Practical Difficulties of Eliminating Externalities

As Alison Butler does not fail to address in her article, eliminating externalities can be extremely complicated.  Assigning property rights seems logical in simple examples, as we hope that principles of the market will create an equilibrium between private and social costs.  In practice (using the chemical plant upstream from a town example), however, it seems like it would be very difficult to A. quantify environmental damage with a dollar amount (how much should the firm pay the town), and B. gauge the opinion of a community regarding the optimal level of pollution (what level of pollution should the town pay the firm to reach).  As Butler notes, this all becomes increasingly confusing as these problems become international, as the natures of different nations inherently predispose them to accepting different environmental practices and policies, making the formation of international agreements on these issues much more difficult to obtain.  

News: IPE and the Environment

A couple of relevant topics in the news recently as we will be discussing the environment this week:

Last week, the U.S. and China released a "joint announcement" on climate change, with both sides setting long term targets to lower emissions and utilize alternative fuels.

Climate change was also a subject of interest at this weekend's G20 summit in Australia, where additional countries joined in on committing to combating climate change.

Hopefully these types of proclamations from the world's leading economies will encourage more actors in the public and private sectors to follow suit. 

Nudge: Improving Decisions About Health, Wealth, and Happiness

            Nudge: Improving Decisions About Health, Wealth, and Happiness, by Richard Thaler and Cass Sunstein, is about how people make decisions.  Thaler and Sunstein realize that, despite the depiction of homo economicus in economics textbooks, where humans are assumed to always act rationally and make decisions unfailingly well, the idea of the economic man carries little weight, and that human beings often make poor choices.  Poor decision-making can be the result of a several variables, such as bias, “inertia” (otherwise known as laziness), or, most importantly, the circumstances under which decisions are made.  The authors emphasize that the way that choices are presented can have a major impact on the decisions people make.  Inevitably, this means that those in charge of designing the choice structure, known in the book as “choice architects,” can have significant influence over people’s decisions.  One particularly illustrative example of a choice architect is that of someone who designs the way food is arranged in a cafeteria.  If the designer knows that different food arrangements will lead people to consume different foods, then the designer has the ability to alter consumption choices based on cafeteria design.  Thaler and Sunstein propose that if all choices will be influenced by choice architects then better choice architecture can be used to help people make better decisions.  They explain that by adhering to the idea of “libertarian paternalism,” a type of intervention that maintains individual liberties, choice architects can subtly “nudge” people to make certain choices while maintaining the liberty and individuality of the chooser.

            When are nudges appropriate?  Despite criticizing humans' ability to make decisions, Thaler and Sunstein do not believe that humans need help making every decision that they face.  According to the authors, nudges should be reserved for difficult decisions that are infrequent, situations in which people may not have adequate experience or information to make the best choices.  An example of this would be selecting a mortgage, a situation in which people often lack a detailed understanding of the results of their choices.  The authors also endorse nudges when choices and their consequences are separated in time (choosing a time to wake up vs. actually getting out of bed) or when choosers are forced to make choices to which they get little feedback or guidance (understanding fees associated with a cell phone bill).  Under any of these unique sets of circumstances, people could likely use assistance from choice architects.

            In order to preserve the libertarianism proposed by libertarian paternalism, nudges made by choice architects must not force choosers to relinquish their right to choose.  Choosers should also face low opt-out costs, which will allow them to choose autonomously with little difficulty.  Instead, changes in choice architecture are simply meant to make it easier for people to make good choices.  By understanding human tendencies and behavior, choice architects can influence peoples' behavior without having to directly impose outcomes on individuals.  Thaler and Sunstein explain a variety of tools that could be used as nudges, such as improving default options, providing choosers more information and feedback, and reducing barriers to action.  While all of these nudges can have extremely beneficial impacts on peoples' lives, choosers are never forced or compelled to make certain decisions.  Choosers, however, maintain the right to ignore these nudges and continue to choose poorly, thus preserving libertarianism.

            All of this talk about libertarian paternalism sounds simple, as public or private institutions only need to use their insider information and wisdom to help people make good decisions.  But what constitutes a “good” decision?  Thaler and Sunstein ask this question in their introduction to show that there are a variety of ways to interpret this question.  Think about another example from the book: In 2000, Sweden privatized its Social Security system. The government allowed individuals to create their own retirement portfolios, but also provided a default option for people who were either too busy, too lazy, or too absent minded to select their own.  How does a government go about creating a “good” retirement portfolio for the default option, in order to create a choice architecture model that will be beneficial for people that do not create their own?  Should the idea of a “good” portfolio be the one that will provide the best returns?  Or would “good” be a portfolio that most closely resembles the portfolio people would have chosen independently?  Or should there be no default portfolio at all, forcing people to make choices or not have any sort of retirement plan?  You can see that this all becomes very complicated, and that while choice architecture can be very influential, coming up with the definition of a “good” choice can be controversial. 

            Another issue, raised by Thaler and Sunstein in the closing chapter of their book, is the slippery slope posed by these interventionist (yet libertarian) policies.  If choice architects have the capacity to make people’s lives better, why don’t the choice architects turn nudges in to mandates, or “shoves?”  In other words, why even leave people with the ability to make bad choices?  The concept of libertarian paternalism opens the door for “hard” paternalists to stretch these theories to their limits.  While the authors believe that people of all parts of the political spectrum should be able to see the wisdom of libertarian paternalism, strong anti-interventionists and other’s wary of loss of liberty may resent these policies (see the link in my last blog post).  A related problem is that there is not necessarily anyone overseeing choice architects, which could pose a problem if the choice architect was inherently "bad."  If choice architects lose sight of the libertarian aspect of nudges, an escalation in the scale of paternalism could lead to a slippery slope.

            The ideas of libertarian paternalism and social economics are relatively new phenomena.  While the government and other institutions have started to embrace some of these policies (Sunstein has served as an advisor to President Obama), it is quite likely that we will see additional research in these fields have a continued impact on our lives.  A detailed understanding of social economics can help us better understand why people make poor choices (like how financial crises happen) and how interventions can help correct these problems. 

           

Early Thoughts on Nudge

http://mediamatters.org/video/2010/09/22/beck-cass-sunstein-is-the-most-dangerous-man-in/171019

I've posted a link to a video from 2010 in which Glenn Beck presents his (extremely unbiased) opinion on Cass Sunstein, the author of my book, Nudge.  In the video, Beck calls Sunstein "the most dangerous man in America." As talk show hosts seem to "conveniently" gloss over many of the details, here are a few to remember in order to understand how Sunstein would respond:

1. Nudges, according to the principle of Libertarian Paternalism, are suppose to create choice architecture that provides low-cost opt-out rights in order to ensure that people maintain their freedom to choose.  In other words, the right to choose not to be influenced by Nudges must always be maintained. 

2. Nudges are best for influencing decisions that are difficult and rare, where people may be lacking the adequate experience or information to make the best choices.  While Sunstein does acknowledge the Homer Simpson qualities of humans, he believes that people are very capable of making easy decisions that they have experience making, such as choosing which groceries to buy, while they may struggle with difficult decisions, such as selecting retirement plans or mortgages.

More to come on Wednesday.