Professor Bainbridge...on law, politics, religion, culture & food

Obama and Behavioral Economics

I’ve been pretty good about keeping politics out of this third of my blog family, but there’s an an interesting discussion in the blawgoshere about Senator Barack Obama’s purported reliance on behavioral economics in policy making, which likely will be of interest to readers of this blog.

David Leonhardt wrote in the NY Times that:

Senator Obama’s ideas, on the other hand, draw heavily on behavioral economics, a left-leaning academic movement that has challenged traditional neoclassical economics over the last few decades. Behavioral economists consider an abiding faith in rationality to be wishful thinking. To Mr. Obama, a simpler program — one less likely to confuse people — is often a smarter program. ...

Mr. Obama — the onetime community organizer — tends to look at economic policy more like a foreign-policy realist looks at the world. He will sometimes remind aides that policies that look good on paper don’t necessarily work in the real world. “That’s his thing,” says Austan Goolsbee, Mr. Obama’s top economic adviser.

This prompted Free Exchange to observe that:

The example policy we are provided is the mandatory opt-out savings plan:

Mr. Obama would ... require companies to deduct money automatically from their employees’ paychecks and place it in a savings account the employee owned. Employees could opt out of the program. But if they did nothing, they would end up saving money. It’s an idea that comes directly from academic research showing that savings rates have jumped when individual companies have adopted such plans.

This kind of behavioural economics-inspired policy is said to be a good example of so-called “libertarian paternalism” because it leaves the employee free to choose either to participate or not. It is worth pointing out the weird assumption implicit in tagging this sort of thing libertarian.

The standard libertarian view is that individuals and firms must be free to negotiate the terms of labour contracts. If employee and employer are not free to enter into a contract that does not include the opt-out savings program, then the policy is hardly libertarian in the standard sense. Nor is this “soft paternalism”, as it is sometimes said to be. Rather, this is what philosophers would call “impure paternalism”. That is when some individuals are coerced in order to protect the welfare of other individuals, such as when it is made illegal to manufacture cigarettes in order to protect the welfare of the people who might smoke them if made.

In the case of the Obama-style savings program, workers are paternalistically prevented from entering into alternative labor contracts (ones that include no savings program at all) by the means of government regulation of employers. Indeed, a great deal of labour regulation is paternalistic in just this way, meant to prevent workers from harming themselves by entering into “unacceptable” labour contracts.

Whether this leaves workers better off in the end, I won’t venture here to say. But I think one should acknowledge that allowing individuals to make certain choices after they have been prevented the option of making others, for their own good, is just plain old paternalism. If a restaurant is prohibited from offering me anything but a salad, should I rejoice in my freedom to choose the dressing?

It also prompted a long and very thoughtful analysis from Josh Wright, who observes that:

I’m not convinced that Obama’s policies have much to do with a behavioral economics-based platform. Leonhardt raises Obama’s savings plan (opt-out 401(k)’s), broad based tax cuts for the middle class, and opposition to a health care “mandate” as examples of policies informed by behavioral economics. I understand the the connection between the 401k default policy and behavioral economics. But the second two examples don’t strike me as have much do with with the insights of behavioral economics per se. The link between tax cuts and the lessons of behavioral economics, in this context, is tenuous at best. And as Ezra Klein notes while taking the position that he doesn’t see much behavioral economics in Obama’s positions either, one might suspect that a health care mandate would be more in line with the teachings of behavioral economics rather than Obama’s plan.

It is important to remember that the promise of the field of behavioral economics is to identify systematic and predictable deviations from individiual rationality in economic environments. Whether or not this young and growing field in economics lives up to this promise in a manner that translates into sensible legal reforms has yet to be seen as a general matter. I’ve written here that I am unconvinced that behavioral economics has lived up to this promise in the field of consumer contracts where the tools of neoclassical economics generates greater explanatory power.

The point is that the mere assertion of individual irrationality is not a case for behavioral economics, nor any sort of “libertarian paternalism.” For starters, a serious proponent of such interventions must be able to demonstrate the “errors” must be systematic, predictable, and convincingly documented empirically (and in real markets). Then, and only then, does it make sense to seriously discuss the costs (including the long-term dynamic costs emphasized by Klick and Mitchell) and benefits of potentially paternalistic interventions. Indeed, a part of the classical argument for libertarianism is a presumption not that individuals do not make mistakes (there are surely costs associated with being right “all” of the time), but that individuals making their own decisions leads to better outcomes in the long run. Regardless, merely asserting deviations from the rational actor model and calling for government regulation on the behalf of individuals who do not know what is best for them has little do to with behavioral economics or “New Paternalism.” It’s just good old-fashioned paternalism.

I’m inclined to agree with Josh on three key points: that (1) Obama’s policies really aren’t well grounded in behavioral economics, (2) libertarianism doesn’t rely on rational choice theory (although they have some relevance to one another), and (3) behavioral economics generally provides only weak justification for government intervention. As I wrote in Mandatory Disclosure: A Behavioral Analysis,

The analysis herein suggests three (complementary, rather than competing) potential answers to behavioral economics-based market failure claims. First, there will be a strong temptation to use behavioral economics too glibly. Advocates of government intervention will be tempted to jump from positing the status quo bias, citing the coffee mug experiments, to an assertion that the government needs to shake up the status quo, without demonstrating that the bias is truly valid in the specific setting at hand.  Second, a certain degree of skepticism about the power of law to effect social change seems warranted. Indeed, behavioral economics itself offers additional reasons to doubt the capacity of law as agent for social change. Finally, one cannot justify government intervention without asking whether the case for it survives endogenizing the state.

The last point still strikes me as especially important. As I wrote:

In addition to the standard prudential arguments in favor of limited government, which counsel caution in concluding that a purported market failure requires government correction, behavioral economics itself argues against presuming the desirability of intervention:

Proposals designed to address biases generally entail the intervention of judges, legislators, or bureaucrats who are [themselves] subject to various biases. The very power of the behavioralist critique—that even educated people exhibit certain biases—thus undercuts efforts to redress such biases. In addition, the decisions of government actors also may be adversely influenced by political concerns—specifically interest group politics. Thus interventions to “cure” bias-induced inefficiency may ultimately produce outcomes that are worse than the problem itself.

In other words, the claim that law can correct market failures caused by decisionmaking biases or cognitive errors treats regulators as exogenous to the system. Once the state is endogenized, however, regulators must be treated as actors with their own systematic decisionmaking biases. It thus becomes evident that behavioral economics loops back on itself as a justification for legal intervention.

Given that most of us in corporate law have had to address the claims of behavioral economics (or made such claims), it’s interesting to see behavioral economics break into the public debate. As such, those of us who have long labored in this vineyard have an obligation to point out the problems with making policy on the basis of behavioral economics-based claims of market failure.