surprises from our recent economic history
Reflecting back on our recent economic history bring to my mind a two sad surprises.
Even as a behavioral economist who generally believes in the prevalence of irrationality in our every day life, I place some stock in the main mechanism that should have maintained the efficiency of the financial markets: competition. In principle, the drive for competition among individuals, banks, and financial institutions should get the actors in the market to do the right thing for their clients as they fight to outdo their competition. After the Wall Street fiasco, I expected and hoped that in the spirit of competition some financial institutions would change their way given the new information about the risks they were talking and self-impose restrictions on themselves. I did not expect that they would do so because they were benevolent, but because they wanted to get the business of those who have lost trust in the financial institutions.
Surprise one: Sadly, the forces of competition do not seem to have any effect on the functioning of our financial institutions and Wall Street seems to be back to is pre-fiasco structure.
We are now discussing the possibility of health care reform, which arguably is even more messed up than our financial institutions (about 18 percent of GDP, bad incentives, bad intuitions, and the leading cause for bankruptcy before the current housing problem). When I look at the health care debate, it seems to be fueled by ideological beliefs about the importance of competition and freedom of choice on one hand, and the evilness of regulations and limits on the other. As someone who loves data beyond theories, it is surprising to me how little we know about the effectiveness of different versions of health care, and how sure people are in their own beliefs — which makes it an ideological and not a very useful debate (this is just a small surprise).
But what is the most surprising to me is that the tremendously expensive lessons we have experienced about the efficiency of markets and self interest do not seem to carry to the health care debate. As a society, we still seem to be enamored with the ideology of free markets, and have not seemed to update our beliefs in their efficiency despite the evidence. On the bright side, it looks like behavioral economists will have a lot of work for the foreseeable future.
The Upside of Irrationality, explores some positive and some negative ways that irrationality plays out in our lives.
Two comments.
First, most financial institutions, like most publicly held companies, have two sets of stakeholders: customers of their products and their stockholders. I read that many of the institutions that were deeply involved in the mess that has cost so many so much are doing quite well themselves, from a revenue standpoint. If they are not making changes, it is because they hold the welfare of one set of stakeholders’ very high, and the other… not so much.
On the health care side, market forces don’t come into play any where near as much as most industries. I see a few reasons for this. First, nobody chooses to get sick, and so the idea of customer choice goes out the window from the get-go. Even supposing we had a choice of several providers, the idea of saying, “My genetic predisposition is towards heart disease and diabetes, and therefore provider B is the best choice,” feels ridiculous, though it would be sensible. Also, most of us (who have coverage) get our insurance through our employers, so our choice is made for us. I know very few people who have left one job for another specifically to get different health benefits. Any? Yes. I’ve known folks who have done that. But just to move from one huge insurer to another? Nope.
When you’re forced to do things — either by the circumstances of health or through the activities of a more powerful force — you tend to cover it with a veneer of magical thinking. At least I do. I don’t understand why I get ill, I don’t know anything about how I might be treated, I have no choice in insurer… so I take those feelings/thoughts that I have about the universe and really stand behind them.
It’s my health. It’s important. Life and death, eh? So I should have strong opinions.
I just can’t seem to base them on anything that’s meaningful or distinct to me.
I have two questions. First, could you explain why you felt the drive for competition should get actors in the market to do the right thing for their clients? It strikes me that arbitraging risk and “ratings shopping” would have forced financial institutions and rating agencies to act against their clients long-term interests to remain competitive against those focusing on short-term profits.
Second, why do you feel that the financial crisis and the health care debate are equivalent? If you are indeed right and competition doesn’t have any effect on functioning of financial institutions, it seems that the cause would be unresolved principle-agent problems, asymmetric information, and moral hazard on the part of the financial managers. The problem in the health insurance market would include asymmetric information, but be complicated by the fact that many health care goods are Credence goods and by an adverse selection with respect to those wishing to purchase health insurance.
Thanks.
I think that it’s not that the health care debate and the financial problems are equivalent in terms of how the systems function, what is similar is that both are political/social issues which are being handled with basically complete disdain for basic rationality or statistical rigor; and are instead viewed with blind certainty resulting from preconceived positions (freedom of choice on one hand, evil regulation on the other). Neither of these positions nor debating between them is likely to create an improved functioning system.
Of course, that will not prevent both sides from creating incredibly complex models which will then be used to justify their position – both to themselves and others. But this, too, is nothing new. It’ll be an amazing day when people realize that in general we make up our minds THEN look for supporting evidence, unless we apply effort to at least try and be objective. On the healthcare debate I don’t see much effort being applied to any kind of rational analysis.
