The Implications of Behavioral Economics

Peter Van Doren joins us for a discussion on Richard Thaler’s work in behavioral economics.

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Peter Van Doren joins us once more on the podcast, this time for a discussion on Richard Thaler’s work in behavioral economics.

What’s the difference between behavioral economics and more traditional neoclassical economics? Is the goal of behavioral economics really to implement consumer preferences? Are “nudges” paternalistic and insulting, or do they merely—as behavioral economists would say—create default conditions to correct the influence of cognative biases that stop people from doing what they actually want to do anyway?

Show Notes and Further Reading

Listeners may be interested in our other Free Thoughts episodes with Peter Van Doren.

Van Doren mentions this debate in Regulation between Jonathan Gruber and W. Kip Viscusi.

This Crazy Mouse Won’t Leave Me Alone by Dan Deacon is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 International License.

Shootin Stars by Aero Chord feat. DDARK provided by NoCopyrightSounds: https://www.youtube.com/watch?v=PTF5xgT-pm8

Transcript

Trevor Burrus: Welcome to Free Thoughts, I’m Trevor Burrus.

Aaron Powell: And I’m Aaron Powell.

Trevor Burrus: Joining us today is Peter Van Doren. He’s a Senior Fellow at the Cato Institute and editor of Regulation magazine. Welcome back to Free Thoughts.

Peter Van Doren: Thanks for having me.

Trevor Burrus: Earlier in fall or about two weeks ago, three weeks ago, Richard Thaler won the Nobel Prize in Economics. [00:00:30] That’s what we’re going to discuss today, Richard Thaler, and what he did for economics, so I guess the first question is what do people think of when they think of Richard Thaler and why was he important?

Peter Van Doren: Richard Thaler is associated with development of what is called behavioral economics, and it is … The adjective ‘behavioral’ is meant to contrast this brand of economics with what is typically taught to freshmen in Econ 101, which is neoclassical economics.

[00:01:00] First, let me describe briefly what neoclassical economics is and then describe how behavioral differs from it. Neoclassical economics in its purest theoretical form is an elegant mathematical exercise in which there are preferences of consumers and they’re called utility functions, and they have a function form; they have a mathematical shape [00:01:30] to them. Consumers also have budget and therefore a budget constraint. Firms seek inputs in the market at market prices and firms maximize profits. You throw all these together and you say, “How can firms maximize profits and consumers maximize utility at the same time and what does the result look like?”

You can do this, all on paper, using calculus [00:02:00] and you come up with an answer. That answer is always referred to, by traditional economist, as Elegant. What they mean by elegant is this pure love for mathematics as an exercise and then the question, of course, is whether what this has to do with real people in the real world.

That’s always been a contentious issue. Going back to Milton Friedman, Milton Friedman is famous for saying, ” [00:02:30] Well, the real world acts as if it knows all of these mathematics. Even if we ask the people and they don’t know it, they actually are compelled by market forces to act as if they know all these math are maximizing because if they don’t, they would lose all their money, all right” This claim that if you’re not maximizing profits you would fail as a firm and if you’re not maximizing [00:03:00] your own welfare as a consumer you would realize it over time through learning and would use your money more carefully so as to have more of it to get the stuff that you want.

Behavioral economics is rooted in psychology and it originally started as a critique by social psychologists of economics. This has as much to do with the sociology of academic conflict, as anything else.

Economics, [00:03:30] to be honest, to lord over the social sciences in the university.

Trevor Burrus: Because they have math?

Peter Van Doren: In part, the math. They argued that other parts of the social sciences didn’t have, “A rigorous theory of behavior i.e. math.” The sociology and psychology talked about people but economics really modeled behavior.

Trevor Burrus: Well, I want to ask about this because [00:04:00] you said Neoclassical, but is Classical economics that way? In Thaler’s presidential address he says that Adam Smith seemed to think this way about people and it strikes me as odd that anyone ever assumed that people were that robotic, I guess, as for lack of a better term that that was the way to do economics was to assume essentially perfect utility functions, robotic predictable behavior. Before the Neoclassical revolution, if that’s you want to call it, Adam Smith [00:04:30] and other earlier economists did not think that way about people.

Peter Van Doren: I think that’s fair to say, I think Thaler’s typology of the break of neoclassical economics from something called Classical or whatever term you want to apply, I think that’s fair. The real push towards what we call neoclassical economics is actually … It started with Pareto and Marshall, but the real drive [00:05:00] occurs after World War II with Samuelson and his famous textbook and the so called welfare theorems of economics and things like that.

Again, the behavioral critique starts out as a critique coming from social psychology but then … And Daniel Kahneman won the Nobel Prize earlier for that portion of it. His colleague, Amos Tversky was deceased [00:05:30] and therefore could not win the award but was also a co-author with Kahneman of all of this stuff. Thaler is later and adds his own arguments to it.

Basically, the critique is the following that people make systematic cognitive errors that are not consistent with the maximization and figuring everything out mathematically framework, that is the heart [00:06:00] of neoclassical economics.

Now, let me give you … Each of these cognitive defeats has a paper associated with it and para-papers. They rooted in experiments done with undergraduates.

People should know that behavioral economics is very related to and developed from what’s called experimental economics where don’t go out and study firms and consumers but you actually [00:06:30] take, typically, undergraduates, have a controlled groups: an experimental group, read them a series of instructions and see if they figure things out in the way that neoclassical economics suggests.

