Bailout

Can behavioral economics cause real harm?

By Felix Salmon

George Loewenstein and Peter Ubel are about as expert on behavioral economics as it gets, so it’s interesting that they’ve taken to the op-ed page of the NYT today to urge politicians to spend less time on nudges and more time making substantive policy changes.

The problem here is that although behavioral economics can result in policies with positive effects, it can also mean that those policies get put into place instead of ones which really have teeth.

Prime Minister David Cameron of Britain recently promoted behavioral economics as a remedy for his country?s over-use of electricity, citing what he claimed were remarkable results from a study that reduced household electricity use by informing consumers of how their use compared to that of their neighbors.

Under closer scrutiny, however, tests of the program found that better information reduced energy use by a mere 1 percent to 2.5 percent ? modest relative to the hopes being pinned on it.

Compare that with the likely results of a solution rooted in traditional economics: a carbon tax would instantly bring the price of energy into line with its true cost and would unleash the creative power of the marketplace to generate cleaner energy sources.

Behavioral economics should complement, not substitute for, more substantive economic interventions.

You can quibble with the specific example here — Barbara Kiviat notes that other studies show greater effects — but conceptually it’s easy to see that any behavioral-economics solution carries with it a potential problem, which interestingly enough might be exactly the kind of thing best studied by behavioral economists.

Consider an issue with two possible lines of attack: a cheap behavioral-economics solution, B, and a more expensive and politically-fraught substantive solution, S. Does implementing B make implementing S less likely? If B didn’t exist, would S be more likely to come about? Surely there are cases where the answer to both questions is yes — and where therefore behavioral economics is a bad thing, not a good thing. The ability to cover up issues with a behavioral band-aid is often just a way of doing as little as possible while appearing to tackle the issue at hand.

That said, in a lot of cases S would never happen anyway, and in those cases B is better than nothing. And in other cases S will happen either way, and again adding B to the mix is going to be a good thing. So the only cases we’re worried about are the ones where the existence of B significantly changes the likelihood of implementing S. I wonder how common that is.

Full post as published by Macroprudential on July 15, 2010 (boomark / email).