Friday, 7 March 2014

Behavioural economics: a short run phenomena?

Peter Klein at the Organizations and Markets blog points us to a paper which looked at an Indian tea plantation that changed its employment contract in such a way as to weaken the pay-for-performance incentives and found a substantial increase in output ... at least in the beginning.
In the one month following the contract change, output increased by a factor between 30-60%, the exact number depending on the choice of counterfactual and the set of controls applied. This large and contrarian response to a flattening of marginal incentives is at odds with the standard model, including one that incorporates dynamic incentives, and it can only be partly accounted for by higher supervisory effort. We conclude that the increase is a “behavioral” response.
So the behavioural economists will be happy.

Yet in subsequent months, the increase is comprehensively reversed. In fact, an entirely standard model with no behavioral or dynamic features that we estimate off the pre-change data, fits the observations four months after the contract change remarkably well.
So standard incentive theory strikes back.

The findings of the paper suggest that the behavioural responses may be transitory, especially in employment contexts in which the baseline relationship is delineated by financial considerations in the first place. This change over time does not sit well with the behavioral economics models. The paper's results also suggest that when considering an empirical strategy for looking at changes in contracts it is better to examine responses to the change over an extended period of time.

1 comment:

Jim Rose said...

George Stigler in the 1960s made a marvellous critique of what became behavioural economics back in the early 1960s by saying that in every decade for the last 150 years, economists dabble in psychology.

They missed the point of economics as a method. The simple hypothesis behind economics is so powerful because it can account for so much of human behaviour.

Richard Posner went further and argued that behavioural economics may not be a science in Popper's sense of falsifiability.

He referred to Cardinal Bellarmine’s famous debate about what he saw in Galileo’s telescope which was pointing to the moons rotating around Saturn. Cardinal Bellarmine explained this way as a trick of the devil.

Behavioural economics, in Posner’s view, is close to explaining anomalies either as cognitive quirks or rational behaviour. Nothing is an anomaly for behavioural economics so nothing can falsify it.

Posner’s key point was “Rational-choice economics makes the analyst think hard. Faced with anomalous behaviour, the rational-choice economist, unlike the behavioural economist, doesn't respond, "Of course, what do you expect?" Troubled, puzzled, challenged, he wracks his brains for some theoretical extension or modification that will accommodate the seeming anomaly to the assumption of rationality.”