Each of these defects has a name to it and I’ll give you three: one is the endowment effect. On previous discussions we’ve had I’ve mentioned Ronald Coase and the Coase theorem. The Coase theorem says, “It doesn’t matter what the distribution [00:07:00] of property rights is to start out the game.” As long as you can freely transact and you can trade these things it doesn’t matter where you start out, will always end up at an efficient result, but the distribution of wealth will be different because we started out a different place.

The endowment effect says the willingness to pay for something versus the willingness to accept for something i.e. do you have it and then how much would demand to give it away. [00:07:30] In the Coase theorem, that’s the same as how much are you willing to pay to get it from someone else. If those two prices differ: if the willingness to pay and the willingness to accept differ, then distribution of rights and where you start out the game affects efficiency where you’ll end up.

The endowment effect papers argue that the Coase theorem doesn’t work.

Trevor Burrus: On the endowment effect, is that, and I’m going to get more into this later, [00:08:00] unless … Let’s still to the endowment effect here. Is it … When we call that irrational or when we call it just something that makes Coase not work the way that people thought, you’re making …

Peter Van Doren: Because, I mean, maybe people just …

Trevor Burrus: Is it okay to care more about losing something than gaining it?

Aaron Powell: Yeah. The loss hurts more.

Trevor Burrus: Yeah.

Peter Van Doren: I don’t want to use … I’m uncomfortable … Just me personally, I don’t [00:08:30] want to traffic in the terms rational or irrational and rather stick to … For the Coase theorem to work as a theory of outcomes, the willingness to pay and the willingness to accept must be the same. If they’re not, then whether railroad has to pay the farmer to pollute or the farmer has to pay the railroad to stop, then those two initial assignments of property [00:09:00] rights will change how much pollution there is in the result: in the equilibrium, so whether one wants to label this …

To get neoclassical to “Work,” the willingness pay and willingness to accept have to be reasonably close to each other. Otherwise, you’ll have endless political fights over who has rights because those rights, [00:09:30] everyone knows, will, in fact, go a long way towards determining the outcome.

Aaron Powell: Does work here require mathematical exactness to the predicted outcome. We could say that, yes, people might have slightly more loser version and so they’re going to take … It’s going to hurt them more they’re willing to give up slightly more to prevent a loss than they would be to get an equal gain, [00:10:00] but if that slightly is only, really, slightly, then could we still say that the Coase theorem works even though on the tiniest margins it maybe off a little bit but in the aggregate, on the whole, it still is going to come out awfully close to what it predicted?

Peter Van Doren: That is an empirical question, so in the real world, yes. I mean, that’s … Your errands arguments are all possible. Once the results are not [00:10:30] exact, then we’re into utilitarian land where we have to evaluate outside this whether the results differ enough so that they matter for whom. Then, that’s i.e. if you’re an environmentalist, this, you might say this matters enough so that I want the right to have clean air to start with, I think it is … I do not [00:11:00] want to have to pay for it, and I think it’s … Then they would introduce the term ‘morally wrong or something’ … They would introduce some philosophical adjective to say, “By golly, I think this status quo that I’m on is a whole lot better than the one you’re proposing because …” We can avoid … See, in Neoclassical you avoid all those arguments if it doesn’t matter at all, but once you introduce the possibility of it mattering, you then are [00:11:30] into, let’s call it an A-scientific world, where we have to have a back and forth of how much all of this matters or doesn’t matter.

Trevor Burrus: Did the Coase theorem … Maybe this is a typically ignorant Trevor question about the economics, but does the Coase theorem, as I understand it, even as it was formulated and went about, does it ever really work in the real world because you also to populate zero transaction costs, which is not a thing in the [00:12:00] world.

Aaron Powell: Right.

Trevor Burrus: I mean, Thaler makes this point … This is one thing about Thaler that’s always confusing, I couldn’t figure out how much he’s actually adding to the discipline because either at neoclassical people were passed through in this frictionless universe physics problems, which Thaler makes this point in his presidential address comparing it, you have a theorem in here that has no transaction costs, so that’s frictionless universe and then you add in noise and then you see how much you can control for the noise. Then, you make a comparative [00:12:30] analysis about, “Well, generally speaking we want people to be able to trade to make property right to be able to make themselves better off.” There are going to be some difficulties there, but as Aaron pointed out they might be on that better.

I guess I’m just trying to ask why did he want ever think to Coase theorem describe reality because it just doesn’t. It describes like a computer program about people being able to make transactions instantaneously without transaction costs but it doesn’t describe reality.

Peter Van Doren: A good question. The … [00:13:00] We haven’t got to this yet but we’re getting to it, which is there’s underlying political disagreement lurking in our questions which is in a neoclassical world, if everything works out the way the theorem say, then the role for government … Then the possibility of collective action, “Improving” welfare of anyone is zero.

Trevor Burrus: [00:13:30] It would be a perfect well-oiled machine of which all optimal … Everything went to their highest and best use and all optimal … Can be … To optimal and everything on those lines and government would have no …?

Peter Van Doren: Well, and then the only role for government is not to make markets more efficient but simply distributional i.e. who ought to have rights and why and should we ever tax some people and give it to others. As opposed to claimed that, if I do this: pass [00:14:00] this law or put this tax in or put this regulation in, I can improve welfare or make people better off. That language is much less possible in a neoclassical world or more limited whereas in a behavioral world where people are making errors all the time, the possibility then for better informed government regulation to improve welfare is very large. That … Even though I’m trying [00:14:30] to keep that out of the current discussion, that’s actually lurking beneath all this discussion.

Aaron Powell: She said there were three of these cognitive biases that we’re going to talk about, so had the endowment effect.

Peter Van Doren: The second is hyperbolic discounting or translated: this is making errors from a conventional accounting economic point of view between choices in the distant future and choices in the near future and choices in the present.

Trevor Burrus: [00:15:00] You described, and I remember we were hanging out socially, you said that that’s what drug addicts do. That’s the economic term.

Peter Van Doren: Economic term for what drug addicts do is hyperbolic discounting.

Trevor Burrus: Which means right now the pleasures of this is what I really need and anything else in the future is just irrelevant.

Peter Van Doren: Yeah, and I’m not going to worry about the hangover.

Trevor Burrus: Yeah …

Peter Van Doren: Well, it’s actually a little more … hyperbolic discounting is not getting the near future versus [00:15:30] the distant future correct. It’s not just present versus, it’s actually caring about next month a whole lot more than caring about five years from now, and then present value of normal econ and accounting framework that leads to weird results: odd behavior.

Well, I’ll talk about policy examples; we’ll get [00:16:00] to that but … The endowment effect is whether distribution effect sufficiency, this discounting effect is probably construed is there’s a lot of policies that are alleged to help consumers save more and do things for the future. A lot of climate change discussion hinges on this distinction as well.

The third cognitive error …

Trevor Burrus: Just to clarify, you mean that [00:16:30] if people who are trying to get us to change our behavior for climate change are saying that, if we prefer a new gas- car in the short term without looking at the 100 years in the future, then we’re hyperbolic discounting.

Aaron Powell: Yes.

Peter Van Doren: We’re getting things …

Trevor Burrus: We’re drunk on oil. In other words, we’re drug addicts for oil basically.

Peter Van Doren: Yes.

Trevor Burrus: Okay.

Peter Van Doren: The third cognitive error is called optimism bias. It is the belief that bad things happen to other [00:17:00] people but not to you.

Trevor Burrus: True, in my life so far. I think it will continue to be all good things are happening to me.

Peter Van Doren: It’s also called ‘young people’. Its real world alleged result is the lack of demand for insurance. Lots of … From a neoclassical point of view, people seem to under-insure. They do not buy products that [00:17:30] exist that would allow them to buy the mean of an outcome and reduce the variance that might occur.

Trevor Burrus: This is just in terms of … We’re trying to figure out why you people would buy the right amount of insurance without running actuarial tables on themselves. I mean, how much do I need if … At 16, how much insurance do I need? What is … How does someone …?

Aaron Powell: … Economist.

Trevor Burrus: Yeah. Actually, they say, “Here’s the chances [00:18:00] you’re going to get hit by a bus.”

Peter Van Doren: The terms economists use is consumption smoothing: that is the goal, our goal whether you know it or not is to smooth consumption over our lifetimes, and so there’s …

Trevor Burrus: You mean that every human being’s goal?

Peter Van Doren: Yes. In a neoclassical framework, one wants to reduce the variance and consumption over time i.e. here’s an anomaly from that perspective. The income of people in the United States goes down drastically after retirement. [00:18:30] They say, “What? How come you’re willing to live this way and then suddenly you have this steep cliff?” You should consume less when you’re younger, save more and smooth consumption so you don’t have to go through this heartbreak of a loss of consumption during retirement and so on.

Aaron Powell: My question with these, you refer to them in particular economics; people refer to them as errors. Then, [00:19:00] when we get to the sellers: a partner and Cass Sunstein, the two of them wrote the book “Nudge” which is about, then, how do we engineer policy to, in this case, preserve freedom whilst nudging people to not fall prey to these errors, right? We can get to … I’m sure we’ll talk about that, whether that works and what the problems with it are, but the very notions of them are errors, it seems to me that the thing that makes them [00:19:30] errors in the mind of both the neoclassicals and the behaviorist is that they differ from the economist’s notion of how a person ought to behave.

Peter Van Doren: Not ought to, is. Remember, neoclassical is a positive theory: an elegant, and then as Trevor says unrealistic theory of behavior. The whole unrealistic part, when you’re within an economics’ department of the old school in [00:20:00] the way that I was taught, pretty much fades away.

I mean, I was looking at econ lectures online this morning in preparation for this; what are people taught now. I mean, you’re taught to understand calculus, math and maximizing having … You’re taught the words ‘elegant result’, you learn the Arrow–Debreu theorem which says, if we have complete markets for everything and people do everything right, then [00:20:30] welfare is maximized, etcetera. Then, you learn deviations from that later on. Even though it’s a positive theory of behavior, there is this underlying ‘odd’ kind of lurking but technically odd isn’t part of it.

Aaron Powell: Right, but when talk about something like hyperbolic discounting, we’re looking down our noses at the people who … You just said why do people … People seem to get this cliff when they hit, [00:21:00] and what they would prefer is this, why don’t they prefer this, or they’re like people don’t take into account risks in the right way and so they’re not buying the right amount of insurance.

