The Frontal Cortex

Behavioral Economics and Bureaucrats

Jane Galt mocks liberal interpretations of behavioral economics:

[This] also applies to behavioural economics, which the left seems to believe is a magical proof of the benevolence of government intervention, because after all, people are stupid, so they need the government to protect them from themselves. My take is a little subtler than that:

1) People are often stupid
2) Bureaucrats are the same stupid people, with bad incentives.

Pithy, yes. Accurate, not so much. Behavioral economists and neuroeconomists haven’t discovered that people are “stupid.” Instead, they’ve discovered that the neoclassical assumptions of economics are “stupid,” or at least woefully incomplete.

Now I agree with Jane that behavioral economics doesn’t automatically justify a new brand of liberal paternalism. Government bureaucrats aren’t any more “rational” than the average man-on-the-street. In fact, I hope behavioral economists and neuroeconomists don’t fall into the same trap as neoclassical economists, which is to confuse their theoretical models with prescriptions for behavior. As far as I’m concerned, theory and prescription should stay far apart. We still know way too little about the human brain to start basing our social policies and governmental regulations on the latest Nature fMRI paper. It’s much safer to stick with our basic libertarian beliefs.

That said, many of our markets and governmental policies are still based on these blatantly incorrect assumptions about human decision-making. (Neo-classical economists may dislike government, but they’ve helped design many of its policies.) For example, economists assume that everybody will save enough money for retirement. (This is the Friedman-Modigliani life-cycle model of saving). Of course, out in the real world, many people don’t save enough. Thanks to the gee-whiz wonders of fMRI, neuroeconomists can now understand why saving money is so difficult. By taking these experiments into account, neuroeconomists and behavioral economists can subtly redesign our decision-making process so that we make “better” decisions.

For example, Richard Thaler of the University of Chicago has designed a simple plan to increase the national savings rate. Rather than asking people whether they want to start saving right away, Thaler has companies ask people if they want to opt into a 401 (k) savings plan in a few months. Since this allows people to make decisions about the distant future without contemplating the present, it bypasses our impulsive instincts. Trial studies of this program have been a resounding success: after three years, the average savings rates went from 3.5 percent to 13.6 percent.

This is the type of liberal paternalism I can support. It begins with an identification of a clearly irrational bias: people have a tendency to value the present more than the future. It then identifies a societal harm based on this bias: people don’t save enough for retirement. It then designs a limited plan to improve our decision-making process, so that we can overcome our own biases. This sort of endeavor doesn’t strike me as a dangerous threat to libertarianism. It’s just good public policy.

As Alan Sanfey, a neuroeconomist at the University of Arizona recently told me, “A lot of governmental policy and regulation is based on the old economic assumptions about decision making. But since we presuppose that people are always going to act in a rational manner, these policies don’t work, because people don’t act that way.”