Tuesday, December 23, 2008

Irish Policy and Behavioural Economics

Ideas from behavioural economics have not yet entered in a meaningful way into the Irish economic policy debate. This will change in the next couple of years if for no other reason than the current dominant ideas are hitting substantial limitations. I think grand theories about how behavioural economics might transform the current situation are not helpful but below are some suggestions of where to start looking. I hope people read these with some common sense as they are clearly just areas to examine rather than an alternative economic recovery plan.

1. Innovation policy should seek to incorporate insights from behavioural economics. It is not sufficient to simply provide facilities and funding or build huge blocks of activity in certain areas. Fundamental processes such as risk aversion, loss aversion, procrastination, status seeking, peer effects and related processes are part of the innovation process as are intrinsic incentives. The potential for "motivation crowding out" in government policies that seek to centralise the innovation process needs to be taken much more seriously as does the nature of intrinsic motivation itself. This should inform how policy is set with respect to the communication of incentives, the use of prizes and awards, the degree of control given to researchers at different stages, and the setting of promotion metrics. Innovation policies need to further examine the cultural and educational contexts of innovation to begin to examine testable ways of altering urban design, tax incentives, public awareness and so on. The recent "Smart Economy" document outlines government policy with respect to innovation. Those interested in applying behavioural economics should read this and examine areas of intersection

2. The Irish labour market is in real trouble with respect to a growing group of young men who do not see any outlet for their identity in the new types of jobs being provided. How this could be solved is unclear but simply assuming the wage rate or better search facilities will be sufficient to deal with the complex psychological issues in this area of the labour market is clearly insufficient.

3. Policies directed toward energy efficiency, transport and other areas in which consumer behaviour is central need to look clearly at the ideas from behavioural economics. "Nudge" is not a bad place to start to read about some of this work. Again, people should use common-sense when taking these ideas into account. The British debate has turned from an interesting discussion of how behavioural economics might be applied into a turgid bun-fight about whether this could lead to Thatcherism or extreme socialism depending on who is providing the rant. It really has very little to do with any of that and instead those interested in improving policy should examine discrete points of intersection between policy and behavioural economics

4. Furthermore, financial regulation certainly needs to attempt to take on board psychological aspects of consumer and investor behaviour. The standard behavioural models of investment should only be viewed as theoretical benchmarks. Investment institutions, in particular, need to be examined as complex hierarchical agencies in which psychological processes such as compliance, conformity, unrealistic optimism and so on drive behaviour as much as rational investment appraisals. Similarly, consumers should be viewed as making decisions subject to an array of psychological processes that, under some conditions, lead to behaviour that is sub-optimal by any reasonable definition of the term.

5. Competition and utilities regulation needs to examine how psychological processes, in particular the endowment effect, place constraints on switching behaviour. A recent EU conference (below) addressed this in depth.


6. Policies surrounding savings incentives, pensions, government regulations, taxation and so need to be tested to make sure that surface features such as complexity, awkwardness and so on are not leading to sub-optimal decisions. The Save More Tomorrow paper by Thaler and Benartzi is the most famous example of the use of a behavioural intervention to promote saving and the core idea of this type of policy needs to be examined in the irish context.


7. The well-being literature should be interrogated for usefulness to policy. Should policy makers take this work on board and what might this imply for policies in areas such as urban planning, health care systems development, social insurance and so on? I have blogged at length about research papers in the area that examine the psychological consequences of unemployment, business loss and home foreclosure and this is a rapidly expanding literature. But can it be useful? Richard Layard's book is one place to start and one of his main thrusts was the need to expand the provision of cognitive behavioural therapy and these policies seem now to be actively underway in the UK. It is important that we debate this properly in Ireland.

Happiness by Layard

Happiness for Beginners

8. All of this needs to be examined in the context of the aging and health of the Irish population. One crucial dynamic in Ireland at present is an aging population which will imply higher pension commitments and greater health care burden in terms of chronic illness. Examining how individuals make provisions for their future health and finance is now crucial to thinking about policies to manage a demographic transition. This involves, among many other things, examining the psychology of savings and investment, health risk behaviours, chronic illness management and so on. All of these issues are at the intersection of health, psychology and economics and yet many of the people working in each of these areas are indifferent to the other two. A major improvement in Irish policy could be realised by a stronger collaboration in these areas.

9. If any of the above ideas are to be integrated into policy they should be done so in a structured and scientific way emphasising small-scale trial studies that focus on defined outcomes in ways that can be causally related to specific policy changes.

10. Also, none of the above in any way implies that we should ignore core areas of public policy such as fiscal management, trade legislation, development of transport and energy infrastructures, monetary policy and so on. Nor does it neccesarily imply that the role of government should be increased or decreased.

1 comment:

Liam Delaney said...

Just to save people the hassle of thinking up a witty retort below is a very witty jab at behavioural economics and policy