The Law & Economics of Organization: New Challenges and Directions
Nov. 30-Dec. 1, 2012
The Walter A. Haas School of Business, with support from the Alfred P. Sloan Foundation, is issuing a call for original research papers to be presented at the Conference on The Law & Economics of Organization: New Challenges and Directions. The conference will be held at the Haas School of Business in Berkeley, CA, on Friday, November 30, and Saturday, December 1, 2012. A reception and dinner will follow a keynote address by Nobel Laureate Oliver Williamson on Friday.
The purpose of the conference is to take stock of recent advances in the analysis of economic organization and institutions inspired by the work of 2009 Nobel Laureate Oliver Williamson and to examine its implications for contemporary problems of organization and regulation. Empirical research and research informed by detailed industry and institutional knowledge is especially welcome.
Relevant topics include but are not limited to
the nature, role, and implications of bounded rationality and opportunism as they relate to issues of contracting and the institutional framework governing contractual relationships
government intervention in the market through regulation, antitrust policies, and direct investment (e.g., energy market and health care regulation; patent enforcement; concession contracts in alternative legal environments; government tax preferences for and subsidization of technologies and markets)
the operation and regulation of financial markets and institutions (e.g., the origins of and responses to the financial crisis; the role of credit rating agencies; financial and futures market organization and regulation)
legal and economic determinants of corporate organization, from joint ventures to the organization of corporate boards (e.g, labor restrictions and corporate organization; organization of high technology companies; regulation of corporate boards)
Paper proposals or, if available, completed papers should be submitted on line at http://www.bus.umich.edu/Conferences/Haas-Sloan-LEO-Conference by March 31, 2012. The deadline for completed papers is November 1, 2012. Selections will be made by the conference organizers, Professors Pablo Spiller (Berkeley), Scott Masten (Michigan), and Alan Schwartz (Yale). Conference papers will be published in a special issue of the Journal of Law, Economics, & Organization.
Tomorrow morning at 10:30 I’ll be on a panel at AALS discussing behavioral economics and antitrust law and policy.
The panel includes: James Cooper, Bruce Kobayashi, William Kovacic, Steve Salop, Maurice Stucke, Avishalom Tor and myself. Its a really good group and I’m looking forward to the discussion. Here are the session details:
The program will focus on the influence of Behavioral Economics on Antitrust Law and Policy. Behavioral economics, which examines how individual and market behavior are affected by deviations from the rationality assumptions underlying conventional economics, has generated significant attention from both academics and policy makers. The program will feature presentations by leading scholars who have addressed how behavioral economics impacts antitrust law and policy.
In my presentation I’ll be discussing my work on the topic (co-authored with Judd Stone) and some extensions of that work.
TOTM alumnus Todd Henderson recently pointed me to a short, ten-question interviewTimeMagazine conducted with Nobel prize-winning economist Daniel Kahneman. Prof. Kahneman is a founding father of behavioral economics, which rejects the rational choice model of human behavior (i.e., humans are rational self-interest maximizers) in favor of a more complicated model that incorporates a number of systematic irrationalities (e.g., the so-called endowment effect, under which people value items they own more than they’d be willing to pay to acquire those same items if they didn’t own them).
I’ve been interested in behavioral economics since I took Cass Sunstein’s “Elements of the Law” course as a first-year law student. Prof. Sunstein is a leading figure in the “behavioral law and economics” movement, which advocates structuring laws and regulations to account for the various irrationalities purportedly revealed by behavioral economics. Most famously, behavioral L&E calls for the imposition of default rules that “nudge” humans toward outcomes they’d likely choose but for the irrationalities and myopia with which they are beset.
I’ve long been somewhat suspicious of the behavioral L&E project. As I once explained in a short response essay entitled Two Mistakes Behavioralists Make, I suspect that behavioral L&E types are too quick to reject rational explanations for observed human behavior and that they too hastily advocate a governmental fix for irrational behavior. Time’s interview with Prof. Kahneman did little to allay those two concerns.
Asked to identify his “favorite experiment that demonstrates our blindness to our own blindness,” Prof. Kahneman responded:
It’s one someone else did. During [the ’90s] when there was terrorist activity in Thailand, people were asked how much they’d pay for a travel-insurance policy that pays $100,000 in case of death for any reason. Others were asked how much they’d pay for a policy that pays $100,000 for death in a terrorist act. And people will pay more for the second, even though it’s less likely.
This answer pattern is admittedly strange. Since death from a terrorist attack is, a fortiori, less likely than death from any cause, it makes no sense to pay the same amount for the two insurance policies; the “regardless of cause” life insurance policy should command a far higher price. So maybe people are wildly irrational in comparing risks and the value of risk mitigation measures.