These are all things that we’re saying this is incorrect behavior. I don’t think … We haven’t really … It sounds impossible to talk about it without instilling that value claim into it. I guess, so the question that I have is why, at the [00:21:30] very beginning, why should we accept the economists’ notion of human rationality or utility? Maybe people deviate from this stuff simply because the economist got it wrong. People actually … They do prefer stuff now over the future and that’s perfectly okay and there’s no good argument against it. It just clashes with the economist view of how people … Economists aren’t like the rest of us.

Trevor Burrus: Let me add. I concur on [00:22:00] that which is just … It seems like the neoclassicists want us to be squares, right? I mean, basically we don’t go skydiving or we’re going to jump our motorcycle across a ditch or a smoke or eat a burger. I mean … Is he irrational in neoclassicist model?

Peter Van Doren: Let me start to respond. First of all, it’s hard to …

Trevor Burrus: Did we ask the same question or do we have different questions?

Peter Van Doren: [00:22:30] Different.

Trevor Burrus: Okay, because this is part of our confusion and this is why we bring Peter on.

Peter Van Doren: Let me go to Aaron’s first … I was actually going to deal with this at the end rather than …

Aaron Powell: Okay. I apologize.

Peter Van Doren: Because Trevor wanted to get there which is the goal of either neoclassical or behavioral to actually just implement people’s preferences? Allegedly, certainly, neoclassical is. [00:23:00] Behavioral says it is because cognitive errors prevent people from implementing what they really want to do because they don’t know how to it. They don’t know how to do present value discounting calculations correctly, so we need to educate them about how to do that and to create default conditions so that they’re steered into that.

Then, to [00:23:30] change Aaron’s question into fundamentally, so what if … nudge, right? The most famous experiments around are not of what I’ve just described, but rather there is strong empirical evidence that no one disputes that the default conditions in 401-K plans in the workplace have a profound effect on whether people save or not during their work time. Neoclassical [00:24:00] people originally said, “But even if you make people save more in the workplace, they may undue it with credit cards outside the workplace,” so net savings behavior might not actually improve or increase.

There’s a study now of people in Denmark. Denmark, because it’s Nordic and they keep total records on everyone’s life.

Trevor Burrus: It’s like Gattaca.

Peter Van Doren: Yeah. The Danish can be studied extensively. They did a nudge-fact [00:24:30] and they made the default that you’re involved in workplace savings behavior. Then, they could study all their other banking and financial records and they showed that savings did increased. At least for the Danes, the nudge to alter the status quo from being out a system to being in a retirement system did increase savings behavior. But then this paper said, at the end, what if people really don’t want to save? Which is what [00:25:00] Aaron’s asking.

Aaron Powell: Yeah.

Peter Van Doren: In other words, if the world isn’t full of Sheldons and Peters, it’s full of different kinds of people.

Trevor Burrus: What I’m thinking about is also when neoclassical came with the Samuelson, I’m thinking about leave it to Beaver, all right. I bet more, in June, saved exactly the right amount of money that economists will tell them they should save.

Peter Van Doren: Well, there’s a very middle class, middle brown, middle …, Everything to this. [00:25:30] Your cultural critique says this doesn’t know anything about sex, drug and rock and roll or something to that effect.

Allegedly, when we teach neoclassical, it allegedly has, at its heart, just preferences so thus it is allegedly accommodating to both your critiques that, in fact, [00:26:00] the author that comes to mind actually in smoking behavior in Kip Viscusi work which we’ve talked about before. Economists …

Trevor Burrus: Well, he was doing how much representative life cost? Is that what …

Peter Van Doren: Cost per life saved, but a lot of his work is also on smokers: do smokers understand risk? Are smokers irrational, are smokers under/over informed, [00:26:30] should we regulate their … All these questions that you’ve asked and we could go right to smoking.

Viscusi surveyed smokers and he asked them: how much do you think the life expectancy of the average smoker? He specified it as remembering a packer day or something. I mean, some average amount of smoking for smokers. He said, “How much is your life expectancy reduced on average given the day that we have in the United States?” [00:27:00] The average answer among smokers was 20 years. In the data, the actual result is somewhere in the order of four to six years, if I’m remembering correctly. A very large difference.

We concluded smokers seemed to be well informed. If anything, overestimate the risk of premature death and they continue to smoke.

Trevor Burrus: Which means smoking must be amazing to you. [00:27:30] I mean, that even implies if you took their preferences into account, if you think it’s more dangerous, and that it is on average and you’re paying New York City prices for cigarettes so $15 a pack, then smoking must be incredible to you.

Peter Van Doren: Correct.

Aaron Powell: Unless you’re marred in like a runaway loser version.

Trevor Burrus: You mean you don’t want to lose them?

Aaron Powell: You don’t want to lose them or you think it’s going to be terrible, if I stop this. Not that it’s amazing that [00:28:00] I do this but the pain of quitting is going to be extraordinary, or whatever the effect nicotine has but there’s evidence so nicotine is a cognitive enhancer, but that cognitive enhancement wears off pretty quick in the sense that the cognitive boost you get from it, over time, you’re really just operating at normal level, but if you don’t have the nicotine you operate at way below level, so maybe the awareness of that.

