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Richard Thaler joins *Economic View*
His first column is on behavioral economics and mortgages; excerpt:
Some critics contend that behavioral economists have neglected the obvious fact that bureaucrats make errors, too. But this misses the point. After all, wouldn’t you prefer to have a qualified, albeit human, technician inspect your aircraft’s engines rather than do it yourself?
The owners of ski resorts hire experts who have previously skied the runs, under various conditions, to decide which trails should be designated for advanced skiers. These experts know more than a newcomer to the mountain. Bureaucrats are human, too, but they can also hire experts and conduct research.
Posted by Tyler Cowen on July 4, 2009 at 07:25 PM in Economics | Permalink
Comments
False analogy. His "technician" is more akin to a blood-letter, those old-timey doctors who practiced a particularly deadly kind of medicine probably since the other relevant branches of science were not nearly as developed as they needed to be. Good intentions, sure, but the brutal hummer of government bureaucracy and top-down legislation is hardly the proper manner of effecting positive (and lasting) change.
Posted by: Billare at Jul 4, 2009 8:10:44 PM
The mortgage bubble doesn't strike me as a very plausible nail for Thaler's libertarian-paternalist hammer. No amount of lib-pat nudging is going to steer you to a traditional 20%-down loan if you haven't got the 20%.
The mortgage market's "aircraft mechanics" would have been the loan officers. Not too promising an analogy.
Posted by: Paul Zrimsek at Jul 4, 2009 8:11:47 PM
"Bureaucrats are human, too, but they can also hire experts and conduct research."
Doesn't this also apply to non-bureaucrats? What makes bureaucrats better at hiring experts than people who work in the industry and stand to lose money if they don't know what they are doing?
Posted by: Jayson Virissimo at Jul 4, 2009 8:14:45 PM
Why Professor Thaler is wrong, yet again.
Have you ever tried to figure out exactly how much you are being charged in fees on your 401 (K) or 403 (B)? Good luck trying to find out. The benefits person at your company is unlikely to know. They can give you some general percentages but they rarely understand wrap fees or if the funds are giving a kickback to the manager.
You can try to go to the Federal regulators, where you may be shocked to learn that you are not entitled to know how much you are being charged by the firm managing your retirement money. The Federal government requirements are minimal. A quarterly statement that will almost never give anything like a dollar amount that went to the managers is required but that's about it.
Why is this? The best explanation is that the firms that sell 401 (K) plans, especially to smaller employers, long ago captured the regulators. The firms selling these plans have huge incentives to hide their true cost structure. Individuals paying the fees rarely understand them and usually get half truths when they enquire.
I have written Senators, Congressmen, etc to complain but they really are not interested in the topic. Why? Why do they refuse to pass legislation that requires that firms clearly disclose all the fees that people pay?
What is it about the behavior of politicians and bureaucrats, combined with interests of businesses, that so often work against the interests of consumers. And once in place only an act of Congress is able to change the rules.
I humbly suggest that reading Stigler, Friedman, Becker, and Schultz shouldn't be too much to expect from a University of Chicago economist.
As to Professor Thaler's other points. I don't automatically trust a technician who inspects an aircraft's engine. As a matter of fact if he is a government employee I wonder if he is some hack who got his job through political connections. Or worse some brain dead idiot protected by some union until he actually kills two hundred people. You see I think if the rules make it possible for firms to be well run and turn a profit, the firms have huge incentives to make the planes safe. Indeed more incentive then some political hack inspector who has little skin in the game.
And if ski resorts want to hire experts, let them. But OSHA running ski resorts, that is just too funny. I have to stop now, I'm laughing too hard
Posted by: DanC at Jul 4, 2009 8:20:51 PM
The problem with the bureaucratic "technicians" is not that they are necessarily less competent than those in the business worls. The problem is that the incentives are wrong. Government regulators have an incentive to reward the administration's supporters. Business practitioners have an incentive at least to make sure their firm doesn't go bankrupt.
-dk
Posted by: Dick King at Jul 4, 2009 8:23:39 PM
Above should have read
A quarterly statement (that will almost never give anything like a dollar amount that went to the manager) is required but that's about it.
Posted by: DanC at Jul 4, 2009 8:25:47 PM
What drives an airline to hire qualified technicians to inspect the engines? A great desire to do the right thing, or the profit-and-LOSS motive. Loss is capitalized because market critics don't seem to understand the power of losses as an incentive.
What exactly drives bureaucrats to hire qualified technicians? Thaler argues that they *can.* Well that's helpful. I suppose I *can* repair an aircraft engine.
Posted by: Steve Miller at Jul 4, 2009 8:50:50 PM
Alan Greenspan, the great bureaucrat with access to billions of dollars, didn't hire anyone to explain him the "new financial products". They were too complex to understand, so complex that he didn't know how to look for an expert in the yellow pages. Professor Thaler may send him the directions of how to look for one, with a copy to Bernanke. Or maybe Professor Thaler can organize Wa$hington Po$t-sponsored salons to train bureaucrats in the fine art of contracting experts.
