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There is an embarrassing blind spot in the behavioral law and economics literature with respect to implementation of policy whether via legislation or administrative agency.  James Cooper and William Kovacic — both currently at the Federal Trade Commission as Attorney Advisor Commissioner, respectively — aim to fill this gap with a recent working paper entitled “Behavioral Economics: Implications for Regulatory Behavior.”  The basic idea is to combine the insights of public choice economics and behavioral economics to explore the implications for behavioral regulation at administrative agencies and, in particular given their experiences, a competition and consumer protection regulator.

Here is the abstract:

Behavioral economics (BE) examines the implications for decision-making when actors suffer from biases documented in the psychological literature. These scholars replace the assumption of rationality with one of “bounded rationality,” in which consumers’ actions are affected by their initial endowments, their tastes for fairness, their inability to appreciate the future costs, their lack of self-control, and general use of flawed heuristics. We posit a simple model of a competition regulator who serves as an agent to a political overseer. The regulator chooses a policy that accounts for the rewards she gets from the political overseer – whose optimal policy is one that focuses on short-run outputs that garner political support, rather than on long-term effective policy solutions – and the weight she puts on the optimal long run policy. We use this model to explore the effects of bounded rationality on policymaking, with an emphasis on competition and consumer protection policy. We find that flawed heuristics (e.g., availability, representativeness, optimism, and hindsight) and present bias are likely to lead regulators to adopt policies closer to those preferred by political overseers than they otherwise would. We argue that unlike the case of firms, which face competition, the incentive structure for regulators is likely to reward regulators who adopt politically expedient policies, either intentionally (due to a desire to please the political overseer) or accidentally (due to bounded rationality). This sample selection process is likely to lead to a cadre of regulators who focus on maximizing outputs rather than outcomes.

Here is a little snippet from the conclusion, but please go do read the whole thing:

The model we present shows that political pressure will cause rational regulators to choose policies that are not optimal from a consumer standpoint, and that in a large number of circumstances regulatory bias will exacerbate this tendency. Our analysis also suggests special caution when attempting to correct firm behavior as regulatory bias appears likely more durable than firm bias because the market provides a much stronger feedback mechanism than exists in the regulatory environment. To the extent that we can de-bias regulators – either through a greater use of internal and external adversarial review or by making a closer nexus between outcomes and rewards – they will become more effective at welfare-enhancing interventions designed to correct biases.

Thinking about the implications of behavioral economics at the regulatory level is incredibly important for competition and consumer protection policy (think CFPB, for example).  And I’m very happy to see scholars of Cooper and Kovacic’s caliber — not to mention real world agency experience to bring to bear on the problem — tackling it.   For full disclosure purposes, I should note that I have or am currently co-authoring with each of them.  But don’t hold that against them!  Its a thought provoking paper upon which I will have some more thoughts later on, as well as tying it in to some of the work I’ve done on behavioral economics.  For example, Judd Stone and I explore a related problem of the implications of firm level irrationality — both for incumbents and entrants — in this piece, and find the implications for antitrust policy less clear (and in some cases, absent) than have behavioral antitrust proponents.  See also Stone’s post during the TOTM Free to Choose Symposium on BE and Administrative Agencies.

Filed under: antitrust, behavioral economics, consumer financial protection bureau, consumer protection, federal trade commission

In the Huffington Post, Marcus Baram warns against those who claim to be concerned about over-regulation on Wall Street and in the consumer protection sphere.  Baram writes:

Today, Wall Street is again on the attack against a regulatory overhaul that includes more stringent investor and consumer protections. Though the financial landscape is far different and the details of the proposals have changed since 1912, the industry is using much of the same alarmist rhetoric to oppose new regulations and rules.

JPMorgan chairman Jamie Dimon recently complained that proposed rules on derivatives, capital buffers and too-big-to-fail banks are bad for America. Wall Street could lose customers to European banks, he said.

