Tuesday, July 21, 2015

Who Will Nudge the Nudgers?

Behavioral economics builds on insights from psychology that show a number of specific ways in which people (spoiler alert!) are not fully rational decision-makers. For example, people have limited self-control, so they may neglect to save money or exercise or invest in the training in such a way that they later come to regret their decisions. People can have a hard time understanding complex decision problems, so when it comes to making decisions about the form of their mortgage or insurance policy or when to start drawing Social Security, they may tend to use rules-of-thumb or stick with a default option even when that approach might not serve them well. People's preferences often have features that are not fully rational, like "loss aversion" in which people value losses as worse than same-sized gains. For example, it turns out that people are less likely to sell stocks or homes that have declined in value, because we are averse to accepting that a loss has in fact occurred.

The writing on behavioral economics often follows this pattern: first explain why people aren't rational, and then suggest a government policy--sometimes called a "nudge"--that could help people to overcome their irrationality by providing certain kinds of information structured in a certain way, or by specifying default options that would work better for most people. But what happens if the insights of behavioral economics are also applied to government? After all, if we are going to take into account that people often display a lack of self-control, have difficulties in understanding complex situations, and preferences that appear quirky in certain situations, then it makes sense to apply these same insights to elected officials and regulators.

W. Kip Viscusi and Ted Gayer offer a some early analysis and discussion toward a theory of "Behavioral Public Choice: The Behavioral Paradox of Government Policy," recently published in the Harvard Journal of Law & Public Policy (38:3, pp. 973-1007). For example, they write (footnotes omitted):
"[T]he behavioral economics literature .. frequently recommends “soft paternalism” policies that seek to change the structure of the choices available to individuals in order to encourage a more desirable outcome. But, as behavioral agents themselves, policymakers and regulators are subject to the same psychological biases and limitations as all individuals. Many, although certainly not all, behavioral economics papers focus on the biases and heuristics of ordinary individuals, while seemingly ignoring that regulators are people too and thus subject to the same psychological forces. One study finds that, of the behavioral economics articles proposing paternalistic policy responses, 95.5% do not contain any analysis of the cognitive abilities of policymakers ...  Professor Cass Sunstein observes, “For every bias identified for individuals, there is an accompanying bias in the public sphere.”
Indeed, Viscusi and Gayer point out a number of reasons why less-than-rational behavioral responses may be more prevalent among government decision-makers than for economic actors in the private economy. Here are some examples: 1) Private actors (like consumers and firms) need to bear the immediate costs of their decisions in a direct way, while elected officials and regulators do not. 2) Public policies are often influenced by the loud voice of concentrated special interests, who can overwhelm the quieter and more diffuse voices for the general interest. 3) Market actions evolve from an interaction of many buyers and sellers, and the checks and balances that such a process provides, but government actions can evolve from a much smaller number of potentially overconfident technocrats, who have a personal and career interest in pushing their own agendas.

When you combine these sorts of factors with the behavioral economics insights, it's easy enough to suggest examples where behavioral factors may be potentially leading government policy astray. Here are a few examples drawn from Viscusi and Gayer:

  • People often overestimate risks that have an objectively low probability, but underestimate risks that have an objectively high probability. At an extreme, people worry much more about airplane crashes and shark attacks than the statistics would justify, but worry less about car crashes and high blood pressure. If people driven by news media coverage become highly concerned in the short term about what looks like an objectively small risk, do government regulators act in the same behaviorally driven way? 
  • People are often severely adverse to facing losses, even with the potential for even larger gains. Is the Food and Drug Administration, for example, too loss-averse when it thinks about allowing approving potential new drugs--worrying so much about losses that it doesn't give sufficient weight to potential gains? 
  • People can get tunnel vision, thinking about risk and costs in one context in a way that they wouldn't be comfortable applying in other contexts. Examinations of government regulations suggest that some impose a social cost of $3 million or less per life saved, while others impose a social cost involving billions of dollars per life saved (like the cost of the Environmental Protection Agency Superfund clean-up program). If government regulators across all areas applied a common cost-benefit standard, we could ramp up the cost-effective regulations, cut back the cost-ineffective regulations, and save more lives at lower cost. 

Most of the examples in the paper are draw from government regulatory decisions about health and safety issues, but the arguments they present may have an even broader application. For example, think about elected officials and regulators in the spirit of behavioral economics: they often lack self-control; have a difficult time evaluating complex situations; tend to stick with rules-of-thumb and default options rather than accept the cognitive and organizational costs of re-evaluating their positions; do not evaluate costs and benefits in a consistent way across different contexts; are not good at evaluating risks accurately, instead often respond to limited information and hype; and are overly averse to the risk of taking responsibility for decisions that might turn out poorly.  This perspective must have widespread implications for decisions involving the complexities of the tax code or government budgets, policies affecting the workforce and the environment, openness to new sources of domestic and foreign competition, and foreign policy as well.

Insights from behavioral economics applied to consumers, workers, savers, investors, and firms often suggest some basis for government actions to "nudge" behavior in other directions. But it seems plausible to me that behavioral economics as applied to government will suggest that a number of existing government actions are misdirected or misconceived. And when that happens, it's not clear who will "nudge" government in appropriate directions. Just as the "nudge" policies applied to consumers may sometimes specify what default options should usually be taken, or perhaps limig the number of options available, perhaps behavioral economics as applied to elected officials and regulators suggests the potential importance of specifying their default actions and limiting their choices.

Of course, the problem here is a classic one in political economy. Here's the formulation from the Federalist Papers #51, typically attributed either to James Madison or Alexander Hamilton,

"But what is government itself, but the greatest of all reflections on human nature? If men were angels, no government would be necessary. If angels were to govern men, neither external nor internal controls on government would be necessary. In framing a government which is to be administered by men over men, the great difficulty lies in this: you must first enable the government to control the governed; and in the next place oblige it to control itself."
A modern behavioral economist with a focus on public policy might write, "If angels were to govern people, neither external nor internal controls on government would be necessary. But if voters under the influence of behavioral economics elect political leaders who have this same focus, and if those leaders appoint regulators and administrators who are also under the influence of behavioral economics, you must find ways to oblige such a government to control itself.

Or as the Roman poet Juvenal wrote long ago: "Quis custodiet ipsos custodes?" It's usually translated as "who will watch the watchers?" But for the combination of behavioral economics and political economy, perhaps the more apt translation would be: "Who will nudge the nudgers?"