A Nightmare of a Dream Team
Dec 19, 2011, Vol. 17, No. 14 • By ANDREW FERGUSON
Is it possible that the people who run the Obama administration aren’t as smart as we’ve been led to believe?
If we save our stimulus cash, do we still get cheese?
Stay with me here, seriously. I’m thinking now of the administration’s much-publicized devotion to behavioral economics. Not long after his election, Time magazine noted that Barack Obama had surrounded himself with a “dream team” of behavioral economists, outside-the-box envelope-pushers like Peter Orszag, who became the administration’s first head of the Office of Management and Budget, and Cass Sunstein, whom the president appointed as his “regulatory czar.”
Behavioral economics is très chic. All the coolest economists are into it. It partakes of the obsession with social science that has lately gripped the country’s smart people, who exhibit a grinding need to quantify human behavior so that it will become more predictable, describable, and controllable. To meet demand, a steady flow of “studies” in human behavior passes through the sluice gates of university departments of accounting, psychology, marketing, sociology, business, and of course economics. From these the behavioral economists build vast edifices of theory and now, thanks to President Obama, public policy too.
The most salient of these policies was the Making Work Pay tax credit of 2009 and 2010. It was an essential element of the president’s famous $250 billion “middle-class tax cut,” which was slapped like a defibrillator onto the limp and supine figure of the American economy a couple years ago. The MWP was carefully designed according to the principles of behavioral economics, and now it seems not to have worked the way it was supposed to.
Behavioral economics is based on the belief that we human beings behave irrationally in measurable and predictable ways, and quite often we don’t have the slightest idea why we do what we do, though social scientists can do experiments that will tell us. This point of view contrasts with the working premise of more traditional economics, which assumes that people will pursue their economic self-interest, rationally defined.
When the Bush administration decided on a temporary tax cut to stimulate the economy, in 2001 and again in 2008, they merely sent everybody a lump-sum check, assuming that we’d all spend it and send a good jolt through the ol’ defibrillator.
The Bush administration, as we all know, was not très chic. It was full of fuddy-duddies. They didn’t understand the up-to-date social science experiments with which behavioral economists keep current. The Obama administration, by contrast, decided it would be scientific. Its economists designed what a headline in the New Yorker called “A Smarter Stimulus.”
The New Yorker’s finance columnist quoted Richard Thaler, a prominent behavioral economist (and colleague of Sunstein). He has decreed one of the axioms of his discipline—that ordinary people put money into “mental accounts.” What he means is that we will be more or less likely to spend money depending on how we think of it and how we came by it. If it’s just dropped in our laps, we will think of it as wealth. If it’s given out to us over time in small amounts, we will think of it as income, if we notice it at all. The distinction is crucial in understanding how we humans spend and save.
“People tend to consume from income and leave perceived ‘wealth’ alone,” Thaler told the New Yorker columnist, who went on to explain the policy implications.
In giving a tax cut, he wrote, “you don’t want to give [taxpayers] one big check. . . . Instead, you want to give them small amounts over time.” Why? Because we won’t notice the small increases in income that the tax cut gives us when it’s spread out over many months. Oblivious to what the government has done for us, we’ll just go ahead and treat it like all other income and spend it in marvelously stimulative ways.
Obama’s economists thus designed a tax cut that would give us more money by decreasing the amount of income withheld from our paychecks. It was a way of outsmarting the taxpayers. The behavioralists were tricking us, as it were, into spending money that we might otherwise save. Sometimes such tricks are necessary. Remember: We’re irrational.
Irrational, but also stubbornly uncooperative. Not long after the adjustments in withholding took effect, a trio of economists decided to try to figure out how we planned to spend our new money. They surveyed a “representative sample of households,” 500 in all, and simply asked the question. Their findings were recently released.
“Just 13 percent of households,” they wrote, “said that the 2009 tax credit would lead them to mostly increase their spending.” The other households said they were going to save the tax-cut money or use it to pay off debts. Morons.
