Traditional Chicago Economics Under Pressure: Beyond The Thaler-Posner Debate

Richard Posner is against the proposed new Consumer Financial Protection Agency (CFPA).  This is, of course, not a surprise.  Posner has always been an articulate advocate of the view most often associated with economics at the University of Chicago: market-based outcomes are invariably better than the alternatives, and anything that interferes with consumer choice is a bad idea.

Posner wraps this opposition to the CFPA into an odd attack (near the end of his WSJ op ed) on the personal decision-making abilities of Richard Thaler – a leading economist on consumer choice, misperceptions, and mistakes. (More on Thaler here.)

Thaler, also of the University of Chicago, hit back hard yesterday.  He is right that Posner mischaracterizes the CFPA proposal, and points out that his agenda – and that of Cass Sunstein, formerly of Chicago and now a czar in the adminstration – is simply to provide consumers with a framework for better decisions.  He implies that Posner defends defective baby cribs and their equivalent.

I would go further.

Think of it this way.  We’ve learned a great deal about how consumers make decisions, including when they get things right and wrong.  Behavioral economics, marketing, and related social science have made big strides (e.g., follow the work of Dan Ariely).

But all of this research is also available to companies.  Perhaps they knew some of this before from trial-and-error, but there is no question that many of the techniques corporate America uses – and we as consumers find ourselves “up against” – is cutting edge manipulation of our decisions.

We worry a great deal about how corporations lobby to shape their regulatory environment.  This is a struggle that is at least 150 years old in its modern form (e.g., railroad concessions), and much older if we think about powerful people bribing their way into advantageous relationships with the state.

In addition, companies now have powerful new tools to shape how we perceive our potential choices.  Some of these tools might be good for us also – I’m open to argument on this.  But within some particular spaces, including financial products, it’s clear that many of these “innovations” are actually clever ways to extract value from consumers.

Traditional Chicago economics always had its weaknesses – particularly when you focus on the fact that the “rules of the game” are often shaped by the more powerful.  Thaler and Sunstein (and others) are trying to modernize this view more generally, while keeping the element of consumer choice as central.

But if the balance of power has shifted – due to technological innovation in social science – further towards corporations and away from consumers, then the task ahead is much harder.

Unless companies are compelled to keep their offerings “simple enough to understand”, we will face repeated rip-offs and crises – both macroeconomic and personal – arising from our financial sector.

Originally published at The Baseline Scenario and reproduced here with the author’s permission.

2 Responses to "Traditional Chicago Economics Under Pressure: Beyond The Thaler-Posner Debate"

  1. Walt French   August 1, 2009 at 1:26 pm

    “Unless companies are compelled to keep their offerings “simple enough to understand”, we will face repeated rip-offs and crises – both macroeconomic and personal – arising from our financial sector.”

    It seems the whole notions of anti-trust and regulation have suffered badly of late, and not the least because writers of excellent intelligence have adopted the language of the street instead of academe.Let’s put these notions into the framework of serious economic research. What is going on here? Is it oligopolistic power? … asymmetric information leading to incomplete markets?And (only) then, on to policy! Can these faults be remedied through market innovations? What is the least intrusive way of fixing them?

  2. Anonymous ibid.   August 3, 2009 at 11:03 pm

    Simon has identified a key point that Walt highlighted. One has to work in product design to understand how the system of confusing consumers works. For example, why do drugs have two different names (Remicade/infliximab)? Why are there so many models of TVs? These are deliberate means to confuse consumers.Now, in fairness to companies, some of the profusion of models has to do with the product development cycle. Because companies are rushing products to market, there are small batches with minor updates. Versions with minor updates get new serial numbers. Those new serial numbers are critical for repair, since they define the train of parts that supports the item. Those versions are critical for defining recalls and lesser responses to batch failures. But nowadays, how many things get repaired? And why don’t they let the customer in on what all those model numbers mean?I bought a TV today. I think I got a pretty good deal, though I’d be very curious to know why the company put that particular model on sale. As long as there is total asymmetry of information, consumers will get screwed. But how to fix it? Even with wonderful screening tools, such as online shopping services and Consumer Reports, it was very difficult to reach a reasoned choice.