Behavioural Economics

By 14/01/2016Blog
Written by Narottama Bowden

The underlying assumptions within orthodox economic theory abstract from reality often to under-describe economic processes. Consequently, differences in efficiency and productivity are not considered or explored to result in a limited understanding of economics processes and intra-firm dynamics. The role the labour force plays in the long-term success of business goes far beyond being a productive input into the production process and organisational structures, and management and remuneration strategies, can significantly shape how labour can perform such a role.

The current thinking around economics is not helpful for society. It does not fully consider the role played by firms and their workers and their contributions to wider economic progress.

Behavioural economics can begin to rationalise the behaviours of various stakeholders in society in both the short and long-run and assess the welfare outcomes of various actions of stakeholders. Cooperation has been shown to maximise long-run welfare in various situations and can illuminate thinking on why the relationships between business and wider society in recent times have broken down. Similarly, asymmetry of information and other market failures breed uncertainty which provokes behaviour in agents that restricts social welfare creation, misaligns incentives and shortens the time horizons of agents. In such an environment, the breakdown of cooperation between societal stakeholders produces outcomes where private actions adversely affect society and relationships within it.

Behavioural economics can show why it is beneficial for stakeholders in society to cooperate and that the breakdown in relationships before the economic and financial crises was based on irrational decisions.

Management theory and literature on the principle-agent problem can help towards explaining why business had stopped serving society prior to the economic and financial crises and also contribute to the creation of a blueprint for better business. Additionally, how we conceptualise the firm and define its purpose will influence its motivations and therefore its action within society. By considering why firms exist, society can better conceptualise how business can once more best serve society and how they would be best internally organised to achieve this outcome.

Management theory and other literature suggest why events unfolded as they did and indicate how business can be improved. By thinking about why firms exist society can begin to realise what they expect from firms and how they can get it.

By gaining an understanding of where value is created within business, rewards can more fairly be distributed to those worthy, helping to foster a culture conducive to long-run business success and an innovative environment. An understanding of the centrality of organisations in this process as opposed to a market-centric approach allows for this process of recalibrating business to the needs of society to commence.

The rewards from business can be more fairly distributed if we accurately account for where value comes from. Such fairness can incentivise innovation for the bettering of society.

Our full article on Behavioural Economics can be found here.