Behaviorism on the Road to
Serfdom: Misuse of Science in
the Service of Bad Regulation
Presentation to Annual Meeting of the Association for
Private Enterprise Education
Carl A. Johnston, Ph.D., Interdisciplinary Center for Economic Science at
George Mason Univ.; 3330 N. Washington Blvd, Suite 400J, Arlington, VA
22201; e-mail [email protected]
Abstract: Beginning in 2009, Congress launched the most comprehensive regulatory effort
since the 1960s affecting many parts of the economy. In the process, government often
cited Behavioral Economics (BE) principles for justification. In particular, new rules
design tended to reflect principles of “Choice Architecture and “Libertarian Paternalism”
that came into vogue since 2000. Using this paradigm, regulators extended the scope of
what could be regulated by using “nudges” to pre-empt bad behavior where traditional
regulators would intervene only post-hoc with traditional “hard” command-and-control
structures. Sometimes these regulatory methods confuse the issues in important debates.
This paper examines a number of the new regulation efforts, the behavioral arguments used
to justify them, as well as counterarguments.
We draw two sets of conclusions: (1) that prominent economists have for years noted
inadequacies of BE arguments when spread to broader contexts, particularly their
unsuitability as a guide to government regulation. Much of the new regulation suffers from
these shortcomings, and (2) that economic research has not followed up adequately on
certain alternative research agendas, in particular the one set out by Smith, Walker 1993,
that take an entirely different approach to the conclusions used to justify Libertarian
Paternalism. We propose moving ahead on this agenda.
Table of Contents
Introduction .................................................................................................................................................................. 3
BE History ...................................................................................................................................................................... 3
Libertarian Paternalism ........................................................................................................................................... 4
A Sampling of LP Regulation................................................................................................................................... 5
Nudging and Consumer Information ..................................................................................................................... 5
Comparative Effectiveness Research ...................................................................................................................... 5
Insurance Choice .............................................................................................................................................................. 5
Hyperbolic Discounting and Fleet Mileage Standards.................................................................................... 6
Endowment Effect and Saturated Fats.................................................................................................................. 6
The Emergence Of Libertarian Paternalism And Related Movements ................................................. 6
Coffee Cups..................................................................................................................................................................... 7
Libertarian Paternalism is a response to Discovered Irrationality ........................................................ 7
To Anti-Anti-Libertarians And Back Again ......................................................................................................... 9
Camerer and Asymmetric Paternalism ................................................................................................................. 9
Plott, the Unreconciled?............................................................................................................................................ 9
Robinson: Does LP Make Sense? ........................................................................................................................ 10
Smith takes on the deepest Issue....................................................................................................................... 10
New Directions in Research ................................................................................................................................. 11
Works Cited and Bibliography ............................................................................................................................ 13
Introduction
The original title of F.A. Hayek’s signature book, “The Road to Serfdom,” was: “Studies
on the Abuse and Decline of Reason.” Much of that famous book addressed the habit
of authoritarian governments to disguise popular social prejudices as pseudo-science
and then use “science” to justify collectivist policies. Thus, bias cloaked as reasonablesounding critiques of open-competition can result in authoritarian state intervention;
freedom of choice is replaced by government planning in the name of science. Hayek
took a hard line against such policies, arguing that market and planning cannot coexist in the same society.
“Both competition and central direction become poor and inefficient tools if they are
incomplete; they are alternative principles used to solve the same problem, and a
mixture of the two means that neither will work and that the result will be worse than if
either system had been consistently relied upon.” (Road to Serfdom, Pp. 89-90.)
In a sense, scientifically-based Behavioral Economics (BE) has become a justification
to extend the reach of government beyond the traditional realm. Research by
psychologists and economists over the past five or six decades has raised questions
about the rationality of the judgments and decisions that individuals make. As noted
by (RH Thaler and Sunstein 2003)“People do not exhibit rational expectations, [they]
fail to make forecasts that are consistent with Bayes’ rule, use heuristics that lead
them to make systematic blunders, exhibit preference reversals (that is, they prefer A
to B and B to A) and make different choices depending on the wording of the
problem…”
By cataloging a list of common decision-making errors that even highly competent,
well-functioning people make in predictable situations, this research has been turned
into a broader program of “paternalistic” policies that broaden the scope of
government intervention. As Camerer (somewhat bluntly) puts it, the new challenge
of government “… is figuring out what sorts of ‘idiotic’ behaviors are likely to arise
routinely and how to prevent them, while imposing minimal restrictions on those
who behave rationally.” Camerer adds that the “whole range of “paternalistically
protected category of ‘idiots’ includes most people at predictable times.”
