Friday, February 23, 2007

Behavioral Economics and Economies of Scale

Via Greg Mankiw, we have this from Jane Galt:
....behavioural economics, which the left seems to believe is a magical proof of the benevolence of government intervention, because after all, people are stupid, so they need the government to protect them from themselves. My take is a little subtler than that:
  1. People are often stupid.
  2. Bureaucrats are the same stupid people, with bad incentives.

I think Jane is wrong, partly anyway. The arguments about bad bureaucratic incentives are as strong as ever, but behavioral economics does provide a significant shift in the overall balance toward the side of government intervention. As raw material, bureaucrats are the same stupid people as the general population, but unlike the general population, they can be trained, at relatively little cost, to be less stupid.

Bureaucrats can be trained to make rational decisions in their particular areas of responsibility. Since only a fraction of the population are bureaucrats, and since the training for each bureaucrat can be limited, this training is feasible, whereas it would be prohibitively expensive to train the general population to make rational decisions in every area of their lives. In actual practice, I believe, most bureaucrats – well, many bureaucrats, anyhow – have been trained to do cost-benefit analyses and to recognize and judge the relevant costs and benefits. The average person standing in a drugstore or a grocery store has not had – and should not be required to have – the education needed to be an FDA administrator.

I see training as a special case of economies of scale that are involved in rational decision making. Even for a highly rational person, it is simply impractical – indeed, irrational – to make every decision rationally, or even to make most decisions rationally. It is costly to counter the brain’s natural irrational tendencies, and there are too many decisions to make; most of them have to be made by the not-so-intelligently designed autopilot. But when one person can make a decision for a large group, it becomes efficient to invest the resources required to produce a rational decision, even if the decision is one that a rational individual would not decide to decide rationally for herself.

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Blogger Gabriel Mihalache said...

Well, and who trains those that are supposed to train the bureaucrats? :-) Turtles all the way down, Knzn.

Also, do you think that bureaucrats want to be taught? Don't they have their own agenda?

"Behavioral" features come on top of the Public Choice stuff, so it DOES make things worse. Not only are their incentives incompatible with the stated aim of their job, but now they fail even at being self-interested, with even worse consequences (We all know the model where public goods are provided optimally, as a side-effect of the political incentive structure. Kiss those results goodbye).

Plus, cost-benefit analysis is beyond dubious. I USD for me weights equally with 1 USD for you? That's just bad policy, put it anyway you want it.

It's great to see you're back!

Fri Feb 23, 03:02:00 PM EST  
Anonymous Anonymous said...

I'm also glad to see you back.

Having worked in Washington and for a major multinational corporation I see little difference between public and private bureaucrats.

Fri Feb 23, 04:53:00 PM EST  
Anonymous ldqb said...

I like your take on the education of bureaucrats knzn. After all, they are usually trained by economists, and they do learn cost-benefit analysis (at least in good bureaucrat schools). It is true that cost-benefit analysis suffers from many deficiencies, as most measurement techniques do. It's a tough job all around to measure aggregate pleasure and surely a good teacher of bureaucrats would drive that point across.
CBA weights can be chosen by the analyst - for example, Stern suggests that the cost of global warming should be absorbed more heavily by developed countries because of their historical advantage (I like that expression, it sounds so much more civilized than imperialism).

Fri Feb 23, 09:25:00 PM EST  
Blogger Gabriel Mihalache said...

There is one difference... private bureaucrats get fired. Lifetime employment is very rare in their case, for one reason or another, but the norm for state bureaucrats.

Much flab in the private sector goes away at the next cost-cutting exercise, or the one after that.

ldqb, the problem with C.B.A. is not one of measurement. It's conceptual and moral-political. The idea that government should aim to please me is, frankly, disturbing and loaded with huge dangers. Prescott managed to score some shots at GNH here. People are perfectly able to please themselves and each other :-)

Besides, market efficiency doesn't require the efficiency of each and every participant, but rather enough (professional) traders doing arbitrage and so on.

As for education... let's not assume that it MUST be the state doing the teaching. Each individual has an incentive to "get rational" so if the thesis here is correct, regarding irrationality and the benefits of rationality, then we'd expect people to educate themselves. Which some/many do. Although the ideas and theories they pick up might not be to my or your taste.

Sat Feb 24, 02:23:00 AM EST  
Blogger knzn said...

Gabriel: “Each individual has an incentive to "get rational" so if the thesis here is correct, regarding irrationality and the benefits of rationality, then we'd expect people to educate themselves.” My whole point is that this isn’t so much the case. Each individual has an incentive to get a little bit rational, but getting rational is costly and often not worth the cost. Bureaucracy enables us to distribute the benefits of rationality, thus reducing the cost per beneficiary. To the extent that people can coordinate collective action, they have a stronger incentive to educate bureaucrats than to educate themselves.