Baram includes economist, and my co-author, David S. Evans in his list of those “crying wolf” over over-regulation:

At a congressional hearing on the Consumer Financial Protection Bureau, banking consultant David S. Evans attacked the “hard paternalism” of its interim director Elizabeth Warren. He cautioned that the bureau “could make it harder and more expensive for consumers to borrow money.”

Such Cassandra-like warnings are common in the history of financial regulation.

I think Baram might want to have this one back if given the chance.  His point is that the Dimon and David Evans and others are concerned about imposing an enormous regulatory burden are wrong.  Of course, I am no scholar of Greek mythology, but I seem to recall that Cassandra was right!  Her curse was that nobody believed her accurate predictions about the future.  Baram may have stumbled upon something here.

But more seriously, at a time when the unemployment rate is over 9%, when the intellectual architects of the CFPB were quite frank about favoring a regulatory approach that would restrict access to consumer credit (see here), and when the flow of credit is critical to economic growth and recovery, one has to be pretty deeply committed to the cause to so brazenly ignore predictions that massive regulatory structure just might hold the economy back.

Evans’ testimony at the House Hearing on the CFPB is available here.

Filed under: consumer financial protection bureau, consumer protection, economics, regulation

Daniel Kahnemann and co-authors discuss, in the most recent issue of the Harvard Business Review (HT: Brian McCann), various strategies for debiasing individual decisions that impact firm performance.  Much of the advice boils down to more conscious deliberation about decisions, incorporating awareness that individuals can be biased into firm-level decisions, and subjecting decisions to more rigorous cost-benefit analysis.  The authors discuss a handful of examples with executives contemplating this or that decision (a pricing change, a large capital outlay, and a major acquisition) and walk through how thinking harder about recognizing biases of individuals responsible for these decisions or recommendations might be identified and nipped in the bud before a costly error occurs.

Luckily for our HBS heroes they are able to catch these potential decision-making errors in time and correct them:

But in the end, Bob, Lisa, and Devesh all did, and averted serious problems as a result. Bob resisted the temptation to implement the price cut his team was clamoring for at the risk of destroying profitability and triggering a price war. Instead, he challenged the team to propose an alternative, and eventually successful, marketing plan. Lisa refused to approve an investment that, as she discovered, aimed to justify and prop up earlier sunk-cost investments in the same business. Her team later proposed an investment in a new technology that would leapfrog the competition. Finally, Devesh signed off on the deal his team was proposing, but not before additional due diligence had uncovered issues that led to a significant reduction in the acquisition price.

The real challenge for executives who want to implement decision quality control is not time or cost. It is the need to build awareness that even highly experienced, superbly competent, and well intentioned managers are fallible. Organizations need to realize that a disciplined decision-making process, not individual genius, is the key to a sound strategy. And they will have to create a culture of open debate in which such processes can flourish.

But what if they didn’t?  Of course, the result would be a costly mistake.  The sanction from the marketplace would provide a significant incentive for firms to act “as-if” rational over time.  As Judd Stone and I have written (forthcoming in the Cardozo Law Review), the firm itself can be expected to play a critical role in this debiasing:

Economic theory provides another reason for skepticism concerning predictable firm irrationality. As Armen Alchian, Ronald Coase, Harold Demsetz, Benjamin Klein, and Oliver Williamson (amongst others) have reiterated for decades, the firm is not merely a heterogeneous hodgepodge of individuals, but an institution constructed to lower transaction costs relative to making use of the price system (the make or buy decision). Firms thereby facilitate specialization, production, and exchange. Firms must react to the full panoply of economic forces and pressures, responding through innovation and competition. To the extent that cognitive biases operate to deprive individuals of the ability to choose rationally, the firm and the market provide effective mechanisms to at least mitigate these biases when they reduce profits.