Trevor Burrus: This would be hyperbolic discounting? [00:28:30] Peter made a face, by the way.

Peter Van Doren: No, I just have …

Trevor Burrus: … Addicted, right? I mean, what would Richard Thaler say, I mean, do you think about the smoking argument, the Viscusi?

Peter Van Doren: That’s a good question. I don’t think …

Trevor Burrus: Or what would be the general behavioral critique of that?

Peter Van Doren: Jonathan Gruber, we did a two-part series …

Trevor Burrus: The American, the ACA, healthcare designer guy?

Peter Van Doren: Yeah. Jonathan Gruber, Healthcare Economist MIT and Kip Viscusi [00:29:00] debated in the pages of Regulation some 10, 11, 12 years ago, I’d have to go look it up on this issue. Gruber came up with the term ‘Internality’ not ‘Externality’. See, Viscusi went on to argue that smokers seem to know the risks and still behave the way they do and, thus … And then he went on, “Is there an externality? Do smokers cause the rest of the society money?” He concluded, ” [00:29:30] No, because they do die sooner. They don’t collect Social Security to the extent that healthy people do and, thus, the taxes they pay over their lifetime, net of the benefits they receive. In effect, he argued that smokers subsidize non-smokers in the American political economy which most listeners of this may find that incredible but that’s a pretty agreed up … Well, accepted result from [00:30:00] Viscusi.

Then, Gruber went on to say, “All right.” Viscusi knocks out the externality discussion. He then invented the term ‘Internality’: a fancy word for you’re messing up in the way that you and Aaron are asking me which is you can’t possibly want to smoke because if you knew how it would be when you were old you would never do this when you were you, is nature of this argument.

He came up with a dollar of a cigarette, [00:30:30] what’s the trust cost to a person: him or herself of smoking when they’re young given what they’ll experience when they were old?

I will put the side-on with this podcast.

Trevor Burrus: Opening the show notes, yeah.

Peter Van Doren: Then, Tom Firey, the Managing Editor of Regulation who has a Masters degree in Philosophy wrote, “Who’s the more valid preference: the younger self or the older self? Now, if discounting involves cost to you in the future [00:31:00] versus benefits to you in the present, what’s the appropriate philosophical status of the older self versus the younger self if they could even talk to each other which, I guess, is that what you’re asking me?

Trevor Burrus: I mean, to some extent. I mean …

Aaron Powell: Or the older person simply … I mean, if you’re smoking during your youth, going to rock and roll shows, having lots of sex and all that maybe there are problems later, but you still get to look back on your youthful days and memories of them so we end up in a total [00:31:30] recall style argument. You’re paying up cost from memories that you’re then going to be able to enjoy ongoing.

Trevor Burrus: It just seems there’s a big, slippery slope here with old people will tell young people all the time, if we could go Rick & Morty time machine and say, “Okay, seven year old Trevor is going to come back and tell me I need to exercise, put sunscreen on learn to play the cello [00:32:00] is because …”

Aaron Powell: This is being recorded, correct?

Trevor Burrus: Exactly … 3,000th episode when we were that old we’ll go back and listen, but I mean, “Hey, I can learn to play the cello right now.” That would probably give me great pleasure in the long run. It’s like if your parents are still kids we’ll make you learn the piano lesson because you’re going love playing piano when you were older.

Peter Van Doren: Yeah. The problem with that is that had seven year old Trevor [00:32:30] done all of those things instead of all the things that seven year old Trevor did, then nearly 40 year old Trevor would be totally lame.

Trevor Burrus: … Might be live, for example. I don’t want to be lame.

Peter Van Doren: I’m fairly lame.

Trevor Burrus: Does it make sense to make this old/young. I mean, is that … That goes to this other good question to get back to the subject. The other question we’re just having a more revealed preference [00:33:00] theory basically in the behavioral econ critique.

Peter Van Doren: I’m sure. Let me …

Trevor Burrus: It seems very difficult. This, of course, a lot of critiques have been offered to.

Peter Van Doren: I mean, when economists do math, it’s very precise. When we switch to economists using language to describing or me using language to describe what math is or isn’t doing, [00:33:30] we’re switching to a different realm. As I said earlier, economists … In general, economists don’t like language. Well, traditionally, economists don’t like language; they like math because math is … It is clear what is going on. When we try to use words to describe what it is [00:34:00] the math means … You ask me these question and then there’s this big, long pause and I’m trying to figure out if other economists who are listening to this, would they agree or disagree with how I’m trying to describe this in language. Boy, I’m worried that they’ll disagree because I’m getting a little aspect of it wrong.

Trevor Burrus: No, I wouldn’t worry about that because I think that what we are trying to smuggle in what you’ve [00:34:30] implied … Politics of the matter, right?

Aaron Powell: Any of Peter’s errors in this hour of conversation are the fault of Trevor and me.

Trevor Burrus: Exactly. We’ll put that disclaimer, but I think we’re also trying to bring up these inherently political parts of this which, if you do in this mathematical econ you …

Peter Van Doren: I think if everyone were on and stand both sides, that’s lacking. I’ll give you some quotes. [00:35:00] I mean, Thaler was President of AEA and had a presidential address in January of … It was published in the AER and I’ll give you some quotes. This is his rip-roaring defense of behavioral economics. He basically tells neoclassical traditionalists: it’s over, you’ve lost. Get the eff out of my way. No, I mean, I read this and I talked to my colleague, Jeff Miron, and I said, “Wow, this [00:35:30] not a professor with a pipe talking about his life’s work, this is a we-won, you-lost, go away.

