Should we Get Rid of the Preference Concept in Normative Economics?

Douglas Bernheim (with his co-author Antonio Rangel) is a major contributor of the recent developments within the so-called ‘behavioral welfare economics’ (BWE) research program. BWE can be viewed as an attempt to lay the theoretical foundations for the normative turn of behavioral economics that has been engaged in the late 1990s. Contrary to (too) many contributions within behavioral economics that merely take a casual approach to normative issues, the BWE pioneered by Bernheim and others builds on and extends the formal apparatus of welfare economics to cases of various behavioral inconsistencies. In this light, Bernheim’s recent paper “The Good, the Bad, and the Ugly: A Unified Approach to Behavioral Welfare Economics” published in the Journal of Benefit and Cost Analysis in which he attempts to develop a unified approach to BWE is worth reading for anyone interested in behavioral and normative economics.

Bernheim’s paper covers a lot of ground and makes many important points that I cannot discuss in detail here. I would retain however a very general idea that Bernheim never explicitly develops but which is nonetheless at the core of a key difficulty the normative turn of behavioral economics has given rise to, i.e. the problem related to the use of the preference concept in the normative analysis. Welfare economics has indeed historically made used of an account of welfare in terms of preference satisfaction. The pervasiveness of this account is due to several factors, at least two of them being especially prominent. First, the preference-satisfaction view of welfare is tightly related to a form of consumer sovereignty principle according to which economists should defer to individuals’ judgments regarding what is good or best for them. This principle may itself be justified on different grounds, for instance epistemic (individuals have a privileged access to the knowledge of what is good for them) or ethical (we must defer to individuals’ judgments because individuals are autonomous agents). Whatever the specific justification, the consumer sovereignty principle indicates that there are presumably strong reasons to view the satisfaction of preferences as being constitutive (or at least a good proxy) of welfare. Second, these reasons are strengthened by the formal isomorphism between the binary preference relation that is at the core of the notion of rationality in economics and the ‘better than’ relation that underlies any welfare judgment. As all microeconomic textbooks explain, rationality in economics correspond to the existence of well-ordered preferences over some domain of objects. In particular, this presupposes that the binary preference relation is transitive. On the other hand, there are good reasons to take the ‘better than’ relation as being intrinsically transitive – in the same way as the ‘taller than’ relation for instance. The fact that preferences and welfare judgments are well-ordered obviously makes easier (though obviously does not require) to assume that one can be directly mapped into the other. Problems however arise once it appears that individuals do not have well-ordered preferences. This is precisely the motivation behind the whole BWE approach.

As it is well-known, standard welfare economics essentially adopt a revealed preference stance and therefore associates welfare and choice. According to Bernheim, such an association is done on the basis of three premises:

Premise 1: Each agent is the best judge of our own well-being.

Premise 2: Our judgments are governed by coherent, stable preferences.

Premise 3: Our preferences guide our choices: when we seek to benefit ourselves.

Bernheim’s unified approach accepts (with several qualifications) premises 1 and 3 but rejects premise 2. This is important because, as I indicate just above, premise 2 has been essential in the economists’ endorsement of the preference-satisfaction view of welfare. In the normative writings of behavioral economists, premise 2 tends to be kept even in the face of experimental results by postulating that individuals have ‘true’ (or ‘latent or ‘inner’) preferences that failed to be revealed by choices. Crucially, these are these preferences rather than the actually revealed ones that are assumed to be well-ordered. Alternatively, it is sometimes assumed that individuals are endowed with several and mutually inconsistent preference orderings which, depending on the choice context, may determine one’s choice. Bernheim rejects, rightfully I believe, these views. He rather endorses the ‘constructed preference’ view according to which “I aggregate the many diverse aspects of my experience only when called upon to do so for a given purpose, such as making a choice or answering a question about my well-being”.

Bernheim’s endorsement of the ‘constructed preference’ view is important to understand why he continues to accept premises 1 and 3, even with qualifications. Regarding premise 1, he basically grounds it on the consumer sovereignty principle I discuss above. The qualification of premise 1 rests on the fact however that not all individuals’ judgments provide a correct assessment of their welfare. Berhneim argues for the distinction between ‘direct’ judgments, referring to ‘ultimate objectives’, and ‘indirect’ judgments, referring to the determination of means to achieve ultimate objectives. Only the latter but not the former are susceptible of mistakes that should be accounted for in the welfare analysis. Another way to state Bernheim’s claim is that behavioral economics cannot provide evidence for the fact that individuals are eating too much or insufficiently saving. But it can demonstrate that given their aims, individuals fail to make the best choices. Premise 3 then indicates that individuals’ aims, under appropriate conditions, indeed guide their choices. This makes choices often – but not always – a good indication of individuals’ welfare judgments. On this basis, Bernheim claims that choice-based welfare analysis should be regarded as preferable to approaches relying on self-reported well-being, including hedonistic measures favored by some behavioral economics. The unified approach to BWE Bernheim is suggesting proceeds through two steps: first, the behavioral welfare economists should determine the ‘welfare-relevant domain’ by identifying which choices merit deference (i.e. which choices are actually guided by welfare judgments); second he should construct a welfare criterion based on the properties of choices within that domain. Since there is no presumption that individuals’ preferences and judgments are well-ordered (rejection of premise 2), the resulting welfare-ordering will most of the time happened to be incomplete.

As I say above, the main lesson I retain from Bernheim’s paper is that we should probably completely abandon the preference concept in normative economics. To understand how I arrive at this conclusion, two points should be noted. First, Bernheim’s unified BWE approach does not rely on any assumption of the existence of true or inner preferences. There are choices on which the welfare analysis can build (the welfare-relevant domain) but this is completely unrelated to the existence of true preferences. The determination of the welfare-relevant domain will rather depend on the identification of mistakes or cases of lack of information and even once this is done, there is no guarantee that the choices will be coherent. Second, rather than preferences, Berhneim rather uses the term ‘judgments’ to refer to what is reflected by choices. Bernheim shows that ultimately the individual’s welfare judgments are reflected by a welfare relation that is isomorphic with a choice-based binary relation that has minimal formal properties (especially acyclicity). Interestingly, even if one rejects Bernheim’s choice-based approach, the alternative SRWB approach can also completely dispense with the preference concept since it does not need to stipulate that individual have well-ordered inner preferences.

As a conclusion, it may be worth remarking that Bernheim’s unified approach is somewhat ambiguous regarding the relationship between welfare judgments and choices. In a revealed-preference perspective, we may suppose that (possibly incoherent) choices reveal (possibly incoherent) welfare judgments. But at the same time, there is a sense in which Bernheim’s whole argument builds on the idea that choice-based welfare analysis is preferable because our choices are guided by our welfare judgments. In particular, the identification of mistakes is possible only because we can – at least in principle – identified either a gap between ultimate judgments of welfare and actual choices (what Bernheim calls ‘characterization mistakes’) or inconsistencies in judgments.  In either case, the relevant criterion for the welfare analysis is not that individuals are making inconsistent choices per se but rather how judgments and choices are articulated. Added to the fact that the unified approach naturally calls for the use of non-choice data, this indicates a real departure from the revealed-preference view that is still pervasive in welfare economics. All of this as interesting implications for another topic related to the normative turn of behavioral economics, i.e. libertarian paternalism, but I leave that for another post.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s