Wednesday, February 15, 2006

Meet the Market

I have many heroes in economics, but John List is my latest hero. What has he done, other than publish dozens of articles in top journals? He's taken Behavioral Bullshitters head on. When pro-behavioral types scream that they have "empirical" evidence (based on handing out mugs to students or asking people how they feel after a colonoscopy) that people don't behave rationally*, List says, "Behavioralists, meet the market," and then goes on to show how people experienced in market settings, in the world, doing what they do to actually make a living, act as economists would predict. Inexperienced agents, and college students in behavioral lab experiments, make all kinds of goofy mistakes that get people worked up, but market interaction has a knack for washing away those kinds of "irrationality."

Here is the abstract of his latest paper, "The Behavioralist Meets the Market: Measuring Social Preferences and Reputation Effects in Actual Transactions," published this month in the Journal of Political Economy:

The role of the market in mitigating and mediating various forms of behavior is perhaps the central issue facing behavioral economics today. This study designs a field experiment that is explicitly linked to a controlled laboratory experiment to examine whether, and to what extent, social preferences influence outcomes in actual market transactions. While agents drawn from a well-functioning marketplace behave in accord with social preference models in tightly controlled laboratory experiments, when they are observed in their naturally occurring settings, their behavior approaches what is predicted by self-interest theory. In the limit, much of the observed behavior in the marketplace that is consistent with social preferences is due to reputational concerns: suppliers who expect to have future interactions with buyers provide higher product quality only when the buyer can verify quality via a third-party certifier. The data also speak to theories of how reputation effects enhance market performance. In particular, reputation and the monitoring of quality are found to be complements, and findings suggest that the private market can solve the lemons problem through third-party verification.

*Many behavioralists don't even recognize that most microeconomic theory hinges on procedural rationality rather than substantive rationality, and that making mistakes, succumbing to bias, etc. are generally examples that violate the latter and not the former.