Richard Thaler Explains Behavioral Economics to Richard Posner
Richard Posner, who usually shows at least some subtlety in his reasoning, trotted out all the usual Republican talking points against the Consumer Financial Protection Agency in the Wall Street Journal, choosing to attack Richard Thaler along the way for no apparent good reason. The core of his argument is that since Thaler has previously advocated investing a larger proportion of one’s portfolio in stocks, and this would have been a bad strategy in 2008, he cannot possibly be right when it comes to financial regulation. I’m not kidding – that’s the whole second half of the article. And Posner doesn’t even ask, let alone answer, the question of whether Thaler might have been right over a longer timeframe, say since 1993, when Thaler published the paper that he cites.
I was thinking about responding, but on the one hand I didn’t want to seem obsessed with Posner after my previous two posts, and on the other hand I couldn’t think of anything to say I hadn’t already said in my response to Peter Wallison, since Posner’s arguments are a subset of Wallison’s (except for the bizarre attack on Thaler).
Thaler solved my problem by responding himself on Paul Solman’s site (hat tip Mark Thoma). Enjoy.
By James Kwak
I think we already discussed this…
Bond Girl
August 2, 2009 at 6:35 pm
Well, you know how I hate to be too blunt on these matters. Richard Posner fancies himself as some kind of modern intellect. He is a prototypical example of the ivory tower man with his head in the clouds. When it comes to the topic of Economics Posner couldn’t carry Richard Thaler’s jockstrap.
Ted K
August 2, 2009 at 7:10 pm
Regulation is fine in theory, but in practice it all has to do with the quality of the regulators. One of the head honchos of this blog wrote a very popular article in The Atlantic, one of the themes being “regulatory capture.” In the current environment, creating another agency which the oligarchy can find a way to game doesn’t seem like a path to progress.
Perhaps a simpler answer would be personal responsibility. If a contract is too complex to understand, either get a plain explanation in writing, or don’t enter into it.
Oh, and prosecute all the fraud that led to the current debacle. President Obama said it the other night in his press conference. People were making loans “they knew could not be paid back.” And then selling/securitizing those loans. That’s fraud, plain and simple. Where are the prosecutions, Mr. President?
eric
August 2, 2009 at 11:35 pm
Here is my non-expert opinion. I can’t help feeling those who resist a CFPA may not understand the party is over.
By some estimates the true unemployment rate in the United States could be 20%. How can you stimulate the economy through — consumer spending — when most of the consumer spending in the past decade was billions if not trillions of dollars financed by credit packaged in CDOs and washed through CDSs that are now backstopped by taxpayers’ money?
Meanwhile the real winners in this game are those financiers who made $5-$10-$20-$100 million or more in annual income that will and has been tax-sheltered as much as possible.
So is the financial meltdown another normal market cycle? Is there room for another interest rate cut? Is there room for more qualitative easing?
Tippy Golden
August 3, 2009 at 3:24 am
typo,
should read “quantitative” easing
Tippy Golden
August 3, 2009 at 11:05 am
How will the United States stimulate its economy this time around?
Tippy Golden
August 3, 2009 at 3:32 am
I always love it when people who are experts in one area allow their egos (and thereby influence political views) to take them into areas of expertise in which they do not belong. I have great admiration for great jurists, as I do for great physicists. I would want neither of them trying to be head chef in my favorite restaurant or provide for my surgery if I were a heart patient. Judge Posner would serve himself and all of us better if he kept his expert opinions restricted to his area of expertise. I fancy myself to be highly qualified to opine in financial products, but would not be useful at all in launching rockets for NASA. Time to put this to rest and us out of his misery.
Bayard
August 3, 2009 at 5:29 am
Bayard is being too polite on this point. Posner hardly ever seems more than to meander through ideological Chicago School cliches when he writes on the subject matter of the day, minute or second. Posner is like one of those experts that Phil Tetlock studies – their ego seems to grow in proportion to their error. I prefer the opinions of cab drivers when it comes to financial and economic policy in contrast with an ideological babble that shouldn’t pass as thought. Bayard hopes that Posner would keep his expert opinions restricted to his expertise, but it seems that Posner is an expert in writing thinly veiled ideological treatises so perhaps we should let him babble on. I know little about his performance on the bench but I find it hard to trust the judgement of such an overall blowhard.
Matt
August 3, 2009 at 6:14 am
The difference is that surgery, cooking, and rocket science are actual skills whose results can have a reality-based measure.
