Archives For behavioral economics

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.

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. Continue Reading…

Nobel Speculation Time

Josh Wright —  8 October 2010

Every year around this time, I repeat my prediction that Armen Alchian, Harold Demsetz, and Ben Klein will win the Nobel Prize for contributions to the theory of the firm, property rights, and transaction cost economics.  I understand that last year’s prize makes this combination less likely, but I see no reason to deviate.  I make the case for that combination, one that I think compares quite favorably to the more frequently discussed trio of Hart-Holmstrom-Tirole, in the linked post.  One can also imagine an Alchian / Demsetz prize for narrowly grounded in their work on property rights.

As Armen’s long-time collaborator William Allen put it in his own letter to the Nobel Committee on Armen’s behalf:

Economics is a broad discipline in methodology, as the Committee is fully aware, ranging from detailed historical, institutional, legalistic description to totally abstract, arcane theory. All such approaches, techniques, and emphases are appropriate. But there is much specialization among the members of the fraternity. And, increasingly, the profession has dealt in rigorous, elegant manipulation, even when the work is purportedly empirical—and even when the substantive results hardly warranted such virtuoso flair. Professor Alchian is a splendid technician, and he has contributed significantly and conspicuously to general “theory.” But, in contrast to many, he has always appreciated that the final payoff of Economics is elucidation of the real workings and phenomena of the world. I know of no one at any time who has had a finer sense of how to use economic analytics to explain the world. Sometimes the explanation requires involved, complex analysis, and Professor Alchian does not fear to use the tools which are required; what is uncommon is his lack of fear in using the MINIMUM tools which are required. In large part, his peculiar genius (the word is used advisedly) is to make extraordinarily effective use of elemental, and often elementary, techniques of analysis. And a host of people—many of whom are now in strategic positions in universities, in government, in the legal system, in the world of business and finance—have enormously benefited from the tutelage of Professor Alchian. … I present Armen Alchian as a giant—a giant who, because of his lack of pretension, is easily overlooked by laymen and even by some supposed professionals—who has greatly honored his profession and uniquely contributed to its usefulness. He would grace the distinguished fraternity of Nobel Laureates.

Indeed.  See also Fred McChesney’s entry on Alchian’s pathbreaking contributions to economic science is available here, and David Henderson’s entry on Alchian in the Concise Enyclopedia of Economics here.

Thomson-Reuters also adds Kevin M. Murphy (another Bruin, at least as an undergraduate!) to their “Watch list” this year, which is also a splendid idea.

Gordon Tullock remains, along with Armen, at the very top of the list of the most deserving.

I’m seeing a lot of predictions for Thaler / Schiller.  That would be the prize that least surprises me.

 

In a policy speech earlier this year, Commissioner J. Thomas Rosch of the Federal Trade Commission advocating the incorporation of behavioral economics into antitrust analysis suggested one concern that others might have with the approach was that “behavioral economics was simply liberalism masquerading as economic thinking.”   The Commissioner himself has been a vocal proponent of incorporating insights from behavioral economics into antitrust, as has already been done in the consumer protection realm (see, e.g. CFPB).  Indeed, with Cass Sunstein’s appointment at OIRA, the recent creation of a “Nudge” team in David Cameron’s Cabinet (aka “behavioral insight team”) in the UK, the CFPB, and the calls from at least one Federal Trade Commissioner to modify antitrust analysis suggest the behavioral regulatory regime is no longer right around the corner; it has arrived.

I’ve been a critic of incorporating behavioral economics into other areas of the law, but especially antitrust (see Nudging Antitrust Part 1 and Part 2).  The problem, as I see it, is not that behavioral economics is itself illegitimate.   To the extent behavioral economics is successful in documenting systematically predictable deviations from rationality, and a robust understanding of the conditions under which those deviations will occur and when they will not, it will contribute much to economic science.  This post, however, is not about behavioral economics, behavioral economists, or the costs and benefits of behavioral regulation.  In antitrust, as with consumer protection generally, the far greater concern from my perspective has always been the threat the regulators, judge and policymakers would misapply the behavioral literature for ends it does not support.  Consistent with that view, one might not be surprised that in antitrust, like in other areas of the law, behavioral insights have nearly uniformly been applied to argue in favor of greater intervention.  The concern, to adopt Commissioner Rosch’s frame, is not that it is behavioral economics that is liberalism masquerading as economic thinking; instead, the concern is that it is antitrust regulators, legal scholars, and policy makers that will misapply it in order to “dress up” preferred policy positions in a veil of economic rigor.  Indeed, behavioral antitrust proposals in the literature are beginning to proliferate, advocating greater intervention in all areas of antitrust: Cartels, mergers, and monopolization.  In each, behavioral economics is employed in favor of a presumption supporting increased antitrust intervention.

In our new paper, co-author Judd Stone and I take on that presumption, but also offer a broader critique of the presumption that the existing behavioral economics literature generates important antitrust policy-relevant implications at all in our recently posted article, “Misbehavioral Economics: The Case Against Behavioral Antitrust.”

In an obvious sense, existing antitrust tools are already capable of incorporating information about consumer irrationality.  If consumers predictably deviate from rational choice (e.g., because of a status quo bias), these biases will be reflected in their actual behavior.  For example, if consumers are irrationally reluctant to switch from Coke to Pepsi in response to a change in relative prices, this is reflected in their actual behavior and existing antitrust tools are sufficient to capture these effects through estimates of demand elasticities and the like.  If behavioral antitrust is to supplant existing tools of antitrust relying on rational choice models (and of course, this includes both Chicago price theory and Post-Chicago game theory), it is going to have to offer a theory of firm irrationality.  And indeed, advocates of behavioral antitrust such as Commissioner Rosch, Maurice Stucke, Amanda Reeves, and others claim that they have done precisely that.