BE History
BE’s foundational works were written just after World War II. Important discoveries
in BE include work by Maurice Allais (Allais 1953) showing that individuals act
irrationally when dealing with uncertainty and gambles that might result in a loss. A
100% gain of 50 cents, for example, is more valuable to individuals than a
statistically-identical gamble in which there is a 50% chance of a $1 gain and a 50%
chance of winning $0. People also value what they have already much more than what
they could get by trading it for something else (the so-called endowment effect).(D.
Kahneman, Knetsch, and Thaler 1990). Other biases include the anchoring effect in
Behaviorism on the Road to Serfdom: Misuse of Science in the Service of Bad
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3
which people weight their estimation toward most recent evidence, even if that
evidence is random (Fischhoff et al. 1974), as well as a tendency to be “fair” to trading
partners even when more self-serving behavior would be an advantage (Fehr and
Gachter 2000).
Libertarian Paternalism
BE has spawned a literature about what interventions are best when it comes to
protecting people from their own irrational behavior while sparing those who behave
rationally. The best known of these is called “Libertarian Paternalism (LP).” (Thaler
and Sunstein 2003; Sunstein and Thaler 2008) In this framework, the government
sets prescriptive standards for economic behavior and “nudges” people and
institutions toward those standards. “Nudges” act by influencing “choice structure”
rather than by outright regulation or prohibition. Areas affected include the Internet,
telecommunications, the health care system, energy, transportation, banking, credit
cards, financial markets, the environment, and manufacturing. In the process,
government frequently cited BE principles for justification and design of the new
regulations. LP policy-makers sometimes think of themselves as “choice architects”
who can have wide-ranging influence over individual behavior by narrowing and
ordering the choices available to people at various points of contact with the
government. The palette of policy tools includes:
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Simple defaults (choosing one default for all audiences);
Ordering choices in such a way that more beneficial possibilities are accounted for (for
example, putting the dessert on a separate table so that a person encounters the cost of
getting up from the table before getting to the calorific reward);
Forcing choice (withholding the product or service by default, and releasing it after an
active choice is made);
Limiting choice to a few approved items (as opposed to the presumed economic logic that
more choices are always better than fewer choices);
Providing information about “bad” choices and about what other people think about “bad”
behavior (filling your restaurant menu with information about your foods’ content of “bad”
things like fat and “good things” like vitamins.
BE is now woven into the formal fabric that governs regulation-setting at the federal
level—though in a cautious and conservative-sounding way. The Obama
Administration’s formal regulation-setting authority (set out in Executive Order 13563
released in January 2011, directs regulators to “identify and assess available
alternatives to direct regulation, including providing economic incentives to
encourage the desired behavior, such as user fees or marketable permits, or
providing information upon which choices can be made by the public…
“Where relevant, feasible, and consistent with regulatory objectives, and to the extent
permitted by law, each agency shall identify and consider regulatory approaches that
reduce burdens and maintain flexibility and freedom of choice for the public. These
approaches include warnings, appropriate default rules, and disclosure requirements
as well as provision of information to the public in a form that is clear and
intelligible.” (Office of Management and Budget 2011)
Moreover, the guidance tells agencies “to use the best available techniques to quantify
anticipated present and future benefits and costs as accurately as possible. Where
appropriate and permitted by law, each agency may consider (and discuss
qualitatively) values that are difficult or impossible to quantify, including equity,
human dignity, fairness, and distributive impacts.”
The line separating the issues that individuals and governments should decide is
formally on the table. It appears that the question has become “how far we can go
with abstract objective principles of how ‘rational’ people ‘should’ act.” (Smith and
Walker 1993), p. 246
A Sampling of LP Regulation
The argument has spilled over into numerous regulatory questions too many to name
here, but what follows is a sampling.
Nudging and Consumer Information
By narrowing choice of foods for people you can improve their choices. Defaults have
been shown to have strong effects on real-world choices in domains including
investment (Cronqvist & Thaler, 2004; Madrian & Shea, 2001), insurance (Johnson et
al, 2003), marketing (Goldstein et al, 2008) and beyond.
Comparative Effectiveness Research
The “Patient Protection and Affordability Care Act,” (PPACA, or Health Care Reform)
created a “Comparative Effectiveness Research” (CER) project to compare available
treatment options using scientific research methods. By creating information about
which medical treatments are most “efficient” (and hence which are, by negation,
wasteful), it is hoped that consumers and doctors will choose treatments with better
cost characteristics.
Insurance Choice
BE bias is a huge problem for health insurers. It means that healthy people stay out of
the insurance market, removing a source of premium income to pay for people with
illnesses. Even when healthy people get insured (it is assumed), they face a
temptation to buy the “wrong” kind of insurance—policies with low premiums, high
deductibles and little (again, assumed) economic value. (Chaikind et al. 2010) PPACA
contains numerous provisions seeking to offset the “Endowment Effect” which keeps
people from valuing their current health too highly given the health threats that they
face. The government may have overreached here by going beyond “nudges” to a full
individual mandate for citizens to buy health insurance or face penalties. As of this
writing, the mandate was being reviewed by federal courts and was a substantial
political issue.
Behaviorism on the Road to Serfdom: Misuse of Science in the Service of Bad
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Hyperbolic Discounting and Fleet Mileage Standards
Hyperbolic discounting bias is a distortion of the rational assessment of time value
where individuals value immediate consumption exponentially more highly than
future consumption or saving. (Frederick, Loewenstein, and O'donoghue 2002)
An LP regulator might look for ways to discourage the purchase of big fuel guzzling
cars by giving consumers and automakers incentives to spend more on fuel-saving
automobile technology, which, in turn, allows people to spread their fuel
consumption over a greater number of miles.
If “the market” will not produce more fuel efficient cars, then government should give
consumers a “nudge” by decreasing the supply of gas guzzlers. The Obama
Administration has planned the most ambitious fleet economy fuel standard in
decades. (Committee on the Effectiveness and Impact of Corporate Average Fuel
Economy (CAFE) Standards, National Research Council 2002)It would provide incentives
for all manufacturers, including those that exceed the fuel economy targets, to
continually increase fuel economy, while allowing manufacturers flexibility to meet
consumer preferences.
Endowment Effect and Saturated Fats
In many products saturated fats were replaced with trans fats, which have since been
determined to be detrimental. However, the cure has been arguably worse than the
illness since in the overall American diet saturated fat was replaced with increased
consumption of refined carbohydrates and grains. Scientific findings suggest that
polyunsaturated fats would be a preferred replacement for saturated fats for better
heart health. Thus, after nudging consumers into swearing off of transfats, a
conscientious “paternalist” now must take responsibility for the consumers’
replacement menu.
The Emergence Of Libertarian Paternalism And Related Movements
Leading experimental economists have all published critiques of behavioral
economics and its suitability as a guide for administering public policy. The
consistent theme of those writings is that behavioral departures from the rational
expectations model are evident but their meaning is in dispute. Some argue that the
science justifies further movements in the direction of Libertarian Paternalism.
Others criticize Libertarian Paternalism for overreaching by creating a ‘choice
architecture’ that produces post hoc outcomes deemed rational by an omniscient
rational planner. Finally, some argue that irrational outcomes may be the result of
institutions and environments that insufficiently value rationality. We will propose a
substantially different research agenda based on the as yet theoretically unstudied
use of incentives to motivate rational behavior being used in impoverished public
schools and elsewhere. (Smith and Walker 1993)
Though it may be an oversimplification, the aspect of behavioral economics most
focused upon is the so-called “Endowment Effect.” This type of irrational behavior
was first documented in a famous classroom economic experiment in which coffee
cup trading was used to challenge the notion that classical economics and Coase
theory of exchange. This experiment gives us an excellent way to enter into a
conversation about differences of interpretation between Libertarian Paternalists
and other economists who are slower to reject rationality as a basis for economic
action.
Coffee Cups
In order for two parties to trade an object, the buyer’s willingness-to-pay (WTP) for
the object in trade has to exceed the seller’s willingness-to-accept (WTA). If the two
amounts are equal, or the WTA is greater than WTP, no trade occurs. Insofar as the
WTA does not reflect the replacement value of the underlying object and is instead
higher, we can speak of ‘deadweight loss’ arising from the fact that no gains from
trade are realized. (D Kahneman, Knetsch, and RH Thaler 1990)
In the coffee cup experiment, coffee mugs are randomly given to half the subjects in
an experiment. The subjects then conduct a market in the mugs. According to the
Coase theorem, about half of the mugs should trade. Actual markets, however,
produce a volume that is always significantly less than Coase predicts. On the other
hand, the experimenter can then introduce tokens whose values have been induced
with higher values and the correct trading volume is observed. (Kahneman, Knetsch,
and Thaler 1990) The experiments together both reemphasize the notion that
endowment effect may exist and also eliminate Coasian arguments that the refusal to
trade is a function of transaction costs that eliminates gains from trade. (D Kahneman,
Knetsch, and RH Thaler 1990)
Kahneman does, however, acknowledge that there is a possibility that the higher
sellers’ WTA occurs because subjects might have believed the coffee cups were a kind
of public good which they destroyed by selling them. Their “guilt” at destroying a
public trust, therefore, might have caused a reluctance to trade. This desire to
overvalue a good that was given to the person as a ‘gift’ more than it was worth is said
to be a manifestation of ‘loss aversion’ the situation that occurs when losses are
weighted more than gains. (Kahneman, Knetsch, and Thaler 1990)
Another possibility is that subjects had a “sentimental attachment” to the coffee cups
which increased WTA. At the end of the day, however, Kahneman is resolute in the
assertion that the behavior is simply irrational. “The differences in preferences or
taste demonstrated by more than 700 participants in the experiments reported in this
paper cannot be explained in this fashion (as sentimental attachment).” (Kahneman,
Knetsch, and Thaler 1990) p. 1342
Libertarian Paternalism is a response to Discovered Irrationality
For those who accept the notion that Kahneman et al have found considerable
evidence of a persistent unreasonableness in human behavior under certain
circumstances, the question becomes: what do we do about behavior that fall into
Behaviorism on the Road to Serfdom: Misuse of Science in the Service of Bad
Regulation
7
predictable irrationality traps? In this context, (RH Thaler and Sunstein 2003)bring
up the notion of Libertarian Paternalism. Their argument is that the irrationality is
due to certain kinds of resource contraints faced by individuals: information,
cognition, and willpower.
“That is, we emphasize the possibility that in some cases individuals make inferior
choices, choices that they would change if they had complete information, unlimited
cognitive abilities, and no lack of willpower.” P. 175 (RH Thaler and Sunstein 2003)
LP fills the need for an idea of what government can “do” to protect people from their
own irrational behavior by suggesting ways that government can assist individuals by
filling gaps in information, cognitive ability and willpower. (Thaler and Sunstein
2003; Sunstein and Thaler 2008) In this respect, the government sets prescriptive
standards for economic behavior and “nudges” people and institutions toward those
standards. “Nudges” act by influencing “choice structure” rather than by outright
regulation or prohibition.
Libertarian Paternalism may be said to underly classical regulatory philosophy. As
Camerer notes: “Health and safety regulation of dangerous occupations was based on
fears that pressure to provide for one's family might lead people to incur risks
deemed unacceptable to the larger society. Regulation of narcotics may stem from
concerns that narcotics have the capacity to turn ordinarily functioning people into
the equivalent of ‘minors,’ or ‘idiots.’” To this may be added paternalistic policies such
as food content labels, warnings on cigarette packs, active anti-tobacco advertising,
and FDA drug regulation.
These policies impose minimal costs if the conservatives are right, and maximal
benefits if rationality and will-power are as bounded as many behavioral economists
believe. Asymmetric paternalism might equally well be designated by the term we use
in our title: "paternalism for conservatives."