A critical battleground for behaviorally-based regulatory intervention, including antitrust but not limited to it, is the question of whether agencies and courts on the one hand, or firms on the other, are the least cost avoiders of social costs associated with cognitive bias.  Stone & Wright argue in the antitrust context — contrary to the claims of Commissioner Rosch and other proponents of the behavioral approach — that the claim that individuals are behaviorally biased, and that because firms are made up of individuals, they too must be biased, simply does not provide intellectual support for behavioral regulation.  The most obvious failure is that it lacks the comparative institutional perspective described above.  Most accounts favoring greater implementation of behavioral regulation at the agency level glide over this question.  Not all, of course.

For example, Commissioner Rosch has offered the following response to the “regulators are irrational-too” critique:

My problem with this criticism is that it ignores the fact that, unlike human beings who make decisions in a vacuum, government regulators have the ability to study over time how individuals behave in certain settings (i.e., whether certain default rules provide adequate disclosure to help them make the most informed decision). Thus, if and to the extent that government regulators are mindful of the human failings discussed above, and their rules are preceded by rigorous and objective tests, it is arguable that they are less likely to get things wrong than one would predict. Of course, it may be the case that the concern with behavioral economics is less that regulators are imperfect and more than they are subject to political biases and that behavioral economics is simply liberalism masquerading as economic thinking.24 My response to that is that political capture is everywhere in Washington and that to the extent behavioral economics supports “hands on” regulation it is no more political than neoclassical economics which generally supports “hands off” regulation. On a more serious note, perhaps the best way behavioral economics could counter this critique over the long run would be to identify ways in which the insights from behavioral economics suggest regulation that one would not expect from a “left-wing” legal theory.

For my money, I find this reply altogether unconvincing.  It amounts to the claim that government agencies can be expected to have a comparative advantage over firms in ameliorating the social costs of errors.  The fact that government regulators might “get things wrong” less often than one might predict is besides the point.  The question is, again, comparing the two relevant institutions: firms in the marketplace and government agencies.  “We’re the government and we’re here to help” isn’t much of an answer to the appropriate question here.  There are further problems with this answer.  As I’ve written in response to the Commissioner’s claims:

But seriously, human beings making decisions “in a vacuum?”  It is individuals and firms who are making decisions insulated from market forces that create profit-motive and other incentives to learn about irrationality and get decisions right — not regulators?   The response to the argument that behavioral economics is simply liberalism masquerading as economic thinking (by the way, the argument is not that, it is that antitrust policy based on behavioral economics has not yet proven to be any more than simply interventionism masquerading as economic thinking — but I quibble) is weak.

As calls for behavioral regulation become more common, administrative agencies are built upon its teachings, or even more aggressive claims that behavioral law and economics can claim intellectual victory over rational choice approaches, it is critical to keep the right question in mind so that we do not fall victim to the Nirvana Fallacy.  The right comparative institutional question is whether courts and agencies or the market is better suited to mitigate the social costs of errors.   The external discipline imposed by the market in mitigating decision-making errors is well documented in the economic literature.  The claim that such discipline can replicated, or exceeded, in agencies is an assertion that remains, thus far, in search of empirical support.

Filed under: antitrust, behavioral economics, behavioral economics, consumer financial protection bureau, consumer protection, doj, economics, federal trade commission

The new Consumer Financial Protection Agency seems designed to be accountable to no one…

Read the full piece here.

The GAO has recently issued a report on medical devices.  The thrust of the report is that “high-risk” medical devices do not receive enough scrutiny from the FDA and that recalls are not handled well.  This report and other evidence indicates that the FDA is likely to require more testing of devices.  As of now, most medical devices are approved on a fast track that requires significantly less testing than that required for new drugs.  (As I have discussed in a forthcoming Cato Journal article, medical devices are also subject to more immunity from state produce liability lawsuits.)

The GAO report is remarkable.  The GAO defines its mission as

“Our Mission is to support the Congress in meeting its constitutional responsibilities and to help improve the performance and ensure the accountability of the federal government for the benefit of the American people. We provide Congress with timely information that is objective, fact-based, nonpartisan, nonideological, fair, and balanced.”

