Sep 20

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.