics of firms and households, macroeconomics, public finance, international trade, monetary economics and inflation,... Public Choice, economics of the political sphere, bureaucracy theory, theory of lobbyism, economics of law and constitution,...

21 S The Economic Approach 1.2. Some Examples (cont.) Economics of child work, alcoholism, criminality, terrorism and peace, group pressurce, identity management... Applications also in biology/ecology, e.g. to explore animal behavioral strategies. Accusation of economic imperialism : universal explanatory strategy across disciplinary bounderies. Justified? Mäki, U. (2016), Economics Imperialism: Concept and Constraints. Philosophy of the Social Sciences 46(5), pp.

22 S The Economic Approach 1.3. The liberal prejudice Many economists have the tendency to be liberal. Reasons: Explanation starts with the individual and its subjective preferences. Nobody is better informed about it as the individual itself. Social exchange relationships are voluntary. Thus, as individuals are rational, they will decide consistent with their preferences and thus create mutual benefits in the voluntary exchange relationships. Absence of coercion or force by any ideology is beneficial. Scepticism against any ideology and any claims of the state which is not legitimated by individuals (via democratic elections).

23 S The Economic Approach 1.3. The liberal prejudice What about market failure? Voluntary exchange relationships will not always guarantee Pareto efficiency: persistent market power, externalities, information asymmetries. Possibility of collective regulations to overcome or to mitigate these problems. Moreover, individual freedom requires at least minimal capabilities and equal opportunities might legitimate to some extent a social welfare state.

24 S The Economic Approach 1.3. The liberal prejudice Recall methodological individualism: policy makers, members of interest groups, members of political parties are also maximizing their utility (which could be shaped by ideologies). Government (or any collective entity) is not a benevolent decision maker! Economists are also analysing government failure. Economists typically claim for restricting the governmental power to those things which are legitimated by the individuals, to bind behavior of policy makers to rules, to establish checks and balances, to establish rule of law and well working institutions.

25 S The Economic Approach 1.4. Are there alternatives? According to Lakatos, even the core concepts can be debated on a rational basis while Kuhn describes changes as a sudden paradigm shift. The core of mainstream economics is criticized for many reasons (some of them discussed in the next chapter). One criticism is that it drives out alternative views from the academic discourse, especially in teaching. The mainstream is often identified with neoclassical economics, and as alternatives are often mentioned: (Post-) Keynesianism, Marxism, Institutional Economics, Behavioral Economics, Austrian School, Evolutionary Economics, Ecological Economics, Feminist Economics etc. Actually, economics always have been somehow pluralistic which is in line with liberal prejudice.

26 S The Economic Approach 1.4. Are there alternatives? Some claims: Mainstream is defined an a very broad sense. Large parts of e.g. Behavioral Economics, Political Economics, Institutional Economics are dealing with the same core concepts but might differ regarding the belt. Other approaches share major convictions but slightly deviate from few core ideas, e.g. Ecological Economics. Some alternative approaches are very domain specific (e.g. Ecological Economics or Feminist Economics). Some alternatives are more eclectic and do not have a uniform methodological approach (e.g. Behavioral Economics, Ecological Economics). But there is no fear of contact core ideas could be rationally discussed.

27 S Limits of the Economic Approach Literature: Noteboom, B. (2014), How Markets Work and Fail, and What to Make of Them. Cheltenham: Elgar. Keen, S. (2011), Debunking Economics: The Naked Emperor of the Social Sciences. Revised and expanded edition. Zed Books: London. Sometimes radical fundamental critique: economic mainstream concept as a totem, a zombie, an ideology, or brainwash. However, the critique of methodological foundations should not have an aggressive ideological attitude!

28 S Limits of the Economic Approach 2.1. Methodological individualism, aggregation problem, and macroeconomics Problem of aggregation: Methodological individualism doesn t have any implications about the proper way to aggregate individual decisions. Nevertheless, one has to make drastic assumptions in order to derive even simple results such like a market demand curve: From individual preferences and given budget constraint we derive an individual demand curve for a good. By assuming identical and completely independent households, or even simpler: a representative household, we obtain a downwards sloping aggregate demand curve.