Our fundamental point is to offer the provocative claim that the models of firm irrationality underlying these proposals is flawed because the models employed do not account for irrationality of both firms and rivals / entrants.  We demonstrate that for any given behavioral bias, if one assumes it applies to both incumbents and entrants — we also assume the robustness of these effects even when one must transport them from the individual context to the firm, where it often makes less sense to do so — many if not all of the antitrust implications wither away.  Further, those that are left do not necessarily favor greater intervention.  If advocates of behavioral antitrust seek to supplant the underlying model modern antitrust analysis which treats firms as rational economic agents, the competing models must offer more realistic accounts of firm irrationality.  We conclude that, at least for now, behavioral economics remains irrelevant to antitrust policy.

The abstract is below the fold.

Continue Reading…

A Plug and Some Links

Josh Wright —  29 September 2010

I’ll be talking about the Intel Settlement in an ABA program, The Intel Settlement: A Perspective From the Trenches, today at lunchtime along with a great group of panelists with a wide variety of perspectives on the issue, Kyle Andeer (FTC Counsel), Ken Glazer (KL Gates), and Henry Thumann (O’Melveney & Myers).   If you’re interested, you can register and get call-in numbers at the link above.

And now, some links:

Which CFPB Will We Get?

Josh Wright —  17 September 2010

Todd mentions Elizabeth Warren’s “kick off” speech for the CFPB, in which she accepts the new “President and Special Advisor to the Secretary of the Treasury” gig, and tells us what the new Bureau is all about:

The new consumer bureau is based on a pretty simple idea:  people ought to be able to read their credit card and mortgage contracts and know the deal.  They shouldn’t learn about an unfair rule or practice only when it bites them—way too late for them to do anything about it.  The new law creates a chance to put a tough cop on the beat and provide real accountability and oversight of the consumer credit market.  The time for hiding tricks and traps in the fine print is over.  This new bureau is based on the simple idea that if the playing field is level and families can see what’s going on, they will have better tools to make better choices.

Like Todd, I find this articulation of the mission relatively innocuous.  Of course, that is different from believing that even this narrowly defined mission will be successful in generating new consumer benefits.  And as Todd notes in his post, there are reasons to be skeptical about whether or not even this narrow mission will succeed.

Todd writes that he doesn’t doubt Professor Warren’s sincerity about this mission.  Nor do I.  But I do believe that the “real” mission of the CFPB isn’t simply disclosure of terms and hidden fees.  I suspect so do its supporters — of which I am not one.

Why do I think the mission is broader than disclosure?  First, I doubt there would quite the fuss that we’ve seen over who runs the Bureau if all that were at stake was who would oversee the imposition of a set of mandatory disclosures on credit cards and other loans.  More importantly, I predict a more ambitious CFPB because both Professor Warren and others have themselves advocated for a much broader vision.  As I’ve observed (and written about elsewhere with economist David Evans):

[T]he blueprint for what was then the Consumer Financial Protection Agency was based in large part on using the insights of behavioral economics to design regulation in consumer credit markets.  Advocates of behavioral law and economics have generally taken a dim view of consumer borrowing, arguing that consumers over-value current consumption and do not adequately account for the costs of repayment in the future.  Policy proposals from this literature include a variety of prohibitions of consumer lending, including restrictions on subprime lending, payday lending, banning credit cards, unbundling the transacting and financing services offered by credit card companies, and usury laws.

An evaluation of the proposals emerging out of the behavioral law and economics literature concerning consumer credit go far beyond mandatory disclosure.  The much-discussed “plain vanilla” requirement, for example, reaches into the realm of product design.  But even a cursory read of this literature, including proposals from Elizabeth Warren and Michael Barr, reveals much more ambitious proposals that run much greater risks for consumers.   Moreover, many of these proposals are grounded in the behavioral economics tradition, and embrace the view that consumers are systematically irrational when it comes to financial products and that the government would make better decisions for consumers for their own protection.

As I’ve pointed out with Evans (and again with Todd Zywicki), the behavioral advocates have not adequately made their case as a matter of economic theory or empirical evidence, nor have they sufficiently overcome concerns that the behavioral approach satisfies a careful cost-benefit analysis that accounts for the dynamic costs of dampening individual incentives to improve decision-making and regulator error.  Unfortunately, it is not difficult to find examples of exactly this type of error.  The potential for false positives with this approach is incredibly high.  And the costs of false positives, and the total costs imposed on consumers, exacerbated by the opportunity for even stricter state law measures.

The CFPB in Elizabeth Warren’s “mission statement” is a different, and less ambitious CFPB than described in Professor Warren’s academic work, and in the work of those advocating a behavioral approach to consumer credit.  Which one will we get?  Theory and data suggest that when confronted with a choice between narrow and less powerful regulator and one with more power and a broader mandate, the smart money is that we’ll observe the latter.  If that prediction holds true, and we get the CFPB promised by its advocates when they contemplated its design, access to consumer credit will fall and there is a significant risk that consumers will be made worse off on the whole.

Here’s to hoping we get the less ambitious CFPB promised in Professor Warren’s press release.