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

Behavioral Welfare Economics and the ‘View from Nowhere’

As Richard Thaler has just received a well-deserved ‘Nobel prize’ for his pioneering contribution in behavioral economics and behavioral finance, many commentators are reflecting over the scientific and ethical significance of Thaler’s work and more generally of behavioral economics regarding policy matters. Thaler is of course well-known for having developed with legal scholar Cass Sunstein the whole nudge idea as well as the seemingly oxymoronic “libertarian paternalism” notion. In a somehow challenging review of Thaler’s contribution, Kevin Bryan expresses some worries regarding the ethical implications relating to the nudging practice:

“Let’s discuss ethics first. Simply arguing that organizations “must” make a choice (as Thaler and Sunstein do) is insufficient; we would not say a firm that defaults consumers into an autorenewal for a product they rarely renew when making an active choice is acting “neutrally”. Nudges can be used for “good” or “evil”. Worse, whether a nudge is good or evil depends on the planner’s evaluation of the agent’s “inner rational self”, as Infante and Sugden, among others, have noted many times. That is, claiming paternalism is “only a nudge” does not excuse the paternalist from the usual moral philosophic critiques! Indeed, as Chetty and friends have argued, the more you believe behavioral biases exist and are “nudgeable”, the more careful you need to be as a policymaker about inadvertently reducing welfare. There is, I think, less controversy when we use nudges rather than coercion to reach some policy goal. For instance, if a policymaker wants to reduce energy usage, and is worried about distortionary taxation, nudges may (depending on how you think about social welfare with non-rational preferences!) be a better way to achieve the desired outcomes. But this goal is very different that common justification that nudges somehow are pushing people toward policies they actually like in their heart of hearts. Carroll et al have a very nice theoretical paper trying to untangle exactly what “better” means for behavioral agents, and exactly when the imprecision of nudges or defaults given our imperfect knowledge of individual’s heterogeneous preferences makes attempts at libertarian paternalism worse than laissez faire.”

As Noah Smith however rightly notes, that is not a problem that is peculiar to the nudge approach nor more generally to behavioral welfare economics:

“There are, indeed, very real problems with behavioral welfare economics. But the same is true of standard welfare economics. Should we treat utilities as cardinal, and sum them to get our welfare function, when analyzing a typical non-behavioral model? Should we sum the utilities nonlinearly? Should we consider only the worst-off individual in society, as John Rawls might have us do?
Those are nontrivial questions. And they apply to pretty much every economic policy question in existence. But for some reason, Kevin chooses to raise ethical concerns only for behavioral econ. Do we see Kevin worrying about whether efficient contracts will lead to inequality that’s unacceptable from a welfare perspective? No. Kevin seems to be very very very worried about paternalism, and generally pretty cavalier about inequality.”

According to Robert Sugden, what standard and behavioral welfare economics have in common is that they endorse – if implicitly – the ‘view from nowhere’ in ethics. The latter – whose name has been coined by Thomas Nagel – is the view that goodness or rightness is to be judged according to criteria set by some exogenous impartial or benevolent dictator. In welfare economics, the criteria imposed by the benevolent dictator are instantiated through a (Arrowian or Bergsonian) social welfare function (SWF). An SWF is itself traditionally obtained through the definition of the relevant informational basis (which kind of information should be taken into account in the normative analysis) and aggregation rule (how to use this information to make social evaluations and comparisons).

In this perspective, it is right that standard and behavioral welfare economics share a feature that some may regard as problematic: the very definition of the relevant SWF is left to a putatively impartial and benevolent being who is thought to lay outside the group of persons to whom the normative evaluation is addressed. The problem with the view from nowhere is that it creates a divide between the one making the impartial ethical judgments and evaluations and the persons whose welfare, rights and so on, are the objects of these judgments and evaluations. That means that welfare economics as a whole is somehow paternalistic in its very foundations.  Arguably there is a difference between standard and behavioral welfare economics: the latter is more restrictive regarding the relevant informational basis. In the classical preference-satisfaction account of welfare that most welfare economists endorse (including most but not all behavioral economists), preferences whatever their content are considered as relevant from a welfare point of view. Behavioral welfare economists argue however that it is legitimate to ignore preferences that are revealed by choices resulting from cognitive biases, lack of awareness, errors and so on. This only contributes to strengthen the paternalistic tendencies of welfare economics. In other words, the difference between standard and behavioral welfare economics is not one of nature but rather “merely” of degree.

Ultimately, it is important to acknowledge that welfare economics as a whole is not fitted to discuss most issues related to (libertarian) paternalism, especially the problems of manipulation and autonomy. Welfare economics is nowadays essentially a theoretical framework to make social evaluations given exogenous welfare criteria but cannot be a substitute for moral and ethical reasoning (though the related social choice approach can be a way to reflect on ethical problems).