Actually, we know quit a lot about the effectiveness of various systems to finance health care — simply look at how it is done around the world. The journalist T.R. Reid has gone on a global quest to gather data, which he presents in his new book “The Healing of America: A Global Quest for Better, Cheaper and Fairer Health Care.” Reid presents the broad outlines in a lecture he recently gave at the Commonwealth Club.
I agree. I lived in The Netherlands for four years and couldn’t really tell you any significant difference in the qualty of health care – I’ve had good medical results here and there. The cost and administration experience is a different matter – I have FAR more problems here after going to a doctor or hospital than I ever had in Holland.
You’re right, there’s lots of information and evidence that we could use to make the whole debate a very reasonable one. The problems is, we don’t. Instead, most people are entrenched in their pre-conceived ideas and select the evidence accordingly. You won’t believe the comments I get from people when I relate my personal experiences, which are admittedly too small a sample to base a decision on.
I completely agree that the health care debate it too mired in “beliefs” and void of data. The data is out there, because we CAN look at the models in other countries, as well as at the plan currently in place in Massachusetts, where everyone is required to purchase health insurance, and where a state-subsidized plan exists for those who can’t purchase through an employer or a private plan. We KNOW how those systems work. There IS data about the pro’s and con’s.
If the designers of the reform were willing to acknowledge the known issues, perhaps they would take a bit of extra time to design a plan that avoids the issues that are evident in Massachusetts and elsewhere, while retaining the benefits. If the opposition were willing to acknowledge the benefits, they could assist in designing that plan.
But everyone in Washington, on both sides of the isle, seems to prefer ideological debates over hard-core analysis and problem solving. Its faster and easier. As many sales people will tell you, despite the analysis we tell ourselves we do, the decision to buy (and vote) is based on emotion.
By the way, a good summary of the Massachusetts plan is at http://www.theweek.com/article/index/99709/The_Massachusetts_model
By the way, a good summary of the Massachusetts plan and its benefits and shortcomings is at http://www.theweek.com/article/index/99709/The_Massachusetts_model
Dan, could you provide some details re. what exactly you mean by “change their way” and “pre-fiasco structure”.
There is just too much room for interpretation in your words. But I assume that you have very specific points in mind.
With respect to health care reform, it seems to me that you have a natural avenue for participation, by experience and by training. For example, once you proved that there is a patient benefit in removing bandages slowly, did you show your research to the hospital where you stayed? If you did, did the hospital accept your research and change there protocols? Did you forward this research to medical governing bodies?
I have an interest in applied ethics and it seems to me that there is a natural bridge between behavioral finance and applied ethics. Any thoughts?
Keep up the great work,
Paul Nelson
круть…инетересно было прочесть
On the health care debate, I wonder if calling it health care coverage would help. The term health ‘insurance’ is the term that seems to allow companies to not cover pre-existing conditions. Please don’t squish me I’m an old man.
Having recently changed to a low premium, high deductible policy with the belief that I would take on some responsibility for medical decisions within a free market, I was struck by the reality.
In the past month, I needed an operation, with a choice between open or a laparoscopic procedure. I was told that open was cheaper, but when I tried to get the actual price, neither the hospital nor the insurance company could tell be the charged or the allowable cost. Even though most of the cost would fall on me, I was the only one who was not allowed to know the price.
Free markets assume consumers have access to information. In a system where the most basic, transactional information is a secret, we have no domestic foundation to even support ideological perspectives, never mind analysis driven by objective data. We have a long way to go on this one.
It’s a very rational point to correlate the the health care debate and the recent financial institutions free market procedures however wouldn’t it also be fair to incorporate the government’s involvement in welfare, transit, postal, and education?
According the the latest report I could find (http://cnsnews.com/news/article/54400), Welfare has soared under the current administration. In 2010, the USA will spend more on welfare than we did on the ENTIRE Iraq war under Bush. This breaks down to the average household paying $638 per month for welfare vs $100 per month for the war.
Education has also veered towards private for-profit institutions. According the the National Center for Education Statistics June 2009 report The Condition of Education 2009, from 1996–97 to 2006–07 school years, Private for-profit institutions increased conferment of associate’s degrees by 108.1%, bachelor’s degrees by 485.1% and master’s degrees by 898%. A shift was also evident in the share of master’s degrees awarded by institution type. For 1996-1997 school year public not-for-profit institutions awarded 56% of all master’s degrees and private for-profit awarded only 1%. By 2006–07 school year, public institutions awarded 48 percent of all master’s degrees and private for-profit institutions awarded 8 percent.
On February 17, 2009, President Obama signed into law The America Recovery and Reinvestment Act of 2009. Included in the Act was an allocation of approximately $30.8 billion for College Affordability programs. Of that $30.8 billion, $17 billion is to close the shortfall in the Pell Grant program and boost grant amounts by $500 to $5,350 in the first year and more in the second year. The remaining $13.8 billion is to boost the tuition tax credit from $1,800 to $2,500 for families earning up to $180,000.
