Archives For behavioral economics

No, Nudge Was Not on Trial

Josh Wright —  28 January 2011

Slate’s David Weigel ran an otherwise informative piece on Cass Sunstein’s testimony, as head of OIRA, at a recent House Energy and Commerce Committee.  The headline?  Nudge on Trial: Cass Sunstein Defends the White House Against a Republican Attack.  From Weigel’s description of the hearing, there was some general hand wringing about whether there is too much or too little regulation, whether the number of regulations is higher or lower under the Obama administration than during the George W. Bush administration, some run-of-the-mill posturing from questioners.  Weigel concludes the hearing ended “with Sunstein having done no obvious harm to his mission.”

All fine.  And like I said — the article was informative with regard to the hearing.  But its a pretty sloppy and misleading headline.   There are, I think, some interesting issues concerning whether the Obama administration has retreated from behavioral economics a la Nudge, whether (as Ezra Klein contends) Republicans hate behavioral economics, and the role of behavioral economics in administrative agencies and regulation.   Unfortunately, the article really wasn’t about Nudging or behavioral-economics based regulation at all.  If Nudge is going to have its trial — it will be another day.

In the meantime, you can start here for some good background reading on the topic.

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.

Editor’s Note: I invited Professor Thaler to respond to the TOTM Free to Choose Symposium, and he graciously accepted and offered the following response.

Richard Thaler is the Ralph and Dorothy Keller Distinguished Service Professor of Behavioral Science and Economics at the University of Chicago Booth School of Business.

I have now had a chance to read through the contributions to this event and have a few thoughts to share.  I cannot, of course, reply to everything that has been said here, and in any case, most of what I would say already appears in print.  Before getting into specifics let me say one thing up front:  take a deep breath!  These posts have a lot of emotion.  I am not sure why.

On to specifics:

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Free to Choose Wrapup

Josh Wright —  7 December 2010

Thanks to all of the participants for the excellent posts over the last two days.  There are a couple of excellent comment threads where the conversation continues, and I hope that over the next few days participants and readers will get a chance to comment on the posts.  Indeed, if any of the participants feel inspired to send in another post in response to something they read or otherwise, I’ll be happy to post it here and let the discussion continue.  We hope that you’ve enjoyed it.  The posts are compiled below for your convenience, and also at the Free to Choose Tab at the top of the blog.

Free to Choose?

A Symposium on Behavioral Law and Economics

December 6-7, 2010

December 6th


Josh Wright, Introduction

David Friedman, Behavioral Economics: Intriguing Research Project, With Reservations

Larry Ribstein, Free to Lose

David Levine, Behavioral Economics: The Good, The Bad, and the Middle Ground

Henry G. Manne, Behavioral Overreach

Geoffrey A. Manne, Interesting Doesn’t Necessarily Mean Policy Relevant

Thom Lambert, Behavioral Economics and the Conflicting Quirks Problem: A “Realist” Critique

Christopher Sprigman & Christopher Buccafusco, Valuing Intellectual Property

Judd E. Stone, Misbehavioral Economics: The Misguided Imposition of Behavioral Economics on Antitrust

Ronald Mann, Nudging From Debt

Richard Epstein, The Dangerous Allure of Behavioral Economics: The Relationship Between Physical and Financial Products

December 7th

Claire Hill, The Promise of Behavioral Law and Economics

Kevin McCabe, Behavioral Economics and the Law

Tom Brown, Camel Spotting: Is Behavioral Economics Really Beyond Redemption?

Christopher Sprigman & Christopher Buffafusco, Behavioral Economics and the Road from Law to Lab

Stephen Bainbridge, Mandatory Disclosure: A Behavioral Analysis

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

Todd Henderson, Project Behavior: What the Battle is Really About

Judd Stone, Behavioral Economics, Administrative Agencies, and Unintended Consequences

Douglas H. Ginsburg & Joshua Wright, A Taxonomy of Behavioral Law and Economics Skepticism

Douglas H. Ginsburg & Joshua Wright, Behavioral Economics: The Never-Ending Quest for a Third Way

Douglas Ginsburg is Circuit Judge, U.S. Court of Appeals for the District of Columbia.

Joshua Wright is Associate Professor, George Mason University School of Law.

In the brave new world contemplated by the advocates of government policies informed by behavioral law and economics, many more aspects of each individual’s life will be regulated, or more stringently regulated, than at present.  Within the legal academy, the growth of the behavioral law and economics movement has been dramatic.  Surveying all legal publications from 1980 through 1984 reveals that only a single article made mention of the phrase “behavioral economics.”  In 2005 through 2009, however, there were 917 such articles.  What, we must ask, accounts for the great and increasing attraction of the subject to legal academics?

