When “Nudge” Goes Bad

Posted by Jeff Carter
on March 3rd, 2013

Richard Thaler and Cass Sunstein wrote a book called Nudge. It’s based on the economic research behavioral economists have done over the past ten years. Thaler is a leader in this part of economic theory.

One of the premises of behavioral theory is that market participants are not rational.

In isolated incidents, and anecdotally, everyone sees irrational people. It’s an appealing theory. Stock market participants see what they would call irrational behavior all the time. But this behavior has been difficult to quantify.

When I first read and was exposed to Behavioral Economics at the University of Chicago, it was extremely interesting to me. As I delved deeper into it, the theories seemed less like economics and more like the things I learned in Consumer Behavior from Marketing theory.

That doesn’t mean there isn’t a lot of merit in what Thaler is studying. There is. However, in the wrong hands it can be extremely dangerous.

Economic theory isn’t ever looked at as “middle of the road”. Economists always test their theories out in the extreme. It puts a lot of stress on the theory and allows economists to make inferences back to the middle.

For example, examining perfect competition in a rational marketplace allows economists to make projections about marketplaces that don’t have perfect competition. Hey, it’s complicated and why they offer graduate studies in this stuff.

Cass Sunstein takes Behavioral Economics to that extreme. He is actively instilling it into the regulatory canon of the Obama administration. The way Behavioral Economics is being used meshes well with the hard left wing theories of a well run government.

The left wing wants more government participation in your life. You may have heard, “The Nanny State”. The left takes that theory to the extreme and wants to plan every little piece of your life from cradle to grave.

That’s why the left wing wants nationalized mandatory pre-K education for everyone. It’s why an idea like Obamacare is appealing. That’s why taking control of retirement planning for everyone is a great idea to the left. Behavioral economic theory turns government into the shepherd and its constituents into sheep.

For classical economists, it’s a shockingly bad idea that goes against all the precepts of basic economics.

Thomas Sowell does a great job explaining why in this article.

When an individual makes a poor choice, it usually only affects that person or the people immediately adjacent to that person. When a government does it, the consequences can be devastating.

In a market economy, there is enough diversity and buffer built in to cushion a lot of bad decision making. Market economies can adjust and come back quickly from adverse decisions. Centrally planned ones can’t.

Sowell lists some of the extreme government decisions that have been made using theories of Behavioral Economics.

Think about the First World War, from which nations on both sides ended up worse off than before, after an unprecedented carnage that killed substantial fractions of whole younger generations and left millions starving amid the rubble of war.

Think about the Holocaust, and about other government slaughters of even more millions of innocent men, women and children under Communist governments in the Soviet Union and China.

Even in the United States, government policies in the 1930s led to crops being plowed under, thousands of little pigs being slaughtered and buried, and milk being poured down sewers, at a time when many Americans were suffering from hunger and diseases caused by malnutrition.

The Great Depression of the 1930s, in which millions of people were plunged into poverty in even the most prosperous nations, was needlessly prolonged by government policies now recognized in retrospect as foolish and irresponsible.

There are plenty of other examples of centrally planned policies that are more subtle-but still cause massive strife. Education policies and energy policies have doomed millions of children to poor educations and artificially increased the cost of energy to power our economy.

Sowell is right when he says the intellectual elite want to dictate to the rest of us how we should behave and act. They want to control access, limit us, or give everyone free stuff depending on what it is.

I am reminded of the time I was at a party with a journalism professor from Northwestern University. He was a liberal. As we were leaving he said, “It’s been nice to meet you this evening. I appreciated your perspective. Wouldn’t it be better if only people like us could vote?”

That says it all.

Follow me on Twitter, like Points and Figures on Facebook.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.