Methodenstreits between
behavioural and neoclassical (or
keynesian) economics
Vladimir Avtonomov
National Research University Higher School of Economics
Moscow
Primakov NRI IMEMO of the Russian Academy of Sciences
Moscow
The tale of two canons
• Methodenstreits in the history of economics
seem to be focused on the degree of
abstraction permissible in the economic
science
• There is an approach of differentiating
between two canons of economic science
according to the degree of abstraction (Erik
Reinert)
The tale of two canons 2
• The First more abstract canon is deductivist,
based on metaphors and models borrowed from
natural sciences (such as equilibrium), uses a
simple assumption of human motivation (homo
oeconomicus).
• The Second canon is less abstract, based on
everyday experience, plurality of human
motivation. It is inseparable from specific local
and temporal contexts. Its main objective is to
produce a useful economic theory
When does a MS come about?
• MS emerge when in one of the canons there
is a breakthrough: a new technique of analysis
is invented and used ( marginal analysis, game
theory/expected utility hypothesis in the first
canon, or psychological and sociological
methods in the second).
What happens during a MS?
• 1/ Both canons tend to exaggerate their
differences but this helps to draw general
attention of scientific community to important
methodological problems.
• 2/ The dispute leads to a “victory” of one of
the sides
• 3/ Both sides take into account the position of
their adversaries often using their
instruments (progressive stage)
Mini-MS 1/ Simon against
maximization
• Instrument : case-studies in organisations
• Challenged: neoclassical microeconomics
(maximisation assumption)
• Simon proposed a bounded rationality model
(using the psychologial concept of aspiration level
introduced by Kurt Lewin) as an alternative to
full rationality with maximizing.
• He described some algorithms (heuristics) of
decision making which could be considered as
optimizing decision. But these heristics did not
approximate the global optimum.
Mini-MS 1 Stage 1
• Counterarguments: Neoclassical economists
argued that taking into account the costs of
acquiring information would make
behavioural economics excessive.
(Stigler,1961).[Infinite regress]
• Bounded rationality didn’t allow prediction of
human behaviour, assuming it to be too
volatile. [Ronald Heiner rather conclusively
proved the opposite (Heiner, 1983)].
Mini-MS 1 Stage 2
• In general Simon’s challenge was not
accepted by the mainstream economists.
Simon received the Nobel prize in 1978 but in
this rare case the Nobel prize seemed to be
delivered ahead of time before the acception
to the mainstream
Mini-MS 1 Stage 3
• Synthesis Simon’s ideas made their way into
economic theory including its influential
branches.
• New institutional transaction costs economics of
OLiver Williamson (already mainstream),
• X-efficiency theory of Leibenstein,
• evolutionary economics of Nelson and Winter,
• 'cognitive economics' using networks and agentbased simulations
Mini MS 1a between R.Lester and
F.Machlup (marginalist controversy)
• Instrument: the survey method
• Challenged: the realisticness of neoclassical
microeconomics
• American Economic Review 1945-1950
Mini MS 1a Stage 1
• R.Lester conducted a survey of manufacturers
which proved that they never used “equating
at the margin” while deciding how many
workers to hire and how much output to
produce.
• Fritz Machlup disproved Lester’s thesis about
non-validity of neoclassical theory on
methodological grounds (as if) later
elaborated by M.Friedman
Mini Ms 1 a Stage 2
• Machlup was proclaimed the winner
Mini MS 1a Stage 3
• Baumol’s and others’ theory of the firm with
alternative goals
Mini-MS 2. Around incorporation of
von Neuman/Morgenstern
behavioural axioms in economics
• Instrument: psychological experiments
• Challenged:expected utility hypothesis
• This Mini-MS evolved around two discoveries :
game theory and expected utility theory on
the side of the First Canon and psychological
experiments on the side of the Second
Mini MS 2.1. Stage 1-2-3
• in 1952-1954 – the dispute between M.Allais
and L.Savage.
• Savage did not recognize his defeat but
corrected his position (normative/decriptive)
Mini MS2.2 Stage 1
• 1970-ies new psychologists’ reseach from the
University ofMichigan: Slovic and Lichtenstein
preference rev ersals
• Counterarguments: laboratory experiments could
not approximate the real economic behaviour.
The important experiments by Grether and Plott
(1979) who aspired to prove these theses
surprisingly proved the opposite: anomalies can’t
be eliminated by perfection of experimental
techniques.
Mini MS2.3. Stage 1
• The new real MS was observed in 1985 at the
Conference in Chicago University organized by
R.Hogarth and M. Reder. (“ The Behavioral
Foundations of Economic Theory”, 1986).
Mini MS2 Stage 3
• On the one hand behavioural economists did their best to
become more model-like (prospect theory of Kahneman
and Tversky). In fact Tversky and Kahneman inherited
Savage’s descriptive/ normative distinction. Normative
theory is OK! They gave the descriptive one.
