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Behavioral Economics: The More We Learn, The Less We Seem To Know

-- By MichaelDuignan - 06 Apr 2010

Neoclassical economics has, over a half century, come to exert great influence over legal structures. As a positive system, it lends mathematical precision to legal thinking. As a normative system, it shapes vast areas of law dealing with transaction and choice. Some wonder if its legal influence, however, has reached a zenith. As new tools enable researchers to discover the human brain and its cognitive limitations, some economists now question the assumptions neoclassical economics made concerning human nature. If a social theory is ultimately valued by how well it explains the forces guiding human behavior, this essay considers how such questioning might affect normative principles anchored to the neoclassical model.

The Hand Formula

In the 1947 case of United States v. Carroll Towing Co., J. Learned Hand put forth his eponymous formula for negligence liability. Where the burden of avoiding harm is less than the probability of the harm times the loss associated with the harm (B < P x L), the defendant who chooses not to avoid harm acts without requisite care. In that Hand introduced the idea of cost-benefit analysis as a bright line rule of tort liability, Carroll Towing represents prescient use of rational choice theory to render consistent qualitative judgments in the law. And though the Hand formula was non-binding, it retains analytical significance; it presumes a reasonable person is always capable of making rational decisions before acting.

Rational Choice Theory and the Law

The contemporary debate is fiercest at U. of Chicago, with Richard Posner representing the traditional law and economics movement, and Richard Thaler leading the developing field of behavioral economics (developing, because, as of yet, the field is without a formal theory).

According to Posner, the full range of human psychology can be sufficiently explained within rational choice theory. Fellow Chicagoan Gary S. Becker in his 1976 paper The Economic Approach to Human Behavior said, “[A]ll human behavior can be viewed as involving participants who [1] maximize their utility [2] from a stable set of preferences and [3] accumulate an optimal amount of information and other inputs in a variety of markets." At 14. Though generally accepted, the universality of the rule has invited challenge ever since.

Thaler, along with Cass Sunstein and Christine Jolls in A Behavioral Approach to Law and Economics, counters that certain peculiarities of human nature, though predictable, lie outside the scope of the traditional model. In so many words, the more evidence one can produce showing human decisions do not mirror neoclassical presumptions, the less explanatory power the traditional model retains as applied to the law. At 1474.

Reasonable Persons, In Spite of Ourselves

Dan Ariely, author of Predictably Irrational, delightfully exposed the relativity of choice in a social experiment. A group of 100 college students were given an advert from The Economist magazine and asked to select one of three annual subscription options: print-only for $59, online-only for $125, or print-plus-online for $125. A small portion opted for the first, none for the second, and the overwhelming majority for the third, print-plus-online option. Then, Ariely asked another group of students the same question, only this time he removed the second online-only option that no one wanted. When deciding between print-only for $59 and print-plus-online for $125, the majority of students opted for the cheaper package.

The shift in students’ subscription choice undermines Becker’s assumption that people make decisions from “a stable set of preferences.” Ariely demonstrates that people’s preferences are not always fixed and absolute, but can be dynamic and relational to the environment in which choice is permitted to occur. According to Ariely, the way to get people to choose option A over option B is to add option A', a clearly less desirable alternative to option A, thereby increasing the relative attractiveness of option A.

Choice as a Double-Edged Sword

Under rational choice theory, multiple consumption options increase the likelihood that a given consumer will be able to find a choice suitable to his or her fixed preferences. However, Ariely suggests that benefit may be illusory, because carefully designed choices may actually shape the preferences of the individual. Obviously, this idea bears great significance for generally accepted notions of personal autonomy inherent in constitutional law. Yet, for anyone who's ever entered a supermarket with one item in mind, and left carrying a something else altogether, the potentiality of relative preferences is not totally far fetched.

What if we are simply so overwhelmed by multiple choices that we are blinded to our true preferences? Or what if a range of choices sometimes animates dormant preferences that we could not see otherwise? Either way, the prospects are not good for neoclassical assumptions. Further, the discovery of relative preferences has begun to infiltrate the way new market regulations are proposed. And neoclassical adherents are successfully shouting down such heretical assertions by labeling them old news.

General Implications for Normative Systems

As Thaler et al did not profess to have an answer to rational choice theory, the movement is limited to poking holes in the neoclassical model. Neoclassical economists will likely respond with the tested Whac-A-Mole approach: reinterpret rational choice theory in increasingly clever ways to explain away behavioral economists' findings as they arise.

If continuity is an essential goal of a normative structure, then, ideally, this debate engenders productive results for the law and economic movement, by encouraging it to reconsider and revise its premises, thereby strengthening the structure and the legal principles that depend on it. However, Thurman Arnold in The Folklore of Capitalism posited, "[l]aws and morals and economics are always arrayed against new groups which are struggling to obtain a place in an institutional hierarchy of prestige." At 4. If one adopts this view, the escalating debate around rational choice theory might signal the rumblings of an intradisciplinary holy war through which a new set of economic principles emerges. As an aspiring lawyer, the latter scenario presents both an exciting and disconcerting prospect, in that neoclassical assumptions undergird great real estate beneath contract, criminal and property law. My plan is to stay tuned.

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