Sunday, November 18, 2012

Voter and Consumer Irrationality: An Extension

Questioning rational choice is not a sufficient basis for arguing for government intervention. But my past few posts questioning standard market propositions in the case of health care are not meant to promote every single government regulation. Rather, I wonder if we can try to further the study of economics and public policy by reversing the typical way public choice economics is applied.

When I think of public choice economics, I think of papers about how the marginal costs and benefits of lobbying lead to poor government policies or how decentralizing the functions of governments leads to a competitive equilibrium with better governmental policies. At its core, I interpret this line of analysis as using the success of markets to explain why governments fail. Markets succeed because marginal costs line up with marginal benefits, and thus governments fail because these costs and benefits are distorted. Markets succeed because there is competition between firms, and thus governments fail because there is no competition. What I want to propose is that we change the direction of this line of thought, and start from the vast literature on why governments fail, and see if that can teach us about why certain markets fail. 

This is why I think behavioral economics is so important. By reducing biases down to core psychological first principles, it highlights the connection between government and market failure. But we should also make sure to avoid thinking that policy makers themselves are perfectly rational. As John Papula pithily points out:
Why in the world do behavioral economists who study our flaws and irrational quirks advocate centralized power in the hands of a small group of flawed overlords? If people are irrational, so are government regulators, only they have corrupting monopoly power.
As such, I agree that it is important that behavioral economists grasp the concept of public choice, but also for public choice to grasp the concept of behavioral economics. There exist reasons for why the market often overcomes behavioral biases, but then there also exist markets in which those mechanisms don't function well. And most likely, we can trace these mechanism failures to arguments past public choice economists have made about the failure of government. That is my conjecture, and I hope to be able to pursue further analysis of health care under this framework.

Voter and Consumer Irrationality: Two Sides of the Same Coin

One strong argument against the government provision of services is that democracy is a very imperfect substitute for markets. As noted by Bryan Caplan, voters have a hard time rationally evaluating policy options, and thus the public choice economy may be a very bad one. The natural conclusion of this argument is that, to the greatest extent possible, the provision of goods should be pulled away from government and the responsibility should instead be allocated to the market. Yet this line of logic contains its own contradiction: if voters cannot rationally choose the right public policy, how can they be expected to make the right private choice?

Now, I don't mean to say markets never work. I am very happy with the way capitalism has treated me, both in terms of the large historic liberalizations that brought me to this country as well as in the small conveniences that improve my everyday life. I don't mean to reject this. But what I want to suggest is that the acceptance of the irrational voter hypothesis suggests that we should take a closer look at our acceptance of the perfect market equilibrium in many different sectors, in particular health care.

Bryan Caplan, in his work on voter irrationality, outlines four main biases: the anti-market bias, anti-foreign bias, make-work bias, and pessimistic bias. 

Anti-market bias refers to the public's systematic bias towards policies that interfere with prices and profits, such as farm subsidies or rent control. I like to think of it as the public's bias against simple supply and demand explanations of the market. 

Anti-foreign bias refers to the way the public tends to see people from other countries as fundamentally different from itself, and thus the bias causes people to under-estimate the benefit of free trade and immigration. People focus on the auto jobs outsourced by free trade and the native fast food restaurant replaced by immigrants, while paying little attention to the new opportunities and technologies granted by interaction with foreigners.

Make-work bias refers to the way the public confuses productivity with having a job. As Caplan cleverly states, "For an individual to prosper, he only needs to have a job. But society can prosper only if individuals  do a job, if they create goods and services that someone else wants." People tend to make the classic luddite fallacy, that new technology destroys more jobs than it creates, and that, as a result, technological growth actually worsens the standard of living.

The fourth and final bias, pessimistic bias, refers to the way the public tends to overemphasize the things the get worse over time, and forget the ways that life improves. Recession is confused for regression, and the massive technological advances of the markets, such as improvements in information technology and energy infrastructure, are forgotten.

Yet when I think about these biases, I would argue that they all are manifestations of a more fundamental psychological bias: a bias towards salience.

Salience refers to the way certain effects or phenomenon are more apparent and more obvious. We should be familiar with this idea of salience in our everyday lives. It's easy for me to enjoy the concentrated fun of watching old episodes of scrubs, it takes more effort to remind myself of the dispersed benefits of working hard on math homework. It's easy for me to catch up on the extra hour of sleep, it takes more effort to remind myself of the long-term benefits of exercising in the morning. As Katherine Baicker, Sendhil Mullainathan, and Joshua Schwartzstein like to joke, "Our research has definitively determined that running is unpleasant and donuts are tasty," and as such, people tend to choose the salient joy of tasty donuts and the immediate avoidance of hard running instead of the long term benefits of consistent exercise. Or as Thaler and Sunstein put it in their book Nudge, very rarely do people ever make new years resolutions to smoke more cigarettes or drink more alcohol.

I would argue that salience forms the basis of Caplan's irrational voter biases. Salience means that people tend to see the direct negative impacts of market liberalization, and neglect the role of the fallacy of composition in hiding the harms that arise from government intervention. In the case of the anti-market bias, the benefit from paying farmers is salient, whereas the cost of higher food prices are dispersed and not as apparent. In the case of the anti-foreign bias, the closed steel mills down the street are immediately visible, whereas the newly created jobs in the software industry and management consulting are not as visible. In the case of the make-work bias, people directly observe the seamstresses fired and don't see the new women, who on count of greater general prosperity, are then given the chance to go to college for a better life. And finally, in the context of the pessimistic bias, people tend to worry about the bad changes more than the good. People complain more about the rising price of gas and food, which they buy everyday, and not the fall in computer prices, which they rarely have the chance to purchase.

Re-framing the issue in terms of fundamental psychological first principles adds to the way we should interpret the irrational voter hypothesis. Rather than seeing the phenomenon of the irrational voter as an isolated problem that makes government policy ineffectual, we should see the irrational voter as a more general irrational person. As such, there may be certain (not all) markets, such as health care, that do not liberalize in the way other markets do. In the case of health care, because certain differences between doctors, such as bedside manner, are more salient than others, such as improved recovery times, a simple market liberalization may not always promote the best health outcomes. We need to think again, again, about why we need reform. Promoting price disclosure makes the costs consumers pay more salient. Moving away from an employer provided health care system towards individual insurance with an individual mandate makes the costs of choosing bad insurance more salient. But just kicking back and "letting the market (not) work", and treating healthcare just like "consumer electronics, telecommunications, computers" or cars is not a sufficient answer. And if we can move away from fiery rhetoric about socialism and capitalism and towards a grounded and pragmatic analysis of psychology and behavioral economics, only then can a meaningful dialogue on healthcare can occur.

Update 11/18: I extended some of my thoughts on public choice and health care here.