The types of “nudges” that could be applied might include more defaults on insurance
policies. For example, health insurance might include a default choice in which
individuals would waive their right to a court trial in the event of a dispute and rely
instead on arbitration. Consumer finance transactions could be subject to broader
disclosure on fees and costs of funds. The federal government could expand
legislation by requiring similar disclosures in a variety of other loan situations,
“including reverse mortgages, insurance premium financing, title loans, home equity
loans, home improvement loans, and credit sales contracts.”
However, some economists do not accept that BE should be applied even as carefully
as the “conservative” LPs would take it.
To Anti-Anti-Libertarians And Back Again
Other economists accept the behavioral proof that individuals are irrational under
certain circumstances but reject the “nudge” approach. In particular, a group of selfidentified “conservative” economists worried that direct application of BE to
regulation leaves too much room for regulators to “over-nudge” the economy at the
expense of rational choice makers. (Jolls, Sunstein, and R Thaler 1998)who have
advocated an approach dubbed ‘anti-antipaternalism’-a skepticism about
antipaternalism, but not an affirmative defense of paternalism."
Camerer and Asymmetric Paternalism
Yet another group of concerned economists in (Camerer et al. 2003) have offered
“asymmetric paternalism” as a modification that imposes a benefit/cost analysis on
LP activity to prevent non-pareto regulation. The idea here is that any move to be
‘paternalistic’ ought to be reversible (in case the theory is misstaken) and subject to
the test that ‘benefits’ of the paternalism substantially outweigh costs, particularly
costs imposed on those behaving rationally without paternalism.
“This Article, and our pursuit of an approach we term ‘asymmetric paternalism,’ reflect
trepidations shared among all of the authors about the use of behavioral research to
justify paternalistic policies. We have two major concerns. First, while research in
behavioral economics documents common mistakes, those mistakes are typically far
from universal,…and we worry that paternalistic policies may impose undue burdens on
those people who are behaving rationally in a particular situation.
Camerer continues:
“Second, behavioral economics is in an early stage of development, and therefore its
findings should elicit more caution than those from more "mature" fields (which are by
no means themselves invulnerable to revision). For those prone to give unabashed
support for paternalistic policies based on behavioral economics, this paper argues that
more discipline is needed and proposes a possible criterion… Our approach accords even
better with a second justification for paternalism which focuses on situations rather
than persons.” (p. 1213)
Plott, the Unreconciled?
Finally, there are the economists with profound doubts about LP. At least some of
Charles Plott’s writing can fit within this rubric. His concern may be not so much
about the artifacts discovered by BE in the laboratory as their meaning and doubts
about how far it can be generalised. The position arises from a view on the
importance of details in experiment design as well as a reluctance to do away entirely
with homo economicus too casually.
The most difficult philosophical conundrum posed by Plott and others is that if
subjects are predictably rational under specific institutional rules in the laboratory in
experimental conditions, then it must be the case that irrationality arises only
Behaviorism on the Road to Serfdom: Misuse of Science in the Service of Bad
Regulation
9
because circumstances outside of a laboratory cause it. Thus, “mistakes” by
individuals are a product of fallible rules, incentives and institutions not indvidual
capacity to reason.
“The mechanics of how buyers and sellers get together can substantially influence
market performance. That is, for the same underlying incentives, the market
performance is affected by a change of institutions.”, p. 1489 (Plott 1982)
The argument against this proposition is best stated by RH Thaler and Sunstein
(2003).
“In a fully rational world, such design choices would have little effect (at least in high
stakes situations) because agents would simply choose the best option for them
regardless of the default.”, p.176
Robinson: Does LP Make Sense?
Here we can take a small departure from the work of the theorist and experimenter
to consider the opinion of people whose primary interest is in assessing benefit/cost
of regulation. (Robinson and Hammitt 2010)These authors find that:
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While researchers have found an increasing number of behavioral deviations from
neoclassical economic assumptions, it is not yet clear how significant many of these
deviations are in terms of pervasiveness.
It can be very difficult to distinguish “real” from “mistaken” choices or values.
Much of the research involves small scale laboratory experiments and needs to be
supplemented by additional fieldwork to explore the real-world importance of the
findings. Also, deviations are often dependent on the context, and more work is
needed to determine whether the deviations found in the contexts frequently studied
are equally important in the context of policy decisions we consider.
