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Intro to behavioural law & economics


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This are the slides for an introductory lecture on behavioural law and economics I gave as part of the economic analysis of law unit at the University of Bristol Law School in March 2017.

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Intro to behavioural law & economics

  1. 1. Law and economics 2.0 Dr Albert Sanchez-Graells University of Bristol Law School 6 March 2017
  2. 2. Agenda • This lecture provides an introduction to the critique of traditional economic analysis of law that has resulted from developments in behavioural economics – ie ‘law and economics 2.0’ • The main focus will be on the behavioural challenge to the rationality assumption (homo economicus) and the impact it has on the theorisation of law from an economic perspective
  3. 3. Short recap of the homo economicus The neoclassical economic analysis of law with which we have engaged most of the time is based on rational choice theory This implies: • Rationality, perfect information & risk neutrality* • Individuals are rational maximisers of their utility (within their constraints)
  4. 4. Short recap of the homo economicus • Becker offers a typical account of those principles: “[A]ll human behavior can be viewed as involving participants who [1] maximize their utility [2] from a stable set of preferences and [3] accumulate an optimal amount of information and other inputs in a variety of markets.” [The Economic Approach to Human Behavior (1976) 14] • Thaler & Mullainathan spell out the implications “The standard economic model of human behavior includes three unrealistic traits— unbounded rationality, unbounded willpower, and unbounded selfishness” [“Behavioral Economics” in The Concise Encyclopeida of Economics, 2nd edn (2008)]
  5. 5. How do we (think that we) think? • There is growing popularity and acceptance of Kahneman’s dual process theory: (1) intuitive & automatic thinking (2) reflective & rational thinking [Thinking Fast and Slow (2011)] • Rational choice theory / homo economicus is easier to reconcile with system 2, but fundamen- tally incompatible w/ system 1
  6. 6. Behavioural challenges to homo economicus • Economists had been doubting the assumptions underlying rational choice theory for a long time [notably, Thaler’s Quasi Rational Economics (1991)] • Jolls, Sunstein & Thaler (1998) provided a strong criticism of the theory of rational choice and its application to law and economics on the basis that individuals are affected by • Bounded rationality • Bounded willpower (or self-control) • Bounded self-interest
  7. 7. Bounded rationality • “Bounded rationality … refers to the obvious fact that human cognitive abilities are not infinite. We have limited computational skills and seriously flawed memories” • “The departures from the standard model can be divided into two categories: judgment and decision-making. Actual judgments show systematic departures from models of unbiased forecasts, and actual decisions often violate the axioms of expected utility theory.” (Jolls, Sunstein & Thaler, [1477]).
  8. 8. Bounded willpower • “… human beings often take actions that they know to be in conflict with their own long-term interests.” • “… the demand for and supply of law may reflect people’s understanding of their own (or others’) bounded willpower” (Jolls, Sunstein & Thaler, [1479]).
  9. 9. Bounded self-interest • “the term bounded self-interest [is used] to refer to an important fact about the utility function of most people: They care, or act as if they care, about others, even strangers, in some circumstances. (Thus, we are not questioning here the idea of utility maximization, but rather the common assumptions about what that entails.)” • “… the agents in a behavioral economic model are both nicer and (when they are not treated fairly) more spiteful than the agents postulated by neoclassical theory.” (Jolls, Sunstein & Thaler, [1479]).
  10. 10. Core behavioural law & economics (2.0) • Popularised by Thaler & Sunstein (2008) [choice architecture; libertarian paternalism] • Biases and blunders • Rules of thumb: anchoring, availability & representativeness • Optimism & overconfidence • Loss aversion • Status quo bias • Framing • Mindless choosing & self-control • Herd behaviour • Conformity, spotlight effect, social contagion
  11. 11. Is that all? Psychologists and sociologists could surely expand the list of ways in which individuals (sometimes/regularly/ always?) deviate from rational thinking Where to stop?
