Abstract revolutions or: if something is new, the old thing must be bad

There is a part of this small, otherwise enjoyable article about the advent of neuroeconomics that bothers me. The premise of the piece is that neuroeconomics is "seeking a physical basis for [economic theory] inside the brain". This is a field that is certainly sexy and possibly exciting; a while back I argued that it is a field that in some sense rediscovers the absolute primacy of "preferences" as the keystone of economic theory. I said:

The potentially exciting thing about neuroeconomics is that, even allowing for inexactness, it might tell us more about the actual hedonic motivators of people. Ambitious, yes, but not unimaginable. Of course, to an economist who wasn't under the mistaken impression that simplified preferences are supposed to be realistic, it might just amount to saying "your simplification is a simplification", which is slightly less exciting news. Or not news at all.

OK. In today's article, we learn that 

modern economic and financial theory is based on the assumption that people are rational, and thus that they systematically maximize their own happiness, or as economists call it, their “utility.”

Since it's hard to figure out what is going on in people's heads, the argument continues, we employed an idea called revealed preference, the reconstruction of unobserved objectives from observed choice. Neuroeconomics, the claim runs, may one day be able to identify brain structures that are associated with various components of choice, and so neatly sidestep the problem of unobservability.

But this is much too much:

While Glimcher and his colleagues have uncovered tantalizing evidence, they have yet to find most of the fundamental brain structures. Maybe that is because such structures simply do not exist, and the whole utility-maximization theory is wrong, or at least in need of fundamental revision.

Utility-maximization theory is wrong. It is wrong by construction, because it is a model, and models are wrong by construction. Why must we go through this? It might be easier to sell me an iPod if you first convince me that CDs are useless, but that's marketing. Why do we need to market neuroeconomics this way? That tiny little word "wrong" up there is a sin, because it belies the very essence of modeling as a means to make sense of things.

Is it perhaps that what we should understand by the quote is that looking into the brain will tell us that people are not, in some sense, maximizing their hedonic pleasure by the choices they make? This amounts to both an attempt to open the black box called "preferences" and to pin down the (biological?) process by which decisions are actually made. If this is the sense in which utility-maximization will be proved "wrong", then in the first place it is not clear to me that neuroeconomics can accomplish such a thing. Leaving aside the tricky questions of intent, free will and consciousness, can there be anything inside the black box but another, and another? The leap from the correlates of physical choices in brain activity to the content or existence of a utility function is huge.

But more importantly, even taking literally the notion that we will be able somehow to trap preferences or process in a cage, it is surely impossible that any breadth or depth of evidence on what these preferences are could preclude the need for us to model. What if the thankless treadmill of refining imperfect models of the world could at last be switched off, that there is an apple of knowledge that will free us from the need for models ever again? This is a seductive idea, but it cannot be. To do away with models would be to be as complex as reality, and that is a fight that reality will win every time. 

More rationality, and a million models

Here is an article on a conversation with Raquel Fernández that I found very interesting. The whole thing is worth reading, but I will quote at length this passage on rationality:

There is a beauty to the models in and of themselves. You assume, for example, that people are rational. I don’t think any really good economist thinks that people are perfectly rational, but, on the other hand, if you want to model people as not rational, all of a sudden it’s not clear what choice you should make. There are a million and one ways to be non-rational; there’s only one way to be rational within the confines of a model. Rationality means one thing: you’re maximizing your welfare subject to constraints. Now, if you say people don’t always maximize, and they’re beset by this and that, then all of a sudden you can have a million models. And that’s a little bit unsatisfactory too.

This is pretty close to my own view. My extra take is that any "irrational" behavior - and so anything that the "million models" generate - can be rationalized, either by revising what we assume that the decision-maker cares about, or by adding constraints on the decision-maker's ability to choose: the question of rationality is a red herring.

Daniel Kahneman and the rational choice model

Daniel Kahneman has a new book, "Thinking Fast and Slow", that is prompting a lot of excellent articles about his work. For example, Vanity Fair has a nice article by Michael Lewis. Back when I was an undergraduate, Kahneman and Amos Tversky's Prospect Theory paper was one of the first academic papers I read that motivated me to become an economist.

The article quotes Kahneman as being astonished to learn early in his career that:

The agent of economic theory is rational, selfish, and his tastes do not change.

I just want to point out that this model of decision-makers in economic models is more innocuous than it seems. It means that when we put a decision-maker in an economic model, we assume that she

•  has things that she cares about, and
• will do the best she can to achieve the things she cares about. 

This is what we mean by rationality. The great thing about this assumption is that it is completely flexible - it can accommodate any preferences at all.

For example, the decision-maker might care about the wellbeing of her neighbor, and so give up some of her own material wealth to help her neighbor be better off. This is both rational and selfish!

For any decision we observe, some preferences will rationalize it. As economic theorists, the crucial assumption is therefore not rationality, but on what it is that the decision-maker cares about and what constraints there are on her making a good decision.

The great contribution of Kahneman and Tversky was to present evidence on the psychological constraints on our decision-maker's ability to achieve the things she cares about. Making decisions is hard: even if I know what I want to achieve, "doing the best I can" is subject to how I process the options I have to choose from.

Rationality is not supposed to be a realistic model of the process by which people actually make decisions. Rather it attempts to capture the outcomes of decision-making in a plausible way, so that we can try bit by bit to analyze economic settings without simply saying "people are completely unpredictable, so let's give up". Kahneman and Tversky helped to show how to write models of rational choice that better reflect the decisions we observe people make.