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A Book Review of Misbehaving: The Making of Behavioral Economics

By Andy Yue
Senior Economics Major from Zeng Zhou, China
Reviewed December 18, 2015

As the title of the book suggests, the center focus of this book is behavioral economics. The author, Richard H. Thaler, is a professor of behavioral science and economics at the University of Chicago Booth School of Business. As one of the major contributors to the establishment of what we known today as behavioral economics, Thaler wrote this book to record his own journey of exploring behavioral economics as well as to suggest to his readers that the “behavioral approach” is a better way of doing economics compares to the conventional “rational approach”. Thaler’s book is both historical and educational, informative and argumentative.

In the early chapters of the book, Thaler first examined the problems and limitations of the traditional way of doing economics. Most traditional economic theories, as Thaler argues, “[are] not derived from empirical observation. Instead, it is deduced from axiom of rational choice, whether or not those axioms bear any relation to what we observe in our lives every day.” (p. 348) The fundamental assumption of traditional economics is the assumption that people will maximize the resources they have. However, in real life, very few people have the proper skill sets to maximize the resources they have. Even if they have the proper skill sets, they would not have the time to go through the intricate thinking and calculation required to maximize the resources they have every time they need to make a decision. Hence, the fundamental assumption that “people will maximize the resource they have” is divorced from reality, and it necessarily follows that traditional economics, which is constructed on top of this very assumption, is divorced from reality.
           
With the sober understanding of the problems and limitations of traditional economics, Thaler calls his readers to seek better ways of doing economics. In the book, Thelar suggested two better ways—the “behavioral approach” and “clever econometrics”.  Both of these two ways of doing economics share the same distinctive characteristic—data driven. The core of the “behavioral approach” is controlled experiments, instead of assuming what people would do in a given situation, behavioral economists gather data from carefully controlled experiments to find out what people actually do in a given situation. The majority of Thaler’s book is about various behavioral experiments he conducted, and how SIFs (supposed irrelevant factors) influence people’s decision-making process. The results of these experiments uniformly refuted the fundamental assumption of traditional economics. Thaler did not write much about what he calls “clever econometrics” in this book since it is not the center focus of the book. Nonetheless, it is not hard to recognize that “clever econometrics”, similar to the “behavioral approach”, also requires an enormous amount of real world data. This emphasis on empirical observation is what made these two ways of doing economics vastly different from the traditional way of doing economics.
           
In the conclusion of the book, Thaler pointed out the fact that the “behavioral approach” has became one of the mainstream ways of doing economic studies and it has helped people in many different areas, especially in finance. Overtime, people have increasingly realized the limitations of conventional financial indicators (such as price), and many investors are starting to shift their focus from theoretical analysis to real-world observations. And this shift of focus has made people more rational (in the sense that their decisions are more based on reality), and it has produced tangible developments in the market.
At the same time, Thaler also pointed out the fact that in some areas of economic study, which the “behavioral approach” could help greatly, people have not yet adopt this new and better way of doing economics; instead, the majority of the economists in these areas still insist on traditional economic theories. Among these areas, macroeconomics is one that matters the most to the society as a whole. Thaler believes the way we do macroeconomics will be improved as we introduce the “behavioral approach” into the discipline. The introduction of the “behavioral approach” into macroeconomics is also critical for promoting economic freedom. In the past, government officials often base their important economic decisions on hypothetical, sometimes arbitrary, assumptions and misunderstand the need of the society and its people. Because of this, their decisions often turn out working against the society’s interests, and thus undermine economic freedom. It is to the society’s best interests to meet the needs and maximize the happiness of its members. To achieve this goal, the society must produce goods that meet people’s needs and allows the free exchange and distribution of these goods. The role of the government is to promote the production and distribution of the goods that meet people’s needs. With the “rational approach”, government officials often decide what people need, instead of observing what people truly need. As the result of this approach, government polices often end up promoting the production of goods that people don’t really need, and taking resources away from the free production of goods that meet people’s needs. These policies also restrict the free exchange of goods and services, instead of allowing people to freely exchange goods they don’t need for goods they need, the government makes the decision regarding what should be exchanged since people’s needs have already been decided. Under such approach, people’s ability to freely use their resources is also undermined by rigid tax polices. With the help of the “behavioral approach”, government agencies would be able to base their decisions on real world situations, instead of basing their decisions on hypothetical assumptions. As the government officials based their decisions on empirical data, they may better understand what the society and its people truly need, and provide the necessary assistances to fulfill these needs, thus promotes economic freedom.
           
At the very end of the book, Thaler challenges his readers to “observe, collect data and speak up.” This sums up some of the essential aspects of economic freedom—observing the world as it is, then confirm the observations with real world data, and speak up when there is a problem. By doing these, we may know better what to produce to meet people’s needs. By doing these, we may also know better the ways of exchanging and distributing these goods to maximize people’s happiness. By doing these, the government may be an aid in the free production, exchange and distribution of goods that meet people’s needs. Nonetheless, one thing we must take notice is the fact that economics and politics are indivisible from each other. Practices that make better sense economically may not be adopted for political reasons. Even when the government officials were presented with better conclusions made by using the “behavioral approach”, they might still ignore these conclusions due to political concerns.