aTypical Joe: a gay New Yorker living in the rural South

Monday, April 07, 2008

A Dose of Libertarian Paternalism

Shankar Vedantam has a column in the WaPo today looking at Cass Sunstein and Richard Thaler’s important work:

In their new book, “Nudge,” [link] the authors suggest that policymakers should artfully guide people to make better decisions by designing the way choices are presented to them. The work has drawn the attention of the presidential campaign of Sen. Barack Obama (D-Ill.), and Thaler said that he and Sunstein have become informal advisers to the campaign. Several ideas related to mortgage-policy reform and the credit markets have been “adopted and adapted” by Obama, Thaler added.

Sunstein, a law professor, and Thaler, an economist, have long been students of psychology. They call themselves libertarian paternalists—because they agree with the libertarian insight that people benefit from having choices. But Thaler and Sunstein also argue that people regularly make systematically irrational choices. (Many academics divide their money equally between stocks and bonds.)

“We agree with people who want to allow the market to flourish, so we are libertarians in that sense,” Sunstein said. “On the other hand, we don’t believe you can just have markets and then declare victory. It is legitimate to be paternalistic in terms of steering people in directions that will increase the likelihood they will do well.” [...]

Setting up default choices is one of the recurring themes of “Nudge,” because a lot of research shows that people are powerfully influenced by default options. When new employees are told that retirement accounts will be started for them unless they object, for example, most sign up cheerfully. When told that the accounts will not be started unless they opt in, most employees do not sign up because not having the account is then the default choice.

It is not surprising that Thaler and Sunstein’s approach would appeal to Obama’s post-partisan views: On the meltdown in subprime mortgages, Thaler and Sunstein criticize the liberals who call for the end of such mortgages as well as the conservatives who reject any form of regulation. The problem, they argue, is not that the mortgage industry came up with a tool to offer money to people with poor credit, but that the industry got away with being deliberately opaque.

Most home buyers, including MBA students at a top school, as one study found, have trouble comparing loan offers and discerning broker fees—money that goes to middlemen—from interest, money that investors need to take on the risk of lending their cash. Consumers who get the best mortgages invariably pay the least in fees.

If all mortgage lenders were required by law to disclose the terms of their loans electronically, Thaler predicted that Web sites would immediately emerge to translate those offers into plain English so people could compare loans: “You apply for a mortgage, and you get an e-mail with a file that has all the features of your mortgage. You upload it into Mortgage-Helper.com, and it will tell you what that mortgage really means. It will say, ‘Here are your payments this year, and here is what happens next year, and here is what happens if interest rates went up, and are you aware there is a prepayment penalty of $7,000, and, by the way, here are three other loans that have the following features.’ . . . This is the way to make markets efficient.”

Here’s Sunstein and Thaler’s principal paper, Libertarian Paternalism Is Not an Oxymoron (a brief 45 pages).