Forum on behavioral law and economics

Lynne Kiesling

Have you been tempted to nudge? Persuaded by arguments in favor of default opt-ins for things like retirement savings plans? Or do you think behavioral economics is largely about committing the Nirvana fallacy by holding out for some perfection that is only possible in theory? Regardless of your familiarity with or persuasion by behavioral economics, the behavioral law and economics forum right now at the new Library of Law and Liberty will inform you, and may influence your opinion on the foundations, usefulness, and policy relevance of behavioral law and economics. While I found all of the contributions valuable, in particular I found that the lead essay by Joshua Wright and Douglas Ginsburg gave thorough background and articulated many of both the exciting and original ideas in behavioral economics and the criticisms and concerns that I have had.

My two main criticisms of behavioral economics (which also applies to behavioral law and economics) are that its practitioners are happy to recommend policies that constrain individual consumption choices due to individual biases but don’t treat individuals in their policy maker roles symmetrically, and that it ignores or undervalues the benefits of discovery and error correction processes in social systems. The first one is familiar to many classical liberal critics of behavioral economics — it’s essentially a public choice critique of behavioral economics. If individuals are cognitively limited and/or biased when making their individual consumption choices and you model them as such, why don’t you model them as similarly limited or biased when the same individuals are in the role of policy maker, making consumption choices on behalf of others? More prosaically, what makes you think that a cognitively limited policy maker will make any better decision on your behalf than you will?

The second criticism is the core knowledge problem point; inherent complexity and inescapable diffuse private knowledge means that social systems that reward error correction (e.g., enabling arbitrage that leads to goods movements and price convergence across markets) place a value on error and its correction, that it communicates information, and it is unavoidable in a complex system … but that in complex systems with “good enough” negative feedback loops, those systems are self-correcting over time without the need for constraints on individual choices.

Wright and Ginsburg articulate this second point quite clearly, in the course of laying out what they see as the high-level map of the behavioral research agenda:

The first stage of the behavioral economics research program is best described as developing a comprehensive theory of errors.  The theory-building exercise thus far has focused largely upon the effort to catalog circumstances in which economic decision-makers appear systematically to depart from rational choice behavior.  The second step required to make the theory of errors policy-relevant is to map the conditions under which specific errors are more or less likely to affect decisions and then to generate estimates of the social costs imposed by those errors.  This step is particularly important when the incidence of a particular decisionmaking error is context specific, unevenly distributed throughout the population, and likely to interact systematically with other errors.  The third step is to compare the costs of any proposed corrective intervention against the social benefits produced by reducing the rate of error.  At present, however, research in behavioral economics does not appear to have moved much beyond the first step.

The minimum required to correct recurring and systematic errors is an accounting of their social costs and benefits.  The behavioral law and economics literature exhibits a strong tendency to ignore the social benefits of error. At the same time, it tends to overestimate the social costs of errors or at least implicitly to assume the social benefits from reducing identified errors will be greater than the social costs of interventions aimed at correcting those errors.  This tendency explains the current condition under which “virtually every scholar who has written on the application of psychological research on judgment and choice to law has concluded that cognitive psychology supports institutional constraint on individual choice.”[6]

Now that I look at it, both of my criticisms are criticisms of asymmetry. I think a reasonable behavioral economics theory should treat individual biases symmetrically in the various roles they play in social systems, and I think that theory should also account for the fact that error has both social benefits and social costs. Yes, that makes the theory less tractable, but it makes it more useful, and to quote my favorite statistician George Box, “all models are wrong, but some are useful.”

This issue is certainly relevant in the electricity technology and regulation space. I can remember a couple of years ago, when Nudge first came out, a very thoughtful and forward-looking person I know in this area was excited at the prospect of using regulation to establish particular default choices for energy efficiency, for dynamic pricing, and so on. I think this person was surprised at my lukewarm response, which was lukewarm precisely because I don’t think we can assume that we’d have better outcomes from policy makers imposing their view of what’s socially optimal to overcome our biases that slow down innovation in smart grid and so on. How can we be so sure that what we policy makers, technologists, and analysts think would be the best thing for these individuals would actually be the best thing for them individually, and/or that it would overcome whatever biases we think are leading to less energy efficiency than we would experience otherwise? Moreover, unless we’re talking about pretty light-handed things like having time-of-use as the default pricing for default residential service, such regulation can play havoc with individual autonomy and agency and sovereignty, and I find that morally insupportable. Rather, why don’t we incorporate the idea that there are benefits from social error and its decentralized correction into our institutional design, and come up with regulatory institutions that remove the barriers to profiting from decentralized error correction?

A considered and thought-provoking read.

By the way, this forum will be at the top of their forum page for the next couple of days, but a new forum will be up soon! So the goodies will keep coming.

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One thought on “Forum on behavioral law and economics

  1. Thanks for this post. Sorry about commenting so late. I agree fully with your sentiments. Here are some more thoughts on the matter as it interests me a lot.

    In The Constitution of Liberty, Hayek writes about this on page 29:

    “[h]umiliating to human pride as it may be, we must recognize that the advance and even the preservation of civilization are dependent upon a maximum of opportunity for accidents to happen. These accidents occur in the combination of knowledge and attitudes, skills and habits, acquired by individual men and also when qualified men are confronted with the particular circumstances which they are equipped to deal with. Our necessary ignorance of so much means that we have to deal largely with probabilities and chances.”

    “[o]ur whole problem is to make the mistakes as fast as possible” (J.A. Wheeler quoted by Hayek).

    So the benefit with individuals making mistakes, instead of the government, is that there will be many more of them, they will be more varied and corrections to them will be much more numerous and easy to implement.

    From our biology, it also appears that Mother Nature thinks like Hayek. I cannot find the source where I read this, but apparently, only people suffering from depression give accurate estimates of their abilities. So the rest of us are designed to attempt a great many things that are, on average, beyond what we are capable of. Most of the time, we will fail, but sometimes we will succeed spectacularly.

    And, in a free economy, not only fraudsters will appear, but also bodies that either help us overcome our misplaced optimism, and others that make good use of it.

    I have never run with a pulse watch, but I recently talked to someone who said it had ruined his running form. With the pulse watch, he ran in “reasonable” way, instead of pushing himself.

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