• R.Thaler pointed in his works towards empirical correction
of neoclassical consumer choice theory (disregarding
opportunity costs, taking into account sunk costs etc.)
• The new behavioural economics unlike the old one (Simon)
concentrated not on outright refutation but rather on
weakening or correcting neoclassical assumptions which
made them mainstream-compatible.
Mini MS2 Stage 3 - Institutional
synthesis:
• Research programms in behavioral economics
supported by Alfred Sloan and Russel Sage Foundations
included prominent psychologists and econmists
(Baumol, Schelling, Akerlof, Summers, Shleifer),
• The new journal of AEA (Journal of Economic
Perspectives opened with a series of Thaler’s articles
on anomalies (14 articles were published in1987-1991).
• С 1992 г – Behavioral Economics Roundtables (Akerlof,
Blinder, Camerer, Elster, Kahneman, Loewenstein,
Tversky, Thaler, Schelling, Schiller 4 Nobel prizes!)
training programs for graduates –
Mini MS2 Stage 3
• On the other hand, using experimental methods
new rules were designed that allowed people to
behave more rationally. (experimental economics
of Vernon Smith). Smith (began in 1959)
emphasized time and institutions required for a
market to reach an equilibrium. Extending
microeconomics through economics of
information and technology of transactions .
Smith studied not individuals but economic
agents
Mini MS2 Stage 3
• Neoclassical economists included
psychological results in their theories (Arrow
Risk perception in Psychology and Economics
1982).
MS 3 Katona against Keynesian
orthodoxy
• Instrument: social surveys
• Challenged: Keynesian macroeconomics and
macroforecasting
• Katona opposed “aggregate causality” of
Keynesian macroeconomics and argued that
intervening psychological variables should be
taken into account when analysing durable goods
purchases. These variables are significantly
affected by non-economic variables and could be
explored by means of surveys used in sociology
and social psychology
Mini MS 3 Stage 1
• Counterarguments: Katona’s psychological
intervening variables could be “approximated
away” by objective economic variables. Then
consumer confidence can be modelled without
any recourse to psychology.
•
• Katona’s reply was twofold: first intervening
variables are affected also by non economic
variables. Secondly: the subjective weights of
different variables can be learnt only from
respondents themselves.
Mini MS 3 Stage 2-3
• The dispute over these matters (surveyed by
Waerneryd, 1982) was rather long and ended
as follows: survey method was maintained by
its early practitioners in a rather narrow field
eliciting consumer and business sentiment
indexes for the purposes of business cycles
forecasting. CIRET conferences.
• Outside – not used
Mini MS 4 in finance
• Instrument: statistical data and
neuroeconomics
• Challenged: efficient market hypothesis :
prices on the financial markerts incorporated
all relevant information. There couldn’t be
such things as bubbles and one never could
beat the market.
Mini Ms 4 Stage 1
• Anomalies in this case were already there before the
EMH was formulated. One can just recall numerous
instances of financial panics or J.M.Keynes’s chapters
about financial markets in the General Theory
• Richard Thaler in 1985 introduced ( in the article
written with De Bondt) the term Behavioral Finance.
Thaler and De Bondt using historical data proved that it
was indeed profitable to buy underappreciated stocks
• Robert Shiller (1981) who began by proving that since
1871 present value of dividends was highly stable but
the stock prices were not
Mini MS 4 Stage 1-2
• During the above mentioned Chicago conference
Merton Miller was especially harsh in trying to
suppress Behavioral Finance
• Fama who at first argued that the more profitable
stocks were simply more risky had to concede (in
the article with French, 1992) that non risky
stocks proved to be more profitable, though they
proposed other measures of risk besides CAPM
to save the EMH.
Mini MS 4 Stage 2
• Fama and Shiller were simultaniously awarded
the Nobel prize – the draw!
Mini Ms 4 Stage 3
• Fama who didn’t accept behavioral movement
used another strategy to explain the evident
anomalies. He added to his models of financial
markets a new economic actor – general
public whose emotional and uninformed
reactions could lead to apparently irrational
behavior.
Mini MS 5 Thaler and Sunstein against
Law and Economics
• Challenged: Posner’s Law and Economics.
Coase theorem
• Endowment effects : loss aversion means that
people evaluate gains and losses
asymmetrically
Conclusions: some controversial
progress
• As a result of all this behavioral economists using economic models
as reference points and modifying them somewhere ascended to
the mainstream.
• Behavioural economics spread its influence among new segments
of economics: behavioural finance, behavioural game theory,
behavioural law and economics, behavioural industrial organization,
behavioural development economics and even behavioural
macroeconomics.
• experimental (psychological) methods were used to supplement
and prove neoclassical theory in the long run (V.Smith)
• mainstream economists adopted not the methods but some
general assumptions of behavioural economics for instance the
assumption of limited and asymmetrical information
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