Or maybe, as boundedly rational (but not systematically irrational) beings, they just don’t want to waste effort answering silly, hypothetical questions about the maximum amount they’d pay for stuff. I remember exercises in Prof. Sunstein’s class in which we were split into groups and asked to state either how much we’d pay to obtain a certain object or, assuming we owned the object, how much we’d demand as a sales price. I distinctly recall thinking how artificial the question was. Given the low stakes of the exercise, I quickly wrote down some number and returned to thinking about what I would have for lunch, what was going to be on Sunstein’s exam, and whether I had adequately prepared for my next class. I suspect my classmates did as well. Was it not fully rational for us to conserve our limited mental resources by giving quick, thoughtless answers to wholly hypothetical, zero-stakes questions?
If so, then there are two possible reasons for subjects’ strange answers to the terrorism insurance questions Kahneman cites: Subjects could be wildly irrational with respect to risk assessment and the value of protective measures, or they might rationally choose to give hasty answers to silly questions that don’t matter. What we need is some way to choose between these irrational and rational accounts of the answer pattern.
Perhaps the best thing to do would be to examine people’s revealed preferences by looking at what they actually do when they’re spending money to protect against risk. If Kahneman’s explanation for subjects’ strange answers were sound, we’d see people paying hefty premiums for terrorism insurance. Profit-seeking insurance companies, in turn, would scramble to create and market such risk protection, realizing that they could charge irrational consumers far more than their expected liabilities. But we don’t see this sort of thing.
That suggests that the alternative, “rational” (or at least not systematically irrational) account is the more compelling story: Subjects pestered with questions about how much hypothetical money they’d spend on hypothetical insurance products decide not to invest too much in the decision and just spit out an answer. As we all learn as kids, you a ask a silly question, you get a silly answer.
So again we see the behavioralist tendency to discount the rational account too quickly. But what about the second common behavioralist mistake (i.e., hastily jumping from an observation about human irrationality to the conclusion that a governmental fix is warranted)? On that issue, consider this portion of the interview:
Time:You endorse a kind of libertarian paternalism that gives people freedom of choice but frames the choice so they are nudged toward the option that’s better for them. Are you worried that experts will misuse that?
Kahneman: What psychology and behavioral economics have shown is that people don’t think very carefully. They’re influenced by all sorts of superficial things in their decisionmaking, and they procrastinate and don’t read the small print. You’ve got to create situations so they’ll make better decisions for themselves.
Could Prof. Kahneman have been more evasive? The question was about an obvious downside of governmental intervention to correct for systematic irrationalities, but Prof. Kahneman, channeling Herman “9-9-9” Cain, just ignored it and repeated his affirmative case. This is a serious problem for the behavioral L&E crowd: They think they’re done once they convince you that humans exhibit some irrationalities. But they’re not. Just as one may believe in anthropogenic global warming and still oppose efforts to combat it on cost-benefit grounds, one may be skeptical of a nudge strategy even if one believes that humans may, in fact, exhibit some systematic irrationalities. Individual free choice may have its limits, but governmental decisionmaking (executed by self-serving humans whose own rationality is limited) may amount to a cure that’s worse than the disease.
Readers interested in the promise and limitations of behavioral law and economics should check out TOTM’s all-star Free to Choose Symposium.
There has been plenty of Hurricane Irene blogging, and some posts linking natural disasters to various aspects of law and policy (see, e.g. my colleague Ilya Somin discussing property rights and falling trees). Often, post-natural disaster economic discussion at TOTM turns to the perverse consequences of price gouging laws. This time around, the damage from the hurricane got me thinking about the issue of availability of credit. In policy debates in and around the new CFPB and its likely agenda — which is often reported to include restrictions on payday lending — I often take up the unpopular (at least in the rooms in which these debates often occur) position that while payday lenders can abuse consumers, one should think very carefully about incentives before going about restricting access to any form of consumer credit. In the case of payday lending, for example, proponents of restrictions or outright bans generally have in mind a counterfactual world in which consumers who are choosing payday loans are simply “missing out” on other forms of credit with superior terms. Often, proponents of this position rely upon a theory involving particular behavioral biases of at least some substantial fraction of borrowers who, for example, over estimate their future ability to pay off the loan. Skeptics of government-imposed restrictions on access to consumer credit (whether it be credit cards or payday lending) often argue that such restrictions do not change the underlying demand for consumer credit. Consumer demand for credit — whether for consumption smoothing purposes or in response to a natural disaster or personal income “shock” or another reason — is an important lubricant for economic growth. Restrictions do not reduce this demand at all — in fact, critics of these restrictions point out, consumers are likely to switch to the closest substitute forms of credit available to them if access to one source is foreclosed. Of course, these stories are not necessarily mutually exclusive: that is, some payday loan customers might irrationally use payday lending while better options are available while at the same time, it is the best source of credit available to other customers.
