The Neuroeconomics Revolution

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I Can't Hear Poors
The Neuroeconomics Revolution

Project Syndicate

Robert J. Shiller

November 21, 2011

NEW HAVEN – Economics is at the start of a revolution that is traceable to an unexpected source: medical schools and their research facilities. Neuroscience – the science of how the brain, that physical organ inside one’s head, really works – is beginning to change the way we think about how people make decisions. These findings will inevitably change the way we think about how economies function. In short, we are at the dawn of “neuroeconomics.”

Efforts to link neuroscience to economics have occurred mostly in just the last few years, and the growth of neuroeconomics is still in its early stages. But its nascence follows a pattern: revolutions in science tend to come from completely unexpected places. A field of science can turn barren if no fundamentally new approaches to research are on the horizon. Scholars can become so trapped in their methods – in the language and assumptions of the accepted approach to their discipline – that their research becomes repetitive or trivial.

Then something exciting comes along from someone who was never involved with these methods – some new idea that attracts young scholars and a few iconoclastic old scholars, who are willing to learn a different science and its different research methods. At a certain moment in this process, a scientific revolution is born.

The neuroeconomic revolution has passed some key milestones quite recently, notably the publication last year of neuroscientist Paul Glimcher’s book Foundations of Neuroeconomic Analysis – a pointed variation on the title of Paul Samuelson’s 1947 classic work, Foundations of Economic Analysis , which helped to launch an earlier revolution in economic theory. And Glimcher himself now holds an appointment at New York University’s economics department (he also works at NYU’s Center for Neural Science).

To most economists, however, Glimcher might as well have come from outer space. After all, his doctorate is from the University of Pennsylvania School of Medicine’s neuroscience department. Moreover, neuroeconomists like him conduct research that is well beyond their conventional colleagues’ intellectual comfort zone, for they seek to advance some of the core concepts of economics by linking them to specific brain structures.

Much of modern economic and financial theory is based on the assumption that people are rational, and thus that they systematically maximize their own happiness, or as economists call it, their “utility.” When Samuelson took on the subject in his 1947 book, he did not look into the brain, but relied instead on “revealed preference.” People’s objectives are revealed only by observing their economic activities. Under Samuelson’s guidance, generations of economists have based their research not on any physical structure underlying thought and behavior, but only on the assumption of rationality.

As a result, Glimcher is skeptical of prevailing economic theory, and is seeking a physical basis for it in the brain. He wants to transform “soft” utility theory into “hard” utility theory by discovering the brain mechanisms that underlie it.

In particular, Glimcher wants to identify brain structures that process key elements of utility theory when people face uncertainty: “(1) subjective value, (2) probability, (3) the product of subjective value and probability (expected subjective value), and (4) a neuro-computational mechanism that selects the element from the choice set that has the highest ‘expected subjective value’…”

While Glimcher and his colleagues have uncovered tantalizing evidence, they have yet to find most of the fundamental brain structures. Maybe that is because such structures simply do not exist, and the whole utility-maximization theory is wrong, or at least in need of fundamental revision. If so, that finding alone would shake economics to its foundations.

Another direction that excites neuroscientists is how the brain deals with ambiguous situations, when probabilities are not known, and when other highly relevant information is not available. It has already been discovered that the brain regions used to deal with problems when probabilities are clear are different from those used when probabilities are unknown. This research might help us to understand how people handle uncertainty and risk in, say, financial markets at a time of crisis.

John Maynard Keynes thought that most economic decision-making occurs in ambiguous situations in which probabilities are not known. He concluded that much of our business cycle is driven by fluctuations in “animal spirits,” something in the mind – and not understood by economists.

Of course, the problem with economics is that there are often as many interpretations of any crisis as there are economists. An economy is a remarkably complex structure, and fathoming it depends on understanding its laws, regulations, business practices and customs, and balance sheets, among many other details.

Yet it is likely that one day we will know much more about how economies work – or fail to work – by understanding better the physical structures that underlie brain functioning. Those structures – networks of neurons that communicate with each other via axons and dendrites – underlie the familiar analogy of the brain to a computer – networks of transistors that communicate with each other via electric wires. The economy is the next analogy: a network of people who communicate with each other via electronic and other connections.

The brain, the computer, and the economy: all three are devices whose purpose is to solve fundamental information problems in coordinating the activities of individual units – the neurons, the transistors, or individual people. As we improve our understanding of the problems that any one of these devices solves – and how it overcomes obstacles in doing so – we learn something valuable about all three.
I Can't Hear Poors
nuclear launch detected

Good stuff. Neuroeconomics could be something that can finally explain that blasted utility/indifference curve.

I wonder how Austrians are going to react to this one though. They already reject economic models that use any form mathematical/statistical approaches because they argue that human behaviour cannot be "quantifiable" and so instead use a priori like deductive reasoning to form their arguments. Well now it turns out you can model human behaviour via the merging field of neuroeconomics, a field that might make it even tougher for the Austrian school to gain mainstream acceptance.


My non-expert Austrian response:

Utility/indifference and all those things are psychological. This is a psychological study. Psychology ends where economics starts, at the action axiom. How people come to make their decisions isn't a matter of economics, but of psychology and biology.

The Austrians have basically the same interpretation with some tweaks on the edges.

Empirical economists have an infinite number of theories because they fail to recognize the futility of their method for economics to explain it as a whole. The economy is a complex system, not any simpler than that. The empiricism that has worked for the natural sciences has worked for the natural sciences because those systems are not complex systems. The economy is a complex system, so we can only get limited insight from the application of the scientific method to economics.
nuclear launch detected

I agree that economics is a complex system that is difficult to model using just the scientific method, but I don’t think it’s impossible. We need the math to backup the models because without the empiricism, without the ability for it to be falsifiable, economics devolves into nothing but opinion based as facts and untestable sophistry. This is the major criticism of the Austrian method.


I consider the use of the empirical methods (scientific method, learning from experiences) to be the study of business. Math, computer science and most of philosophy is rooted in "sophistry". I wouldn't consider this a meaningful nor valid criticism. It comes off as "Austrian econ is bullshit because I don't like it's method". It doesn't matter (to me) which method is used for study of any subject, as long as it's defensible.

Economists readily admit that economic models are purposeful simplifications of how people interact in the real world. They can never be 100% precise because people don't behave in a deterministic fashion. Nevertheless, most of the information we have about economic life has been gained from experience, not by a priori insight. I agree that some economic laws are a priori. You don't need to go out into the world to see that something has to be produced before it can be consumed. But most other economic laws are derived from experience like the laws of supply and demand.

Economics could benefit from developments in psychology and neuroscience. They could help economists understand how economic information influences stock market fluctuations. They could help economists understand the motives of economic actors and develop more accurate models.