In using behavioral economics in cost-benefit analysis, the issue becomes
identifying where the findings from behavioral economics might lead to analytical
approaches that differ from typical practices.
The tension between unquestioning acceptance of individual choices and
acceptance of only those that are judged to be rational and welfare-enhancing is at
the heart of many of the implications of behavioral economics for the conduct of
benefit-cost analysis.
While analyses provide important and useful information, policy decisions are
rarely, if ever, based solely on their results. Decisionmakers often seek additional
information that cannot be easily captured in an economic analysis. Some analytic
steps directly involve predicting future behavior, while others use behavior more
indirectly to value non-market outcomes.
Smith takes on the deepest Issue
We are left with what seems to be an extraordinary set of questions. Where exactly
does rationality exist; whose job is it to apply it, and who determines how much is
enough? Is it in the mind of the planner? In the design of the institution? Is it innate
within individuals? Or do rational outcomes rely, like pieces of a puzzle, on the
contemporaneous existence of institutions that match certain quirks of individuals?
Here we turn to Smith and Walker (1993). Smith is the thinker who appears to have
taken on the most fundamental questions. And we may consider whether or not
answering Smith’s questions would resolve all of the other concerns we might have
about LP and BE. In Smith, Walker, the authors review the literature to find that the
bulk of experimental work has strengthened, not weakened, the evidence that people,
on balance, act rationally insofar as they seek to increase rewards.
A survey of thirty-one experimental studies which report data on the comparative
effects of monetary rewards and opportunity cost shows: (1) several studies in which
increased rewards shift the central tendency of the data toward the predictions of
rational models; (2) in virtually all cases rewards reduce the variance of the data
around the predicted outcome. This is consistent with a model in which rewards are
balanced against decision cost in agent behavior and explicates the argument that
when rational models fail it can be attributed to low opportunity cost of deviations from
the rational prediction. (Smith and Walker 1993)
Smith argues that “rational choice theory is a correct first approximation to the
analysis of decision behavior, but it is incomplete, and making it more complete
requires the guidance of data from experimental designs motivated by this objective.”
p.246
“One can think of z as the decision cost or effort (concentration, attention, thinking,
monitoring, reporting, acting) which the subject applies to the task presented by the
experimenter…If z is recognized as lurking within every subjective model of decision,
then we are primed to expect to find its traces, and where z is thought to be of
substantial importance…seek to establish this proposition by manipulation of the
experimental procedures that affect z and thus y.”p.247 [y being the value of the
decision variable chosen by the subject, given his/her perception, evaluation, analysis
and understanding of the instructions]
“How far one can go in using decision cost concepts to resolve anomalies in standard
individual decision theory remains open.” , p.254
New Directions in Research
Literature on adaptive and behavioral economic modeling often cite decision making
costs as part of implicit justification for such models. It makes sense therefore to
conduct experiments that seek to find out if thressholds for rational thinking exist in,
for example, the coffee cup experiments, and at what level. If rationality can be
incentivized in one treatment and absent when the incentive is withdrawn, then it
must exist within the individual subject before the experiment and the institution
plays an important role. On the other hand, if this binary relationship between
Behaviorism on the Road to Serfdom: Misuse of Science in the Service of Bad
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1
incentives and rationality exists in some experimental environments and not others,
then motivation (in the form of incentives) may be a necessary but insufficient
condition for rational behavior and institutional factors may play a role. If
motivational incentives do not matter in any case, then rationality may exist outside
of the individual in the institution or elsewhere. Finally, if motivational incentives
have no effect and changing institutions also has no effect but produces only “white
noise” this would contradict most other evidence available in the BE literature, but it
would certainly raise a different set of questions. Smith, Walker’s retrospective study,
however, is some comfort with respect to this last point.
Some of this research may be most useful to policy-makers who have been
concocting—frequently out of sheer frustration—new policies that incentivize effort
in otherwise seemingly intractible problem areas, such as motivating inner city
children to strive for grades.
The important concluding point of this exercise is—while encouraging a new thrust
in experimental research along the lines suggested by Smith—that the policy
implications for BE are not yet cast in stone and certainly are not fully encompassed
by LP or any of its offshoots. Homo economicus may yet be eradicated but it should
not happen before the other options have been explored.
Works Cited and Bibliography
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