Saturday, May 9, 2009

A Nudge State, Nanny State or No State?

The public service has often been portrayed as either ineffectual or overbearing. It either produces nothing of value or worse it extracts from the dynamism of markets. With the advent of a new theory of the state, could things be about to change?

It was
David Brooks who proclaimed the rise of the “Behavioral Revolution” back in October 2008. He was speaking of the way regulatory frameworks are now taking account of imperfect rationality in much the same way that they took account of imperfect competition and imperfect information as part of the natural progression of relaxing assumptions about "efficient markets". The purpose of such regulatory reform is to protect consumers from schemes that exploit their lack of rationality or self-control.

The structure of any decision-making process is neatly depicted
here. Imperfect rationality means that faulty perceptions lead to false risk assessments lead to poor decisions by rational actors. These perceptual biases as described by Kahneman and Tversky provide the rationale for "nudges" or even "shoves" by the state to guide the most vulnerable in society to make good decisions without imposing harm on the rest.

The term coined by
Colin Camerer for this philosophy was asymmetric paternalism or libertarian paternalism as adapted by Thaler and Sunstein. Cognitive psychology and neuroscience is helping to confirm the dominance of human emotions in swamping reason under certain conditions. Consider a decision you have made in the past involving any one of the following:
  • Credit and savings
  • Houses and cars
  • Education
  • Careers
  • Marriage
  • Addictions
  • Child bearing
  • Health
Any one of these decisions involves a certain amount of emotional content. The infrequency of these decisions makes it improbable that individuals benefit from personal learning. And they have long lasting even intergenerational consequences. Social learning from family and friends as well as public education campaigns may help. But to the degree that people are subject to confirmation or self-serving bias (where we seek out information that confirms our position), forgetfullness, and a high correlation across groups, we witness their decisions having a cumulative or even contagion-like effect on financial markets, public health, industrial competitiveness and so on.

For those of us who provide analysis and advice in the public service or as part of political staff (whom we in the public service jokingly call the "dark side"), this means rethinking the way we design policies in the coming years.
The dichotomy is no longer between letting free markets work or imposing big goverment interventions. It means that the profession of public policy so often derided for not producing enough value or distorting its creation now has a way of enhancing value for the benefit of both markets and society.

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