Economics, the scientific method, and behavioral economics - Part I

Series Name Department of Economics
Speaker Professor Ali al-Nowaihi
Type Lectures & Talks
Starts at Oct 01, 2013 05:30 PM
Ends at Oct 01, 2013 06:30 PM
Venue Ken Edwards Building, Lecture Theatre
Open To Public
For Bookings Contact 0116 252 2320

Ali al-Nowaihi (Part I, 1st October 2013) Sanjit Dhami (Part II, 8th October 2013)

“If a single one of the conclusions drawn from it [Einstein’s general relativity] proves wrong, it must be given up”. Albert Einstein (Nobel prize in physics,1921) in a letter to The Times, London, 28 November 1919.

“To be important ... a hypothesis must be descriptively false in its assumptions”, Milton Friedman (Nobel prize in economics, 1976), 1953, p.14.

The heart of the scientific method, the method so successfully adopted by the natural sciences, is the severe testing of theories and the acceptance of refutation based on the empirical evidence. We can never prove a theory to be true, for the next observation might reject the theory. Nevertheless, we can get closer to the truth by eliminating what is false.

If we give up the idea of refutation based on empirical evidence, then the view of the powerful, but not necessarily the right view may prevail. Liberal democracies have avoided this fate by embracing the spirit of the scientific method, fallibility. Thus, the opposition is institutionalized and protected and freedom of expression is guaranteed. In Britain the opposition is described as “Her Majesty’s Loyal Opposition”, loyal to the country but opposed to the administration.

The judiciary too works along scientific lines. In law, innocence is never proved. The legal process assumes that a person is innocent. The jury then examines the evidence, and if the evidence is found sufficient, rejects innocence. Of course, innocent persons can be wrongly convicted. But this is no reason to abandon the judicial system. Rather, convictions can be overturned based on new evidence. Similarly, in science, refutation is fallible. But this is no justification to abandon scientific methodology. A refutation of a theory can always be overturned in the light of new empirical evidence (and this has frequently happened).

Neoclassical economics is the dominant paradigm in economics despite it being strongly empirically refuted. The dogmatic adherence to neoclassical economics1 has hindered progress in economics and also diminished its policy relevance. Recent years have seen the development of behavioural economics, the fastest growing field in economics, that is much better empirically supported. Professor Ali al-Nowaihi and Professor Sanjit Dhami, have been collaborating
for nearly a decade in the area of behavioral economics.

In the first inaugural, Professor al-Nowaihi outlines the scientific method and the methodological positions taken in economics. The immunizing stratagems adopted by the mainstream in economics to avoid refutation are outlined. He also compares and contrasts the relative failure of the mainstream approach in economics with the spectacular success of the mainstream approach in physics. He makes a strong case for economics to accept a standard of rigor (in the sense of conformity to the evidence) that is not inferior to that of physics.

In the second inaugural, Professor Dhami discusses some examples from the joint work on behavioural economics with Professor al-Nowaihi. In particular, he focusses on their work in solving the four decade old tax evasion puzzles. Given actual probabilities of being caught and the magnitude of fines, the rate of return from tax evasion for an amateur tax evader is about 98%. So why does anyone pay taxes? Further, neoclassical economics predicts that as the tax rate goes up, people should evade less, which is refuted by the evidence. They solved these puzzles2 using the Nobel Prize winning work on prospect theory, to which they have also made theoretical contributions. Their work was then confirmed with data from 3.6 million Swedish taxpayers and also formed a part
of the literature that informed the compliance strategy of HMRC.

Time permitting, other examples of their work may be briefly alluded to. These could include, the behaviour of humans in the domain of very low probability events, the effect of the human desire for fairness in social redistribution, the role of time preferences, and a new solution concept for static games.
1Compare and contrast the two quotes at the head of this paper, the one from Einstein with the one from Friedman.
2Note that these "puzzles" are actual refutations. But the mainstream, refusing to accept them as refutations, labels them "puzzles".

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