Review of the book "Misbehaving - The Making of Behavioral Economics" by Richard H. Thaler.

I have complex feelings about the field of economics. Note that I didn’t say the "science of" economics. I pretty clearly don’t believe that word is appropriate, "dismal" or not. Formal study of economics was a requirement for my university degree and since those innocent beginnings I’ve had serious philosophical doubts about the field. I remember thinking at the time that I should be able to convert the knowledge I was receiving in an economics class directly into cash. Either that or what exactly is the point? I have taken engineering classes which I felt I could indeed convert directly into a conceptual design for a reasonably safe bridge. I don’t feel this way about economics at all. At its best I feel there may be elements of truth in the field’s orthodoxy but to me it mostly seems like astrology which also contains elements of truth and also has not made me a penny richer.

I remember sitting in those economics classes looking at supply/demand curves etc. and getting an unsettling sense that they were tacitly doing something the culture of physics is quite honest about; they were talking about spherical cows in a vacuum. I think that physicists don’t mind this because such simplifications often lead to a deeper understanding of the situation. Physicists gloat over the fact that real cows falling through the earth’s dense atmosphere can actually be approximated by an amalgamation of spherical cows in a vacuum. This sort of thing is even true for computer science too.

Unfortunately for economists who styled their art after such thinking, this is not how economics works. Useful economics must primarily ask questions like, "Why the hell would someone throw a cow from an airplane?" Only in the last few decades has economics started to turn to such questions. It’s been a radical transformation. So radical that economics has bifurcated into "economics" and "behavioral economics". I believe it’s only a matter of time before "behavioral economics" changes its name to "economics" and the old economics is forgotten like the old geology that couldn’t acknowledge plate tectonics for half a century despite overwhelming evidence.

This book is basically the inside story of this transformation from the perspective of one of its leading revolutionaries. Thaler does seem about as well qualified as anyone to tell the tale. First, not only can he appreciate that real human beings are generally the participants in economic activity, he also knows that real humans do not like reading the kind of prose normally written by economics professors.

Richard Thaler does also seem to be one of the most important economists to the field of behavioral economics. If any one person created the field it would be him. (Of course I just read a history of the subject written by him so maybe I’m biased.) The only people perhaps more important to the field are Tversky and Khaneman who, despite winning a Nobel prize in economics, are ostensibly and revealingly not economists.

The book is a superb introduction to behavioral economics. Beyond the interesting history of this new field, it contains many fascinating insights into how markets behave. Or don’t. It contrasts the new thinking with old ideas like the "efficient market hypothesis" of traditional economics. Here is Thaler and EMH’s creator, Eugene Fama, having an excellent discussion about it. The EMH basically says if you see $10 lying on the ground it must be an optical illusion because if it were real, someone would have already picked it up. I am sympathetic to the idea that beating the market (i.e. reliably finding unclaimed money) is extremely hard and perhaps impossible. But I believe that if it’s possible or impossible, the reasons mostly involve the problems of irrational thinking. It’s difficult for me to conceive of how a steaming load of irrational thinking can create efficient markets (as Fama allows may be possible).

I think what I like about this book is that it really nicely chronicles the field of economics going through a serious philosophical rethink. I am more interested in the philosophy of the topic and I see many parallels with my main philosophical interest, probability. Not only are humans easily tricked into believing in obvious incorrect future outcomes, but how we even think about the concept of predicting future outcomes is extremely tenuous. This business about economics (behavioral or Newtonian) lacking predictive power is obviously important. It may be that economics can be defined as: the philosophy of looking at the world in a way that if a reliable rule to predict the future is discovered, the rules instantly change. I have to say I lean that way, but, obviously not entirely. If I did, it would be utterly pointless to even think about economics.