In any event, one important testable implication for the economic theories of payday lending relied upon by critics of such restrictions (including myself) is that restrictions on their use will have a negative impact on access to credit for payday lending customers (i.e. they will not be able to simply turn to better sources of credit). While most critics of government restrictions on access to consumer credit appear to recognize the potential for abuse and favor disclosure regimes and significant efforts to police and punish fraud, the idea that payday loans might generate serious economic benefits for society often appears repugnant to supporters. All of this takes me to an excellent paper that lies at the intersection of these two issues: natural disasters and the economic effects of restrictions on payday lending. The paper is Adair Morse’s Payday Lenders: Heroes or Villians. From the abstract:
I ask whether access to high-interest credit (payday loans) exacerbates or mitigates individual financial distress. Using natural disasters as an exogenous shock, I apply a propensity score matched, triple difference specification to identify a causal relationship between access-to-credit and welfare. I find that California foreclosures increase by 4.5 units per 1,000 homes in the year after a natural disaster, but the existence of payday lenders mitigates 1.0-1.3 of these foreclosures. In a placebo test for natural disasters covered by homeowner insurance, I find no payday lending mitigation effect. Lenders also mitigate larcenies, but have no effect on burglaries or vehicle thefts. My methodology demonstrates that my results apply to ordinary personal emergencies, with the caveat that not all payday loan customers borrow for emergencies.
To be sure, there are other papers with different designs that identify economic benefits from payday lending and other otherwise “disfavored” credit products. Similarly, there papers out there that use different data and a variety of research designs and identify social harms from payday lending (see here for links to a handful, and here for a recent attempt). A literature survey is available here. Nonetheless, Morse’s results remind me that consumer credit institutions — even non-traditional ones — can generate serious economic benefits in times of need and policy analysts must be careful in evaluating and weighing those benefits against potential costs when thinking about and designing restrictions that will change incentives in consumer credit markets.
There is an embarrassing blind spot in the behavioral law and economics literature with respect to implementation of policy whether via legislation or administrative agency. James Cooper and William Kovacic — both currently at the Federal Trade Commission as Attorney Advisor Commissioner, respectively — aim to fill this gap with a recent working paper entitled “Behavioral Economics: Implications for Regulatory Behavior.” The basic idea is to combine the insights of public choice economics and behavioral economics to explore the implications for behavioral regulation at administrative agencies and, in particular given their experiences, a competition and consumer protection regulator.
Here is the abstract:
Behavioral economics (BE) examines the implications for decision-making when actors suffer from biases documented in the psychological literature. These scholars replace the assumption of rationality with one of “bounded rationality,” in which consumers’ actions are affected by their initial endowments, their tastes for fairness, their inability to appreciate the future costs, their lack of self-control, and general use of flawed heuristics. We posit a simple model of a competition regulator who serves as an agent to a political overseer. The regulator chooses a policy that accounts for the rewards she gets from the political overseer – whose optimal policy is one that focuses on short-run outputs that garner political support, rather than on long-term effective policy solutions – and the weight she puts on the optimal long run policy. We use this model to explore the effects of bounded rationality on policymaking, with an emphasis on competition and consumer protection policy. We find that flawed heuristics (e.g., availability, representativeness, optimism, and hindsight) and present bias are likely to lead regulators to adopt policies closer to those preferred by political overseers than they otherwise would. We argue that unlike the case of firms, which face competition, the incentive structure for regulators is likely to reward regulators who adopt politically expedient policies, either intentionally (due to a desire to please the political overseer) or accidentally (due to bounded rationality). This sample selection process is likely to lead to a cadre of regulators who focus on maximizing outputs rather than outcomes.
Here is a little snippet from the conclusion, but please go do read the whole thing:
The model we present shows that political pressure will cause rational regulators to choose policies that are not optimal from a consumer standpoint, and that in a large number of circumstances regulatory bias will exacerbate this tendency. Our analysis also suggests special caution when attempting to correct firm behavior as regulatory bias appears likely more durable than firm bias because the market provides a much stronger feedback mechanism than exists in the regulatory environment. To the extent that we can de-bias regulators – either through a greater use of internal and external adversarial review or by making a closer nexus between outcomes and rewards – they will become more effective at welfare-enhancing interventions designed to correct biases.
Thinking about the implications of behavioral economics at the regulatory level is incredibly important for competition and consumer protection policy (think CFPB, for example). And I’m very happy to see scholars of Cooper and Kovacic’s caliber — not to mention real world agency experience to bring to bear on the problem — tackling it. For full disclosure purposes, I should note that I have or am currently co-authoring with each of them. But don’t hold that against them! Its a thought provoking paper upon which I will have some more thoughts later on, as well as tying it in to some of the work I’ve done on behavioral economics. For example, Judd Stone and I explore a related problem of the implications of firm level irrationality — both for incumbents and entrants — in this piece, and find the implications for antitrust policy less clear (and in some cases, absent) than have behavioral antitrust proponents. See also Stone’s post during the TOTM Free to Choose Symposium on BE and Administrative Agencies.
