Behavioural Economics in Public Choice

I have been writing on the different schools of economic thought through the ages. One interesting take-away from the last half-century is how much economists’ attention has been drawn away from mechanical, macroeconomic explanations and towards how people actually make their economic decisions. There is, for example, a revival of the Austrian School, which stresses the subjective nature of values and economic choices; the Public Choice School, which looks at how collective decisions are made, and the consequences of that for economics; and Behavioural Economics, which attempts to bring human psychology into the study of personal choices.

At the heart of the Public Choice School approach is the idea that every stage of the democratic decision process — from elections, through the legislature, to the bureaucracy that implements the laws and the judiciary that interprets them — is riddled with self-interest, leading to decisions that are irrational and often factional. And for its part, Behavioural Economics hinges around the idea that natural biases in the way human beings see and respond to events also creates some shocking irrationalities.

Behavioural Economics has applied this psychological approach largely to the ways that individuals make choices. But I wondered what might be revealed if we took it into the making of collective decisions. Is there more than mere self-interest at work? Is the democratic process not riddled with other psychological biases too.

To start with, one of the strongest natural biases identified by Behavioural Economic is risk aversion. It is why bad news sells newspapers; we are much more alert to and concerned about bad things than good ones, partly because bad things can be fatal to us. But this shows up in the public choice environment too. I saw an example of this in the Thatcher era, when a UK-wide private hospital company decided to bid to build and run a new NHS hospital. Department of Health bureaucrats were so keen to cover their own backs that the tender documents with all their provisos formed a metre-high stack, requiring the company’s response to be even higher. And how did the bureaucrats respond to this bid to run NHS provision in a completely new way? After two months of silence, the first question they asked was what kind of cutlery would be used in the staff canteen. 

Can’t be too careful, they say. But yes, that was too careful, and indeed the political system abounds in being too careful. We pass laws and regulations that attempt to keep people completely safe from harm. It is irrational, because the extra cost of guaranteeing that extra featherbedding is huge; and overprescriptive regulations thwart people from trying new ways of doing things that might just prove more productive, and even safer.

As we make our way through the other cognitive biases identified by Behavioural Economics, we see the democratic — i.e. political — system falling for every one of them. Bounded rationality, for example: rather than consider very possible implication of every possible option, we tend to follow ‘rules of thumb’. And if those work reasonably well, we tend to stick with them (what these economists call ‘satisficing’) even though other rules of thumb might actually work better. In Public Choice terms, Bryan Caplan showed the bounded rationality of electors: they tend to favour government solutions, for instance, over market solutions. As do politicians, of course. And for their part, bureaucrats, especially regulators, tend to assume the superiority of regulation over competition.

How decisions are presented. the choice architecture, also affects personal choices. That is the whole theory behind ‘nudge’ — tell people the downsides of smoking, for instance, and they will probably do less of it. But it works in political decision-making too. Should we have more free trade, which could deliver better choice and lower costs? Well, international competition might also create job losses too, and you can be sure that the media focus will be on the unemployment (risk aversion). No wonder that electors and politicians opt for protectionist policies.

Confirmation bias is another human quirk, where we see and judge things in terms of our own beliefs, rather than against any objective standard. Politicians are particularly prone to this error. Rent controls, for example, make it less worthwhile for property owners to rent out rooms and homes; so they evict their tenants and quit the market. That leads to calls for more tenant security. And if owners can’t evict people anyone but can’t make any money out of them because of the rent controls, they just let their properties fall into disrepair. Which is taken to be proof of how greedy ‘landlords’ are and leads to yet further controls… and so on, until the whole rented sector dries up. Rationally, we should scrap the controls and let the market allocate things. But rationalism is little use in politics.

Politics abounds with another bias, the sunk costs fallacy. The high speed rail link (HS2) between London and Birmingham is costing hundreds of billions of pounds for very little difference in journey time, but so much construction has been done that politicians are embarrassed to pull the plug on the project. The same happened with Edinburgh’s (three times over budget and five years late) new tram system and Scotland’s (also three times over budget and five years late) replacement ferries.

Politicians also make decisions on the basis of salience. What is playing in the media today — prison escapes, dangerous dogs, school truancy — is likely to shape policy far more (and more urgently) than longer term issues — like disincentives in the tax and welfare systems — that might be far more significant in their effects.

The Behavioural Economics bias list goes on. Optimism bias — plenty of evidence for that in public procurement, and projects like the postwar replacement of ‘slums’ with ‘modern’ blocks that people hated even more. Or mental accounting — sticking with 1001 budgets for separate projects, rather than re-thinking spending as a whole (as Canada did in the 1990s). Or the endowment effect of over-valuing what we already have (like ‘our’ ‘precious’ NHS). I have decided to explore all this psychology of public choice in more detail. If we know exactly what foibles are producing such daft public policy, after all, we might be able to do something about it.