Intro to behavioural law & economics

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Law and economics 2.0Dr Albert Sanchez-GraellsUniversity of Bristol Law School6 March 2017

AgendaThis 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 2.0The 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

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)

Short recap of the homo economicusBecker 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 traitsunbounded rationality, unbounded willpower, and unbounded selfishness [Behavioral Economics in The Concise Encyclopeida of Economics, 2nd edn (2008)]

How do we (think that we) think?There is growing popularity and acceptance of Kahnemans 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

Behavioural challenges to homo economicusEconomists had been doubting the assumptions underlying rational choice theory for a long time [notably, Thalers 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 byBounded rationalityBounded willpower (or self-control)Bounded self-interest

Bounded rationalityBounded rationality refers to the obvious fact that human cognitive abilities are not infinite. We have limited computational skills and seriously flawed memoriesThe 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]).

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 peoples understanding of their own (or others) bounded willpower(Jolls, Sunstein & Thaler, [1479]).

Bounded self-interestthe 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]).

Core behavioural law & economics (2.0)Popularised by Thaler & Sunstein (2008)[choice architecture; libertarian paternalism]Biases and blundersRules of thumb: anchoring, availability & representativenessOptimism & overconfidenceLoss aversionStatus quo biasFramingMindless choosing & self-controlHerd behaviour Conformity, spotlight effect, social contagion

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?

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 rationalityJudgment: (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) framingBounded willpower or self-controlReversal of preferences over time; present bias (or hyperbolic discounting) Bounded self-interestSocial preferences (norms of fairness, principle of mutuality)

Behavioural analysis on the riseNow probably more than ever, in particular regardingFinancial crisis (2008)[Taleb, The Black Swan: The Impact of the Highly Improbable (2008)]Political developments (2016)BrexitTrumps electionFake news[Kolbert, Why Facts Dont Change Our Minds, New Yorker, 27 Feb 2017]

Not only an academic issueCreated in 2010Policy work aimed at introducing behavioural approaches to policy-makingApplying Behavioural Insights: Simple Ways to Improve Health Outcomes (2016)Better choices: better deals (2011)

So what is law & econ 2.0 trying to do? As Thaler (2015) has put itWe dont 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]

What does this all mean for (neoclassic) economic analysis of law?

Some counter-criticisms to law & econ 2.0Demsetz 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)

Some counter-criticisms law & econ 2.0Posner 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 hocBehavioural economics is antitheoreticalOn bounded rationality: instrumental thinking is not irrational and preferences may be irrational, but acts on those preferences notOn 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 utilitiesPaper is rather a contribution to the psychological analysis of law than to the economic analysis of lawDiscusses evolutionary biology as part of the economic endeavour (*)

Some counter-criticisms law & econ 2.0Posner 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 peoples ability to process information is limitedthere 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?

Overview of sticky disagreementsThaler has provided a succinct account of the counter-criticisms and sticky points of disagreement between neoclassic and behavioural economistsAs if (marginal theory)Incentives (ie high-stakes)Learning (ie repeated games)Markets (invisible hand)

Additional issues surrounding nudgingAs defined by Thaler & Sunstein (2008: 6), a nudge is any aspect of the choice architecture that alters peoples 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)]