The Limits of Behavioral Law and Economics, Australia Edition

Josh Wright —  21 December 2010

At the excellent Core Economics blog, Andreas Ortman discusses an Australian policy debate involving the Review of the Governance, Efficiency, Structure and Operation of Australia’s Superannuation System (also known as the Cooper Review), and more specifically, retirement savings and the superannuation system.  The Cooper Review drafters contend that the behavioral economics literature strongly supports a mandated default option (MySuper).

Ortmann responds that the Cooper Review overstates the case for behavioral law and economics in the realm of retirement savings, and perhaps consumer financial protection generally:

Arguing that a substantial body of work has emerged in recent decades in the field of Behavioral Economics, Gruen then sells unabashedly that field’s alleged insights as the foundation on which to build the choice architecture of the Australian superannuation scheme.

The result is known: it is likely — if indeed the Cooper Review recommendations will be implemented in its essence, which seems likely at this point — that a mandated one-size-fits-all default option (“MySuper”) will be imposed on superannuation members. Gruen, clearly, see this as progress. After all, superannuation members still have the choice to opt out. Or so he argues.

The argument is problematic for at least two reasons.

First, the paternalism of the MySuper default might indeed save poorly informed consumers from themselves. Unfortunately, the existence of such a default option is also likely to result in consumers being poorly informed and disengaged with their supers in the same way as insurance without deductions leads people to be less careful about the things they have insured. Gruen acknowledges some version of this argument in a footnote on p. 16 but dismisses it in passing in a somewhat snotty manner. Well, like it or not, there is an endogeneity problem here. And to dismiss it out of hand is wrong-headed and troubling. Especially if it comes from as influential a person as Gruen. Recent evidence has shown that even optimal defaults may not be optimal and that, in particular when consumers are fairly heterogeneous, requiring individuals to make explicit choices for themselves may dominate optimal defaults (e.g., Carroll et al, Optimal Decisions and Active Decisions, Quarterly Journal of Economics 2009, pp. 1639 – 1674). The result by Carroll et al. is hardly surprising in light of what we know empirically about the — sometimes quite dramatic – effects of financial literacy and peer effects.

Second, it has become bad habit of highly visible policy and/or opinion makers to appeal to alleged insights from Behavioral Economics. None of the people I have in mind here has ever actually done an experiment and it is clear from their uncritical sampling of the evidence that they do not know the relevant literature or the controversies over the production of the – mostly – laboratory evidence that undergirds much of Behavioral Economics. The simple fact is that pretty much every cognitive bias that psychologists, and behavioral economists, have allegedly identified is contested in the relevant literature. (There’d be too many references to list here but feel free to ask me for the syllabus of my Behavioral Course.) Building the superannuation choice architecture on disputed evidence is problematic at best.

Ortmann’s skepticism, particularly in regards to use and abuse of the behavioral economics literature in policy implementations, is similar to that articulated by Judge Ginsburg in I in our contributions to the TOTM Free to Choose Symposium here and here.