29 S Limits of the Economic Approach 2.1. Methodological individualism, aggregation problem, and macroeconomics However, aggregation is a deep problem: (Grandmont (1992), Hildenbrand (1994), Kirman (1989, 1992), Rizvi (1994)) In general (without drastically simplifying assumptions) it is impossible to derive an aggregated demand curve consistently. Regularities governing the aggregated behavior are not the same governing individual behavior. Macroeconomic regularities cannot be derived from an individual level if assuming many (eventually hereogenous) individuals. Not only macroeconomics but even the behavior on single markets requires assumption of ficticious representative agents which means that de facto methodological individualism is not really taken seriously.

30 S Limits of the Economic Approach 2.1. Methodological individualism, aggregation problem, and macroeconomics Microfoundation of Macro: Modern macroeconomics is based on Lucas (1976) insight that structural equations of macro models have to be disentangeld into behavioral parameters and policy parameters. This requires a microfoundation of macro models. This is necessary as changes of policy variables might lead to an adaption of the agents behavior. If both types of variables are not separated, an econometric estimation of the model (and thus the policy implications) will give misleading results. But given the fundamental objections discussed before (aggregation problem, representative agents) the question is whether the errors made by ignoring the fallacies of the aggregation problem by naïve microfoundation are at least as problematic as ignoring the microfoundation. Moreover: does microfoundation necessarily imply that agents are perfectly rational and making plans which are consistent ex ante?

31 S Limits of the Economic Approach 2.1. Methodological individualism, aggregation problem, and macroeconomics Fallacy of composition: What is true for a single entity is not necessarily true for the aggregate of entities. Examples: An atom is not a living organism. An animal is composed of many various atoms. Does it mean that the animal is also no living organism? Water is wet. Is the H2 O molecule also wet? A football team is composed of excellent players. Is the team also excellent? A single participant of a pop concert could improve his view to the stage by standing up from seat. If all participants are doing so, is there a better view in aggregate?

32 2. Limits of the Economic Approach 2.1. Methodological individualism, aggregation problem, and macroeconomics Economic examples: A single voter has a rational preference order. A group of voters must then also have a rational preference order? (No! Condorcet paradoxon) Keynes paradox of savings: a single household could increase wealth by saving a larger part of income. In aggregate, however, this induces a decline of demand and thus output (income) and wealth is declining. Analogously for repaying debt in order to reduce the debt/income ratio: if all individuals would repay debt, the decline of income (because of lower consumption) is larger than the repayment, and the ratio is increasing. Economies of scope, network externalities, or regional clustering effects: new effects emerge which are a property of the composed entity (e.g. regional cluster) but not of the single firm/member. S.32

33 2. Limits of the Economic Approach 2.1. Methodological individualism, aggregation problem, and macroeconomics Macrofoundation of Micro? Microfoundation approach: many individuals have positive expectations about an asset buying the asset asset price increases asset price reflects (aggregated) individual expectations. Keynes beauty contest : buying asset although individuals believe that it is overpriced. But they believe that most other individuals believe that it is profitable and therefore they demand it. So the asset price increases although all individuals rate it as overpriced. Price reflects beliefs about the beliefs of others (market sentiments = macro phenomenon). Other example: Keynesian unemployment due to expected rationing and adapted effective demand which then results in unemployment. In general, any sort of expected structural change of the model could affect individual behavior which thus leads to structural effects. Colander, D.C. (1993), The Macrofoundations of Micro. Eastern Economic Journal 19(4), S.33

34 S Limits of the Economic Approach 2.2. Bounded rationality and irrational behavior Literature: Kahneman, D. (2011), Thinking, Fast and Slow. New York: Farrar, Straus and Giroux. Thaler, R.H. (2016), Misbehaving. W. W. Norton & Company. More about that in Topics in Behavioral Economics (MW21.6) The term bounded rationality was made popular by Herbert Simon in the 1950ies, immediately after the first axiomatic foundation of expected utility theory. Claim: real individuals do not behave according to the rationality assumptions of economics! However: we have to disentangle whether we are criticizing concepts of the core or of the belt!

