Wednesday, May 21, 2003

You can't get there from here

A while ago I wrote a little about behavioral economics at Chicago. Between then and now I've come across various articles, one in the Economist, that I can't find now which hold behavioral economics as somehow proving standard microeconomics is wrong. This is a mischaracterization. (BTW. Previously I also wrote that Thaler had demonstrated upward sloping demand curves, and this was wrong. Demand curves continue to be downward sloping).

Behavioral ec. shows that people don't think about things in the right way, and this leads them to make suboptimal decisions. Economic markets anticipate people making the optimal decisions, which leads to them producing the absolute best possible outcomes. People who dislike economics (and there are many) bring these two facts together and argue that this means markets hardly ever produce the best outcomes. But there is no reason to think that a roomful of central planners is any less susceptible to the cognitive foibles that behavioral economics exposes, and they have less incentive to get it right than market participants. Taking people who naturally make bad decisions and removing their motivation to get it right does not produce good decisions. When I spoke with Thaler, he was pretty adamant that pro-central planning arguments that draw on behavioral ec. were getting it wrong.

Thaler has co-written a paper with Chicago Law professor Cass Sunstein provocatively entitled Libertarian Paternalism. With a name like that, how can you not read it, but I warn you -- be very careful when reading anything related to economics written by lawyers -- they are notoriously casual with the math. It highlights the fact that since framing matters to the decisions people make, and since it's impossible to offer people a choice without framing it somehow, you can pick the frame that encourages the best outcomes. People are still free to choose whatever they want, but a better frame makes them better off (thus the paternalistic aspect of libertarianism). The key aspect of this is that you can't not offer a frame, there is no way to offer a choice that does not encourage one outcome or another, so there is no absolute freedom a libertarian can claim is being taken away. Please note that this is a far cry from the politics and coercion drenched foaming that characterizes various post-modern positions and that framing is pretty weak in many instances, but you cannot deny it has a (large) effect in some cases.


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