Starting Assumptions

Once upon a time, economics was based on the assumption that human beings are rational. This is obviously false, so why was the assumption even made? Because without such an assumption, the field of economics couldn’t progress – how far can a theory that assumes people do irrational things ever progress? As that old saying goes, “All models are wrong, but some are useful”.

 

As economic theory started to influence government policies, the scrutiny and criticism of economic theories increased. Inevitably, that core assumption of rationality began to draw a lot of flak.

 

A new field called behavioral science developed – this basically said that humans often make irrational choices. The factors for that extend far beyond stupidity – they include all the unconscious biases that make us, er, human. Such as generalizing from just a couple of personal incidents to the universal; or only noticing facts that align with what we already believe. With this as the basis, a new form of economics called behavioral economics emerged – a famous policy that flows from this is the “defaults on forms”. If the government wants to encourage organ donation, for example, it is best to set the default on some commonly used government form to Yes. How does that work? People don’t bother to read the form; or even if they do, they feel guilty about changing the answer to No. Such measures don’t cost the government anything, and yet many Western countries found it increased organ donation significantly.

 

Today, says Pranay Kotasthane, a new description of human behavior is emerging. He explains this with an example. Buying lottery tickets. Purely rational analysis says this is a waste of money. That assessment, over time, nudges the government to more and more paternalistic and at times, even coercive measures to prevent such actions. The new theory of human behavior tells us to look for the “why” – why do people buy lottery tickets? Is it a cultural norm? A way to belong, be part of the group around you? Is it just cheap entertainment that gives one the chance to dream of “What if”? Or does it suggest a deep systemic problem, where people find upward mobility impossible and thus grasp at anything that seems like an opportunity, including lottery tickets?

 

Ok, but how does the new theory lead to different kinds of policies?

“(The focus would be) not just on individual behaviour change but also on addressing the systemic factors that make this behaviour appealing or necessary for some people. This could include efforts to increase economic opportunity, provide alternative sources of entertainment and social connection, and challenge cultural narratives around success and luck.”

 

Kostasthane frames the perfect summary about the kinds of policies that are framed with this one-liner:

“Our starting assumption matters. A lot.”