Daniel Kahnemann and co-authors discuss, in the most recent issue of the Harvard Business Review (HT: Brian McCann), various strategies for debiasing individual decisions that impact firm performance. Much of the advice boils down to more conscious deliberation about decisions, incorporating awareness that individuals can be biased into firm-level decisions, and subjecting decisions to more rigorous cost-benefit analysis. The authors discuss a handful of examples with executives contemplating this or that decision (a pricing change, a large capital outlay, and a major acquisition) and walk through how thinking harder about recognizing biases of individuals responsible for these decisions or recommendations might be identified and nipped in the bud before a costly error occurs.
Luckily for our HBS heroes they are able to catch these potential decision-making errors in time and correct them:
But in the end, Bob, Lisa, and Devesh all did, and averted serious problems as a result. Bob resisted the temptation to implement the price cut his team was clamoring for at the risk of destroying profitability and triggering a price war. Instead, he challenged the team to propose an alternative, and eventually successful, marketing plan. Lisa refused to approve an investment that, as she discovered, aimed to justify and prop up earlier sunk-cost investments in the same business. Her team later proposed an investment in a new technology that would leapfrog the competition. Finally, Devesh signed off on the deal his team was proposing, but not before additional due diligence had uncovered issues that led to a significant reduction in the acquisition price.
The real challenge for executives who want to implement decision quality control is not time or cost. It is the need to build awareness that even highly experienced, superbly competent, and well intentioned managers are fallible. Organizations need to realize that a disciplined decision-making process, not individual genius, is the key to a sound strategy. And they will have to create a culture of open debate in which such processes can flourish.
But what if they didn’t? Of course, the result would be a costly mistake. The sanction from the marketplace would provide a significant incentive for firms to act “as-if” rational over time. As Judd Stone and I have written (forthcoming in the Cardozo Law Review), the firm itself can be expected to play a critical role in this debiasing:
Economic theory provides another reason for skepticism concerning predictable firm irrationality. As Armen Alchian, Ronald Coase, Harold Demsetz, Benjamin Klein, and Oliver Williamson (amongst others) have reiterated for decades, the firm is not merely a heterogeneous hodgepodge of individuals, but an institution constructed to lower transaction costs relative to making use of the price system (the make or buy decision). Firms thereby facilitate specialization, production, and exchange. Firms must react to the full panoply of economic forces and pressures, responding through innovation and competition. To the extent that cognitive biases operate to deprive individuals of the ability to choose rationally, the firm and the market provide effective mechanisms to at least mitigate these biases when they reduce profits.
A critical battleground for behaviorally-based regulatory intervention, including antitrust but not limited to it, is the question of whether agencies and courts on the one hand, or firms on the other, are the least cost avoiders of social costs associated with cognitive bias. Stone & Wright argue in the antitrust context — contrary to the claims of Commissioner Rosch and other proponents of the behavioral approach — that the claim that individuals are behaviorally biased, and that because firms are made up of individuals, they too must be biased, simply does not provide intellectual support for behavioral regulation. The most obvious failure is that it lacks the comparative institutional perspective described above. Most accounts favoring greater implementation of behavioral regulation at the agency level glide over this question. Not all, of course.
For example, Commissioner Rosch has offered the following response to the “regulators are irrational-too” critique:
My problem with this criticism is that it ignores the fact that, unlike human beings who make decisions in a vacuum, government regulators have the ability to study over time how individuals behave in certain settings (i.e., whether certain default rules provide adequate disclosure to help them make the most informed decision). Thus, if and to the extent that government regulators are mindful of the human failings discussed above, and their rules are preceded by rigorous and objective tests, it is arguable that they are less likely to get things wrong than one would predict. Of course, it may be the case that the concern with behavioral economics is less that regulators are imperfect and more than they are subject to political biases and that behavioral economics is simply liberalism masquerading as economic thinking.24 My response to that is that political capture is everywhere in Washington and that to the extent behavioral economics supports “hands on” regulation it is no more political than neoclassical economics which generally supports “hands off” regulation. On a more serious note, perhaps the best way behavioral economics could counter this critique over the long run would be to identify ways in which the insights from behavioral economics suggest regulation that one would not expect from a “left-wing” legal theory.
