Excellent op-ed in today's WSJ by Todd Zywicki and Geoffrey Manne reminds us that The Constitution Says Nothing About Behavioral Economics. As I explained in my article Mandatory Disclosure: A Behavioral Analysis, which is available at SSRN: https://ssrn.com/abstract=329880:
As with any model claiming predictive power, law and economics rests on a theory of human behavior. Specifically, neoclassical economics is premised on rational choice theory, which posits decisionmakers who are autonomous individuals who make rational choices that maximize their satisfactions. Critics of the law and economics school have long complained that rational choice is, at best, an incomplete account of human behavior.
The traditional law and economics response is that rationality is simply an abstraction developed as a useful model of predicting the behavior of large numbers of people and, as such, does not purport to describe real people embedded in a real social order. A theory is properly judged by its predictive power with respect to the phenomena it purports to explain, not by whether it is a valid description of an objective reality. Indeed, important and significant hypotheses often have assumptions that are wildly inaccurate descriptive representations of reality. Accordingly, the relevant question to ask about the assumptions of a theory is not whether they are descriptively realistic, for they never are, but whether they are sufficiently good approximations for the purpose in hand. Until quite recently, empirical research tended to confirm that the rational choice model of human behavior is a good first approximation of how large numbers of people are likely to behave in exchange transactions.
Over the last couple of decades, however, a new school of economic analysis has emerged that challenges the rational choice model precisely on its predictive power. Empirical and laboratory work by cognitive psychologists and experimental economists has identified a growing number of anomalies in which behavior appears to systematically depart from that predicted by rational choice.
Two of the more important examples of these decisionmaking biases are:
- Herd behavior: Why do lemmings leap off that cliff in Norway? What explains fads like Beanie Babies and Pokémon? Herd behavior occurs when a decisionmaker imitates the actions of others, while ignoring his own information and judgment with regard to the merits of the underlying decision.
- The status quo bias: All else being equal, decisionmakers favor maintaining the status quo rather than switching to some alternative state. The status quo bias can lead to market failure where decisionmakers’ preference for the status quo perpetuates suboptimal practices.
As Zywicki and Manne observe, while its proponents claim its neutrality, behavioral economics in fact is now a principal tool in the progressive argument for government intervention:
Behavioral economics has taken the academy by storm over the past two decades. The Obama administration has even looked to the discipline—which posits that psychological biases frequently lead consumers to make bad economic decisions—to shape government policy.
They focus on its use in a pending SCOTUS case: Expressions Hair Design v. Schneiderman.
The case involves New York’s ban on credit-card surcharges. For decades the state has barred companies from tacking on a fee when customers pay with plastic instead of cash. A hair salon now challenges that law, claiming businesses have a constitutional right to impose surcharges—and that behavioral economics provides the theoretical foundation.
Although the two appear to be mathematically equivalent, the salon argues that surcharges are more effective at changing behavior because consumers suffer from a “loss aversion” bias. More customers will decide to pay with cash, the theory goes, if faced with a “loss” (the $1 surcharge) than a “gain” (the $1 discount).
The salon argues that the only meaningful difference between the two pricing schemes is what they’re called—and that’s a matter of free speech. Barring the “surcharge” label but not the “discount” label, the argument goes, violates the First Amendment.
But they caution:
In the laboratory, under unrealistic premises and with no real money on the line, the loss-aversion hypothesis might play out as behavioral economists predict. But even that is unclear: So malleable are these theories that the U.K. Office of Fair Trading has pointed to behavioral economics to argue that surcharging can harm consumers through “drip pricing,” in which the merchant adds fees after the consumer has decided to buy.
When confronted with the messiness of the real world, the effort to extend behavioral economics founders. Far from providing a test case for its widening application, Expressions Hair Designdemonstrates why the field remains little more than an interesting intellectual parlor game. The Supreme Court should resist the invitation to import this unproven economic theory into constitutional law.
I concur, as I explained in my article:
The mere existence of such a market failure does not—standing alone—justify legal intervention. In addition to the standard prudential arguments in favor of limited government, which counsel caution in concluding that a purported market failure requires government correction, behavioral economics itself argues against presuming the desirability of intervention. As Jennifer Arlen has explained (in The Future of Behavioral Economic Analysis of Law, 51 Vand. L. Rev. 1765 (1998)):
Proposals designed to address biases generally entail the intervention of judges, legislators, or bureaucrats who are [themselves] subject to various biases. The very power of the behavioralist critique—that even educated people exhibit certain biases—thus undercuts efforts to redress such biases. In addition, the decisions of government actors also may be adversely influenced by political concerns—specifically interest group politics. Thus interventions to “cure” bias-induced inefficiency may ultimately produce outcomes that are worse than the problem itself.
In other words, the claim that law can correct market failures caused by decision-making biases or cognitive errors treats regulators as exogenous to the system. Once the state is endogenized, however, regulators must be treated as actors with their own systematic decision-making biases. It thus becomes evident that behavioral economics loops back on itself as a justification for legal intervention.