Erin O’Hara on The Free Market Side of Behavioral Law and Economics

Josh Wright —  7 December 2010

Erin O’Hara is FedEx Research Professor at Vanderbilt University School of Law.

Behavioral law and economics (“BLE”) can influence legal policy analysis and regulation in many ways.  On balance, it is not at all clear that this new paradigm undermines a policy commitment to markets.  From one vantage point, the BLE movement can be said to help preserve markets. Importantly, those using the paradigm often start with an underlying assumption that markets are good and that regulations are appropriate only to help correct market defects.  Of course, if “defects” are defined too broadly, the default state of market activity is indeed threatened.  However, the idea that the behavioral movement threatens to erode the primacy of markets that would be achieved without the paradigm erroneously assumes that a government would ever sign onto completely unfettered market behavior.  However desirable a free market state of the world might be, the unfettered markets baseline fails to comport with political realities.  Even setting aside insights from public choice theory (which predicts policy interference with markets), there is always the sense that people aren’t the purely informed rational actors that law and economics models might assume.  Too many people we know and love—our parents, kids, cousins, even ourselves—suffer harm from their decisions as a consequence of a failure to investigate, overcome biases, properly value options etc.  Most people carry an intuition that some market taming/correcting mechanisms are appropriate, and BLE at least helps that discussion proceed rigorously. If so, behavioral law and economics might help to ensure that regulatory actions are market preserving relative to the state of government without those insights.

Moreover, even if we do start with a nonregulation baseline, insights from BLE do not necessarily lead to restrictions on freedom of behavior of market participants.  BLE insights can instead show that regulatory efforts would be unavailing, counterproductive, or unnecessary.  Consider first the possibility that regulatory measures are unnecessary.  More recent behavioral work indicates that deviations from optimal behavior depend a lot on the context in which decisions are made.  If slight variations in decision context influence decision making, then not at all clear that across the board regulatory measures are appropriate.  Instead it might be sufficient to inform people of the circumstances that are likely to lead to poor decisions so that they are forewarned to take extra care in those circumstances.  For example, people who are made to feel rushed and/or made to feel that they owe another an accommodation are more likely to make decisions that disserve their self-interest than are those who are placed in different situations.  And people who are presented with positive affect cues when making a decision are more likely to make those decisions based on heuristic thought processes and less likely to take into account specific relevant information than are people who make the same decisions while being exposed to negative affect cues.  To the extent that simple information about how we make decisions can help to improve those decisions, the value of market activities can be maximized without paternalistic measures.

Legal measures sometimes are justified on the grounds that they help to shape behavior but BLE insights suggest that targeted behavior is unlikely to be influenced by such small regulatory measures.  In those cases, the regulatory justification for some proposed laws is in fact eroded.  For example, the importance of building trust in the doctor/patient relationship is sometimes cited as a rationale for particular medical malpractice and informed consent rules and for imposed physician obligations to treat all patients.  As Claire Hill and I have argued, however, trust in the doctor/patient relationship is so thick that it is likely impervious to these relatively small legal measures.  Similarly, some have argued that laws regarding the admissibility at trial of apologies will affect the perceived strategic utterance of that apology, yet Doug Yarn and I have argued that evolutionary insights into apologetic behavior suggest that people always guard against strategic apologies regardless of the legal rules applied to those apologies.

Sometimes a behavioral insight can be used to show that paternalistic measures aren’t necessary.  A strong endowment effect, for example, might suggest that people don’t impulsively or irrationally give up their belongings to access cash, or at least such impulsiveness is not something we need worry about as a systematic decision making defect.  Similarly, if people overestimate certain small risks, then there may be less need to put regulations in place designed to eliminate those risks (assuming that the individuals can take actions to remove or reduce the likelihood of a harmful result).  In any event, behavioral deviations from those predicted by traditional rational choice theory can be marshaled to help us overcome bad choices, strategic or otherwise.  If so, expensive regulation can be avoided.

In some circumstances, behavioral insights actually help to improve market offerings or other market behaviors so that private market behaviors can generate greater surpluses.  Consider, for example, the insight from Angela Littwin’s work that some consumers would prefer to constrain themselves from having the ability to spend money on tempting items.  If consumers do value these personal constraints, then perhaps there is a market for credit cards that enable consumer to disenable use in some places (i.e. bars or department stores) and/or enable consumers to opt for credit card where limit cannot be raised.  Similarly, Tess Wilkinson-Ryan’s work on liquidated damages and Yuval Feldman and Doron Teichman’s work on contract negotiation and standard-form contracts both provide insights for using the contracting process to enhance contract performance.

To summarize, like traditional law and economics, BLE sometimes justifies unfettered market activity and sometimes justifies regulation.  To the extent that it justifies more frequent regulatory intervention than does a traditional law and economics analysis, the behavioral paradigm is less market friendly than what Milton and Rose Friedman might have had in mind.  But that state of the world will never exist in reality.  Compared to what might transpire otherwise, behavioral law and economics carries the potential of moving us closer to the position that the Friedmans advocated than we’d be without it.

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