35 S Limits of the Economic Approach 2.2. Bounded rationality and irrational behavior Recall that the core concepts do not specify the content of preferences, and assumes subjective (probability) beliefs! Difficult to identify irrational behavior as long as we do not know anything about preferences and beliefs of the particular individual problem of falsifiability! Other-regarding or social preferences, belief-dependent preferences etc. are modifications in the belt in order to cope with empirical observations, but this immunifies the core. E.g. non-selfish behavior could still be described according to consistency requirements.

36 S Limits of the Economic Approach 2.2. Bounded rationality and irrational behavior Bounded rationality is not irrationality. People do not systematically decide against their own goals and interests. They might have difficulties to make optimal choices, and there are systematic deviations from the predictions of Expected Utility Theory.... limited information or limited knowledge. Decision making under incomplete information and uncertainty is the standard case in mainstream economics. The rationality concept does not imply anything about the information or knowledge status of the individual. Is the rationality as such bounded or, instead, the cognitive abilities of the individuals (so that we should add cost of information processing or cost of using scarce cognitive resources)?

37 S Limits of the Economic Approach 2.2. Bounded rationality and irrational behavior Observations from experimental economics: Consider cases where no fancy preferences are involved; clear control of the available information. Individuals fail to perform subjective beliefs which are consistent with Bayes rule beliefs are distorted (framing effects, overconfidence, neglecting base probabilities,...) Given the beliefs (or objective probabilities), individuals fail to behave consistently according to the axioms (endowment effects, violations of transitivity, violations of stochastic dominance, violations of the Sure Thing Princople, framing effects, risk preference reversals, time inconsistent behavior,...). Evidence that individuals do not seek for the optimal choice but for a good option.

38 S Limits of the Economic Approach 2.2. Bounded rationality and irrational behavior How to respond to these findings? Repair job in the belt is not possible, the core concept is challenged. Relaxing the axiomatic framework ( Non-Expected Utility Theory ): possible but not very promising. Giving up the idea of rational choice? What instead? Idea of heuristic behavior which is not derived from a maximization calculus. No ex ante consistency requirement. However: Problem of Ad-Hocism, heuristics are somehow arbitrary. How to justify the assumption of particular heuristics? Individuals still want to achieve something. How to describe that without, again, referring to preferences/utility? Satisficing theory

39 S Limits of the Economic Approach 2.2. Bounded rationality and irrational behavior How important are the individual deviations from Rational Choice approach? Experimental markets are not so far away from the prediction of market theory although participants do not behave (perfectly) rational. Many stylized facts are not systematically in conflict with mainstream models. Justification of the as if approach? Using mainstream models as a work horse. Are there convincing alternatives based on changes in the core, e.g. Behavioral Market Theory, Behavioral Macroeconomics etc.?

40 S Critique to the Economic Approach How Relevant? 3.1. Economic Approaches to Explain Social Behavior Economics belongs to social science as it deals with division of labor. This becomes clear when on looks for a sensible definition of it. Economics is what economists do (Marshall, Say and Viner) sense? Economics is dealing with the economy science as a collection of allotments!

41 S Critique to the Economic Approach How Relevant? 3.1. Economic Approaches to Explain Social Behavior Economics is dealing with scarcity and resource allocation (Lord Robbins) social engineering as result? is economics another natural science? Economics deals with chances and boundaries of human interaction in order to create mutual benefits (Homann and Suchanek) refers to division of labor, transactions etc. economics as social science!

42 S Critique to the Economic Approach How Relevant? 3.1. Economic Approaches to Explain Social Behavior Thus, it is important that Economics deals with social interaction. This implies the danger of arbitrary and non-rational behavior. It also implies that it cannot completely refrain from normative statements. * Positive analysis (analyzing what is) * Normative analysis (using a set of theoretical criteria) Weak vs strong value judgement weak: allocation strong: distribution (not allowed); Is the restriction to weak value judgements weakness or strength?

