The Limits of Economic Analysis

Two stories from yesterday touched on one of my pet topics, namely the limits of economic modes of analysis to explain human behavior in consumer contexts.

Story one was Inside Higher Ed’s lead on the “high borrowing” that some people do for graduate programs, with a nontrivial number of students winding up with six-figure debt and degrees that seem, in the economic sense, not worth it.

Looking at the data and writing at The New York Times, Kevin Carey, head of the education policy program at New America, observes that the debt levels for some of this graduate study “make little sense.” “Borrowing for graduate school can be a sound financial decision, if the degree reliably leads to a well-paying career. But the new federal data suggests that the graduate school market often behaves in strange and erratic ways. It is not a classic Econ 101 situation in which demand and prices rise with the value of the services received. Sometimes, it seems the opposite.”

Carey recognizes that the goal of providing transparent pricing and outcome data may not be enough to change behaviors. The “market” is “dysfunctional.”

Story two was a recap of a large-scale attempt to ameliorate the “undermatching” phenomenon by “nudging” students with information about more selective colleges. The study, using a national sample of 18,000 students, was built on a previous, smaller study, which found that the nudging worked.

This one found no effect.

The researchers declared, “Our evidence suggests that one key issue is students received the information but did not use it to consistently apply to colleges of higher quality. Data on SAT score sends suggests that students became interested in both higher and lower quality institutions, though even these changes were of a relatively small magnitude and unlikely to result in large changes to observed enrollment. Thus it appears that efforts to shift college enrollment were thwarted at the application stage. Given the influence of neighborhood, family and peers in the college selection process, the type of information we provided may not have been sufficiently novel or compelling to change student behavior.”

In other words, students didn’t do what we thought they would (or should), and we’re not sure why.

They believe the solution is to pursue more intensive methods of student outreach. Maybe an email isn’t enough.

But here’s something to consider. What if the market isn’t dysfunctional? And what if students aren’t acting “irrationally” when the nudge away from undermatching has no effect? What if the research needs to now go deeper? We have the what (the behavior). Now we need to know the why (the story).

The reason the limits of economic modes of analysis are one of my pet subjects is because in my day-to-day work as a marketing researcher, I am constantly bumping up against those limits. I can’t share specifics because the projects are proprietary to clients, but much of the work we do involves diving in where the rational (often economic) hypotheses around behavior have proved unsatisfactory. Those darned consumers just aren’t doing what the economic analysis predicts -- what the heck is going on here?

To uncover those hidden causes, we employ an array of qualitative and quantitative tools that seek to create rational explanations for the seemingly irrational, and guess what?

It works. The irrational turns out to be rational, just in unexpected ways. One of the reasons I enjoy the work is because each project involves this kind of problem solving, making sense out of the senseless, or corralling a lot of seemingly disparate and unrelated data into something explicable and useful for our clients. It is very challenging, and each project requires something like a custom approach to uncover the data that tell the story.

But economic theory largely eschews narrative, because narrative is messy. There may be many whys underneath the what. Behavioral economics tries to address this -- and the nudging study fits that portion of the field -- but it is nonetheless limited by the bounds of what is judged as “rational.”

A choice that appears to not have an economic payoff is de facto “irrational,” but what if some of these choices merely reflect different rationales?

Carey discusses several disparate examples.

• The American Art Academy of San Francisco, a for-profit school that offers a master’s degree in design and applied arts whose graduates average six-figure debt.
• The USC online master's in social work, the No. 1 online program in the country, also has graduates with more than six figures of debt despite social work being a low-paid field.
• And also veterinary school, which, despite it requiring a four-year postgraduate degree and board certification, carries a median wage of somewhat less than $100,000 -- a good salary to be sure, but difficult when coupled with the $230,000 debt, which comes coupled with doing one’s veterinary studies abroad.

As I see it, the common thread among each of these examples is pretty simple: desire.

Let’s say I want to be a designer or artist and I want to be connected to a vibrant, artistic city like San Francisco. I know the odds of success are long, but look at the successes. What if I am destined to be one of those successes, but I don’t take the chance? Will I live a life of regret?

Or maybe I want to spend a life helping people and I know I’m going to be poor anyway, but if I don’t have that master’s degree, I’ll never get a chance to do this work in the first place. If I’m going to be in debt no matter what, why not take out a little more debt to get a degree from the No. 1 program in the country and up my odds that I’ll at least have a job I love, even if I’m poor?

Having been in a relationship with a veterinarian since before she started vet school, who is now a board-certified specialist in small-animal internal medicine (requiring four years of post-vet school study), I can testify firsthand that if one’s desire is to do the work, not much will stand in the person’s way. Unlike fashion design, though, there’s no glut of vet school graduates. Those offshore for-profit providers are filling a hole in ways the American Art Academy is not.

The next step for that study on nudging students should be to interview them about why they made those decisions. We have research tools that can eliminate (or at least limit) the guesswork as to why those students didn’t behave as expected. Aren’t there any social scientists these people can talk to?

My hunch is you’d find plenty of rational weighing of factors. They’re just not being rational in the “right” ways. They’re not using the information “consistently” because they are human and humans are famously inconsistent. The belief that we can transparency our way out of these issues seems fantastical to me.

Is desire de facto irrational? Could it be that people are well enough informed about the consequences of their choices but make ones that – from the perspective of economic analysis – still look “dysfunctional”?

Is desire something we must engineer out of our education systems because all that desire is creating inefficiency?

Or what if, rather than waving our hands about all this irrationality and focusing all our efforts on bringing human behavior in line with the economic modeling, we spent more time understanding some of the barriers between people and those desires.

Gimme a call. I know some people who can help with this.