Is Behavioral Economics A Threat To Limited Government?



After a long break, here is finally another post.

This time, I’m going to deal with a subject I’ve began to interest myself in in the past months: Behavioral economics.

Don’t know what it is? Nothing to be embarrassed about. Basically, normally in economics we assume humans are rational. However, we all know humans aren’t fully rational – we don’t know everything for starters, so whatever rationality we have is very bounded by limited information. And even then, we’re not fully rational – we don’t save enough for retirement, we buy houses we can’t afford etc. Why? When? How can irrational behaviors be prevented? These are all questions that behavioral economics deals with.

Behavioral economics is a relatively new field, that really only began to form in the last 30 years or so. Leftists love it: Surely human irrationality proves government intervention is necessary! And in fact, most behavioral economists are left-winged (though in fairness, that goes for most of academia). They assume that human irrationality must justify government intervention. Let’s say humans aren’t smart enough not to buy houses we can’t afford – then the natural solution according to most behavioral economists is to have the government step in and ban people who can’t afford houses from buying them (no, no-one’s actually suggested that – it’s just an example, but you get the idea).

I don’t think that idea holds. Behavioral economics is a useful and exciting science. But here below is three reasons why behavioral economics is not a threat to free markets and limited government:

1) What is rational anyway? 

Rational means maximizing utility (an economic term that roughly translates to “happiness” or “satisfaction”). But how do you prove that a person is or isn’t maximizing his or her utility? How do we prove whether a smoker is maximizing his utility by smoking? It surely seems like an irrational habit to most non-smokers (including myself). The pain of lung cancer surely must surpass any utility gained from the smoking itself, right? Well, it may be easy to think so – I certainly don’t see the point of smoking – but how do we really know this is true for each individual person? And if we’re not sure whether smoking really is an irrational behavior, what right do we have to regulate it?

(Of course, we could still regulate smoking in public places due to the harmful effects of second hand smoking etc, but that’s a different issue).

2) Politicians – not so rational

While behavioral economics have managed to find several flaws with the way consumers act, an area that has been studied much less is  the flawed decision-making of politicians. Politicians base their own decisions not only on the good of the country, or the good of the consumers, but also on the good of, well, themselves. To use economic language, their utility is not only a function of the welfare of the nation they have been set to govern. A politician set to design a tax on tobacco is almost certain to design it in a way that is politically beneficial for him – whether that means setting a too high tax or a too low tax. It is actually not impossible that political intervention manages to screw up the marketplace even more than it was initially.

The problem with behavioral economists (not; economists, not economics) is that every time they find a problem with the market place, they assume that government intervention can solve it. Well, guess what, politicians don’t have complete information either, and just because there is a problem doesn’t mean they’re able to fix it.

As an economist, to support government intervention every time you see a problem is taking the easy way out. “Just let the government fix it” is the academic equivalent to calling for delivery instead of cooking your own food: It’s easy – but it’s not healthy. Instead, what economists should be working on is developing solutions within a free market context. Maybe there is a free market way to educate people about the value of saving for retirement? I don’t know, but given that the free market is where the smartest brains and the most creative minds are, maybe that’s the best place to start. The chance that some clever entrepreneur can work out a way to solve the social security crisis is certainly greater than the chance that a government bureaucrat will be able to fix it.

Additionally, we need to consider that voting is a consumer decision too, and one that is often made in an irrational way. Voters have a tendency to choose politicians they can relate to – which is why Barack Obama gets 90 % of the black vote and Mitt Romney will get a similar share of the Mormon vote. This is absolutely and totally irrational – sure you’d be happier with a president whom you may not be able to relate to very well, but who just might be able to fix the economy? And since voters aren’t voting in a rational way (and voting for whoever you can relate to is just one example of irrational decision-making), how can we count on those elected to fix the irrationalities caused by voters when they make consumption decisions? Most politicians wouldn’t have been elected had it not been for irrationality.

3) Government – a source of irrational consumer behavior

Lastly, I think we need to critically examine how governments are actually causing economically irrational behavior. Or rather I should say; government dependency.

Let’s take for example the drug addict who keeps having more and more kids, knowing the government will pay for them (and, indirectly, pay for the drug addict’s drugs). This wouldn’t happen had it not been for the nanny state. It’s a destructive, irrational behavior not caused by free markets, but by government and its liberal good intentions.

Behavioral economists also often support things like fat and sugar taxes, as overweight people just don’t realize how destructive their behaviors really are – they’re acting irrationally and therefore Big Government needs to step in and save them from themselves. What they miss out on is that government is also providing emergency health care for said overweight individuals. Could it be that the reason why so many obese ignore the health risk associated with their eating habits, is not because they underestimate the risk of getting a heart attack – they just figure someone else is going to pay for their health care so who cares? The same, of course, could be said for smokers.

Another example: How many times have you not heard someone say “Of course this product/service/whatever is safe – otherwise it wouldn’t be legal, would it?” (of course there are several variations – but the point remains). This kind of overreliance on government – caused by individuals being used to the government acting as their nanny, protecting them from all evil – is a very dangerous irrational behavior, but not one you will see many behavioral economics talk about.

For ever 1 minute we spend researching irrational behaviors in a free market economy (and I’m not claiming they don’t exist), we should spend at least 1 minute doing research on irrational behaviors that occur in the ABSENCE of a free market.

Summary

Behavioral economics makes some really good points. First of all, it makes economic models much more realistic. It makes us, economists, think of humans as, well, humans instead of robots. This is a great improvement.

As Christians, we believe that humans are not only not fully rational – we’re a messed up, evil race who were given a paradise but managed to screw ourselves out of it by breaking the one simple rule we had to keep: Don’t eat the apple from the tree of knowledge of good and evil. Hence, behavioral economics takes us much closer to a christian worldview, a worldview where humans are far from perfect. My point is; the problem is not behavioral economics in itself, and intellectual conservatives who bash the science should save themselves the time and trouble. The problem is how the left interprets and applies the findings of behavioral economics. This is not the only science that has been misused this way; political science, sociology, anthropology – all of them are fine sciences that have been taken over by the left and used as tools to promote big government. Our problem is not the science – the problem is, we have still to take them back. Instead of shunning academia and denouncing college grads as “snobs” (as one republican presidential candidate almost did), we need to get an intellectual conservative revival, similar to the one in the 1950′s and 60′s.

If we get our priorities straight, I know we can make that happen.

Thanks for reading.

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  • Vapenbrodern

    Interesting topic. You do have some points, however, I would like to add that on the financial market individual psychological behaviour on part of speculators (such as herd mentality, disaster myopia, the tendency to generalize based on too few observations, valuation of equity according to how one thinks the other speculators values it rather than real economic worth, the list goes on) poses the risk of catastrophic outcomes on an aggregated level.

    This is a danger that should be taken into account when regulating financial markets. Many of these psychological components were after all involved in the mechanics of the subprime crisis, as showed by the testimonies brought forth in interviews with some of the financial leaders after the crisis broke out.

  • Alan

    As someone who regards himself as a conservative I have no problem with behavioural economics. In fact it strikes me as being absolutely in tune with Adam Smith’s Theory of Moral Sentiments

  • MatsBerglund

    Interesting post! People are not and will as group never be rational. That’s also why Adam Smith, John Keynes and those guys never fully understood economics. I hope to read more in this subject in your blog.