43 S Critique to the Economic Approach How Relevant? 3.1. Economic Approaches to Explain Social Behavior What are the methodological implications? Complex theoretical relations need simple and clear language, i.e. mathematics However, economics is not a natural science, controlled experiments are still not possible There are experiments now Neurological economics No argument without a number (wither post-truth politics!) be_ignorant_about_the_world?language=en Internal division of labor along the value chain theory empirical research policy discussion

44 3. Critique to the Economic Approach How Relevant? 3.1. Economic Approaches to Explain Social Behavior The foundations and basic concepts of ecomomics are the following (among others) Microeconomic theory, particularly the model of perfect competition. Macroeconomic theory International trade theory and policy Development problems Theory of bureaucracy Economic theory of politics / public choice Choice of constitutional rules... The economic approach is able to explain a considerable part of human behavior in the economic sphere as well as in other fields. It is particularly well suited if relationships are impersonal and / or anonymous. But even some parts of the personal relationship (e.g. trust) may be explained on the basis of economic theory. S.44

45 3. Critique to the Economic Approach How Relevant? 3.1. Economic Approaches to Explain Social Behavior Applications of the economic approach outside the sphere of economics in the narrow sense. Examples: Rule breaking Criminal activity Spouse selection Child production Human capital formation Terrorism Riots and panic Pollution... Kirchgässner, Gebhard (2008): Homo Oeconomicus: the economic model of individual behavior and its applications in economics and other social sciences. New York: Springer. MacKenzie, Richard B. and Gordon Tullock (1978): The new world of economics: Explorations into human experience. Homewood (Ill.): Irvin. S.45

46 S Critique to the Economic Approach How Relevant? 3.2. Alternative Economic Approaches For long neoclassical or mainstrem economics has been critizised (see also below, section 4). Alternative approaches comprise first some rather established concepts, which are closely conected to mainstream, such as Public Choice New Institutional Economics Constituional Economics Evolutionary Economics Behavioural Economics Austrian Economics Neuro-Economics Post-Keynesianism... Here, the alternative methododological concepts seem to be the main drivers of the development of these approaches.

47 S Critique to the Economic Approach How Relevant? 3.2. Alternative Economic Approaches Second, there are rather new approaches, such as Feminist Economics Ecological Economics Post-Growth Economics Neo-Marxist Economics Transformative Science... It seems as if these approaches are less driven by methodological differneces than an ideological impetus. The intiators often do lack an ecomomic education; per-se not a problem, but it reduces credibility of methodological criticism, particularly if it comes to math!

48 S Critique to the Economic Approach How Relevant? 3.3. Limits of the economic approach Overview: How to identify irrational behavior? The debate about merit goods When is exchange involuntary? Moral limits of the market

49 3. Critique to the Economic Approach How Relevant? 3.3. Limits of the economic approach How to identify irrational behavior? The debate about merit goods Basic idea: there may be cases in which it is desirable that government corrects individual decisions and preferences (Richard Musgrave). Definitions: Merit good: Actors do not consume enough of a good. Subsidize the respective good or service in order to increase consumption. Examples: Education School lunch Health services Cultural events (opera houses),... Musgrave, Richard A. (2008): Merit Goods. The New Palgrave, Vol. 5, London: McMillan, S.49

50 S Critique to the Economic Approach How Relevant? 3.3. Limits of the economic approach How to identify irrational behavior? Demerit good ( sin good ): Actors consume too much of a certain good or service. Put a special tax on that good or regulate supply of the good in order to reduce consumption. Examples: Cigarettes Alcoholic beverages Hard drugs Rregulation of opening hours for shops and bars, Regulation of prostitution,....

51 S Critique to the Economic Approach How Relevant? 3.3. Limits of the economic approach How to identify irrational behavior? Alternative justifications for correcting individual preferences and behavior External effects taxes or subsidies Public goods provision through the government. Insufficient information provide more information. Misleading advertizing inhibit misleading advertizing, provide correct information. Non-rational or irrational behavior???

52 S Critique to the Economic Approach How Relevant? 3.3. Limits of the economic approach How to identify irrational behavior? Types of non-rationality: Behavioral anomalies: Behavior violates basic assumptions of decision theory Differences between existing and perceived opportunities Irrational behavior

53 S Critique to the Economic Approach How Relevant? 3.3. Limits of the economic approach How to identify irrational behavior? Behavioral anomalies, examples: Actors do not maximize their expected utility Information is processed selectively Decisions are considerably influenced by the way the problem is presented Risk-attitude depends on the type of decision to be made Behavior deviates from certain assumptions of decision theory Behavior may appear rational if these assumptions are modified Relevance for public intervention questionable!