But the report on medical devices is entirely unbalanced.  It deals only with procedures for approval and the recall process (both of which are judged inadequate.)  There is no discussion of either costs or benefits.   That is, no evidence is presented that there is any actual harm from the “flawed” approval and recall processes.  Even more importantly, there is no evidence presented about the benefits to consumers from easy and rapid approval of medical devices.

As is well known, virtually all economists who have studied the FDA drug approval process have concluded that it causes serious harm by delaying drugs.  The import of the GAO Report is that we should duplicate that harm with medical devices.  This is an odd and perverse way of providing a “benefit” to the American people.

Filed under: consumer protection, cost-benefit analysis, regulation, torts Tagged: FDA, Medical Devices

Recently the Wall Street Journal had an article about medical billing errors.  These can be very costly because they can impact your credit rating.  But there is one billing practice they missed.  Some health care providers (we have found this with two and it is probably more common) begin the billing date as of the date of service but don’t send a bill until insurance has paid their part.  Then when they do send a bill for the coinsurance  it is “late” and they threaten to turn it over to a collection agency.  In other words, the very FIRST bill you may get already has your account as delinquent.

Filed under: consumer protection, personal finance

First I would like to thank Geoff Manne for inviting me to join this blog.  I know most of my fellow bloggers and it is a group I am proud to be associated with.

For my first few posts I am going to write about privacy.  This is a hot topic.  Senators McCain and Kerry are floating a privacy bill, and the FTC is also looking at privacy. I have written a lot about privacy (mostly with Tom Lenard of the Technology Policy Institute, where I am a senior fellow).

The issue of the day is “tracking.”  There are several proposals for “do not track” legislation and polls show that consumers do not want to be tracked.

The entire fear of being tracked is based on an illusion.  It is a deep illusion, and difficult or impossible to eliminate, but still an illusion.   People are uncomfortable with the idea that someone knows what they are doing.  (It is “creepy.”)  But in fact no person knows what you are doing, even if you are being tracked. Only a machine knows.

As humans, we have difficulty understanding that something can be “known” but nonetheless not known by anyone.   We do not understand that we can be “tracked” but that no one is tracking us.  That is, data on our searches may exist on a server somewhere so that the server “knows” it, but no human knows it.  We don’t intuitively grasp this concept because it it entirely alien to our evolved intelligence.

In my most recent paper (with Michael Hammock, coming out in Competition Policy International) we cite two books by Clifford Nass ( C. Nass & C. Yen, The Man Who Lied to His Laptop: What Machines Teach Us About Human Relationships (2010), and B. Reeves & C. Nass, The Media Equation: How People Treat Computers, Television, and New Media Like Real People and Places (1996, 2002).)  Nass and his coauthors show that people automatically treat intelligent machines like other people.  For example, if asked to fill out a questionnaire about the quality of a computer, they rate the machine higher if they are filling out the form on the computer being rated than if it on another computer — they don’t want to hurt the computer’s feelings.  Privacy is like that — people can’t adapt to the notion that a machine knows something. They assume (probably unconsciously) that if somethingis known then a person knows it, and this is why they do not like being tracked.

One final point about tracking.  Even if you are tracked, the purpose is to find out what you want and sell it to you.  Selling people things they want is the essence of the market economy, and if tracking does a better job of this, then it is helping the market function better, and also helping consumers get products that are a better fit.  Why should this make anyone mad?

Filed under: advertising, consumer protection, privacy, regulation, truth on the market Tagged: “do not track”, privacy, tracking

I have submitted a comment to the Federal Reserve Board concerning Regulation II, along with the American Enterprise Institute’s Alex Brill, Christopher DeMuth, Alex J. Pollock, and Peter Wallison, as well as my George Mason colleague Todd Zywicki.  Regulation II implements the interchange fee provisions of the Dodd-Frank Act.

