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September 14, 2006
The New Market Failure
Russell Roberts
John Cassidy writes about neuroeconomics in the New Yorker and finds a new market failure:
Today, most economists agree that, left alone, people will act in their own best interest, and that the market will coördinate their actions to produce outcomes beneficial to all.
Neuroeconomics potentially challenges both parts of this argument. If emotional responses often trump reason,there can be no presumption that people act in their own best interest. And if markets reflect the decisions that people make when their limbic structures are particularly active, there is little reason to suppose that market outcomes can’t be improved upon.
The limbic structure is the part of the brain that is active when people are angry or feeling distress or generally when they feel emotion, in contrast to the "rational" part of the brain. So the research suggests people may not be acting in their own self-interest as economists usually define it.
Cassidy goes on to talk about savings—people have trouble avoiding the temptation to consume now rather than save—and whether there are ways for people to pre-commit to savings in order to avoid temptation:
Laibson and Brigitte Madrian, an economist at the Wharton School, have studied one such “pre-commitment device” for 401(k) plans, which deduct part of an employee’s earnings each month and invest them in stocks and bonds. Because the plans are often optional, many people fail to join them, even when their employers offer to match a portion of their contributions. Laibson and his colleagues have called for people to be automatically included in the plans unless they choose to opt out. At companies that have adopted such a policy, enrollment rates have increased sharply.
Reforming 401(k) plans is an example of “asymmetric paternalism,” a new political philosophy based on the idea of saving people from the vagaries of their limbic regions. Warning labels on tobacco and potentially harmful foods are similarly intended to keep subcortical structures in check. Neuroeconomists have suggested additional policies, including warning buyers of lottery tickets that their chances of winning are practically nonexistent and imposing mandatory “cooling off ” periods before people make big-ticket purchases, such as cars and boats. “Asymmetric paternalism helps those whose rationality is bounded from making a costly mistake and harms more rational folks very little,” Camerer, Loewenstein, and three colleagues wrote in a 2003 issue of the University of Pennsylvania Law Review. “Such policies should appeal to everyone across the political spectrum.”
I guess I'm not part of the political specturm. Asymmetric paternalism has no appeal to me whatsoever. My next EconTalk conversation will be this Monday with Ed Glaeser—we discuss the dangers of soft paternalism, this kind of so-called gentle urging by the government (warning labels, mandatory opt-out provisions) to "improve" our decision-making.
Glaeser and I share one important belief derived from neuroeconomics: politicians have a limbic region of the brain just as you and I do. Here's a nice article summarizing Glaeser's objections to the new paternalism.
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Comments
As a political aside, the recently enacted Pension Protection Act of 2006 specifically authorizes employers to switch from opt-in to opt-out 401(k) enrollment.
This is about as de minimis an example of paternalism as one can conceive. By contrast, mandatory 401(k) participation, without an opt-out, would be a far more disconcerting development.
Posted by: KipEsquire | Sep 14, 2006 12:48:56 PM
This is Orwellian. It's not control over our lives or nannying, it's "assymetric paternalism." It's not taking away your liberty, it's "keep[ing] subcortical structures in check." Bring on the war with Eastasia.
Posted by: Don | Sep 14, 2006 1:42:31 PM
I think the Onion tackled this topic years ago...
http://www.theonion.com/content/node/39045
Posted by: Don Mynack | Sep 14, 2006 1:47:37 PM
Of course, one could also point out that the primary flaw in Cassidy's article is that he presupposes that "emotional responses" are necessarily irrational.
Given that reason is the use of one's personal value system to choose between competing options, it seems hard to believe that "emotional responses" can be unreasonable in any sense of the word. Am I irrational simply because I choose a different option than another person does? Of course not. It simply reflects the fact that I have a different value system than that other person.
In reality, it appears that Cassidy simply dislikes the choices that some people make, and perhaps even the values they use to make the choices. Indeed, it is quite telling that he does not seem to broach the issue of how we are to determine if a market outcome is "ideal" in the first place. Perhaps only well-to-do, politically connected economists are capable of making such a determination.
Posted by: Ben | Sep 14, 2006 1:59:04 PM
Cassidy writes:
"Because the plans are often optional, many people fail to join them"
Some do fail to join, but the majority with access join voluntarily (the glass is more than half full). Regarding automatic opt-in as being paternalistic, I somewhat agree. However, under those opt-in scenarios people maintain the freedom to opt-out unlike say social security.
Posted by: Mcwop | Sep 14, 2006 2:12:09 PM
"If emotional responses often trump reason,there can be no presumption that people act in their own best interest. And if markets reflect the decisions that people make when their limbic structures are particularly active, there is little reason to suppose that market outcomes can’t be improved upon."
Right, now one just needs an oracle machine that tells the the bureaucrats when people's limbic structures become 'unsoundly' active, so that they can 'improve' upon people's actions. Of course, being attached to such an oracle machine in itself might be enough to set of people's limbic structures.
Posted by: kurt | Sep 14, 2006 4:10:15 PM
The idea that humans don't always act in their own self interest should not be controversial or even interesting. The real insidious effect of soft paternalism is that it hinders incentives for technological and organizational improvement.
Computer viruses have been causing computer damage for years. I would guess that few people ever regularly updated their anti-virus software eventhough very important personal documents and records were at stake. But the market responded. AV software makers automated Internet updates and Microsoft, too, made security of their OS a top priority. These software improvements have greatly improved overall productivity even for the few who used to be diligent in protecting their computers.
Ultimately, when we wake up sober with a wicked hangover and our rationality returned, we make plans never, ever to get drunk again. Eventually, we learn our limits, and I would rather not have some interfering soft paternalist tell me what my limit is.
Posted by: Karl | Sep 14, 2006 8:55:26 PM
Soft paternalism is offensive on a number of levels, including the presumptions that emotional decisions are necessarily irrational, the measurement of irrationality is best done by others, and in the aggregate there is some kind of statistically significant pattern of irrationality that can be corrected for collective benefit. But imagine also the unintended consequences of the resulting moral hazards. If the goal is to increase personal discipline/rationality as measured by others, the aggregated response will almost certainly be increased irrationality elsewhere as yet one more aspect of personal responsibility is gutted. You just have to marvel at the unending creativity of those determined to intellectually justify central planning and the absolute inability to imagine policy knock-on effects. That's MY limbic limbo for the day....
Posted by: M. Smith | Sep 15, 2006 8:25:00 AM
Posted by: laptop battery | Oct 13, 2008 12:14:22 AM
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