Posner v. Thaler - Behavioral Economics

Richard Posner, one of my academic heroes (see here and here), recently criticized the Consumer Financial Protection Agency Act of 2009 in the Wall Street Journal. Although I don't know the details of this act, I was somewhat surprised that in his editorial, Posner went further and criticized behavioral economics and Richard Thaler, one of behavioral economics' strongest proponents:

The plan of the new agency reveals the influence of “behavioral economics,” which teaches that people, even when fully informed, often screw up because of various cognitive limitations. A leading behavioral economist, Richard Thaler of the University of Chicago Booth School of Business, wrote “Nudge: Improving
Decisions About Health, Wealth, and Happiness” last year with Cass Sunstein, who is President Barack Obama’s nominee for “regulatory czar.”

Mr. Thaler, whose views are taken seriously by the Obama administration, calls himself a “libertarian paternalist.” But that is an oxymoron. He is a paternalist with a velvet glove—as the agency will be. Through the use of carrot and stick, the agency will steer consumers to those financial products that it thinks best for them, whatever they naïvely think.

. . .

Behavioral economists are right to point to the limitations of human cognition. But if they have the same cognitive limitations as consumers, should they be designing systems of consumer protection?

Two things struck me about this argument. First, libertarian paternalism, at least as it is defined by Thaler and Nudge co-author Cass Sunstein, is not an oxymoron. They argue this point forcefully in an article called "Libertarian Paternalism Is Not an Oxymoron." This article is one of the forces that converted me to the importance of behavioral economics. Among other things, the article argues that regulators will inevitably influence behavior, since default rules (such as voluntary or mandatory enrollment in retirement plans) affect decisions.

Second, although it may have been tongue-in-cheek, I am surprised by Posner's claim that regulators, because they have cognitive limitations, cannot encourage people to make better decisions. This is a poor argument. Regulators have time to make considered decisions, many consumers do not. Regulators are specialists, most consumers aren't. I was pleased to read that Thaler, in a response to Posner, makes very similar points:

The premise of behavioral economics is that humans are not perfect decision-making machines. We are busy and distracted. We have fields that we know well, but are amateurs in most other domains. If our car breaks down, we go to a trained mechanic. Even the best mechanics will make some mistakes (they are human), but for most of us they still have a better chance of getting our cars to work than doing it ourselves.

Heinzerling - Appointing an Atheist Dean of the Seminary

Although I disagree with a number of President Obama's policies, I appreciate many of his political appointment. I have a lot of respect for his future regulatory czar, Cass Sunstein, and I think Austen Goolsbee has been an excellent advisor. But Lisa Heinzerling's recent appointment as Associate Administrator for the Office of Policy, Economics, and Innovation in the Environmental Protection Agency is an odd and questionable move (HT: Volokh Conspiracy). (To be fair, I'm not sure whether President Obama or the Administrator of the EPA made this appointment.)

In her book Priceless (coauthored with Frank Ackerman) Heinzerling argues that EPA's reliance on cost-benefit analysis is dangerous because, among other things, the process of placing a monetary value on human life devalues it. Heinzerling therefore feels that economics should play a very limited role (if any) in EPA's policy making. She instead urges EPA to make decisions holistically, like the military. (Dean Revesz, a defender of cost-benefit analysis and author of Retaking Rationality, notes with a hint of irony that the decision-making process leading to the Iraq war is the one Heinzerling wants to apply to environmental decisions.)

Though I don't agree with Heinzerling's ideas, I respest her work on cost-benefit analysis. Her critique of CBA helped me to refine my personal views. Still, a few things bother me about this appointment:

First, her appointment seems to be at odds with the mission of Office of Policy, Economics, and Innovation. Thus appointing Heinzerling is the equivalent of choosing an atheist to be the dean of a seminary.

The second reason I feel that Heinzerling is a poor choice is that her views are at odds with regulatory czar Cass Sunstein, who will head the regulatory agency that has oversight over EPA's economic analyses.

It will be interesting to see what changes, if any, Heinzerling's appointment brings.

Regulatory Czar

President Obama, in what I view to be one of his best decisions, nominated Cass Sunstein to lead the Office of Information and Regulatory Affairs. The so-called regulatory czar can have an enormous effect on environmental regulations and regulatory analysis, since OIRA is required to review and approve regulations that have a $100 million-plus effect on the economy. I have enormous respect for Professor Sunstein. Much of my research coincides with Sunstein's solid work on the value of human life and cost-benefit analysis.

The Hill, however, reports that Senator Saxby Chambliss (R-Ga.) wishes to block Sunstein's nomination. The basis for Sen. Chambliss's opposition is statements Sunstein made about hunting and the rights of plants and animals. I find this resistance silly for at least three reasons.

First, no matter what Republicans do, they likely don't have enough votes to block the confirmation of Sunstein. Second, on all matters related to his future job description, Sunstein is quite moderate. Republicans can't hope to do much better but could certainly do much worse. Third, Sunstein likely won't be required to review hunting regulations. Even if he did, he would be required by law to follow cost-benefit guidelines, not his own political agenda.

I hope Sunstein is confirmed as soon as possible.

The Purpose of Behavioral Economics

Professors Christine Jolls, Cass Sunstein, and Richard Thaler published a great 1998 article on behavioral (law and) economics in the Stanford Law Review. One quote strikes me as being particularly insightful:

The project of behavioral law and economics, as we see it, is to take the core insights and successes of economics and build upon them by making more realistic assumptions about human behavior. We wish to retain the power of the economist’s approach to social science while offering a better description of the behavior of the agents in society and the economy. Behavioral law and economics, in short, offers the potential to be law and economics with a higher “R2”—that is, greater power to explain the observed data. We will try to highlight some of that potential (and suggest cases where it has been realized) in this article. (p. 1487)

Proposing more realistic economic assumptions is a pointless exercise unless the assumptions increase the ability of models to predict. Thus, the proof of behavioral economics is, as they say, in the pudding.