But jurisprudence, finance, and for that matter theoretical physics (sometimes) are arguably all phony exaltations of the same old gutter politics.
We know that’s true of “economics”.
Russ
August 3, 2009 at 6:19 am
Eric, the “get it in writing in plain English” approach is all well and good, but what do you do with, say, credit cards? It’s not that the little guy is too unsophisticated to understand; it’s that the 30 pages of fine print that go along with a credit card are designed to intimidate consumers out of paying attention. Not that anyone who does can read and understand them.
The card issuer has all the power, and it’s in BOTH the issuer’s interest and the would be credit user’s interest to take the line of credit…
Elizabeth Warren does a better job of explaining this than I am doing in a post today at NewDeal2.0.
http://www.newdeal20.org/?p=3626
One other thing she mentions? Lax regulatory culture. Which also can’t be fixed by pushing the burden of transparency, symbolized by “in plain English,” onto consumers.
anne
August 3, 2009 at 12:39 pm
Were everyone to restrict what they talked about – offered an opinion about – to their area of expertise, public discourse and dialogue would be at an end. It would be quite literally, the end of politics. Plumbers would be permitted only to talk about clearing drains, lawyers only about torts, etc. Posner is in my view, an ideologue vis law and economics is the holy grail, but he is a public intellectual – a person who comments about matters of public import. There is too little such public debate and discourse in this country, not too much.
D. Christopher Leonard
August 3, 2009 at 1:04 pm
Far be it from me, a mere mortal, to speculate at what Judge Posner had in mind, but I think it goes something like this:
Here is what he probably understands about Nudge:
1. Thaler says behavioral economics shows that people aren’t very good at making certain important decisions. This is certainly true, and you don’t need to be a behavioral economist to know it.
2. The reason they aren’t very good isn’t just because some of us are of low intellectual ability or education, or are more emotional or irrational. Most of us, even cool-headed geniuses, make bad choices.
3. We make these bad choices in predictable situations and in predictable ways – common cognitive errors, etc…
4. But in these situations, a committee of experts could better determine the “best bet” choices a rational person would make to optimize their own interests, if only they had enough discipline, intelligence, education, and cognitive self-awareness.
5. Without banning “bad” behaviors, or nannying the adult population, we could still “nudge”, “encourage”, and/or “incentivize” people (through “choice architecture” or sin taxes) to make better decisions more likely.
Now there’s many obvious objections to this scheme, and to the book’s credit, many are presented more-or-less fairly at the end of the book.
One of the better objections, in my judgment, concerns premise number 4 from above – and this is what Posner, I think, it trying to get at.
In the book, a whole chapter is devoted to the issue of “investment”. The idea is that “individuals invest poorly” which to me is not a very objectionable thesis. The additional nudge notion, however, is “And we (or, if not “we”, some body of experts) *know* how they *should* be investing, and we should encourage them to do it in this better way”
Now – people are bad at investment, but so, it would seem based on recent experience, are nearly all the big banks, large university endowments, pension institutions, and hedge-funds. And, if you believe Posner’s implied numbers, so is Thaler! (at least according to the whole equities vs. bonds bad advice, a case which Thaler himself does not seem to rebut and which appeared in the book.)
Posner’s “Thaler Problem” is essentially one of hubris – the idea that we really know where to nudge people to, which is an essential requirement of justification for realizing the nudge agenda. If we can’t rely on a genius like Thaler to pick an “appropriate” investment strategy to which we should be nudging people with “opt-out” vs. “opt-in” tactics and similar techniques, then perhaps we should not be trying to nudge people at all in the realm.
The argument, I would figure, is because we should be humble enough to admit that beyond some awareness of truly brainlessly bad strategies, we’re not always sure what a “good” strategy is. This is because all the advice we have is based on past experience, but, like the disclaimers always tell us, “past performance is no guarantee of future results” (that warning itself is related to a common cognitive error – and may be the basis of Posner’s criticism of Thaler).
And in areas where we do not know of, or cannot agree upon, a “best” answer, the result will necessarily depend on who is politically in charge – and enlightened “nudging” becomes little more than cover for the raw application of power – the true purpose of which is not human betterment, but usually to serve the interests of those currently in power.
Indy
August 3, 2009 at 3:53 pm
I did not read the Thaler reply beyond the first paragraph because to open a financial dispute with the colourfully told horrible story of the death of a baby is straight out of the demagogue’s box of disgusting rhetorical tricks.
Silke
August 4, 2009 at 7:37 am