Geoffrey Manne on Interesting doesn’t necessarily mean policy relevant

Geoffrey A. Manne is Executive Director of the International Center for Law & Economics and Lecturer in Law at Lewis & Clark Law School

The problem with behavioral law and economics (and its behavioral economics cousin) is not that it has nothing interesting to say, but rather that the interesting things it has to say do not mean what its proponents think they mean.  It is one thing to claim that people are less rational than we thought.  It even one thing to claim that people are systematically less rational than we thought, in predictable and important ways.  But it is entirely another to presume that the implication of this is a larger scope for government regulation to protect the market and market actors from the depredations of this irrationality.

Why?  Well, the market, of course.  Just because individuals may be less-rational than we thought does not mean that the complex and nuanced activities of markets can’t account for these deviations (particularly if they are predictable).  Add to this well-canvassed problems like government actors subject to the same biases, the problem of competing and conflicting biases, and the problem of unacknowledged, contrary implications, and the case for doing anything about behavioral quirks is extremely weak.

Thus, for example, let’s grant that, as many behavioralists aver, hyperbolic discounting exists.  Um, so, if that’s right, what should we do about it?  Force everyone to save more of their paychecks for retirement?  Insist on opt-out rather than opt-in retirement investing?  Ban cigarettes? Raise tax rates? (I don’t know if anyone has argued this one yet, but it seems like a plausible implication, and it’s only a matter of time)

Here’s the problem, as I see it:  Let’s say the behavioralists are right that, in the abstract, people save less money for future consumption than they would like.  Richard Thaler’s solution to this problem is the “Save More Tomorrow plan (pdf),” which takes advantage of people’s alleged current hyperbolic discounting to commit them to future savings that they actually want but can’t otherwise adhere to when the future actually arrives.  This is a “libertarian paternalist” (pdf) solution to the problem.

But there is a problem, even with a libertarian brand of paternalism here. Suppose I am a hyperbolic discounter.  I might very well plan on early retirement (discounting heavily any money I might otherwise be able to earn when I am old(er)) and plan on working very hard now, earning considerably in order to fund my early retirement (perhaps not enough, but even a hyperbolic discounter is not an infinite discounter and, remember, I plan to curtail a large chunk of my future earning—surely I will compensate).  As a hyperbolic discounter I spend far too much of my extravagant earnings, of course (but, again, not all of it because I do understand that I will need to live on something when I retire), but I certainly earn more than I would if I expected to work well into my 80s instead of retiring at 40.  So what happens when I reach retirement age?  Do I have less in savings than I might like or, because I earned so much more than some imaginary baseline, do I have more?  If I have less, I am also am earning more than I would otherwise, and have better future prospects than I would otherwise.  And when the future becomes the present at the time of retirement I will be readily able to “make up” for the lost savings because of my superior earning position.  Which effect predominates?  Who knows?—but certainly not proponents of government actions that would require us to act as though the cost of saving too little outweighs the benefit of being able to earn more.

But wait, you might say—your premise is faulty.  A true hyperbolic discounter would not plan on early retirement and earn more now.  Present leisure time is too valuable and he would discount the benefits of future leisure time too much to plan on early retirement.  But this is exactly my point.  The behavioralists impose imaginary baselines and then explore the implications of a deviation from that baseline in isolation.  If I hyperbolically discount future savings, I probably also hyperbolically discount future leisure, as well as future earnings and, well, everything else in the future.  That may cause me to actually put myself in a better position than I would have been (as in my example), or it might put me in a worse position, depending on a host of factors particular to me and not generalizable in any substantial way across a large population subject to undifferentiated government dictates.

It is interesting that the government action (and, for that matter, the “nudge”) prong of the behavioralist enterprise implicitly assumes that rationality exists on some sort of normative plain, inexorable and ideal—and off of which markets and market actors cease to function in ways that yield positive results.  It is a curious assumption for an inherently subjectivist enterprise, and it gets them into a lot of trouble where, as above, it is taken as given that an identified quirk causes a net deviation from perfectly rational outcomes, without also questioning whether the presumed rational outcome is itself affected by actor’s (or the market’s) compensating.  In other words, given a set level of earning, yes, people may save “too little.”  But if the same psychic effect that causes them to save too little also causes them to earn more in the first place, the net deviation from optimal may be zero, and the effect on savings may be irrelevant–and this effect may be transparent (which helps the behavioralists make their rhetorical case, but doesn’t help them be right).

But assume they do, and in so assuming behavioralists reveal a remarkable pessimism about markets that is seemingly unwarranted by the thousands of years of human history and progress that seems to have taken place before the creation of the Cornell coffee mug (pdf).

What is so hard to understand is why—other than self aggrandizement or political agendas—the behavioralists think their results are so important.  As I said—interesting, most definitely; but with Earth-shattering ramifications? Hardly.  To take one delicious example, it is claimed by no less authority than Richard Thaler, that investors are systematically biased in their investments and thus that stock prices are systematically incorrect.  Or as his asset management company website puts it,

Investors make mental mistakes that can cause stocks to be mispriced. Fuller & Thaler’s objective is to use our understanding of human decision making to find these mispriced stocks and earn superior returns.

This sort of claim has been used to dismiss the Efficient Capital Market Hypothesis and justify a host of regulatory interventions into markets to insure against bubbles, protect investors, make markets more “fair,” etc.  But did you notice the delicious part?  Thaler—himself an advocate of, among other things, the CFPB—is running an asset management company to take advantage of these defects in reasoning!  And with what potential effect (if he is right, that is)?  More accurate capital markets as his investment decisions yield enormous returns (and an ever-increasing amount of money with which to influence markets, of course), affect stock prices, and generate a host of copy-cats eager to take advantage of his brilliant insights, as well.  Who needs government?

As far as I know (see for yourself; see also this (gated)), Thaler has not made scads of money and has not demonstrated that his investment theories are any better than average—suggesting that perhaps we shouldn’t be so quick to enshrine them in perpetual federal bureaucracies managed by know-nothing true believers like Elizabeth Warren.

So perhaps the upshot of all of this behavioral stuff is that, if it’s right, it doesn’t matter because individuals and markets will act accordingly—even behavioralists themselves act as if this is true (all the while denying it in their advocacy and scholarship).  Of course, it is where the claims are incorrect that the real danger lies—both because the claims may nevertheless be believed and because proponents nevertheless want to insist on governments mandating all kinds of regulatory responses based on them.  But “interesting” doesn’t mean “policy-relevant.”