For my money, I find this reply altogether unconvincing. It amounts to the claim that government agencies can be expected to have a comparative advantage over firms in ameliorating the social costs of errors. The fact that government regulators might “get things wrong” less often than one might predict is besides the point. The question is, again, comparing the two relevant institutions: firms in the marketplace and government agencies. “We’re the government and we’re here to help” isn’t much of an answer to the appropriate question here. There are further problems with this answer. As I’ve written in response to the Commissioner’s claims:
But seriously, human beings making decisions “in a vacuum?” It is individuals and firms who are making decisions insulated from market forces that create profit-motive and other incentives to learn about irrationality and get decisions right — not regulators? The response to the argument that behavioral economics is simply liberalism masquerading as economic thinking (by the way, the argument is not that, it is that antitrust policy based on behavioral economics has not yet proven to be any more than simply interventionism masquerading as economic thinking — but I quibble) is weak.
As calls for behavioral regulation become more common, administrative agencies are built upon its teachings, or even more aggressive claims that behavioral law and economics can claim intellectual victory over rational choice approaches, it is critical to keep the right question in mind so that we do not fall victim to the Nirvana Fallacy. The right comparative institutional question is whether courts and agencies or the market is better suited to mitigate the social costs of errors. The external discipline imposed by the market in mitigating decision-making errors is well documented in the economic literature. The claim that such discipline can replicated, or exceeded, in agencies is an assertion that remains, thus far, in search of empirical support.
With the recent announcement of Sendhil Mullainathan as the Assistant Director for Research at the Consumer Financial Protection Bureau (WSJ profile here), while one turns to the question of how economic input will be incorporated into agency decision-making.
Luke Froeb makes a nice point about the organization of economists in administrative agencies:
The FTC, which enforces identical consumer protection laws, is organized along functional lines, with attorneys and economists each writing memos to a bipartisan Commission. By design, this results in conflict between the economists and attorneys, which allows benefit-cost analysis done by economists to be heard at the highest levels of the organizations.
For those more interested in how Mullainathan’s economic views will translate to policy, the correct place to start is in his October 2008 piece (co-authored with Michael Barr and Eldar Shafir) on Behaviorally Informed Financial Services Regulation, which includes discussions of at least ten policy ideas, including:
Full information disclosure to debias home mortgage borrowers.
A new standard for truth in lending.
A “sticky” opt-out home mortgage system.
Restructuring the relationship between brokers and borrowers.
Using framing and salience to improve credit card disclosures.
An opt-out payment plan for credit cards.
An opt-out credit card.
Regulating of credit card late fees.
A tax credit for banks offering safe and affordable accounts.
An opt-out bank account for tax refunds.
I also believe, but not with great confidence, that this particular paper was the first to propose the well-known “plain vanilla” requirement.
The AALS Section on Antitrust and Economic Regulation and the Section on Law & Economics will hold a joint program on Behavioral Economics and Antitrust Law during the AALS 2012 Annual Meeting in Washington, DC. The program will focus on the influence of Behavioral Economics on Antitrust Law and Policy. Behavioral economics, which examines how individual and market behavior are affected by deviations from the rationality assumptions underlying conventional economics, has generated significant attention from both academics and policy makers. The program will feature presentations by leading scholars who have addressed how behavioral economics impacts antirust law and policy. Confirmed panelists include Maurice Stucke (University of Tennessee), Steve Salop (Georgetown University), Avishalom Tor (Haifa University), and Josh Wright (George Mason University). We are looking to add at least one additional panelist through this call for papers.
Those with an interest in the subject are encouraged to submit a draft paper or proposal via email to Bruce H. Kobayashi, at email@example.com by September 1, 2011.
Faculty members of AALS member and fee-paid law schools are eligible to submit papers. Foreign, visiting, and adjunct faculty members, graduate students, and fellows are not eligible to submit.
Registration Fee and Expenses:
Call for Paper participants will be responsible for paying their annual meeting registration fee and travel expenses.
How will papers be reviewed?
Paper will be selected after review of submissions by members of the Executive Committee of the AALS Section on Antirust and Economic Regulation and the AALS Section on Law & Economics. This committee consists of Scott Hemphill (Columbia Law School), Bruce H. Kobayashi (George Mason University Law School), Michael A. Carrier (Rutgers University School of Law), Darren Bush (University of Houston Law Center), D. Daniel Sokol (University of Florida Levin College of Law), Daniel A. Crane (University of Michigan Law School), and Hillary Greene (University of Connecticut School of Law).
Will program be published in a Journal?
Yes, as a symposium in the Journal of Law, Economics & Policy.
Deadline date for submission:
September 1, 2011. Decisions will be announced by September 30, 2011.
Program Date and Time:
Friday January 6, 2012, 10:30am-12:15pm.
Contact for submission and inquires:
Bruce H. Kobayashi
Chair, AALS Section on Antitrust and Economic Regulation
Russell Korobkin (UCLA) provocatively declares the ultimate victory of behavioral law and economics over neoclassical economics:
I am declaring victory in the battle for the methodological soul of the law and economics discipline. There is no need to continue to pursue the debate between behavioralists (that is, proponents of incorporating insights previously limited to the discipline of psychology into the economic analysis of legal rules and institutions) and the defenders of the traditional faith in individual optimization as a core analytical assumption of legal analysis.
