How Biology Helps Shape Choice in Behavioral Economics

By Alain Samson

 

The field of behavioral economics is facing several challenges and opportunities this century; the discipline is trying to find its own identity and position within science and applications. This includes debates around behavioral economics’ most fundamental idea—the causes of human decision-making. Human biology has a more important role in shaping the choices we make than behavioral science theories recognize.

UC Berkeley economist Ulrike Malmendier writes about Henry Wallich, who served as a governor of the US Federal Reserve System in the 1970s and 1980s. Wallich was born in Germany and experienced that country’s hyperinflation during the 1920s. As a result of this experience, he appeared unusually worried about inflation in his approach to interest rate policy. In fact, he dissented 27 times against proposed interest rate decisions by casting a hawkish vote (that is, endorsing a tighter monetary policy to reduce inflationary pressure). Malmendier and her colleagues found the same pattern in other board members—those who had personally experienced higher inflation in their lifetimes made more hawkish votes.

Malmendier writes that traditional economists would attribute choices that weigh personal experience too strongly to a lack of information. Relying only on knowledge derived from one’s own experience is limiting. But this explanation is clearly weak considering the amount of education and information at the disposal of Federal Reserve economists. Behavioral economics, on the other hand, would attribute those choices to biases shared by everyone:

[Advances in behavioral economics] gave us better models, better predictions, and better interventions: from automatic enrollment in retirement plans to simplified disclosure forms. Yet, the behavioral economics revolution has stalled at a decisive point. The human element I appealed to above is still missing, or at least incomplete. To put it in stark terms, human behavior still seems rather robotic. Where previously, in the neoclassical model, it was the output of a perfectly programmed computer, in the behavioral economics model it became the output of a not-quite-so-perfect computer program, one prone to systematic bugs.

Malmendier argues that the experience effects identified by her research suggest that personal experience shapes beliefs, expectations, and decisions, and it does so in ways that cannot be reduced to cognitive error or imperfect information.

Her work has uncovered the effect in other places as well. The Baby Boomer generation alone, for example, is thought to have overpaid about $22 billion for fixed-rate mortgages in the late 1980s and 1990s due to their “inflation-scarred preferences.” Researchers have also shown that growing up in communist East Germany has shaped people’s attitudes toward financial markets in general, including stock market participation, decades after East and West Germany reunified. The magnitude and direction of the effect largely depend on whether experiences were emotionally tagged as positive or negative. And research shows again and again that even experts, whether they are bankers or physicians, are not immune to experience effects. As neuroscience suggests, our memories are strongly shaped by the emotions, such as stress, that accompany events. This explains why the same objective event may not affect different individuals the same way.

The importance of lived experience in later behavior has clear implications for behavioral interventions, implying a shift from the provision of information or education to the targeted design of experiences. Germany, for example, is introducing the Early Start Pension program in 2027, which will give children a small 10-euro contribution that is automatically invested in a stock market fund. This will provide children with a felt experience of how markets work, shaping their perception of stock-market risk and return at a non-existential level.

Isabelle Brocas, economics professor at the University of Southern California, echoes Ulrike Malmendier’s main argument. In her view, environments not only provide information or incentives (the traditional economics view), but they also shape the biological and cognitive systems through which future choices are made.

Brocas argues that economics explains behavior through preferences, which are inferred from observed choices, and influenced by incentives and constraints. In behavioral economics, behavior is partitioned into domains like risk-taking, self-control, social preferences, memory, attention, and belief formation. Brocas asserts that these ideas are useful to explain what individuals do in a particular place and at a particular time. However, they largely exclude biological processes and struggle to explain why behavior changes across contexts or when the same behavioral intervention leads to different outcomes across individuals.

According to this view, economic behavior arises from interacting biological processes that affect not only how information enters and is represented in the decision system (perception, attention, and memory retrieval), but also how that representation is assigned motivational significance and translated into action (valuation, affective appraisal, and inhibitory control).

Economics can become more biologically informed if it takes natural variation more seriously than it currently does. Differences across individuals should not be considered “residual variation” but seen as the developmental result of an interaction between genes (dispositions) and environments. As Brocas notes:

This developmental view is indispensable. Adults do not enter economic models as fully formed agents with timeless traits.

Adolescence is a particularly striking example: reward sensitivity, peer orientation, affective intensity, and control processes all undergo major changes during this period, which helps explain why behavior can be more exploratory, volatile, or socially contingent.

The biology of decision-making also continues to change across the full life cycle.

Emotion is an important part of the machinery, as it determines what feels urgent, threatening, or rewarding, and what deserves attention. It shapes how people interpret ambiguity, how much uncertainty they tolerate, how vividly they imagine future outcomes, and how strongly they react to social cues.

Take the example of adolescent risk-taking. A more developmentally sensitive behavioral policy design suggests that information campaigns about future harm may be weak if the binding mechanism is peer salience at the moment of action. Interventions that reduce “public performance incentives” (social rewards adolescents get from taking risks in front of peers) or provide immediate alternative rewards, for example, may be more effective than policies that emphasize negative future consequences.

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This article was previously published on Psychology Today.