Posted by: E. Barandiaran at Jul 4, 2009 9:15:38 PM
His actual book, Nudge, explained his ideas much better than this post. Basically, the commenters here are right about incentives. What Thaler would like to do, if I grasped his book at all, would be to require some form of lets say simple Excel spreadsheet that had all possible information/points/sources for expenditure to be required by law to be filled out by the loan officer.
This sheet would be created by the third party technician, and be required by law. The whole idea is that he doesn't want to remove choice, he wants to make the complex choices less confusing.
Now this sheet still wouldn't protect anyone of there was abject fraud, but it would protect home-owners who didn't realise that in 5 years they would be paying X + 50 instead of X. Or they didn't realise that would incur penalties for early payment.
On this blog, based on my past reading of comments, I would expect the same people to object to his ideas, not necessarily this article which doesn't explain them well, to be the same ones who object to calories being put on menus. We wouldn't want to give consumers easy access to critical data to help them make an informed choice....that would be bad...for those who know they are making terrible products but don't want to be subject to a free-market without asymmetrical information concerns...
Posted by: Tony Cohen at Jul 4, 2009 10:46:25 PM
To Tony Cohen
What are you taking about? Can you point to a post that argues that information is bad?
Markets tend to evolve quickly, governments slowly. Governments are always fighting the last war or trying to freeze markets (often after being captured by those they sought to control) to the detriment of the public.
This nimble responsive government that Thaler envisions is a fairy tale, with destructive potential.
Posted by: DanC at Jul 4, 2009 11:38:05 PM
Thaler misses his own point. The type bureaucratic error we should fear is not a technical 'mistake' due to a lack of perfect expertise or slight behavioral irrationalities. Rather, we should fear the human 'error' of self-serving motives, neglect, and corruption.
Posted by: Brian at Jul 5, 2009 12:40:13 AM
I think the behavioral economics approach to this question is the correct one; that is, we should be trying to understand the best way to incentivise proper behaviour among civil servants. Thaler seems to have made the error of assuming proper incentives.
Government isn't going away. It's necessary, at least for the foreseeable future. The best thing a student of the social sciences can do for humanity is to understand the best way to structure government's incentives so it does the least damage to society and the most good. Often, we already know what policies make good sense; the question is how to align politicians' and bureaucrats' incentives so they adopt these policies.
Posted by: johnleemk at Jul 5, 2009 2:19:03 AM
I think everyone so far has pretty much stated my feeling on the matter. Incentives matter, in bureaucracy (NOT JUST THE GOVERNMENT KIND) your incentives are CYA and also to build a structure under you. You get fired for mistakes and you generally get paid depending on how many people you have under you and how big the structure you employ. These incentives lead to huge bureaucracies that don't take risks.
This risk aversion is itself a form of risk, not just because of missed opportunities but because the nature of being risk adverse means that large systematic risks can be caused by attempting to control other risks beyond the point they are actually controllable, then treating the situation as low risk. This can be seen in the recent financial crisis.
Another systematic problem in bureaucracy is that the pay structures lead to bloat, but thats an entirely different topic.
Posted by: Doc Merlin at Jul 5, 2009 3:12:04 AM
Arnold Kling is closer to the truth when it comes to most public policy "experts" who make it to the "top":
"The main science of political economy is the science of obtaining and retaining power. As far as expertise goes, the pollster, the fundraiser, and the media expert are all fundamental to the operation. The public policy expert is for decoration. If you want to be an economic policy adviser when you grow up, then my advice is to learn to rationalize the methods used by leading politicians to obtain power.
Is health care reform about health care? No, it is about seizing and retaining power. Was the stimulus about stimulus? No, was about seizing and retaining power. Is cap and trade about global warming? No, it is about seizing and retaining power. Was TARP about saving the financial system? No, it was about seizing and retaining power.
The social scientist’s role in the political process is to say, “X is a problem. Government must solve X. Here are some solutions.” The solutions that rationalize seizing and retaining power will bubble to the top."
Posted by: Greg Ransom at Jul 5, 2009 3:14:31 AM
to Dan C:
You are right that no one, yet, has made the common arguments along the line of 'buyer beware'. Thaler believes that 'buyer beware', if I understand him, is not good enough for overly complex situations where it is not expected that a layman will have the knowledge to make an informed decision.
Based on what has happened recently in the world, is it really a good thing that there might be rapid ever evolving financial services that we can't factor into a spreadsheet for something like mortgages because the government wasn't nimble enough?
Does the potential downside (massive gambling on unknown/untested financial products) against the 'nimble-ness' of the free market really outweigh a world where it would take extra time to get a new financial mortgage option into the hands of the public?
Hell, if you actually established a psychological association with the aforementioned spreadsheet and sense of understanding/fairness/no nasty surprises, then you could let people jump on any old mortgage they wanted, with the understanding that they were not entitled to said spread-sheet because no one had any idea what their new-fangled options might lead to
Posted by: Tony Cohen at Jul 5, 2009 3:29:53 AM
I have written Senators, Congressmen, etc to complain but they really are not interested in the topic. Why? Why do they refuse to pass legislation that requires that firms clearly disclose all the fees that people pay?