Behavioral law and economics wins. And its not close. Korobkin continues:
[T]he battle to separate the economic analysis of legal rules and institutions from the straightjacket of strict rational choice assumptions has been won, at least by and large. The fundamental methodological assumption of rational-choice economics, that individual behavior necessarily maximizes subjective expected utility, given constraints, has been largely discredited as an unyielding postulate for the analysis of legal policy. Yes, such an assumption, even if inaccurate, simplifies the world, but it does so in an unhelpful way, much in the way that it is unhelpful for a drunk who has lost his car keys in the bushes to search under the streetlamp because that is where the light is.
The paper is remarkable on many levels, few of them positive. I understand Professor Korobkin is trying to be provocative; in this he succeeds. I — for one — am provoked. But one problem with claims designed to provoke is that they may sacrifice other virtues in exchange for achieving the intended effect. In this case, humility and accuracy are the first — but not the last — to go. Indeed, Korobkin begins by acknowledging (and marginalizing) those would deny victory to the behaviorists while magnanimously offering terms of surrender:
Not everyone has been won over, of course, but enough have to justify granting amnesty to the captured and politely ignoring the unreconstructed.
Unreconstructed. I guess I’ll have to take that one. Given the skepticism I’ve expressed (with Douglas Ginsburg) concerning behavioral law and economics, and in particular, the abuse of the behavioral economics literature by legal scholars, it appears capture is unlikely. Indeed, Judge Ginsburg and I are publishing a critique of the behavioral law and economics movement — Behavioral Law and Economics: Its Origins, Fatal Flaws, and Implications for Liberty — in the Northwestern Law Review in January 2012. A fuller development of the case for skepticism about behavioral law and economics can wait for the article; it suffices for now to lay out a few of the most incredible aspects of Korobkin’s claims.
Perhaps the most incendiary aspect of Korobkin’s paper is not a statement, but an omission. Korobkin claims that rational choice economics has been “largely discredited as an unyielding postulate for the analysis of legal policy” — and then provides no citation for this proposition. None. Not “scant support,” not “conflicting evidence” — Korobkin dismisses rational choice economics quite literally by fiat. We are left to infer from the fact that legal scholars have frequently cited two important articles in the behavioral law and economics canon (the 1998 article A Behavioral Approach to Law and Economics by Christine Jolls, Cass Sunstein and Richard Thaler and Law and Behavioral Science: Removing the Rationality Assumption from Law and Economics by Korobkin and Tom Ulen) that the behavioral approach has not only claimed victory in the marketplace for ideas but so decimated rational choice economics as to leave it discredited and “unhelpful.” One shudders to consider the legion of thinkers chagrinned by Korobkin’s conclusive declaration.
Oh, wait. The citations prove the behavioral law and economics is popular among legal scholars — and that’s about it. I’ve no doubt that much is true. If Korobkin’s claim was merely that behavioral law and economics has become very popular, I suppose that would be a boring paper, but the evidence would at least support the claim. But the question is about relative quality of insight and analysis, not popularity. Korobkin acknowledges as much, observing in passing that “Citation counts do not necessarily reflect academic quality, of course, but they do provide insight into what trends are popular within the legal academy.” Undaunted, Korobkin moves seemlessly from popularity to the comparative claim that behavioral law and economics has “won” the battle over rational choice economics. There is no attempt to engage intellectually on the merits concerning relative quality; truth, much less empirical validation, is not a mere matter of a headcount.
Even ceding the validity citations as a metric to prove Korobkin’s underlying claim — the comparative predictive power of two rival economic assumptions — what is the relative fraction of citations using rational choice economics to provide insights into legal institutions? How many cites has Posner’s Economic Analysis of Law received? Where is the forthcoming comparison of articles in the Journal of Law and Economics, Journal of Legal Studies, Journal of Political Economy, Journal of Law, Economics, and Organization, American Economic Review, etc.? One might find all sorts of interesting things by analyzing what is going on in the law and economics literature. No doubt one would find that the behaviorists have made significant gains; but one expecting to find rational choice economics has been discredited is sure to to be disappointed by the facts.
Second, notice that the declaration of victory comes upon the foundation of citations to papers written in 1998 and 2000. The debate over the law and economics of minimum resale price maintenance took nearly a century to settle in antitrust law, but behavioral law and economics has displaced and discredited all of rational choice economics in just over a decade? The behavioral economics literature itself is, in scientific terms, very young. The literature understandably continues to develop. The theoretical and empirical project of identifying the conditions under which various biases are observed (and when they are not) is still underway and at a relatively early point in its development. The over-reaching in Korobkin’s claim is magnified when one considers the relevant time horizon: impatience combined with wishful thinking is not a virtue in scientific discourse.