54 S Critique to the Economic Approach How Relevant? 3.3. Limits of the economic approach How to identify irrational behavior? Differences between existing and perceived opportunities: Differences between existing and perceived opportunities lead to a systematic underestimation or overestimation of possibilities and Events decisions may not be optimal. Examples: Actors do not have an insurance because they underestimate the probability of a damage Over-optimism when founding a business, marrying,.... Resignation of unemployed persons Strategic avoidance of certain situations Strategic excessive ambitions Relevance for the justification of public intervention?

55 S Critique to the Economic Approach How Relevant? 3.3. Limits of the economic approach How to identify irrational behavior? Irrational behavior: Definition: Individual behavior is irrational if it violates the own interests, Examples: Consumption of addictive drugs. Self-inflicted injury, suicide. Contradictory behavior. Problem: Identification of irrational behavior requires knowledge of individual preferences! Justification of public intervention based on nonrational behavior of actors?

56 S Critique to the Economic Approach How Relevant? 3.3. Limits of the economic approach How to identify irrational behavior? Remedy for the problem: A correction of individual decisions is justified if the respective actor agrees to the intervention ex-post ( Educational dictatorship ). Problems: One can never know for sure ex-ante that the respective actors will indeed agree ex-post. How does the change of preferences come about? (by brainwashing?) Justification of public intervention based on non-rationality is not in accordance with the economic approach! However: There may exist a problem that requires public intervention even if we are currently unable to explain it on the basis of the economic approach!

57 3. Critique to the Economic Approach How Relevant? 3.3. Limits of the economic approach How to identify irrational behavior? Libertarian paternalism: Nudges Attempt to direct human behavior by means of a conscious design of a decision framework, i.e., gentle persuasion towards certain kinds of desired behavior ( libertarian paternalism ). Goal: Induce rational decisions and support self control. Examples: Sales-promotional placement of healthy food in cafeterias and supermarkets; unfavorable placement for unhealthy food. Shock pictures and health warnings on cigarette packets. Obligatory consultation for certain financial transactions. Supply of contracts that include self-commitment (e.g., saving plans, retirement savings, in case of addiction). Sunstein, Cass and Richard Thaler (2009): Nudge: Improving Decisions about Health, Wealth, and Happiness. Revised and expanded edition, New York: Penguin. Thaler, Richard and Cass Sunstein (2003): Libertarian Paternalism. American Economic Review, 93, Papers and Proceedings, S.57

58 S Critique to the Economic Approach How Relevant? 3.3. Limits of the economic approach How to identify irrational behavior? Nudges the Problems: Who decides? In what way legitimized? Even gentle paternalism may reduce individual freedom (Who pays for respective political campaigns?...). Paternalistic guidance may reduce a person s capability of autonomous problem solving.

59 S Critique to the Economic Approach How Relevant? 3.3. Limits of the economic approach When is exchange involuntary? The concept of coercion : In which cases does coercion cause involuntary exchange? Being held at gunpoint Blackmail Wants to keep the job / avoid unemployment Poverty, hunger, sickness The concept of reasonable alternatives / freedom of choice Market concentration / market power Unreasonable behavior (e.g., price cartels, dumping) Unfair behavior (e.g., false promises and cheating)

60 S Critique to the Economic Approach How Relevant? 3.3. Limits of the economic approach Moral limits of the market Economic exchange may be immoral or harmful. Economics is a value-neutral (amoral) science. It can hardly help to decide which goods should be allocated by the market and which goods should be allocated by nonmarket principles. Sandel, Michael J. (2012): What Money Can t Buy: The Moral Limits of Markets. London: Allen Lane. Sandel, Michael J. (2013): Market Reasoning as Moral Reasoning: Why Economists Should Re-engage with Political Philosophy. Journal of Economic Perspectives, 27(4), See also

61 S Critique to the Economic Approach How Relevant? 3.3. Limits of the economic approach Moral limits of the market Examples for market transactions that might be regarded immoral: Sex for sale Pregnancy for pay Selling citizenship (by the state, by citizens) Selling a kidney or a child for adoption Selling votes in political elections Paying to kill animals (e.g., shoot a walrus) A market for human blood.... Trading certain goods on markets may lead to the erosion of morals in a society. There are moral limits to market allocation! However: Will it help the animals if hunting is probited?