Where behavioral economists got it right, and then got it wrong

Still shot from the movie Cinderella Man. Russell Crowe played the character of James Braddock, also known as Cinderella Man for his Cinderella-like rise from obscurity to world-wide fame.

The Cinderella Man, or James J. Braddock, was an American professional boxer who, due to a fortunate turn of events, found himself facing Max Baer for the title of the heavyweight boxing champion of the world in 1935.

Max Baer was known as one of the most powerful punchers in the history of boxing. He had literally killed two professional boxers earlier in his career. Braddock was an overwhelming underdog. Many feared it was dangerous for Braddock to fight the much bigger, younger and more powerful opponent.

In the years before the title fight, during the Great Depression in early 1930s, Braddock had fallen on difficult times because he suffered injuries to his hand that seemed to have ended his boxing career. He worked as longshoreman on the docks to feed his family of five. He had to go on public relief because he could not earn enough to make ends meet. Then fortune smiled on him.

In the movie Cinderella Man, before the title match, the promoter of the fight shows Braddock a video of an earlier fight in which Baer had killed a professional boxer. Fearing legal ramifications, the promoter tries to dissuade Braddock from fighting Baer. Braddock responds, “[Are you] trying to tell me… boxing’s dangerous? You don’t think triple shifts or working nights on the scaffolds is just as likely to get a guy killed? In my [boxing] profession… I’m fortunate [that people are willing to pay to watch me die].”

To a layman it would seem the odds were much higher that Baer would kill or seriously maim Braddock compared to the odds of same thing happening to Braddock on the docks. For the sake of this discussion, let us assume that is true. But Braddock obviously did not care about the odds. To Braddock, the title fight was a great opportunity worth the risk of death and he thought he was “fortunate” that people would pay to watch him die.

Braddock chose to fight. The Bulldog of Bergen beat all odds and earned what is today known as the biggest upset in the history of heavyweight boxing.

Behavioral economists would say that Braddock’s choice is another example of humans making irrational choices. Irrational, because he chose the option that had a lower expected gain (expected utility).

Behavioral economics is a sub-field of economics that studies the influence of social, psychological and emotional factors on the economic decision making of market players including individuals, businesses, and government. What do you know, humans are not machines, they also possess emotions? Does this come as a surprise to any of you?

Lately, many liberal-progressive economists, politicians, and community leaders have been using the “findings” of behavioral economics research as a convenient excuse to justify large-scale government interventions in almost every aspect of people’s lives. The thinking goes, since people don’t behave rationally, we need government intervention to guide them towards rational behavior.

Richard Thaler (considered one of the founders of behavioral economics) and Cass Sunstein authored a book called Nudge where they present several examples of how society and government can nudge people to make “rational” choices.

Rational according to whom?

One fundamental flaw in these paternalistic arguments is the assumption that there are some all-knowing humans who know what is “rational.”

One of the fondest memories of my childhood was when my dad brought home a special ice cream once every month. In those days (the late 1980s) it was special for the three of us elementary-school aged siblings, even though it was literally plain vanilla ice cream packaged in a cardboard box in the shape of a six-by-three-by-two inch brick. It would barely give each of us about five teaspoon scoops.

I grew up in India in a lower middle class family of five. My dad’s monthly income those days was equivalent to $80 (1200 rupees). The ice cream cost us about two dollars (30 rupees) or two percent of monthly income.

From the perspective of utility, my dad’s choice to spend two percent of his monthly salary on a trivial “perceived luxury was not a rational choice. The nutritional value of plain vanilla ice cream is far inferior to other healthy nutrient-rich foods available in the market. But if you ask my dad whether it was a rational choice, he would say “hell yeah.” (If he knew how to speak with American lingo). For my dad, the happiness that the ice cream gave his three little kids was absolutely worth any “loss” of nutrition.

Was my dad being irrational? Who is correct? Is it the economist who argues in favor of maximization of utility or my dad who valued happiness over utility?