I’ll give you some quotes. He argues there are critiques of these experiments; remember I told you these results come out of experiments, the critique within neoclassical is that if you change the instructions in these experiments a little bit and you allow some learning and you don’t have undergrads doing this in a one-shot framework, the anomalous [00:36:00] results will go away. People don’t get trapped in these cognitive errors.

When asked, in this presidential address, Thaler says, “What do I think of that argument?” Answer, “Learning takes place for little things but it doesn’t for big things.” Where he talked about, “Big things in your life where you only get it to do it once or twice, there’s no possibility of learning.” For him it’s buying houses, financial issues and retirement and savings because you only get to realize you didn’t save enough once. [00:36:30] He emphasizes that high stakes once or twice in the lifetime things people mess up a lot and that’s what he’s worried about.

Let me give you a quote, “No one has ever gotten rich convincing people not to take out unwise mortgages.” That was in his presidential address: the OA financial crisis and then the mortgage … I mean, that’s his one-sentence discussion of attributing everything that happened not to any [00:37:00] of that nuance things that professors are usually famous for, but basically people screwed up, this is evidence, we need to stop people from screwing up because firms get rich when people screw up.

Trevor Burrus: It’s a very anti-market attitude. I mean, to say the least, I could get rich off of that. I mean …

Peter Van Doren: I started to read Shiller and Akerlof’s book.

Trevor Burrus: The Phishing for Phools which is just completely anti-market in another way.

Peter Van Doren: Oh my goodness, I was going to read … Oh, I did it and then [00:37:30] I was going to review it for Regulation and I realized “Oh my goodness, they are …”

Trevor Burrus: On the warpath.

Peter Van Doren: On the warpath, and I thought of sloppy disingenuous it wasn’t in keeping it all with what I thought of Shiller’s work other than this end is columns in the New York Times which I always find to be interesting and thoughtful. This book was a left-of-center rant [00:38:00] in the way that some of our stuff is right-of-center rant. Nobody is well-served by either of these things, in my view, but I was, again, taken aback by how … When … Outside of the journals, when allowed to show the colors, my goodness, I was sad to see that some of my colleagues’ views of left-of-center economics seemed to be confirmed that they weren’t in it for this [00:38:30] elegant theory of behavior that I have been describing rather people mess up, firms make them mess up, they need help and government’s going to give it to them.

Trevor Burrus: It’s highly paternalistic, and their attitude to our people seems to be pretty insulting.

Aaron Powell: This makes think of … I, a few months ago, attended a Liberty Fund symposium on … We nudge and then a bunch of academic [00:39:00] responses to it. one of the things we discussed there was this story that Thaler tells of a party in … It’s told in Nudge where he would have students over for dinner, and he would set out a bowl of mixed nuts ahead. Then, it was like he would notice people didn’t eat much dinner because they filled up on nuts.

He saw this as … This scenario; these people, they’re here for dinner and they’re irrationally eating the nut, and so [00:39:30] he took away the nuts. He put them out for some period of time and then just snapped them back from hid Dinner.

He and Sunstein present this as like and they were so happy. They were like, “I could control myself and it was so nice f you to take those nuts.” The whole time … I’m thinking, “They were just being polite.” They all were like, “What the hell is this guy doing? Why is he being a jerk?” Then Thaler answered them, they’re like, “Well, he’s our professor; [00:40:00] we’re going to be nice. We’re going to tell them he’s being a jerk.” But just this notion of the paternalism so baked. They were thanking me for taking this food from them that I had given them because they couldn’t control themselves around it.

Trevor Burrus: Nut time is over. I can see him coming in and being, “That’s it, guys. This is for your benefit.”

Peter Van Doren: I want to show that … Even though I think and admit that the last five minutes is actually underlying a lot of this dispute, I actually want to raise [00:40:30] above that.

Trevor Burrus: Sure.

Peter Van Doren: And both side our sides and try to stick to a kind of …

Trevor Burrus: Figure out what we can gain from this …

Peter Van Doren: Yeah. Whether there’s … I mean, should we listen to any of this, and if so what and what should we do about it. There are some anomalies that I find troubling and I’ll give you one … In Thaler’s address, he gives the following: he said there was a closed-end mutual fund with the sticker symbol CUBA, Cuba. It rose dramatically on 121414. [00:41:00] The day that Obama announced normalization of Cuban relations even though this mutual fund owned no stocks related to Cuba nor could it because there are no Cuban stocks to own. This financial anomaly persisted for a year in the market.

I mean, I take things like that seriously that it does appear that [00:41:30] the prices of things do seem to vary from their fundamental sometime in financial markets, and that can persist for a long time. Now, I don’t come to an easy. Therefore, we should and then fill in the blanks to have the SEC make sure something.

I think that there are things out there, well, one is under-saving, that, I take seriously and two, these [00:42:00] other financial anomalies where the literature is full of, again, closed-end mutual funds whose components are well known and yet the aggregate is different than the components. How can that be? That makes no sense. Again, financial markets are priced by professionals that are smart; that are etcetera.

Trevor Burrus: Is there anything different about the Cuba thing than say “tulip mania?”