Third, it is fascinating that it is consistently the lawyers, and mostly law professors, rather than the behavioral economists, that wish to “discredit” rational choice economics. Similarly, rational choice economists generally do not speak in such broad terms about discrediting behavioral economics as a whole. Indeed, behavioral economists have observed that “it’s becoming clear that behavioral economics is being asked to solve problems it wasn’t meant to address. Indeed, it seems in some cases that behavioral economics is being used as a political expedient, allowing policymakers to avoid painful but more effective solutions rooted in traditional economics.” There are, of course, significant debates between theorists concerning welfare implications of models, from empiricists interpreting experiments and field evidence. It is the law professors without economic training that want to discredit a branch of economics. It is important to distinguish here between behavioral economics and behavioral law and economics, and between rational choice economics and its application to law. No doubt there are applications of rational choice economics to law that overreach and warrant deserved criticism; equally, there are abuses of behavioral economics in the behavioral law and economics literature. It is a very productive exercise, and one in which law professors might have a comparative advantage, to identify and criticize these examples of overreaching in application to law. But with all due respect to Professor Korobkin, if rational choice economics is going to be discredited — a prospect I doubt given its success in so many areas of the law — some economists are going to have to be involved.
Fourth, in the midst of declaring victory over rational choice economics, Korobkin doesn’t even bother to define rational choice economics correctly. Korobkin writes:
To the extent that legal scholars wish to premise their conclusions on the assumption that the relevant actors are perfect optimizers of their material self-interest, they bear the burden of persuasion that this assumption is realistic in the particular context that interests them.
Elsewhere, Korobkin writes:
My central thesis, which runs through the three parts of the article to follow, is that now that law and economics has discarded the “revealed preferences” assumption of neoclassical economics – that individual behavior necessarily maximizes subjective expected utility . . .
This isn’t the rational choice argument; this barely suffices as a caricature of the rational choice assumption underlying conventional microeconomic analysis. Korobkin falls victim to the all-too-common misunderstanding that the rational choice assumption is a descriptive assumption about each individual’s behavior. Not only is that obviously incorrect, and I suspect Korobkin knows it; anyone with even a passing familiarity with rational choice literature realizes that a host of economists — Friedman, Becker, Stigler, and Alchian, to name a few — have long been interested in, understood, and incorporated irrational economic behavior into microeconomics. The rational choice assumption has never been about describing the individual decision-making processes of economic agents. Perhaps a model with a different assumption, e.g. that all individuals exhibit loss aversion or optimism bias (or half of them, or a quarter, or whatever), will offer greater predictive power. Perhaps not. Economists all agree that predictive power is the criterion for model selection. That is the right debate to have (see, e.g., here), not whether law professors find uses for the behavioral approach to argue for various forms of paternalistic intervention — and, for note, is still the case that this literature is used nearly uniformly for such purposes by law professors. Korobkin’s method of declaring methodological victory on the behalf of behavioral law and economics while failing to accurately describe rational choice economics is a little bit like challenging your rival to “take it outside,” and then remaining inside and gloating about your victory while he is waiting for the fight outside.
Korobkin defends his provocative declaration of victory with the argument that it allows him to “avoid an extended discussion” of a number of claims he has already deemed appropriate to dismiss (mostly through conventional strawman approaches) in favor of focusing on new and exciting challenges for the behaviorists. I offer two observations on the so-called benefits of declaring victory while the battle is still being waged. The first is that avoiding evidence-based debate is a bug rather than a feature from the perspective of scientific method. The second is a much more practical exhortation against premature celebration: you can lose while you admire the scoreboard. Anyone who has ever played sports knows it is best to “play the whistle.”
One final observation. I recall from Professor Korobkin’s website bio that he is a Stanford guy. You’d think he’d be a little bit more sensitive to the risk of losing the game while the band prematurely celebrates victory.
I blogged a bit about the MetroPCS net neutrality complaint a few weeks ago. The complaint, you may recall, targeted the MetroPCS menu of packages and pricing offered to its consumers. The idea that MetroPCS, about one-tenth the size of Verizon, has market power is nonsense. As my colleague Tom Hazlett explains, restrictions on MetroPCS in the name of net neutrality are likely to harm consumers, not help them:
Indeed, low-cost prepaid plans of MetroPCS are popular with users who want to avoid long-term contracts and are price sensitive. Half its customers are ‘cord cutters’, subscribers whose only phone is wireless and usage is intense. Voice minutes per month average about 2,000, more than double that of larger carriers. The $40 plan is cheap because it’s inexpensively delivered using 2G technology. It is not broadband (topping out, in third party reviews, at just 100 kbps), and has software and capacity issues. In general, voice over internet is not supported by the handsets and video streaming is not available on the network. The carrier deals with those limitations in three ways.