Perhaps most shocking to the behavioralists, a similar survey of Bush’s 2008 lump-sum tax cut found that 25 percent planned to spend more in response to it. Neither cut was very stimulative, in other words, but the lump-sum was twice as stimulative as the incremental tax cut. People were not responding the way they were supposed to.
It’s hard to imagine a more thorough repudiation of the behavioralist thesis. And the longer you look, the more the new findings appear to undercut the entire enterprise of behavioral economics.
The behavioral economists were in no mood to concede any essential points, however. Thaler told Businessweek that the new study was fraught with methodological problems.
“The work is certainly worth doing,” he said. “But you can’t do it by asking people to remember what they did with the money.” He listed two other problems that Businessweek paraphrased like so: “People are . . .not very reliable sources of information about their own . . . future spending; and they’re often blind to the things that actually shape their financial decisions.”
This last point is just question begging; Thaler simply reasserts the premise of behavioral psychology—that we’re irrational and don’t know quite what we’re doing or why at any given moment. His other criticisms are keener. As he notes, “self-reporting”—that is, people telling researchers what they’ve done or what they’re about to do—is notoriously unreliable, imprecise, and misleading.
Yet self-reporting is also one of the cornerstones of social-science research, and hence of behavioral economics. Indeed, in gathering the scientific evidence for why their incremental tax cut would work, the behavioralists relied on a study of withholding adjustments made in 1992. The study’s findings rested completely on self-reporting.
How did the behavioralists know their design would work? On what basis did they believe that human beings would behave the way they insisted they would?
Why, science, of course. The study most often cited by behavioralists was undertaken in 2007 and published in 2008. Two researchers at Texas A&M Corpus Christi decided to test the mental-accounting theory. They recruited 141 students and asked them to pretend that they had received a tax refund. Then the researchers—one an accounting professor, the other an economist—gave them all a questionnaire (or “the instrument,” as social scientists call it, sounding scientific). The questionnaire asked the students how they would use the rebate if it was given in a lump sum. Would they invest in stocks, pay off their credit cards, use it for monthly bills, buy furniture or some other durable good, or save it up so they could blow it on a vacation later?
Then the students were asked to pretend the refund had been given them in monthly increments. How would they spend the money then?
And there the experiment ended. The two researchers pored over the answers their students gave and concluded that they had established a truth about the behavior of the human animal. People will spend different kinds of income differently. They keep mental accounts!
They got up a paper and published it in the Journal of Economic Psychology. “Results confirm,” they wrote, “that monthly refunds stimulate current spending significantly more than yearly refunds.”
And so the Obama administration designed its tax cut accordingly. “It’s a policy that works with people as they are,” the New Yorker columnist wrote, “rather than as we imagine they should be.”
This is a key conceit of behavioral economics. Its practioners like to contrast themselves with traditional economists, who are caught in airy, purely theoretical conventions of their own devising—the idea that people behave rationally in their own self-interest, for example. The behavioral brand of economics, on the other hand, is about “how real people behave in markets.”
In reality, it’s about how college students behave in psych labs. And it turns out that college students, even those fine young men and women at Corpus Christi, are not very good proxies for humanity in general.
The question for the behavioralists is whether people are behaving irrationally in refusing to respond to the tax cut as they were supposed to. You could argue that the rational thing for a person to do when he comes in for a windfall in times of economic stress is to save it or pay off his debts. And that’s what Americans did, apparently, whether the stimulus came in a lump sum, as in 2008, or in increments, as in 2009.
In predicting they would do otherwise, the très chic economists thought they had science on their side. In fact, they didn’t have science on their side—they had a flimsy record of fewer than 150 undergraduates who told a handful of graduate students in a Texas classroom in early 2007 how they thought they might behave in a fanciful situation.
Who knew that 141 students in Corpus Christi would wield so vast an influence over U.S. economic policy? Who knew that the government would be run by intellectuals silly enough to let them wield it?
Andrew Ferguson is a senior editor at The Weekly Standard and the author, most recently, of Crazy U: One Dad’s Crash Course in Getting His Kid into College.
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