DanC, it's tough for me to understand what exactly your complaint is. Is it, as implied above, that government is not responsive enough to Thaleresque calls for required disclosure in a standardized format from different businesses? Or is it that such calls are unnecessary since the market will respond to consumer demands for increased disclosure (although it appears too few consumers share your demands for more disclosure from asset managers)? Elsewhere, you state that giving government such power is dangerous but that's a bit difficult to square with your complaint letters to your Congressmen, to say the least.
Posted by: Ricardo at Jul 5, 2009 4:06:23 AM
The argument that 'we' were actually nudging people to the breaking point with respect to loans says that those of us skeptical of "experts" are not missing the point.
So, is Thaler arguing for better experts? I argue for better consumers. Because, at the end of the day we would still, as consumers of public policy, have to know how to watch the watchmen.
Posted by: Andrew at Jul 5, 2009 6:51:45 AM
Have we or have we not had general policy that promoted home loanership? I'm not sure how anyone could argue not.
Posted by: Andrew at Jul 5, 2009 6:55:05 AM
With analogies like "Aircraft technicians" and "ski slope experts" I take it he doesn't read Arnold Kling very often.
I will give him credit for one thing, the marginal home borrower is indeed "Homer Simpson". Would he say that government policies pushing more of them into the housing market is the work of "qualified technicians"? What does he think the incentives are for elected politicians when it comes to people borrowing more money then they can afford?
Posted by: stephen at Jul 5, 2009 8:31:58 AM
To Ricardo
Sorry, I did leave out the rest of the story about 401 (K) and 403 (B)'s.
The government makes it almost impossible for you to go outside your employer if your employer has selected a poor manager for your retirement plan. The government has set forward some basic rules about how an employer can set up pension plans. These were done, it seems, with two initial goals: protect investors and make sure the plans are not top heavy (geared toward high compensation employees).
What has this paternalism done? It makes complex rules that lock you into the employers plan. (You can just go with an IRA plan and skip the employer plan but then the contribution limits are lower and you miss employer matches.) If you are locked into a bad plan, you can try to get your employer to change or you can change jobs. However most people don't know if they are in a high cost or low cost plan. Nor do they often appreciate the impact of high fees.
Absent the paternalism you would be free to select your own plan independent of your employer. While this may have some risks, the potential gains for employees from increased competition in the marketplace is great.
The paternalism surrounding 401 (K) and 403 (B) has lead to a system that keeps employees in the dark about the real cost of the plans, limits individual choice, and is more expensive then it should be.
Posted by: DanC at Jul 5, 2009 9:32:29 AM
Tony Cohen seems to be interpreting Thaler's position as "Let no new thing arise". I'm not seeing that.
Posted by: Paul Zrimsek at Jul 5, 2009 9:56:39 AM
To Tony Cohen
I don't think the problems in the current mortgage mess were on the demand size. Nor do I think that most borrowers were idiots sucked into bad plans that they didn't understand. These stories often sound like the pregnant teenager who claims that they didn't know they could get pregnant doing what they did. Take such claims with a grain of salt.
Moreover the Federal government did take steps to encourage home ownership in marginal buyers. While this does not explain the whole story, I think it had more of an impact then stupid borrowers trapped by greedy lenders. The nudge from the government was to make risky loans to fulfill a political motive.
The bigger collapse was on the supply side. Why were so many firm rushing to supply funds to marginal buyers? Is it because the lenders suddenly became stupid? The failure was that risks were being taken without those firms suffering the consequences of their bad choices. Incentives were distorted. Regretfully the federal government thinks the solution is wage control.
There is nothing wrong with the government requiring that businesses provide more information. Except businesses respond with things like two pages of small print on every contract. Look at the back of the buyers agreement at car dealerships. Does anybody really read that stuff?
If the Federal government can create a better regulatory structure the Obama administration hasn't presented one yet. Even Obama is being advised by people like Thaler, God help us.
Posted by: DanC at Jul 5, 2009 10:09:47 AM
Interesting comments.
So, substitute for "bureaucrats", the following and see if the comments made in response to Thaler still stand:
- policemen
- prosecutors
- judges
- generals
- soldiers
What is the difference between the function of the regulator and the function of the policeman or prosecutor?
Posted by: mulp at Jul 5, 2009 9:19:01 PM
Government regulators have an incentive to reward the administration's supporters. Business practitioners have an incentive at least to make sure their firm doesn't go bankrupt.
So all the stockholder employees of the now defunct, largely unregulated investment banks, who wrote, underwrote, or insured mortgages to people with no reasonable possibility of repayment, were acting to ensure their employers didn't go bankrupt?
On the other hand, prosecutors and judges should be seen to be acting to reward the administration and not enforcing the law in furtherance of justice?
Posted by: mulp at Jul 5, 2009 9:40:21 PM
mulp,
Some differences are the alternatives available and the incentives faced by each group named. The incentives of bureaucrats are different from those of judges. The alternatives to bureaucrats are different than the alternatives to judges.
Posted by: Cliff at Jul 5, 2009 10:00:08 PM
