Archives For Free to Choose Symposium

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”?

Continue Reading…

Kevin McCabe is a Professor of Law at George Mason University and holds appointments at George Mason’s Interdisciplinary Center for Economic Science, the Mercatus Center, and Krasnow Institute.

Having started my career as an experimental economist I probably have a little different, but I hope complimentary, perspective on behavioral economics and other experimental programs in general.

I view the difference between experimental and behavioral economics in terms of (1) what is studied, and (2) how it is studied.  Experimental economists are interested in institutional and organizational rules and how these rules affect both, the joint behavior of participants, and the outcome generating, or process, performance of the institutional rules in question.  To study this the experimental economist induces preferences and implements a microeconomic system.  One major problem for this approach is that ‘risk preferences’ are very noisy, when induced, due either to, the added complexity imposed on subjects of having to work with induced preferences, or that the induced preferences conflict with a subject’s actual preferences.  A second major problem with this approach is that institutional rules that are isolated in the lab often depend on on additional rules that are not being studied, or social and cultural norms that are not present in the lab.  Experimental economists have learned to manage these problems and many interesting research papers have been produced.

Behavioral economists are interested in individual behavior, whether it be individual choices, strategic decision making, or competitive strategies in markets.  The behavioral economist does not in general induce preferences, but does often use salient rewards in a well defined decision theoretic problem defined by decision theory, game theory, or price theory.  As a consequence of not inducing the behavioral economist is interested in the nature of preferences, and the nature of decision making.  One major problem for this approach is that preferences and decisions interact, and it is often not clear whether one is studying the former, the later, or a combination of both.  A second major problem with this approach is that behavior observed in the lab may not capture the full computations that people are capable of making when augmented by technology and institutions.  But again, behavioral economists have learned to manage these problems and many interesting research papers have been produced.

When I refer to experimental economists, or behavioral economists, I am referring to a researcher employing a specific methodology to explore a specific class of problems.  So, in my experience, there are many researchers who employ more than one methodology, and this has proven to be very useful.  But now I can be more specific, thus narrower, and I’m sure subject to more debate.  Lets hypothesize that experiments are all about exploring the computations that humans make.  Under this hypothesis both experimental economics and behavioral economics are methods for exploring computational mechanisms.  In the former case institutions are mechanisms than make computations, and in the later case individuals are mechanisms that make computations, but in the end we will want a computational theory of economics that includes both.  I think this is where we are heading and when I look at some of the most promising experimental programs including economic systems design, which seeks to engineer better institutions, and neuroeconomics, which seeks to understand the computations occurring in embodied brains, it seems that the computational hypothesis is one that will best integrate the different experimental methodologies and best serve to move experimentation forward.

This raises the question, should we use experiments to study the law?  By my hypothesis anything computational can be studied experimentally, and in legal institutions and in legal decision making many interesting computations are made.  This suggests that we could use experiments to study the law.  The downside of course is that our experiments could mislead us, but any source of data could mislead us.  In its favor experiments invite a form of structured debate that is almost impossible to have without them.  In particular, if I don’t like your experiment, then I’m free to run my own counter experiment, and as long as both our experiments replicate, a good theory should be able to explain both results and lead us to a better understanding of the mechanism in question.  If we agree to the theory but are still hesitant to apply our knowledge to the field we are now in a better position to design, and run, a field experiment that can help us decide.

Claire Hill is a Professor of Law at University of Minnesota.

I want to challenge what seems to be a premise of this symposium: that much of the behavioral “contribution” to economics is about people’s “mistakes” (either cognitive mistakes or “weakness of the will”) and the consequent need for paternalistic intervention.   I think the behavioral perspective has much more to offer; I also think that the focus on mistakes is overblown and pernicious.  Behavioral law and economics was supposed to bring more realism to law and economics.  The worldview in which people are either making mistakes or “getting it right” isn’t much more realistic than the one in which people are always “getting it right.”  Moreover, advancing such a worldview as realistic is a step backwards:  the admittedly “unrealistic” but ostensibly “useful” law and economics is being supplanted by the supposedly more realistic binary world in which people either make mistakes or get it right.  To be sure, of course people sometimes do make “mistakes.” A focus on mistakes that is more methodology (how we proceed) than ontology (how the world is) is quite useful:  of all the ways people act other than as the traditional paradigm predicts, the subset we can label as “mistakes” (and, to be more precise, cognitive mistakes rather than “weakness of the will”) may present a particularly good case for regulatory interventions.  Indeed, the label “mistake” is often used for what is actually “weakness of the will” – not a mistake at all, since a person really does want both cake and good health (and, according to some evidence, she may regret more regularly choosing health over the cake than the cake over health).  In those cases, any regulatory intervention is more appropriately justified by externalities.

