Sunday, July 05, 2009

Thaler on Ski Slopes and Mortgages

So what does it take to get me to blog these days? Having an opinion is no longer enough. Apparently I have to be actively irritated.

Richard Thaler is the newest contributor to the NY Times’ Economic View, where in his first column he uses behavioral economics to justify new financial regulations. In the process, he gets up to the same shenanigans that have become familiar to anyone who follows his work on “libertarian paternalism.” Specifically, he continues to disregard the distinction between public and private action.
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.
Here we see two of Thaler’s favorite stratagems deployed at once. First, he relies on a deceptively innocuous, private, and non-coercive example to illustrate his brand of paternalism. Before it was cafeteria dessert placement; now it’s ski-slope markings. Second, he subtly equates private and public decision makers without even mentioning their different incentives. In this case, he uses “bureaucrats” to refer to all managers, regardless of whether they manage private or public enterprises.

The distinction matters. The case of ski-slope markings is the market principle at work. Skiers want to know the difficulty of slopes, and so the owners of ski resorts provide it. They have a profit incentive to do so. This is not at all coercive, and it is no more “paternalist” than a restaurant identifying the vegetarian dishes.

Public bureaucrats don’t have the same incentives at all. They don’t get punished by consumers for failing to provide information, or for providing the wrong information. They don’t suffer if they listen to the wrong experts. They face no competition from alternative providers of their service. They get to set their own standards for “success,” and if they fail, they can use that to justify a larger budget.

And Thaler knows this, because these are precisely the arguments made by the “critics” to whom he is responding. His response is just a dodge, enabled by his facile use of language and his continuing indifference – dare I say hostility? – to the distinction between public and private.

Now, as for the financial aspects of all this. I’m not a finance guy, so I’m less qualified to speak here. The regulations he advocates might be desirable; behavioral justifications for paternalism might make more sense in this context than others. I’m not saying they do, but I’m open to the argument.

Still, something seems fishy about his argument here, which hinges on people being “fooled” by exotic mortgage contracts. Yes, there were some confusing mortgage deals out there, and I’m sure some people didn’t completely understand what they were getting themselves into. But did the lenders – the supposed experts – know any better? Remember that Thaler’s argument here is about letting the experts drive the decisions; that’s the whole point of the ski-slope story. Yet by all indications, the lenders were fooled, too. Both the debtors and the lenders were making the same bet: that housing prices would continue to rise, if not forever, then at least long enough to refinance. Or to put it another way, with respect to the major issue at hand, most of the debtors knew what they were doing: gambling. So while I’m sure some debtors were fooled by funky mortgage contracts, it’s hard for me to believe that was a major driver of the financial crisis.

But as I said, I’m not a finance guy, so maybe there’s more to the behavioral-paternalist angle in this context. I just wish Thaler would be straight-up when dealing with the arguments of his critics.


blink said...

If irritation is what it takes to get you blogging, I wish you lots of unpleasant reading. In any case, it is refreshing to see Thaler called on his sleight of hand with examples. I think many reading his column will have a vague sense of uneasiness, but be unable to pinpoint any errors, so your piece is a welcome corrective.

Admiral said...

As you may intuit, the finance-paternalist angle doesn't really work either because it's not as if the point about incentives doesn't exist there. As Zingales (UChicago) has pointed out, there may be a strong case for DISCLOSURE regulations, but there's a very high hurdle for other financial regulations based on just that incentive structure point.

Aaron Davies said...

I admire your refusal to use the word "slippery" anywhere in this post. I could never have shown such restraint.

All-In-All said...

"Bureaucrats are human, too, but they can also hire experts and conduct research."
Bureaucrats selecting 'experts' is epistemically identical to bureaucrats selecting bureaucrats.

It is not simply the incentive problem, it is the fact that without a profit/loss mechanism there is no way to tell whether your ski-instructor or airplane inspector is actually contributing a valuable productive service which is worth more than he costs. The term 'expertise' disguises this, by ignoring the fact that even a very intelligent, well-educated and (we will presume) not overly biased individual does not necessarily have skills and ideas which are useful allocations of resources.

Being an expert in the mechanics of ships does not make one an expert ship mechanic.

Michael Price said...

I think my analysis of regulation and business cycles is valuable here. Basically I say that the regulation itself is as vulnerable to cyclic problems as the regulated market (or more so).

Dr. T said...

Did you see the latest government news? Federal bureaucrats contracted with a private firm to create a web site that will display Recovery Act spending (a service provided for free by an independent blog). The cost of the web site: $18,000,000. When bureaucrats make such decisions, how can they possibly be trusted by we the people?

ColoComment said...

"So while I’m sure some debtors were fooled by funky mortgage contracts, it’s hard for me to believe that was a major driver of the financial crisis"

Just in the last day or two I saw an article that reported that most foreclosed mortgages were not due to sub-prime quality, but rather that the borrower had no "skin" in the game. Borrower either put nothing or a minimal amount down. It's always easier to gamble with someone else's money than with your own. Another comment that I read somewhere (dang it, I wish my memory were better), suggested that unless a homeowner had at least 10% [I think it was] in equity, he basically was just renting.

Finally, to Dr. T: as I recall that website wasn't going to be fully functional until some 'way off future date. It's gotta be someone's relative who's got that contract, eh?

All-In-All said...

"as I recall that website wasn't going to be fully functional until some 'way off future date. It's gotta be someone's relative who's got that contract, eh?"
All right you Public Choicers, no reason to jump straight to nepotism. Remember the effect of bureuacratic culture, information bias and self-selection.

It's quite possible that they're under a huge degree of executive oversight and scope creep, fueled by funny-money. The government doesn't need ill-will to fail, and corruption usually improves service.

Anonymous said...

Thaler is at best disingenuous and likely being intellectually dishonest to push his ideological convictions.

Behavioral Decision Theory is long on examples the proported irrational behavior but short on market assessments. I await the day that Thaler or one of the other BDT experts shows us market predictions.

Keir said...

Great post. The Thaler crowd was unheard of a few years ago and now they are near ubiquitous at places like the Times blog.

I like this piece Donald Boudreaux wrote for the Freeman in September 2006: