Who said we were rational beings?

March 2, 2007

If you have ever blown your pay cheque on designer shoes or the latest gadget rather than putting it towards your pension, then you know that people do not always make rational economic decisions, writes Chloe Stothart.

Now two economists are calling for psychological theories to be allied with economics to help explain apparently illogical economic choices.

For most of the 20th century, economics has been based on the assumption that people make rational economic decisions, but Robert Sugden of the University of East Anglia and Luigino Bruni from the University of Milan-Biocca, Italy, say many of these theories do not stand up to scrutiny in experiments.

In a paper in the latest issue of Economic Journal , they argue that economics should reclaim the link it had with psychological theories of pleasure and pain in the 19th century but lost in the 20th.

Professor Sugden said interest in behavioural economics, which draws on psychology to explain economic choices, was on the rise. It was considered an "eccentric" branch of the science in the 1980s but has been growing since the mid-1990s, he said.

Behavioural economic theories are now making inroads into political thought. For example, they can shed light on obesity, gambling or inadequate saving for retirement because they show people cannot pass up pleasure today to be better off tomorrow.

Professor Sugden asked: "Does it create a justification for the Government to intervene? For example, should we compel people to save because of the psychological evidence that they are suffering from weakness of will, or should we be more libertarian?"

Even happiness has come under scrutiny. Richard Layard, founding director of the Centre for Economic Performance at the London School of Economics, has found that people in the West have become richer but not happier, contrary to rational expectations.

But behaviouralist economists admit that there are still a few situations where rational choice economics applies. Professor Sugden said: "In areas that are professionalised or where repeated decisions are taken, I would expect rational choice theory to work reasonably well," he said. For example, people driving from home to work daily would eventually be expected to choose the best route based on their experiences from making the journey repeatedly.

Daniel Kahneman, psychologist and public affairs professor, who published a ground-breaking paper on the link between psychology and economic behaviour in 1979, finally received the Nobel Prize in Economics in 2002.

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