For at least the last 40 years, academic legal writing has been highly prone to the vicissitudes of fashion.  Starting around 1970 the fashion turned to economic analysis of law; particularly after Richard Posner published his treatise on that subject in 1973, scores of articles presenting an economic analysis of a particular legal doctrine appeared in the law journals every year.

In something of a reaction to the growing interest in economic analysis, a smaller but prolific cadre of law professors created the Critical Legal Studies (CLS) movement, which in turn inspired cognate schools such as Critical Race Theory, Critical Feminism, and Queer Theory.  CLS, which had a significant following, advanced the idea that all law (including court made law) is indistinguishable from politics, particularly class politics. See, e.g., Morton Horwitz, The Transformation of American Law: 1780–1860 (1977); Roberto Unger, Knowledge and Politics (1975); Mark Kelman, Consumption theory, Production Theory, and Ideology in the Coase Theorem, 52 S. Cal. L. Rev. 669 (1974).   As recounted by Duncan Kennedy, a leading figure in the movement, one of the early projects of CLS was to “produce[] a critique of mainstream economic analysis of law.”

Overtly a leftist movement, CLS turned out to be little more than a species of Marxism.  The self-declared purpose of the CLS movement was “to provide a critique of liberal legal and political philosophy,” with adherents arguing the “liberal embrace of the rule of law is actually incompatible with other essential principles of liberal political thinking.” Andrew Altman, Critical Legal Studies: A Liberal Critique 3 (1990).

Key to the CLS analysis was the notion of “false consciousness,” defined as the “holding of false or inaccurate beliefs that are contrary to one’s own social interest and which thereby contribute to the maintenance of the disadvantaged position of the self or the group.” John T. Jost, Negative Illusions: Conceptual Clarification and Psychological Evidence Concerning False Consciousness, 16 Pol.  Psychol. 397, 400 (1995). Driving a wedge between reality and what people — that is, other people — perceive, creates a space to be filled by some combination of re-education and, insofar as the public is not radicalized, a resort to paternalism.  The combination is nicely encapsulated, and given a Mao-ist tinge, in Duncan Kennedy’s proposal that professors and janitors at the Harvard Law School be required to trade places for one month each year. See Legal Education as Training for Hierarchy, 32 J. Legal Educ. 591 (1982). The ultimate goal of CLS, as stated by Kennedy was that of “building a left bourgeois intelligentsia that might one day join together with a mass movement for the radical transformation of American society.” Id. at 610.

The end of the communist era in Russia and eastern Europe dealt a blow to CLS, as it did to all leftist movements; the worldwide triumph of socialism, which had long seemed inevitable to so many, never seemed more improbable.  That is not to say that CLS vanished or even went underground; the leading authors are still publishing, but new recruits seem to be scarce.

With interest in CLS and other “critical’ movements waning, legal scholars were in danger by the mid-1990s of being remitted to further work in economic analysis of law (or even more traditional doctrinal exegeses).  But unlike the pioneering work in that field, which had been done by academic lawyers with only informal training in economics, such as Posner, Robert Bork, Henry Manne, and Guido Calabresi, by the 1990s the law schools had appointed to their faculties one or more Ph.D economists.  In other words, the field had grown up; creative and talented amateurs gave way to highly trained professionals using the formal tools of economics and statistics.  An assistant professor without significant formal training in economics could not hope to distinguish himself in law and economics, let alone write something to warrant his promotion to a tenured position.

Behavioral law and economics came to the rescue.  Just as the first wave of law and economic scholarship had provided hundreds of opportunities to revisit plowed ground and turn up new insights, behavior law and economics offered a reason to return to the same ground once again with confidence the new approach would yield new results.  Much of the early law and economics work explored the hypothesis that a particular common law rule was efficient or, in the public choice variation, that a particular statutory provision served some special interest and was inefficient.  In the new scholarship, the author would almost inevitably conclude the prevailing rule should be reformed to take account of a cognitive bias of those individuals subject to the rule or to regulate some as yet unregulated conduct in order to protect individuals from the errors they commit in an attempt to pursue their self-interest.

Because behavioral law and economic scholarship yields proposals for law reform less radical than what CLS had produced, it appeals to a larger segment of the legal professoriate than CLS ever did.  At the same time, behavioral law and economics shares with CLS the paternalistic premise that the poor wretches to be benefitted by the insights of their governors suffer from a form of “false consciousness.”  Behavioral law and economics scholars never use that phrase but the concept is the foundation of their entire enterprise.

False consciousness, then, is a hearty perennial, much like the notion that there is a “third way” of social organization that suffers from neither the arbitrary and inefficient nature of government nor the unforgiving ways of the market.  The staying power of the idea reflects the romantic notion that government can help individuals overcome their own frailties and conform their behavior to their stated goals.

