An Economics Fit for Humans

Abstract

The further I have strayed from my days as an undergraduate, the more convinced I have become of the importance of theory—not just to economics, but to any discipline. Theory is important because it is so pervasive in influencing the way we think, the way we analyse problems in our discipline and the nature of the solutions we favour. Often, we fall into ways of thinking about issues without fully appreciating the influence theory is having on us (Keynes 1936). At a time when economic rationalists are so influential in government policy making, theory becomes highly relevant because economic rationalists can be defined as people who take conventional economic theory—the neoclassical model of markets, in its simplest form—and raise it to the status of religious doctrine. In addition, I have become interested in some relatively recent developments in cognitive and social psychology. Psychology has become a lot more interesting to people interested in public policy since the advent of ‘positive psychology’, which has switched the focus from the study of mental illness to the study of people who are perfectly well (Seligman 2002; Kahneman, Diener and Schwarz 1999, p. ix). Two aspects of psychological research present significant challenges to conventional economics: the study of how people make decisions and the study of happiness or ‘subjective wellbeing’. I wish to draw out the respects in which these advances challenge various aspects of economic theory and the policy prescriptions conventionally flowing from the theory. The first challenge—concerning decision making—is being taken quite seriously by the economics profession. The thriving school of economic thought it has given rise to is behavioural economics, and the psychologist who did most to inspire this school, Daniel Kahneman, was awarded the Nobel Prize in economics in 2002. The second challenge to conventional economics—from the burgeoning happiness research—is taking longer to win converts among economists. But I am enough of an optimist to hope that we are witnessing the early stages of another revolution in economics, one to match or even exceed the influence of the Keynesian revolution of the 1940s and 1950s. Surprisingly, Keynes is now being hailed as one of the earliest behavioural economists (Akerlof 2002), though his contemporary followers largely ignored that aspect of his contribution.