Henry Manne on Behavioral Economics

7 December 2010 at 9:59 am Peter G. Klein 1 comment

| Peter Klein |

Henry Manne’s contribution to the Truth on the Market symposium on behavioral economics brought to mind Lasse’s recent post (and the accompanying brilliant paper) on the survivor principle:

What I would like to point out . . . is the irrelevance of much of the substance of Behavioral Economics for “doing” economics. My principal (as a matter of fact my sole) authority for this proposition (though some of Gary Becker’s work also comes to mind) is the magnificent classic article by Armen Alchian, Uncertainty, Evolution, and Economic Theory, 58 JPE 211 (1950). In this work Alchian is himself taking on the “full information” assumption of the classical model, which is actually broader than the rationality assumption attacked by the Behavioralists. The basic conclusion of that work is that, even if individuals or firms make totally uniformed choices (to say nothing of merely somewhat irrational ones) the end result as far as the allocation of resources is concerned will be the same as in the traditional model. This is so because the theory of competition in the classical model is itself a survival theory, and the survival mechanism will operate to winnow out the less efficient uses to which resources will unknowingly or irrationally be put, even if the human actors don’t understand the process or their role in it. Of course, an economy based on this (again) purely heuristic assumption of perfect ignorance would not be as productive as one in which information and rationality play their usual assigned roles, but the difference may not be so great as would first appear and there is nothing peculiar or earth-shattering about finding that there are transactions costs in the world and that in equilibrium they will be accounted for. And, as one begins to add notions of imitation and improvement, as Alchian does, one gets very close to a highly descriptive model of the real economy, and one which has plenty of room in it for all sorts of irrational behavior but without throwing the received theory out with the bath water.

The point that behavioral economics neglects the role of market competition as a moderator between individual behavior and aggregate outcomes is a good one. (We’ve discussed other problems with behavioral approaches before.) Still, I side with Kirzner in his debate with Becker; an entrepreneurial view of the market requires some notion of purpose or intent — I prefer the term judgment — but one far removed from the neoclassical economics, straw-man notion of “rationality” attacked by the behaviorists.