Douglas Ginsburg is Circuit Judge, U.S. Court of Appeals for the District of Columbia.

Joshua Wright is Associate Professor, George Mason University School of Law.

The behavioral economics research agenda is an ambitious one for several reasons.  The first reason is that behavioral economics requires a theory “true” preferences aside from – and in opposition to — the “revealed” preferences of the decision maker.  A second reason is that while collecting and documenting individual biases in an ad hoc fashion can generate interesting results, policy relevance requires an integrative theory of errors that can predict the sufficient and necessary conditions under which cognitive biases will hamper the decision-making of economic agents.  A third is not unique to behavioral economics but is nonetheless significant: demonstrating that behavioral economics improves predictive power.  The core methodological commitment of the behavioral economics enterprise — as with economics generally at least since Friedman (1953) —  is an empirical one: predictive power.  Indeed, no less than  Christine Jolls, Cass Sunstein and Richard Thaler have described the behavioralist research program as the economic analysis of law “with a higher R-squared,” that is, “a greater power to explain the observed data.”

As I’ve observed previously, there are some good reasons to believe that behavioral law and economics (BLE) scholars do not share these methodological commitments.   I’ve discussed previously the example of failure of BLE scholars to even cite, much less grapple with, the work of Zeiler & Plott (or here) regarding the endowment effect.  Zeiler & Plott present and support the provocative claim that current evidence supporting the endowment effect is better explained by experimental procedures than cognitive biases.  Proponents of regulation based on the endowment effect, in my view, need not agree with this interpretation of these findings but they ought to respond to them if they want to be taken seriously.  Unfortunately, out of the 342 articles in JLR discussing the “endowment effect” from 2006 to present, only 35 cite either Zeiler and Plott article.  I find that ratio discouraging for the discipline of behavioral law and economics generally and the prevailing level of discourse.

Indeed, while David Levine is not referring to the BLE literature, he might as well have been when he writes:

Behavioral economics: love it or hate it – there seems to be no middle ground. Lovers take the obvious fact people are not frictionless maximizing machines together with the false premise that economists assume that they are to conclude that all of economics must be wrong. The haters take the equally obvious fact that laboratories are not the real world to dismiss all laboratory evidence that conflicts with their pet theories as irrelevant. In the end they seem primarily to talk past each other.

How can we improve the discourse and get discussion focused on predictive power and consequences of actual behavioral policies proposed or implemented?  The burden here lies with the skeptics.  As Richard Epstein points out, the behavioralists’ message has been clear and effective; indeed, Bar-Gill and Warren’s article generated the Consumer Financial Protection Bureau.  Behavioral skepticism has proven less effective.

Skeptics, including myself, have been decidedly less effective in convincing their respective audiences that specific behavioral proposals should be rejected and conventional economic approaches should (at least for now) prevail in the market for ideas in the academy and in the policy world.  It is true that the skeptics have a number of forces working against them.  One is that BLE is new and exciting.  Arguing that the “conventional” approach outperforms the newest tool in the toolkit is always an uphill battle.  I’ve alluded to a second reason, failure of at least some of the BLE literature to engage with opposing ideas.  But perhaps most important is the failure of the skeptics to present a comprehensive and convincing case that the conventional economic approach systematically can be expected to outperform BLE when the full social benefits and costs of the various approaches and institutions are accounted for.  I’ve long been of the opinion that two primary reasons for this failure are that different strands of the skeptical literature have talked past one another, and that this has led to a failure to present the “full” case against BLE on the record to be evaluated.

Consistent with this view, the goal of this post is not to present any new ideas about behavioral economics or behavioral law and economics, but catalog the various objections that have been raised in the literature, discussing their interactions, and linking to some of the leading scholarship in the area calling into question the assumed superiority of the BLE approach on a variety of grounds.

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Professors Henderson and Ribstein touch on two theoretical failures of the behavioralist movement which both reveal the prematurity of ‘behaviorally-informed’ regulatory proposals: the behavioralist assumptions that (1) behavioral biases theoretically necessitate, or at least enable, public intervention, and (2) governmental entities can net improve individual outcomes over the status quo of unfettered, if limited, human capabilities.  I think both of these observations highlight the shocking dearth of theoretical exploration amongst behavioralists thus far.  I want to focus on connecting these assumptions to the connection between behavioral economics and administrative regulation.

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Todd Henderson is a Professor of Law at the University of Chicago Law School.

