Friday, December 23, 2016

World Bank Report on Behavioral Economics

Humans in the real world behave in ways that are strikingly inconsistent with rational models based in economics. Bounded rationality, bounded self-interest and bounded self-control in human is a pure fiction, not a reality. With these assumptions, the profession of economics with its obsession with mathematical modelling has, over time, hopelessly removed from the complexities on the ground. Global Recession of 2008 was a jolt to the the neoclassical free market purists who were unable to predict market failure. The shock led to to the mainstreaming of behavioral economics. Behavioral economics is a subfield of economics that draws on the psychological, social, and cultural foundations of human decision making.

A Mckinsey report: Redefining Capitalism has summarized this quite good -  Over the past several decades, though, some of the bedrock assumptions of neoclassical theory have begun to unravel. Behavioral economists have accumulated a mountain of evidence showing that real humans don’t behave as a rational homo economicus would. Experimental economists have raised awkward questions about the very existence of utility; and that is problematic because it has long been the device economists use to show that markets maximize social welfare. Empirical economists have identified anomalies suggesting that financial markets aren’t always efficient. And the macroeconomic models built on neoclassical ideas performed very poorly during the financial crisis.

I have previously written on World Bank reports too in a grim sense. But this is different and big. Mind, Society, and Behaviour is a World Bank report of 2015 that will lead to major redesign in the field of Development Economics and Development Policy. The resource material is good for a detailed study and can be utilized as an example for a beginner as well as expert. As per Kaushik Basu, Senior Vice President and Chief Economist of the World Bank :"This Report distills new and growing scientific evidence on this broader understanding of human behavior so that it can be used to promote development. Standard economic policies are effective only after the right cognitive propensities and social norms are in place." (Source)

The report considers the importance of irrational and often unpredictable behavior in human decision making. It is based on theoretical and investigative work that comes with uncovering the underlying rhythms and rules of human behavior. The report stresses that focusing more closely on correctly defining and diagnosing problems with human element can lead to better designed interventions. The report applies the three principles to multiple areas, including early childhood development, productivity, household finance, health and health care, and climate change.

I will quote a passage of the report (page 22) for the glimpse: From the hundreds of empirical papers on human decision making that form the basis of this Report, three principles stand out as providing the direction for new approaches to understanding behavior and designing and implementing development policy. First, people make most judgments and most choices automatically, not deliberatively: we call this “thinking automatically.” Second, how people act and think often depends on what others around them do and think: we call this “thinking socially.” Third, individuals in a given society share a common perspective on making sense of the world around them and understanding themselves: we call this “thinking with mental models.”

Solving last mile challenges and Behavioural Change and The Making of Homo Honoratus: From Omission to Commission are examples of how behavioural quirks lead to success in the public policy. Economics without debates, politics or history is a dead mathematical exercise devoid of any intellectual and humane base. The past is already gilded with Locke, Bentham, Mill and Rawls. In the current age of techno-utopianism, the new star in town is Professor Daniel Kanheman. The transformation of Homo economicus to Homo sapiens has began.

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