  12. 12. Core behavioural law & economics (2.0) • Currently, there is a consolidation of the issues around bounded rationality, willpower and self-control that behavioural law & economics covers [eg Englerth, in Towfigh & Petersen (2015)] • Bounded rationality • Judgment: (a) Heuristics (availability, representativeness); (b) Hindsight bias; (c) Excessive optimism and overconfidence bias (wishful thinking, self-serving bias) • Decisions: (a) anchoring; (b) extremeness aversion; (c) prospect theory (endowment effects, loss aversion and status quo bias); (d) framing • Bounded willpower or self-control • Reversal of preferences over time; ‘present bias’ (or hyperbolic discounting) • Bounded self-interest • Social preferences (norms of fairness, principle of mutuality)
  13. 13. Behavioural analysis on the rise • Now probably more than ever, in particular regarding • Financial crisis (2008) [Taleb, The Black Swan: The Impact of the Highly Improbable (2008)] • Political developments (2016) • Brexit • Trump’s election • ‘Fake news’ [Kolbert, ‘Why Facts Don’t Change Our Minds’, New Yorker, 27 Feb 2017]
  14. 14. Not only an academic issue • Created in 2010 • Policy work aimed at introducing behavioural approaches to policy- making • Applying Behavioural Insights: Simple Ways to Improve Health Outcomes (2016) • Better choices: better deals (2011)
  15. 15. So what is law & econ 2.0 trying to do? • As Thaler (2015) has put it “We don’t have to stop inventing abstract models that describe the behaviour of imaginary Econs. We do, however, have to stop assuming that those models are accurate descriptions of behavior, and stop basing policy decisions on such flawed analyses. And we have to start paying attention to those supposedly irrelevant factors” [that determine the behaviour of Humans even if they would not alter the behaviour of Econs]
  16. 16. What does this all mean for (neoclassic) economic analysis of law?
  17. 17. Some counter-criticisms to law & econ 2.0 • Demsetz has provided a counter-criticism to the behavioural challenge: “The model of human behavior used in economics is a tool applied to gain an understanding of how the decentralization puzzle is resolved, and, like any tool, it is specialized to its primary task. It emphasizes some aspects of human behavior while repressing others” [“Where Economic Man Dwells”, in From Economic Man to Economic System (2011), first ideas from 1996] • Posner similarly stressed that “… in theory-making, descriptive accuracy is purchased at a price, the price being loss of predictive power” (“Rational Choice, Behavioural Economics and the Law” (1998) 50 Stanford Law Review 1551, 1559)
  18. 18. Some counter-criticisms law & econ 2.0 • Posner provided a comment/reply to Jolls, Sunstein & Thaler (1998) • Characterises rational choice as dependent on hyperrationality and dismisses previous efforts to enrich rational choice theory as ad hoc • Behavioural economics is antitheoretical • On bounded rationality: instrumental thinking is not irrational and preferences may be irrational, but acts on those preferences not • On bounded willpower (or weakness of will): hyperbolic discounting can be explained in terms of information costs; ‘multiple selves’ approach (*) • On bounded self-interest: altruism as interdependent utilities • Paper is rather a contribution to the psychological analysis of law than to the economic analysis of law • Discusses evolutionary biology as part of the economic endeavour (*)
  19. 19. Some counter-criticisms law & econ 2.0 • Posner continues to stress that “Rational maximisation should not be confused with conscious calculation … Behaviour is rational when it conforms to the model of rational choice, whatever the state of mind of the chooser … Nor is rationality omniscience. Information is costly, and often the costs are prohibitive, especially when the information one would like to have concerns the future. Rational choice theory accepts that people’s ability to process information is limited—there are costs not only of obtaining information but also of absorbing and using it” [Economic Analysis of Law, 9th edn (2014)] • Does this allow for a reconciliation with the Coase theorem?
  20. 20. Overview of sticky disagreements • Thaler has provided a succinct account of the counter-criticisms and sticky points of disagreement between neoclassic and behavioural economists • As if (marginal theory) • Incentives (ie high-stakes) • Learning (ie repeated games) • Markets (invisible hand)
  21. 21. Additional issues surrounding nudging • As defined by Thaler & Sunstein (2008: 6), a nudge is “… any aspect of the choice architecture that alters people’s behaviour in a predictable way without forbidding any options or significantly changing their economic incentives”. • The normative aspect of behavioural law & economics as enshrined by Thaler & Sunstein (libertarian paternalism) has raised a number of issues that bring the discussion closer to jurisprudence (liberty) • Concerning potential manipulation of choice and the lack of neutrality of choice architecture: transparent and non-transparent nudges [see eg Hansen & Jespersen (2013)]; definitional issues [see eg Hansen (2016)] • Concerning the need for a more sociological approach to these issues (homo oeconomicus culturalis) [eg Frerichs (2011)]