Lying in bed for the past day with a stomach bug, I’ve enjoyed reading the contributions of my friends and colleagues. Perhaps the wisest course would be to, like Leonardo DiCaprio’s character pretending to be a doctor in “Catch Me If You Can,” say “I concur” and slip back under the covers. My general views on the subject of Project Behavior (you can choose your reference: either “Project Runway” or Project Mayhem from “Fight Club”), align with the likes of Manne the Elder, Manne the Younger, Epstein, Lambert, and so on. No surprise there. But that is what I want to write about – why? More specifically, why do views about the value of Project Behavior cleave along political or ideological lines?

Consider economics. There is near universal agreement on the value of thinking of the world through the lens of supply and demand curves, marginal incentives, utility functions, and so on. There may be quibbles with the inputs or application of some economic principles to some cases, but no reasonable person can object to the idea of bringing economic concepts to bear on a particular decision. Other factors, like moral or ethical values, may enter the analysis – economics has never excluded them – and trump monetary ones, but that is expected. Economics is not synonymous with money or capitalism or materialism.

So why should Project Behavior be any different? There are tools in behavioral economics or behavioral law and economics that we can use or not use depending on the situation, but to cast the entire Project into doubt because of some of the applications is like throwing out economics because the Depression-era Federal Reserve or K-Mart or your Uncle Bob practices it badly.

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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.

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Stephen Bainbridge is the William D. Warren Professor of Law at UCLA School of Law.

Mandatory disclosure is a—maybe the—defining characteristic of U.S. securities regulation. Issuers selling securities in a public offering must file a registration statement with the SEC containing detailed disclosures, and thereafter comply with the periodic disclosure regime. Although the New Deal-era Congresses that adopted the securities laws thought mandated disclosure was an essential element of securities reform, the mandatory disclosure regime has proven highly controversial among legal academics—especially among law and economics-minded scholars. Some scholars argue market forces will produce optimal levels of disclosure in a regime of voluntary disclosure, while others argue that various market failures necessitate mandatory disclosure.

Both sides in this longstanding debate assume that market actors rationally pursue wealth maximization goals. In contrast, my work in this area draws on the emergent behavioral economics literature to ask whether systematic departures from rationality might result in a capital market failure necessitating government regulation. I conclude that behavioral economics is a very useful tool, but that it in this instance it cannot fairly be used to justify the system of mandatory disclosure.

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Christopher Sprigman is Professor of Law at the University of Virginia

Christopher J. Buccafusco is Assistant Professor of Law at Chicago-Kent College of Law

In our second post, we want to discuss some of the implications of the study (the details of which we described in our first post). One of the consistent concerns about BL&E in this symposium is about the too-quick jump from data to policy. We should emphasize that we think more work needs to be done to support these potential policy suggestions, but, importantly,we think that the answers to the policy issues rest fundamentally on empirical questions.

As we noted in the previous post, our research supports the idea that creators of new works will value them substantially more than will either mere owners or would-be purchasers of the works. These valuation anomalies are likely to create sub-optimal transaction levels in IP markets. The higher transaction and negotiation costs associated with bridging a large bargaining gap are particularly troubling in the IP context where efficient transfer of rights proves crucial. In both the copyright and patent contexts, initial rights-holders (usually authors in the case of copyright and inventors in patent) often are not particularly well positioned to exploit their work. Given the gap between initial entitlement and effective commercial exploitation, an efficient IP law must provide a smooth transition between the initial rights-holder and the eventual transferee or licensee. In this post, we want to suggest two possible solutions to the transaction costs problems – one based on private contracting and another based on changes to legal entitlements.

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Tom Brown is a partner at O’Melveny and Myers and Lecturer at UC Berkeley School of Law.

At the outset let me thank our hosts for inviting me to participate in what I have come to think of as Truth On The Markets’ annual symposium on topics of particular interest to me. Last year at roughly this same time, TOTM sponsored a symposium on what many surely regarded as an obscure topic, but this year’s subject—the role, if any behavioral economics should play in regulatory policy—should be of much wider interest. Although this topic has a connection to the consumer credit industry (a connection that I plan to explore in a comment on Richard’s post from yesterday), I want to start with the more general question of whether we should be concerned about any effort on the part of the Obama Administration to incorporate the lessons of behavioral economics in regulatory policy. Recognizing that I may be putting invitations to future TOTM symposia at risk by saying so, I think that the answer to this question is no.

The invitation to participate in this symposium sets an ambitious agenda. Indeed, there appear to be as many questions in the invitation as there are issues in the typical law school exam. I, however, want to focus on the premise: “Behavioral legal perspectives appear to be gaining traction in the current regulatory landscape, evidenced by an increasing drive to influence or outright constrain individual choice.” This statement links two concepts—“behavioral legal perspectives” and “an increasing drive to influence or outright constrain individual choice”—that may be related or separate. That is, if we accept that the last few years have seen “an increasing drive to influence or outright constrain individual choice,” is it the case that this drive reflects “behavioral legal perspectives”?

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