Statism and Cognitive Biases

February 20th, 2012

Interesting stuff from Mike Rappaport:

Second, there is also the issue of what is seen and not seen, as articulated by Bastiat.  If the regulation produces certain benefits, but causes harm by preventing certain beneficial actions, the benefits will be seen but the harms may not be.  People will naturally focus on what is seen rather than unseen.  Perhaps this could be understood in terms of an availability bias.  Finally, one might see the self serving bias at work in terms of agency regulations.  Agencies would tend to view positive aspects of the regulated market as the result of their regulations, while viewing negative aspects as having other causes.

In the end, this would appear to be an area ripe for investigation.  Yet, economics and psychology appear to be in the grip of a statist bias that leads them to focus on market actors rather than government actors.  What is needed is another Buchanan and Tullock to set the world straight.

Here Miked discusses Kahneman, and notes that no one applies his work to government (I will!):

Unsurprisingly, the statist bias continues to afflict economics.  The most recent example is behavioral economics.  Economists in recent decades have started to apply the insights of Kahneman, Tversky, and others, who argue that economic actors often do not behave rationally – especially in the way that rational choice theory assumes.  And such economists have argued that the resulting market failures often just government action.  But predictably these behavioral economists typically did not apply their insights to government.  They rarely acknowledge that legislators are unlikely to act rationally and that even so called expert administrative agencies are unlikely to act rationally because of many of the same cognitive biases that behavioral economics emphasizes.  The bias of statism is at work once again.

This article on behavior economics and the SEC looks pretty interesting too:

Investors face myriad investment alternatives and seemingly limitless information concerning those alternatives. Not surprisingly, many commentators contend that investors frequently fall short of the ideal investor posited by the rational actor model. Investors are plagued with a variety of behavioral biases (such as, among others, the hindsight bias, the availability bias, loss aversion, and overconfidence). Even securities market institutions and intermediaries may suffer from biases, led astray by groupthink and overconfidence.

The question remains whether regulators should focus on such biases in formulating policy. An omnipotent regulatory decisionmaker would certainly improve on flawed investor decisionmaking. The alternative we face, however, is a behaviorally-flawed regulator, the Securities and Exchange Commission (SEC). Several behavioral biases may plague SEC regulators including overconfidence, the confirmation bias, framing effects, and groupthink. While structural solutions are possible to reduce biases within the agency, we argue that such solutions are only partially effective in correcting these biases.

Instead of attempting to determine when the behavioral biases of regulators outweigh those within the market, we take a different tactic. Because behaviorally flawed (and possibly self-interested) regulators themselves will decide whether market-based biases outweigh regulatory biases, we propose a framework for assessing such regulatory intervention. Our framework varies along two dimensions. The more monopolistic the regulator (such as the SEC), the greater is the presumption against intervention to correct for biases in the market. Monopolistic regulatory agencies provide a fertile environment for behavioral biases to flourish. Second, the more regulations supplant market decisionmaking, the greater is the presumption against such regulations. Market supplanting regulations are particularly prone to entrenchment, making reversal difficult once such regulations have become part of the status quo.