Peter Van Doren: No. I mean, it’s just …

Trevor Burrus: We’ve known [00:42:30] that for a long time, right? As we talking before we started recording, maybe because I’m not really rooted in the neoclassical tradition but I’m more on the classical tradition for the Economist that I read that the sailor seems to be … It’s reminding us that …

Peter Van Doren: Well, we practice because we come from different intellectual traditions in that part of my Libertarianism probably comes from … In my scholarly life and my studies, I have concluded, [00:43:00] in most circumstances, in most times people get it right and therefore they should be left alone whereas you probably come from a tradition that says, “I don’t care whether they get it right or not, I just want the people to be left alone regardless of the outcomes.”

Libertarians are vote strains, and those of us that are more utilitarian in our nature get skirmish when there is evidence presented to us [00:43:30] that people mess up in certain circumstances and then we need to enter a utilitarian discussion of would fixing the problem, if I can use that term, for those people so mess up with the rights of everyone else who fine without help. I mean, we can even talk about gun control as an aspect of we need to do things for a small set of people that [00:44:00] kill a lot of other people for no reason but to actually implement would so interfere in the lives of everybody who gets it right, if I use that term loosely, that their boards maybe before that calculus were, as we might not be.

The beauty of neoclassical … I know earlier you said, “Well, we all know that it doesn’t work and Coase isn’t right, but again, as Aaron said, “The closer that the reality [00:44:30] is to that, the less scope there is for discussion of all these trade-offs that put us in utilitarian where, who knows, where we know where we’ll come out and we know where they’ll come out, and then it’s just a political fight over and over again rather than … The beauty of scientifically stating, “You don’t need to worry at all ever” is that it just stops the utilitarian’s [00:45:00] discussion from even having to engage in that.

Aaron Powell: Then, is behavioral economics, as a school, basically the practice of identifying through experiments or however else these cognitive biases or errors in thinking, and then applying … Figuring out how to address them within an economic framework or what’s the … Is it simply an identification of problem school [00:45:30] or is there another half of it that’s then … It does something with those problems or revises theories to better address those problems?

Peter Van Doren: It’s not a revision of theory because you can’t do calculus … I mean, all the elegant mathematics that I just described which the heart of traditional neoclassical that goes out the window once people don’t do these things in a mathematically elegant way.

Aaron Powell: Is the not doing those things, is that something that you can [00:46:00] bake back in? You’re changing your utility function curves because now we know the people discount in a different way?

Peter Van Doren: Then you have the possibility of many maximizing … I mean, if the functions wriggle, if I could use that word, rather than having one peak, then we’re multiple equilibria land, and then the role for regulation or taxes or other human [00:46:30] agency comes.

Aaron Powell: Let me ask the question a different way, then, is these inconsistencies from the neoclassical model, are people consistent in their inconsistencies? Is there a typical amount of hyperbolic discounting that we see or is there a typical and measurable amount that we can plug into a function of loser version or do people vary a lot in how far off [00:47:00] of the neoclassical mean line they go?

Peter Van Doren: They vary, and as I said, the results seem very fragile to the specific research design, so the way the questions are asked and the choices that the experimental subjects are given lead to quite a very set of outcomes. Mostly, so far, this research agenda has been bashing away at Neoclassical [00:47:30] with, usually, some policy therefore stuck on the end rather than, in fact, building up a new economic. It’s been, so far, bashing away at the old one because the old one was so entrenched and still is actually for purposes of most undergraduate teaching. No one teaches behavioral to freshmen. You taught it as something you learn after the fact, or it might be included as a little addendum but, first, you got [00:48:00] to learn all the way we did it forever, and then all of these is added on afterwards. Depending on the department, it might be added on earlier or later depending on the ethos of the place.

Trevor Burrus: In some of the situations, when the policy comes up; when policy prescriptions that come out of this which is what Nudge is about, I think some of it has tried to utilize, and one of Aaron’s questions which was, if people are systematically not saving enough. I know [00:48:30] you have some things in your notes about things that do maybe on the policy side, if everyone is generally not saving enough, then we should … This will cast on the scene, we should have the default that they’re saving, for example, is some of the prescription that come of it.

Peter Van Doren: The default architecture is the term of art and it is pitched at us. The good news is many people now take KEDO very seriously as an intellectually [00:49:00] sincere place and thus, Thaler and Sunstein and many other behavior economists say, “Even Libertarian should not object to altering defaults as long as the choice to change is free and not transaction cost-filled. All you have to do is go down to Human Resources or whatever it is we’re talking about, you have an easy, clear right that would [00:49:30] be articulated to you that you can sign here, sign here and then be exempt from whatever it is we’re Nudging you into. The, “Even Libertarians should find that unobjectionable.” I could talk about …

Trevor Burrus: The nudge thing is interesting but I find it interesting that they think it’s not objectionable because … This goes back to this political point and just general [00:50:00] human behavior point, when you’re asking, “What should people be doing saving, not saving? Should they be planning for … Insuring themselves or planning for injury, they should not be doing that. If you had a government that was into nudging into socially beneficial relationships. Let me give you an example, we recently had this big Hub-Hub I think it was a pin when someone wrote a paper that said that getting married, having kids not early and later [00:50:30] is all social indication … That’s a good thing to do in your life. Then, it becomes a question … That was huge explosion that she was being racist and all these other things and classist.