Continue Reading…

Free to Choose: Day 1 Wrapup

Josh Wright —  6 December 2010

I’ve compiled links to the excellent posts from day 1 in here, or you can go to the Free to Choose Symposium tab at the top of the blog.

Tomorrow’s lineup should be more of the same, including posts from Claire Hill, Erin O’Hara, Todd Henderson, Tom Brown, Kevin McCabe, Steve Bainbridge, Christopher Sprigman & Christopher Buccafusco, Judd Stone, and myself (individually and jointly with Douglas Ginsburg).

Here are the posts thus far:

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 Buffafusco, 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

Richard A. Epstein is the Laurence A. Tisch Professor of Law, New York University School of Law, The Peter and Kirsten Bedford Senior Fellow, The Hoover Institution, and the James Parker Hall Distinguished Service Professor of Law, The University of Chicago.

Few academic publications have had as much direct public influence on the law as the 2008 article by my NYU colleague Oren Bar-Gill and then Harvard Law Professor Elizabeth Warren.  In “Making Credit Safer,” they seek to combine two strands of academic thought in support of one great cause—more regulation of financial markets.  They start with the central claim of behavioral economics that sophisticated entrepreneurs are able to take advantage of the systematic foibles of ordinary people, by rigging their products in ways that work systematically to their own advantage.  By plying ordinary individuals will carefully packaged payment contracts, firms can undercut the central postulate of rational choice economics that all voluntary transactions produce mutual gains for the parties.  In its stead we get the wreckage of families and fortunes brought about by unscrupulous bankers in search of a buck.  Warren and Bar-Gill repeatedly talk about the importance of empirical evidence.  Her own work, however, is exceptionally shoddy, as Todd Zywicki has recently pointed out in the Wall Street Journal.

The second strand of their argument refers to the law of product liability in which they claim that government actors at all levels have intervened into markets to cure the information deficits in products that in an earlier age used to maim, if not kill, ordinary consumers.  The exploding toaster is their key example of a product that needs government oversight.  In their view, the key insight is that “sellers have no incentive to invest in making a safer product given consumers’ imperfect information.”  That position, moreover, is barely tolerable if consumers know about their own ignorance because they are then in a position to take precautions to offset the lamentable neglect of product providers.  Yet in those cases where consumers fail to perceive the risks, they get the worst of both worlds.  Sellers can afford to be indifferent to product risk, which leads to many bad consequences for consumers in the absence of firm government regulation.

In their model, financial products have similar characteristics.  It is just a short step therefore to argue that the insights of behavioral economics should transform the way in which payment cards should be regulated, to bring the situation into a closer alignment with the system of product liability regulation. However imperfect, Bar-Gill and Warren insist that the current regulation of consumer products outperforms the current of financial products.

At this point, the proper approach is to accept no small ambitions.  Instead their prescient conclusion runs as follows:

[T]he current legal structure, a loose amalgam of common law, statutory prohibitions, and regulatory agency oversight, is structurally incapable of providing effective protection. We propose the creation of a single regulatory body that will be responsible for evaluating the safety of consumer credit products and policing any features that are designed to trick, trap, or otherwise fool the consumers who use them.

Their fondest dreams have been realized.  By recess appointment, Elizabeth Warren is perched inside the United States Treasury as an Assistant to the President and Special Advisor to the Secretary of the Treasury on the Consumer Financial Protection Bureau. (CFPB)  In that capacity, my hope is that she will come to realize the uselessness of the product liability analogies to which she attaches so much weight.  You have to know something first about the body of law to which you which to compare payment markets.  In this instance, neither Bar-Gill nor Warren have the slightest clue about the evolution of product liability law.

Continue Reading…

Ronald Mann is a Professor of Law at Columbia Law School

The idea that the regularity of behavioral departures from full rationality justifies regulatory intervention has rarely gained more credence than in the context of consumer finance.  The Credit CARD Act of 2009 rests on nothing so much as the supposition that cardholder decisions about spending and repayment reflect systematic misapprehension of the likely patterns of future behavior.  And given Elizabeth Warren’s prior writings with Oren Bar-Gill, we can expect the new CFPB to rely heavily on such regulation.

This symposium seems an apt time to consider the difficulty of designing regulatory regimes that aptly take advantage of perceived behavioral regularities.  My doubt comes not from skepticism about departures from rationality – I have no doubt that consumer use of financial products falls far short of the perfection of the rational actor.  Rather, my point is a typical “second best” critique: the departures from rationality are so unpredictable and contextually specific that intervention designed to remedy one departure without accounting for the others has little chance of a salutary result.

