Whither experimental economics?

When I was applying to graduate school, I looked at three options: neuroscience, computer science, and economics. I had, effectively, done an economics major as an undergrad and had worked at an economic consulting firm. But the lack of controlled experimentation in economics kept me from applying and I ended up as a neuroscientist. (There is, of course, a very experimental non-human economics which goes by the name of ecology, though I did not recognize it at the time.)

I profess to being confused as to the lack of experimentation in economics, especially for a field that constantly tries to defend its status as a science. (Well, I understand: incentives, existing capabilities, and all that.)

A recent dissertation on the history of experimental economics – as opposed to behavioral economics – is enlightening:

“We were describing this mechanism and Vernon says, “You know, I can test this whether it works or not.“ I said, “What do you mean?“ And he says, “I’ll run an experiment.“ I said, “What the heck are you talking about? What do you do?“ And so he hauls seven or eight graduate students into a classroom. He ran the mechanism and it didn’t work. It didn’t converge to the equilibrium. It didn’t produce the outcomes the theory said it would produce. And I thought, okay. So back to [doing] theory. I don’t care; this doesn’t bother me.

It bothered Vernon a lot because we sat around that evening talking and he says, “Oh, I know what I did wrong.“ And he went back the next day and he hauled the students back in the room, changed the rules just a little bit in ways that the theory wouldn’t notice the difference. From our theory point of view, it wouldn’t have mattered. But he changed the rules a little bit and bang that thing zapped in and converged.“

The difference between the two experiments was the information shared with the test subjects. The first time around, the subjects wrote down their number on a piece of paper and then Smith wrote them up on the board. Then he asked the subjects to send another message and if the messages were the same twice in a row he would stop, since that stability would be interpreted as having reached equilibrium. But the messages did not stop the first time Smith had run the experiment a day earlier…

The fact that the experiment did not converge at the first attempt, but did at the second with a change of only one rule (the information structure available to the participants) not required by theory to make its prediction made a lasting impact on Ledyard.

And this is exactly why we do experiments:

[T]he theory didn’t distinguish between those two rules, but Vernon knew how to find a rule that would lead to an equilibrium. It meant he knew something that I didn’t know and he had a way of demonstrating it that was really neat.

In psychology and neuroscience, there are many laboratories doing animal experiments testing some sort of economic decision-making hypothesis, though it is debatable how much of that work has filtered into the economic profession. What the two fields could really use, though, are economic ideas about more than just basic decision-making. Much of economics is about markets and mass decisions; there is very animal experimentation of these questions.

(via Marginal Revolution)

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How trade develops: thinking in terms of “we”

This is an absolutely fantastic classroom experiment by Bart Wilson:

In the traditional market experiment, the experimenters explain to the participants how to trade. For this experiment that seemed more than a little heavy handed if the question is, what is the process by which exchange “gives occasion,” as Adam Smith says, to discovering the “division of labour”? …Thus the first requirement in building the design was that participants would have to discover specialization and exchange…

The participants choose how much of their daily production time they would like to allocate to producing red and blue items in their field. They are then told, deliberately in the passive voice, that “you earn cash based upon the number of red and blue items that have been moved to your house.” What they have to discover is that not only can they move items to their own house, but that they can move items to other people’s houses…

At one extreme, the economy achieves 88% of the possible wealth above self-sufficiency by the last day[.] And at the other extreme, only 6% of the possible wealth above autarky is realized[…] Why the disparity? These students are immediately engaging their counterparts as part of an inclusive “we”. The same is not true in group 4 [which achieved less wealth].

He then goes into detail on the words and mode of thinking that different groups used to develop the idea of trade and markets. The conclusion is that the development of trade and specialization arises from considering the group and not the individual. And this is in a capitalist society! It is not to say that the only way for trade and specialization to develop is a kind of group-consciousness, and it is not to say that it wouldn’t have developed anyway. But it’s a bit of evidence that it can foster the conditions that make mutually beneficial trade networks increasingly likely.

As a second experiment, I would be interested in how quickly students familiar with the idea and the mathematics would find the optimal solution, and how it would evolve in a ‘noisy’ environment. I’d really like to see more advanced analyses of the text as well, the communication networks that evolve, and how they coordinate the development of the intellectual idea. Is there a tipping point? Is it a steady accumulation towards the optimum? Are there ‘laggards’ that are unconvinced?

But this is a great experiment and a great teacher.