The comment makes a rather straightforward and simple point:

We write to express our concern that the Federal Reserve Board has not to date taken the prudent and, importantly, legally required step of conducting a competitive impact analysis of Regulation II, which implements the interchange fee provisions of section 1075 of the Dodd-Frank Act (Pub L. 111-203). We consider this to be one of the most significant legal changes to the payment system’s competitive landscape since the Electronic Funds Transfer Act in 1978. This dramatic statutory and subsequent regulatory change will undoubtedly trigger a complex set of consequences for all firms participating in the payment system as well as for consumers purchasing both retail goods and financial services. The Federal Reserve’s obligation to conduct a competitive impact analysis of Regulation II is an appropriate and prudent safeguard against legal change with potentially pernicious consequences for the economy and consumers. Given the Board’s own well-crafted standards, we do not believe it is appropriate for the Board to move forward in implementing Regulation II without the required competitive impact analysis.

The rest of the comment appears below the fold.

The Board’s bulletin setting forth its role in the payments system lays out the policy that the Fed is supposed to follow “when considering … a legal change … if that change would have a direct and material adverse effect on the ability of other service providers to compete effectively with the Federal Reserve in providing similar services due to differing legal powers or constraints or due to a dominant marketing position deriving from such legal differences.” The bulletin explicitly promises that “[a]ll operational or legal changes having a substantial effect on payments system participants will be subject to a
competitive-impact analysis even if the competitive effects are not apparent on the face of the proposal.”

There is little doubt that Regulation II qualifies for the required competitive impact analysis by this standard as it will likely have a “substantial effect on payment system participants.” Further, several aspects of the proposal impose “differing constraints” on different institutions. The proposal, for example, exempts Fed-sponsored payment systems such as the A C H system from the scope of the regulation while sweeping in alternate payment providers, even though such provider systems are functionally indistinguishable in relevant respect.

The bulletin goes on to provide details of the required competitive impact analysis. For example, the Board must “first determine whether the proposal has a direct and material adverse effect on the ability of other service providers to compete effectively with the Federal Reserve in providing similar services.” If so, the Board must then “ascertain whether the adverse effect is due to legal differences or due to a dominant market position deriving from such legal differences.” If legal differences or a dominant market position deriving from those legal differences are detected, the analysis must then turn to assessing the benefits of the proposed legal change and determining whether those benefits could be “reasonably achieved with a lesser or no adverse competitive impact.” Indeed, the bulletin indicates that “the Board would then either modify the proposal to lessen or eliminate the adverse impact on competitors’ ability to compete or determine that the payments system objectives may not be reasonably achieved if the proposal were modified.” As the bulletin anticipates, such a detailed and careful analysis is fully appropriate to better understand the competitive impact of a significant legal change in the payment system before it is implemented.

As Federal Reserve Board Governor Sarah Bloom Raskin observed in recent Congressional testimony, “Commenters also have differing perspectives on the potential effect of the statute and the proposed rule on consumers,” and “the magnitude of the ultimate effect is not clear and will depend on the behavior of various participants in the debit card networks.”

We agree with Governor Raskin’s observations and conclude that an economic impact analysis of the competitive effects of Regulation II, while a complex endeavor, is a critical one to protect competition in the payment system and consumers. We urge the Board to conduct an impact analysis of Regulation II and to make this analysis available for public comment before implementation of Regulation II.

Interesting readers can search for other comments here.

 

Filed under: banking, consumer financial protection bureau, consumer protection, credit cards, economics, regulation

One of the most fundamental issues in the ongoing debate concerning the costs and benefits of expanded FTC Section 5 enforcement is the extent to which one must be concerned with its collateral consequences.  A central claim of proponents of a broad interpretation of Section 5 coupled with its aggressive enforcement is that concerns with false positives are misplaced because plaintiffs do not have a private right of action, and thus collateral consequences associated with follow-on litigation will be muted.

Read the full piece here.