First, the $40 per month price tag extends a fat discount. Unlimited everything can cost $120 on faster networks. Second, it has also deployed new 4G technology, offering both a $40 tier similar to the 2G product (no video streaming), but also a pumped up version with video streaming, VoIP and everything else – without data caps – for $60 a month. Of course, this network has far larger capacity and is much zippier (reliable at 700 kbps). PC World rated the full-blown 4G service “dirt cheap”.
Third, to upgrade the cheaper-than-dirt 2G experience, MetroPCS got Google – owner of YouTube – to compress their videos for delivery over the older network. This allowed the mobile carrier to extend unlimited wildly popular YouTube content to its lowest tier subscribers. Busted! Favouring YouTube is said to violate neutrality. …
So much for the “consumer welfare” case for net neutrality in practice. Of course, the FCC mandate is one of “public interest,” and not just consumer welfare. So — perhaps another case can be made to defend the MetroPCS complaint? Malkia Cyril from the Center for Media Justice offers just such a case in a recent blog post. The problem with MetroPCS satisfying consumer demand for low-cost prepaid plans? Cyril argues that the “Lowering the price for partial Internet service while calling it “unlimited access” is a fraudulent gimmick that Metro PCS hopes will confuse low-income consumers into buying its phones,” and that it is “un-American to give low-income communities substandard Internet service that creates barriers to economic opportunity and democratic engagement.”
Cyril is wrong that competition for low-price plans makes low-income consumers worse off. The claim is the same one that is often made in defense of restricting the access to low-income individuals to other products (and especially consumer credit) because their purchasing decisions cannot be trusted, i.e. the revealed preferences of those 8 million consumers should be substituted for by the Federal Communications Commission in this case. This is precisely the type of claim for which a little bit of economic analysis can go a long way in shedding some light.
David Honig, co-founder of the liberal Minority Media & Telecommunications Council, makes the relevant points (HT: Hazlett):
One of the wireless carriers is offering three packages, all of VOIP-enabled (so they can get services like Skype) with free access to any lawful website, and all of them clearly labeled:
• Plan A: $40, with no multimedia streaming (that is, no movie downloads such as Netflix, porn, etc.)
• Plan B: $50, with metered multimedia streaming.
• Plan C: $60, with unlimited multimedia streaming.
Could you decide which of these three packages meets your needs?
Or is all this just too confusing? Cyril thinks so.
She writes that Plan A “will confuse low-income consumers” into buying this carrier’s cell phones because they won’t be able to figure out that “if you want the WHOLE Internet, you just have to pay more.”
Well, actually you don’t have to pay more. The most expensive option — Plan C — costs $40 less than the least expensive offering of any of the other carriers. And if you later discover you don’t like Plan A, you can upgrade to Plan B or Plan C with no penalty, or you can pay the $100 it would cost to get service similar to Plan C from competing carriers. And you can do that immediately, since none of these plans has an early termination fee. What’s wrong with paying less for the particular services you want?
Cyril is making a common mistake among us lefties when it comes to low income people — she is being paternalistic. Those poor poor people. They can’t think for themselves, so the government has to make decisions for them. In this case, Cyril argues, the FCC should outlaw Plan A (and maybe Plan B) and require every carrier to offer only full-menu service like Plan C. All this in the name of “net neutrality.”
If I’ve learned anything from my 45 years working with low income folks, it’s this: they’re intelligent and they’re resourceful. They have to be in order to survive. They don’t appreciate condescension or sloganeering in their name. And they have sense enough to know whether they’d rather use an extra $20 a month for movie downloads or for movie tickets — and would rather get discounts for services they do not want or need. …
What the FCC doesn’t need to do is increase costs for those who can least afford it. As long as there’s full transparency, low income people ought to be able to choose Plan A, B or C. Low income people — the underserved — don’t need the FCC to decide, for them, how they can spend their money.
This relates to an important economic point that the proponents of these types of regulation often miss, including in the context of lawyer licensing, but also with respect to the hundreds of state and local regulations impacting hundreds of industries that create barriers to entry in the provision of medical services, dental services, hairdressing, etc. The introduction of lower quality products provides greater choice and significant economic value. The fact that not all consumers demand (or can afford) premium brands and services does not mean that consumers are exploited. Recall Milton Friedman’s statement that lawyer licensing is very much like requiring consumers desiring an automobile to purchase a Cadillac. In this case, low-income consumers would bear the brunt of a restriction against the type of plan offered by MetroPCS.
There is a longstanding debate over the differences between the FCC’s “public interest” standard and the “consumer welfare” standard used in traditional antitrust analysis. Sometimes, the two appear to conflict. Sometimes, as is the case here, with the benefit of economics it is clear the two standards converge. Here’s hoping the FCC doesn’t take the bait.