In pursuit of happiness

Behavioral economists are correct in the sense that individuals do not make choices to maximize utility by focusing strictly on cost-benefit analysis. However, they are wrong in labelling the choices as “irrational.”

The individual’s objective is to maximize happiness, not utility. Both utility and happiness are abstract concepts that cannot be measured objectively.

One could argue that what economists consider utility is in fact what ordinary people would call happiness, and that they are the same for all practical purposes.

In many cases, it is true that utility and happiness go hand in hand. However, there is a huge distinction between the two. And therein lies the fundamental flaw behind behavioral economics-inspired government interventions.

Proponents of government intervention believe that the individual’s focus on short-sighted gain (happiness) leads them to choices that do not maximize long-term gain (utility), and therefore, government should interfere to force or nudge individuals towards maximization of utility. Notice the inherent assumption that somehow individuals in government are not subject to socio-economic and political biases.

Let us consider the example of an individual’s choice to buy or forego health insurance. A large proportion of people in the younger age group of 18 to 34 years tend to forego health insurance and instead use the money on other aspects of life that make them happier. This makes sense because young people need little medical care.

However, the Obama administration forced young people to buy health insurance by imposing penalties. The overtly expressed logic is that young people are being irrational. The real intention was to use the money from healthier young people to subsidize health care of poorer and sicker sections of society.

Notice the inherent deception which is a result of the socio-economic bias of the people in Obama administration. The Obama officials imposed a policy on all young people, based on what the officials perceived as rational, not what was rational according to the young people.

Let’s consider other examples of supposedly irrational behavior.

A disproportionately high number of men, in desperately poor societies, are alcoholics and drug addicts. People in poor and oppressed countries seem to shockingly place a high degree of trust in “god men” and scam artists. Many social activists believe that petty luxuries of poor people in “third world” countries such as shampoo sold in single-use sachets, facial skin-care lotions advertised as fairness-enhancing creams, and cheap tobacco products are manifestations of irrational choices by humans.

The high-minded bourgeois progressives, most of whom do not really know what it is to be desperately poor, are unable to grasp the concept that humans will seek happiness no matter what their present conditions are.

People who are skilled and motivated will try their best to get out of poverty because that is what makes them happy. On the other hand, many poor people will seek happiness in alcohol and drugs.

Freedom is the rational choice

In free societies, an overwhelming majority of people will make choices that will be considered “rational.” That is how humans earned their way out of caves and attained so much prosperity.

We don’t need the bourgeois progressives telling people what is rational or irrational by using government force: prohibitions on alcohol and drugs, trade restrictions, health insurance mandates, taxes on salty-sugary-fatty foods, and so on.

It is these well-intentioned “reforms” by do-gooder progressives that, in the first place, have reduced people into making such “irrational” choices as fighting against seemingly-impossible odds in a boxing ring; earning such low incomes that even tiny expenditures on trivial luxuries consume high percentage of income, turning to alcohol and drugs in utter hopelessness, and rejecting overpriced health insurance.

In societies that are oppressed by dictators and populist-progressive governments, people have fewer available “rational” opportunities leading people to choose other means for attaining happiness, which gives the impression that people are behaving irrationally.

But, if you look at the world from their perspective, their choice to maximize happiness is completely rational. To paraphrase a popular adage, “rational” is in the eye of the beholder.

History is witness to the irrefutable fact that free societies have always been and will always be prosperous. There is no exception whatsoever. Every society that is prosperous today is that way because the people in those societies experienced prolonged stretches of freedom.

Stop judging! Just let people be free to make their own choices. We will all be better off for it.

* Satish Bapanapalli has been an ardent admirer of Milton Friedman’s ideas since 2009. His interest in economics and public policy issues stemmed from watching the spirited debates regarding the causes of 2008 economic crisis. Satish’s ideas closely resonate with libertarian or classical liberal philosophy.

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