Towards a renaissance of economic theory

Abstract

In his penetrating essay, “Theory and Experiment,” Vernon Smith observes that subject behavior often diverges from game-theoretic predictions and asserts that minor fudging with theory is unlikely to solve our problems because “circumstances unknown to us” are responsible for the explanatory failures of neoclassical economic theory. I deal precisely with these issues in TheBounds of Reason (2009a).My remarksheredrawupon several themes fromthis book relevant to specifying a refocused research agenda for the study of human strategic interaction. The core of economic theory is the rational actor model, which holds that individuals have preferences over outcomes, beliefs (called “subjectivepriors”), linking choices to the relativeprobability of alternativeoutcomes, and theymaximize their expected payoffs given these preferences and beliefs, subject towhatevermaterial, informational, and other constraints they face. Many observers consider the experimental work of Daniel Kahneman and others (Kahneman et al., 1982; Gigerenzer and Todd, 1999) as destructive of the rational actormodel. In fact, however, their research has considerably strengthened the rational actor model’s explanatory power, albeit at the expense of increasing its complexity (Gintis, 2009a, Chs. 1 and 12). Most important, these studies have shown the value of modeling using heuristics that conserve on information processing and of including the current state (physiological, temporal and ownership) of the individual as an argument of the preference ordering. In the 1980s, the core of economic theory was extended to include game theory, viewed as the theory of the strategic interaction of Bayesian rational actors. Game theory has become a centerpiece of microeconomic theory alongside the traditional Walrasian model of general market equilibrium. It is important to note, however, that this exalted position is quite recent. The textbooks that expound the received wisdom of today’s practicing economists were written in the early years of the game theory revival, between 1988 and 1995. These textbooks include misconceptions promulgated in the 1980s that have been transmitted to the current generation of economists. As I shall show, some of these misconceptions have been repaired in more recent contributions to game theory. Contemporary experimentalists, however, generally rely on the more traditional body of outdated theory. I here rely on more recent theoretical contributions, especially those of Robert Aumann and Adam Brandenburger and their coworkers, to bring game theory up to date. I then argue that, despite their analytical power, game theory and the rational actor model provide only part of the theoretical toolkit needed to explain human strategic interaction. Moreover, because individuals bring much of the complexity of society into the controlled conditions of the laboratory, game theory and the rational actor model are insufficient to explain experimental results. Concretely, I suggest that (a) these analytical tools must be supplemented by what I term the psycho-social theory of norms; (b) the correlated equilibrium should replace