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Behavioral Public Economics

The standard economic approach to policy evaluation relies on the assumption of rational revealed preferences, which holds that people always choose what is best for them, that their choices do not depend on seemingly inconsequential frames, and that the preferences revealed by their choices are transitive and complete. Despite its centrality to modern Public Economics, this assumption may seem stringent from a psychological perspective. Indeed, the ostensible purpose of many important public policies is to address the concern that people do not always choose what is best for them, and that the determinants of consumer behavior extend beyond narrow self-interested optimization. For example, many countries have established government bureaus that offer consumer protection to guard against the possibility that firms may attempt to exploit unsophisticated buyers. A number of countries have also created “behavioral insights” teams, the role of which is to leverage findings from psychology and Behavioral Economics to formulate more effective government policies. Policy makers often justify otherwise standard policies such as “sin taxes” on cigarettes, alcohol, sugary drinks, and similar goods on the grounds that they discourage harmful behaviors. Arguments for mandatory retirement savings programs often reference consumer myopia.

The existence of such policies, as well as various empirical findings in Behavioral Economics, suggest that the standard approach in Public Economics to policy evaluation may yield misleading conclusions about the welfare effects of some policies, and is simply inapplicable to other policies that influence behavior through framing effects, such as those that determine salience. The rapidly expanding field of Behavioral Public Economics combines the methods and insights from Behavioral Economics and Public Economics to (i) supplement the Public-Economics toolbox with methods that allow for more robust evaluations of real-world policies, (ii) develop innovative policy tools, and (iii) explain why consumers’ responses to policy incentives are sometimes anomalous.

My recent work in this area involves applications of Behavioral Welfare Economics to specific policy issues. Some of the older papers listed below pre-date my work on Behavioral Welfare Economics, and consequently were not informed by the same set of tools. That work is what stimulated my interest the problem of policy evaluation with behavioral decision makers, and led me to develop a formal normative framework.

Publications

Collaborators

  • Andrey Fradkin
    Assistant Professor, Questrom School of Business, Boston University
  • Laurie Hodrick
    Professor Emeritus, Columbia Business School
  • Annamaria Lusardi
    University Professor of Economics & Accountancy, and Academic Director, Global Financial Literacy Excellence Center (GFLEC), George Washington University
  • Jonathan Meer
    Professor, Texas A&M University
  • Jonas Mueller-Gastell
    Student, Stanford
  • Neva Novarro
    Visting Assistant Professor, Pamona College
  • Igor Popov
    Chief Economist, Apartment List
  • Antonio Rangel
    Bing Professor of Neuroscience, Behavioral Biology and Economics at the California Institute of Technology
  • Debraj Ray
    Julius Silver Professor, NYU
  • John Karl Scholz
    Professor and Provost, University of Wisconsin-Madison
  • Dmitry Taubinsky
    Assistant Professor, UC Berkeley
  • Sevin Yeltekin
    Professor of Business Administration, University of Rochester

Peer Advice on Financial Decisions: A Case of the Blind Leading the Blind?

Previous research shows that many people seek financial advice from non-experts, and that peer interactions influence financial decisions. We investigate whether such influences are beneficial, harmful, or simply haphazard. In our laboratory experiment, face-to-face communication with a randomly assigned peer significantly improves the quality of private decisions, measured by subjects' ability to choose as if they properly understand their opportunity sets. Subjects do not merely mimic those who know better, but also make better private decisions in novel tasks.

Evaluating Deliberative Competence: A Simple Method with an Application to Financial Choice

We introduce a method for experimentally evaluating interventions designed to improve the quality of choices in settings where people imperfectly comprehend consequences. Among other virtues, our method yields an intuitive sufficient statistic for welfare that admits formal interpretations even when consumers suffer from biases outside the scope of analysis. We use it to study a financial education intervention, which we find improves the quality of decisions only when it incorporates practice and feedback, contrary to the implications of analyses based on conventional efficacy metrics.

Optimal Default Options: The Case for Opt-Out Minimization

We examine the desirability of opt-out minimization, a well-known and simple rule of thumb for setting default options such as passively selected contribution rates in employee-directed pension plans. Existing results suggest that this strategy is welfare-optimal only under highly restrictive assumptions. In this paper, we dispense with those assumptions and demonstrate far more generally that opt-out minimization is approximately optimal. Our main results require only a small number of weak regularity conditions.

Private Saving and Public Policy

The evidence presented in this paper supports the view that many Americans, particularly those without a college education, save too little. Our analysis also indicates that it should be possible to increase total personal saving among lower income households by encouraging the formation and expansion of private pension plans. It is doubtful that favorable tax treatment of capital income would stimulate significant additional saving by this group. Conversely, the expansion of private pensions would probably have little effect on saving by higher income households.

Veblen Effects in a Theory of Conspicuous Consumption

We examine conditions under which "Veblen effects" arise from the desire to achieve social status by signaling wealth through conspicuous consumption. While Veblen effects cannot ordinarily arise when preferences satisfy a "single-crossing property," they may emerge when this property fails. In that case, "budget" brands are priced at marginal cost, while "luxury" brands, though not intrinsically superior, are sold at higher prices to consumers seeking to advertise wealth.

Addiction and Cue-Triggered Decision Processes

We propose a model of addiction based on three premises: (i) use among addicts is frequently a mistake; (ii) experience sensitizes an individual to environmental cues that trigger mistaken usage; (iii) addicts understand and manage their susceptibilities. We argue that these premises find support in evidence from psychology, neuroscience, and clinical practice. The model is tractable and generates a plausible mapping between behavior and the characteristics of the user, substance, and environment.

The Welfare Economics of Default Options in 401(k) Plans

Default contribution rates for 401(k) pension plans powerfully influence choices. Potential causes include opt-out costs, procrastination, inattention, and psychological anchoring. Using realistically parameterized models, we show how the optimal default, the magnitude of the welfare effects, and the degree of normative ambiguity depend on the behavioral model, the scope of the choice domain deemed welfare-relevant, the use of penalties for passive choice, and other 401(k) plan features.

Poverty and Self-Control

We argue that poverty can perpetuate itself by undermining the capacity for self-control. In line with a distinguished psychological literature, we consider modes of self-control that involve the self-imposed use of contingent punishments and rewards. We study settings in which consumers with quasi-hyperbolic preferences confront an otherwise standard intertemporal allocation problem with credit constraints. Our main result demonstrates that low initial assets can limit self-control, trapping people in poverty, while individuals with high initial assets can accumulate indefinitely.

Do Consumers Exploit Commitment Opportunities? Evidence from Natural Experiments Involving Liquor Consumption

This paper provides evidence concerning the extent to which consumers of liquor employ commitment devices. One widely recommended commitment strategy is to regulate alcohol consumption by deliberately manipulating availability. The paper assesses the prevalence of the "availability strategy" by evaluating the effects of policies that would influence its effectiveness—specifically, changes in allowable Sunday sales hours. It finds that consumers increase their liquor consumption in response to extended Sunday on-premises sales hours, but not in response to extended off-premises sales hours.

From Neuroscience to Public Policy: A New Economic View of Addiction

A growing consensus in neuroscience regarding how addictive substances affect the brain supports the view that the consumption of addictive substances is sometimes rational, and sometimes a cue-triggered mistake. Neuroscientists have gained considerable insight into the specific processes that appear responsible for decisionmaking malfunctions involving addictive substances, and into the conditions under which these malfunctions occur. These insights lead to a new economic theory of addiction that bridges the gap between neuroscience and public policy.

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