Continue Reading…

Judd E. Stone is law clerk to the Honorable Daniel E. Winfree of the Supreme Court of Alaska and formerly Research Fellow of the International Center for Law & Economics.

Behavioral law and economics has arisen to international prominence; between Cass Sunstein’s appointment to head the Office of Information and Regulatory Affairs the United Kingdom’s appointment of a “nudge” bureau, behavioralism has enjoyed a meteoric impact on policymakers.  Thus far, behavioral economists have almost exclusively focused on the myriad foibles or purported cognitive errors which hamper consumer decision-making.  These traits include “optimism bias,” the tendency for an individual to underestimate the likelihood of negative results from their behavior, and hyperbolic discounting, where individuals reveal time-inconsistent preferences (often by over-valuing immediate consumption, at least as measured against some third party’s valuation).

Several recent proposals seek to import these observations wholesale into the antitrust context.  Advocates of “behaviorally-informed” antitrust consistently note the potential presence of one or more individual errors to conclude the necessity of greater interventionism in antitrust, including a Leegin repealer, aggressive Section 2 enforcement, or utilizing Section 5 to “gap-fill” (or intrude upon) Supreme Court precedent hostile to usage of the antitrust laws as a general code of business regulation.  Even conceding the most charitable set of assumptions to the behavioralist enterprise – that behavioral errors are consistent and can be documented within individuals; that these errors persist in markets and are not learned away over time; that these errors aggregate to the firm level; and, necessarily, that these errors are somehow not simultaneously visited upon putative regulators – this attempt is misguided.  In a recent article with Professor Wright, we argue that there is not yet a behaviorally-informed theory of economic behavior relevant to antitrust.  Behavioralist antitrust proposals suffer from a fatal theoretical failure.

Continue Reading…

Christopher Sprigman is Professor or Law at the University of Virginia

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

We would like to start by thanking Josh for inviting us to participate in what promises to be a fascinating discussion on an important subject.  We’re looking forward to engaging with the other members of the symposium.

To begin with, we would like to talk about some of our own experimental research on the valuation anomaly widely known as the “endowment effect.”  Over the past quarter century, laboratory and field research in the social sciences has provided considerable evidence for the existence of a significant gap between the valuations that people attach to goods that they own and the valuations they attach to goods they are considering purchasing.  Thus, in one classic and well-replicated study, subjects to whom a university coffee mug was given indicated substantially higher willingness-to-accept values than subjects who indicated their willingness-to-pay for the mug.  This and similar studies suggest that aspects of goods that should be irrelevant from the perspective of neoclassical economics – such as the fact of prior ownership – can systematically bias valuations of those goods and lead to sub-optimal exchanges and inefficiencies.

In a series of recent studies, we sought to extend these findings into the realm of intellectual property law.  We hypothesized that the valuations that creators attach to their works will be even higher than those of mere owners and would-be purchasers. Continue Reading…

Thom Lambert is Associate Professor of Law at the University of Missouri

Behavioralism is mesmerizing.  Ever since I took Cass Sunstein’s outstanding Elements of the Law course as a 1L at the University of Chicago Law School, I’ve been fascinated by studies purporting to show how humans are systematically irrational.

It is, of course, the “systematic” part that’s interesting.  We all know that people do irrational things on occasion.  What the behavioralists claim is that humans make the same sorts of irrational decisions over and over — that they are, as the title of Dan Ariely’s popular book puts it, “Predictably Irrational.”  Advocates of “behavioral law and economics,” then, contend that policymakers (legislators, regulators, judges) should account for these systematic departures from rational choice when they craft legal rules aimed at maximizing welfare.  They should not, these advocates assert, presume that individuals are rational self-interest maximizers, as traditional law and economics scholars would assume.

While I’ve long been fascinated by behavioral research, and certainly believe that actual facts about how people behave should trump theory, I’ve been reluctant to sign on to the behavioralist law and economics project.  Initially, I harbored suspicions about the research purporting to establish all these systematic cognitive quirks.   For example, I believe (though I’m not sure) that I was a subject in one of those coffee mug experiments that purports to establish the endowment effect (i.e., the effect by which people ascribe a higher subjective value to an object if they own it than if they don’t and would have to buy it).  We did one of those exercises in one of my law school classes, and reports of the studies often refer to experiments involving law students and coffee mugs.  If that’s the sort of experimental data underlying this supposed quirk, it’s hardly robust.  Indeed, as Charles Plott and Kathryn Zeiler recently showed, the endowment effect studies reach quite different conclusions when the questions are posed differently.

After reading Ariely’s fascinating book, which provides lots of detail on how various studies were conducted, I’m less concerned about data quality.  I still suspect, though, that behavioralists are prone to draw hasty conclusions — both positive and normative — from their experimental findings.  I once explained this concern in a short response piece titled Two Mistakes Behavioralists Make, where I criticized two symposium participants for jettisoning rational accounts too quickly in attempting to explain survey findings and for being too quick to advocate governmental solutions to various cognitive quirks (with little regard for government’s own institutional maladies).

The thing that most worries me about the behavioralist law and economics project, though, is the problem of conflicting cognitive quirks.  What’s a policymaker to do when one heuristic would lead humans to reach a particular non-rational conclusion and another simultaneously operative heuristic would push in the opposite direction? Which heuristic trumps? Without knowing that, we can’t predict what actions people will take. Continue Reading…

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…

Henry G. Manne is Dean Emeritus at George Mason University School of Law

Behavioral Economics, like so many efforts previously to upend the hegemony of the neo-classical market model, will leave some footprints on the intellectual sands of time.  However, there is no way that it can accomplish what many of its disciples seem, subliminally at least, to believe:  that we should abandon the traditional model with (because of?) all its implications about private property, competitive markets and individual freedom.  That dream is, of course, ridiculous for one obvious and frequently mentioned reason: Behavioral Economics does not even attempt to offer an integrated theory of resource allocation, the ultimate and necessary mission of any economic theory.  All it does is putter around some select edges of the traditional theory (mainly the very weakly held – and, as we shall see, unnecessary – rationality assumption) and, again like its predecessors in the intellectual history of economics, it claims far more damage to the received model than it actually delivers.

My first observation about the present state of affairs in Behavioral Economic theory is that it builds too ambitiously on the findings of psychology and does not pay enough attention to what economists already well understand.  I don’t know of any respectable economist of the last 80 years or more who has pushed a fundamentalist notion of the rationality assumption in descriptive or analytical economics.  To the extent that some of the more dedicated Behavioralists do accuse devotees of the market model of something like this, they are clearly misunderstanding the heuristic nature of the perfect competition model.  I won’t take the opportunity to try to reeducate them in what economics is all about and what economists do.  Suffice it to say that the model is valuable enough if it does nothing more than paint an idealistic picture of a perfect market – else what’s a heaven for?

What I would like to point out, however, is the irrelevance of much of the substance of Behavioral Economics for “doing” economics.  My principal (as a matter of fact my sole) authority for this proposition (though some of Gary Becker’s work also comes to mind) is the magnificent classic article by Armen Alchian, Uncertainty, Evolution, and Economic Theory, 58 JPE 211 (1950). Continue Reading…

David K. Levine is John H. Biggs Distinguished Professor of Economics at Washington University in St. Louis.

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.

To do economics – behavioral economics or any other kind of economics – it is wise to start with correct knowledge of the facts. Here are some facts that are not as well known as they should be:

  • Modern economics is primarily concerned with the difficulties in making decisions in uncertain and changing circumstances. Learning economics from undergraduate textbooks is dangerous in this respect: most undergraduate textbooks are decades out of date, while modern game-theoretic/information-theoretic/mechanism-design methods have been the focus of economic research both theoretical and applied during those missing decades.
  • The most widely used economic theories do an excellent job of predicting behavior in the laboratory. In competitive auctions, in strategic voter participation and in repeated prisoners’ dilemma games the outcome computed directly from the theory matches with a high degree of accuracy the behavior observed in the laboratory.
  • The issue of the relevance of laboratory studies to non-laboratory behavior has been extensively examined: more money and bigger stakes induce people to behave more carefully, but not in a qualitatively different way than they behave in the laboratory.
  • Modern economic theory and laboratory methods have been successfully combined – that this is a success will probably surprise both the pro- and anti-behavioral economics camps – in the (highly lucrative) field of applied mechanism design.

It must be emphasized that not only does modern economic theory work well in the laboratory, it works well in practice as well. Popular opinion holds that since economists failed to predict the crisis there must be something wrong with economics, to which, no doubt, the solution is behavioral economics. But what modern economic theory tells us about crises is that we cannot predict them. Suppose that we could tell you reliably “next week the stock market will crash.” If this was a reliable prediction then everyone would believe it and so the stock market would not crash next week – it would crash now. Crashes by their nature must be unpredictable. It is odd that nobody criticizes physicists for the lack of predictive power of their models – yet the fact is that it is as central to modern physics that it is impossible to predict which slit a photon will pass through as it is for us to predict when a crises will occur. Perhaps though, the impossibility of predicting crises means that economics is useless? However, we can accurately predict the consequences, for example, of bank bailouts – and we did: you are now living with the consequences of the fact that you ignored us. Continue Reading…