International Law

Does Regulation Solve Behavorial Irrationality?

Professor Larry E. Ribstein has an interesting post and reference to a paper at his Ideoblog: The behavioral problems of regulators

Ribstein argues:

"We often hear about how weak-minded and emotional consumers and investors need regulation to protect them from themselves and from businesses that prey on them. This is particularly significant for financial regulation -- indeed, an important basis of such regulation is that people tend to be irrational when it comes to handling money and investments. And of course we?re hearing this a lot in the wake of the problems with subprime.

I?ve been a skeptic of behavioral economics justifications for regulation in general and financial regulation in particular. See my Fraud on a Noisy Market. One basis of my skepticism is that the same theories that call for consumer protection also apply to the regulators themselves."

I haven't read Ribstein's article, nor David Hirshleifer's paper, so I won't be commenting on them.

But I do agree with Ribstein's conclusion: irrational and emotional consumers are not protected by regulation. Largely because that regulation avoids or ignores the behavioral root causes of irrationality - in franchising, we are told that proper due diligence will avoid bad purchases.

We aren't told how regulators solve the confirmation bias or Wason effect. (They haven't solved either problem.)

Full post as published by Misleading Advertising Law on February 04, 2008 (boomark / email).