Regarding your first comment, I don’t see how the fact that bureaucrats fail at being self-interested means that the consequences are worse, unless you assume a system that is designed to work only when bureaucrats are rational. You might make an argument about voters being irrational and therefore giving bureaucrats the wrong incentives, but to the extent that voters know what they’re doing, why can’t they just design the system so as to elicit the right behavior from bureaucrats who behave in predictably irrational ways? And why would you expect voters to be better at dealing with rational bureaucrats that with irrational bureaucrats? (I’d think it would be easier to trick irrational bureaucrats into doing what voters want. Scam artists take advantage of irrationality, so why can’t voters do the same?)

Even if the behavioral stuff does make things a little worse for bureaucratic behavior, it makes things a lot worse for individual behavior, so it still strengthens the argument for intervention.

As for who does the teaching, I don’t think it matters, unless there is a political dispute over what constitutes rational behavior. People can be trained to behave rationally with respect to particular decisions, and it’s not necessary that the trainers, or the trainers’ trainers, be rational in their own lives, only that they understand what rationality means.

Sat Feb 24, 08:36:00 AM EST  
Anonymous Alex said...

"As raw material, bureaucrats are the same stupid people as the general population, but unlike the general population, they can be trained, at relatively little cost, to be less stupid."

A very valid point.

Sat Feb 24, 01:12:00 PM EST  
Blogger taylorfedrates said...

GM- I spend an inordinate amount of time teaching cost/benefit in Prescott's adopted Arizona state government to bureaucrats. Why? Because our turnover rate is 20%!!! Umm, median tenure is less than seven years- lifetime is quite rare!

Umm, so nobody sticks around and we have to educate newbies on basic cost/benefit so they can change regulations- now does that make me a bit of pita to the new upper manglement that has the latest brainfart to implement and screw up what is working/barely working?

In response to anon- I do disagree- after all if a private bcrat screws up- it is just one corps money- if the public bcrat pulls a boner- its your money!
How much wealth has Iraq cost us?

BTW- I can't remember the last time I had a post grad trained person in policy come through my little assembly line.

Risk management hides downstairs and never asks my opinion on anything- wise bunch.

Rationality is often chucked out at the *political level*- so how can you expect bcrats to change what they have to do- the laws made be made by asses, but they must be implemented- or you can find yourself on the street....

Sun Feb 25, 06:42:00 PM EST  
Blogger Gabriel Mihalache said...

Let me try something else...

Voters don't control politicians. Interest groups (small groups, almost by definition) and party structures control politicians.

Rationality is about achieving your objectives. The objective of a politician is to provide as much private goods to interest groups as possible, given that there's a trade-off between these and public goods in the regular sense.

With smarter "government watchers", the balance tips towards public stuff. With smarter politicians, it tips towards interest group benefits.

Mon Feb 26, 03:14:00 PM EST  
Anonymous Anonymous said...

A key difference between government bureaucrats and the private sector, and a source of advantage as well as disadvantage, is that the profit motive is damped down or almost eliminated for bureaucrats (barring widespread corruption, anyway). Jane Galt is saying that this means bureaucrats have "bad incentives", full stop and period. But in a world of semi-rational decisionmakers and very limited information, there will obviously be cases where it is socially useful to turn down the profit signal in some areas.

Mon Mar 12, 01:28:00 PM EDT  
Blogger Pratik Dattani said...

I agree with Gabriel Mihalache on interest groups. I did some research last year trying to incorporate behavioural economics with public policy, which ocnfirmed this. I was looking at the english Winter Fuel Allowance, which is a payment (£200/£300) paid to pensioners as a lump sum in Winter to help them with their winter fuel bills. Gordon Brown's stated motivation was, Britain has one of the highest instances of winter-related deaths in Europe, and pensioners (poor as they are), are the most susceptible of all groups to temperature variabilities.

But, the fact remained, this was a lump sum paid just in time for Christmas, with no restrictions of how it could be spent. It cost approx 10% of its value to implement, through marketing and advertising costs (marketing costs were high because not everyone claimed this handout). Politically, it was a great success.

However, I found pensioners weren't stupid - they spent the cash as they would any other income, that was not labelled a Winter Fuel payment. That meant disproportionately on presents, christmas trees, alcohol and grandchildren.

£200 is a small enough figure for the rest of the population not to take notice. Pensioners however were very pleased because it was paid as a lump sum. My recommendation was, save the admin, and pay £220 into the Basic State Pension...that however, sums to £4-ish a week. Pensioners would barely notice it week-to-week.

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Sat Aug 14, 05:11:00 AM EDT  
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