The Postal Service, which has a current budget of $12.6 billion, is now running a deficit of more than $820 million, over and above a federal subsidy of $1.5 billion. Time Magazine http://www.time.com/time/magazine/article/0,9171,913226,00.html
Wouldn’t the rational argument state that if the government has major issues running these industries and overseeing the financial sector, they would also have major issues restructuring our health care system?
The healthcare debate is making me wonder about a broader problem in politics. Is it possible that democratic forums amplify the predictable irrationalities of human decision-making?
The US system sharpens this question because there are only 2 major political parties, and there is a very sharp cultural polarization around them – despite the fact that in world terms they are ideologically fairly close to each other.
Each “side” needs to differentiate itself fromt he other, so each needs to find “hot button” issues it can use to galvanize support. Evidence-based problem solving would be favoured in a system where convergence towards a consensus represented a preferred outcome for participants, but in politics, people don’t want to converge towards a solution, they want to maintain their differentiation and vanquish the other party. Hence the peculiar spectacle of social conservatives gloating over Chicago’s failed Olympic bid.
So I am beginning to wonder if perhaps oppositional politics amplifies irrationality. If I were a scholar, I’d be curious to study political efforts to undertake evidence-based reforms, regardless of which party was in power. My guess is that sober, evidence-based reforms will often be opposed in democratic forums by rhetorical inducements to excite irrationalities – like making short-term relative evaluations instead of long-term absolute ones, loss aversion, etc.
In other words, rather than its supposed function of generating fairness in debate, oppositional politics might function to filter rational solutioneering through our predictable irrationalities – forcing solutions to pass an “irrationality test” before being ratified.
This is just a 21st century version of the ancient quarrel between the philosophers and the rhetoriticians, I guess. It also makes me wonder how irrational the irrationalities are, at the level of mass society. First, there is the strategic question – given that all other rational actors are predictably irrational, does that make my own predictable irrationality rational in context? (Given that most people find it okay to cheat, but only by a little bit, especially with those outside a shared social identity – does that make it rational for me to also do it?) Secondly, I wonder about the cumulative effect of irrationality. For example, given that changes to complex social systems produce unintended consequences (in part due to irrationalities), and these consequences can be bad, do the many local irrationalities that produce political gridlock and social inertia actually function to protect social structures from mutation – and might this produce on-average benefits in the evolution of social structure? Does our individual madness sum up to a social method?
If so, then perhaps oppositional democratic debate ends up being good (on average) – precisely because it filters rational decision-making through the filter of our irrationalities. We might get sub-optimal solutions to each and every reform effort made on either “side” (in the US bipolar system) of the political system – but the overall damping-down of institutional change might confer an advantage on much, much longer timeframes of social evolution…
…given human volatility…
…or something like that…
I have just finished reading Predictably Irrational after watching Dan present at a TED seminar. Great book!
However, one question I had was on Chapter 1: The Truth about Relativity and that we tend to be attracted more by those people who have a similar, but less pleasing, friend – because we have a basis for comparison.
However, my observation of being in Asia is that there are plenty of foreign guys on the dating scene who attract women that would be well outside their league back in the US. I have always put this down to the ‘Superman Effect’ – that is Superman only has powers when he comes to earth, not on Krypton. It is the scarcity of these guys that increases their attractiveness, not the fact that there are a bunch of similar comparable types.
Female Asian friends have said that they find the same thing when they go to the US (in fact their complaint is trying to find a guy who will go out with them not because they are Asian (i.e. exotic) but because of who they are.
I am interested in how you manage to fit the concept of scarcity into the theory that we need to have a comparable ‘decoy’ choice to make the relative attractiveness of another choice clear.
Regards
Peter Knight
Regarding the natural competitive forces as a proxy for self-correction of excesses on Wall Street – It appears that where there is a lot of gold to be made, irrational self-serving behaviors are allowed to exist. Think about “Too big to fail”. We taxpayers bailed them out because we were too afraid of what would’ve happened if we didn’t. Maybe the “cure” was worse than the disease!!! So, we (by way of our elected officials) have allowed them to continue on this path and to collect large bonuses for doing so. Perhaps they have been granted a de-facto quasi-monopoly which has allowed this to exist? This could partially explain why natural competitive forces have not corrected this situation?
Regarding the Health Care debate – Politics and emotion trump hard scientific evidence any day of the week!
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Free markets assume consumers have access to information. In a system where the most basic, transactional information is a secret, we have no domestic foundation to even support ideological perspectives, never mind analysis driven by objective data. We have a long way to go on this one.