Let’s say the government decided to do that to us and say, “Well, really you’re making bad decisions by waiting so long to get married or you’re making bad … We’re going to have a default of …”

Aaron Powell: We’re going to opt you into a mate lottery.

Trevor Burrus: Exactly. Opt you into a mate lottery, [00:51:00] and this is good for social welfare. We have all the numbers, it’s good for social welfare, or it’s bad to have kids early so we’re going to give everyone a pill that sterilizes you from the ages of 15 to 25, and you can opt out by the top to the beginning, it maximizes social welfare, we have all the data. Is that the same argument and now it’s really not Libertarian?

Peter Van Doren: It’s analogous. I would argue that; remember [00:51:30] I told you that we should suspend the extreme right and left fear version of this discussion. You have just put …

Trevor Burrus: I have flown some things up there but Eugenics did exist in this country, so it has things where we control in …

Peter Van Doren: I tend to be calm and not worried about things, and I guess, if a big avalanche were headed towards me I might not see it, so intellectually I can’t [00:52:00] ever see us going to what you describe, but is it a version of this? The answer is, I guess, yes, but it’s a long way from 401-K defaults hit the workplace to unless you sign this form and have your parents and grandparents sign it, you are married at 18 in an Amish ceremony or something, I don’t see that coming. Some people on the traditional [00:52:30] right would want that.

Trevor Burrus: True. Exactly. What can we learn from …?

Aaron Powell: Well, I think the concern to take it to less of an extreme than Trevor has is that at its core that the policy prescriptions of Sunstein and Thaler and people are behaving in ways that we don’t think are good for them, and we can bracket the question of whether that, simply, is imposing Sunstein and Thaler’s tastes on other people who might not share those tastes.

Peter Van Doren: [00:53:00] OJ evidence.

Aaron Powell: What we’re going to do is, and Libertarians are to accept this is simply raise the cost of doing the wrong thing by some amount, so it used to be that doing the wrong thing was free because you to pay a cost-opt into the 401-K in terms of the time it took to do that, but now we’re doing to make it so that doing the wrong thing has the cost of opting out that, [00:53:30] first off, that conceptually is simply exactly the same thing as any other provision like, if I want to speed … It’s against the law to speed, but what that simply means is that they’ve raise the cost of speeding because on top … The default is not to have a speeding so now we’ve got speeding and so I can pay-in and at the extreme end they’ve raised the cost of murder by locking me in a cell is the potential cost I might have to pay [00:54:00] for it.

Trevor Burrus: True.

Aaron Powell: I think the other concern at the policymaking level is simply that once you are thinking that way, so it might be anything immediately wrong with saying, “Hey, HR departments, you are to be opted out instead opt-in,” but once you start thinking that way, if people don’t, then, respond in the right way or enough, you’re like, “Well, let’s raise the cost a little more; let’s make it more burdensome to do the wrong,” so [00:54:30] you had to put a slippery slope.

Trevor Burrus: Soft paternalism becomes hard paternalism pretty …

Peter Van Doren: Well, and it’s certainly easier to go there if the behavior in question is engaged in by a minority of people. Smoking, in my adult lifetime, has gone from over 50% of adults to now in the 20% range, depending on the state.

I read in the Times today that New York City … [00:55:00] Sorry, New York State has passed legislation that include e-cigarettes in all existing legislation about banning where cigarettes can be used, so wherever traditional cigarettes could not be used that New York State law also now applies to e-cigarettes and it’s like, “How could …” Whereas …

Now, in middle class discussions [00:55:30] that I have in Suburban dinner parties, the answer of workplaces and whatever are just to announce whatever they are and then you could choose to dine or not dine in places that do or not allow whatever.” “Oh no, we have to have … This has to be gone everywhere. It’s disgusting habit.” It’s like, “I get that once 80% of the country believes one way and 20% does another, then the 80% loses perspectives, [00:56:00] and so your arguments are …It’s … Look …

I mean, the example against which where I said, “Don’t worry is in my lifetime,” we’ve gone from smoking, binge what my parents did to smoking being the most reprehensible thing that any middle class family could ever do, and if they went to a parent-teacher conference and lit-up, the teachers would the social workers and have their kids taken [00:56:30] away. I mean, I can conceive of that.

Trevor Burrus: Rich Thaler and the Nobel Prize and economics, what … We’ve criticized a lot in this episode, but what should we learn from it?

Peter Van Doren: Well, Libertarians believe choice is important and don’t be lulled into thinking that slight alterations of the freedom of choice are slight that you got to be careful, and slight [00:57:00] can turn into a lot. The smoking example that we discussed at the end seems to be an example of that. probably, I don’t think of defending that right to be different enough because, personally, I don’t smoke and haven’t, and I’ve watch as it’s gone away in my lifetime. I’m glad it has because I used to go to college basketball games and you couldn’t see the court because of the smoke [00:57:30] and now you can actually watch the game so that’s a good thing, but for the people who do like to smoke their life is now hell and I don’t fully appreciate that enough in what they have to endure in scorn for the rest of us and the state.

Trevor Burrus: Thanks for listening. This episode of Free Thoughts was produced by Tess Terrible and Evan Banks. To learn more, visit us on the web at www.libertarianism.org.