I have posted a few times (here and here) before on developments in the micro-side of behavioural economics. I think that a lot of policy developments will come out of this area in the next ten years and I have been trying to keep as informed as possible, and have been giving lectures on this in both UCD (to economics students) and TCD (to psychology students). It should go without saying that this area is too broad to give anything approaching a comprehensive summary and my goal here is to point to some areas that might be of interest.
In terms of the Irish policy environment, below are some things that are of particular interest:
1. The role of the financial regulator in ensuring confidence in the financial system and preventing self-fulfilling panics is becoming increasingly studied. Roger Farmer’s recent book “How the Economy Works” fleshes out one model of this and there has, of course, been an increasing interest in the work of Hyman Minksy. The recent book “Animal Spirits” by Robert Shiller and George Akerlof provides an accessible account of one major stream of this literature.
2. Furthermore, the role of the financial regulator in ensuring basic financial competence among actors in the system is being increasingly studied. There was a debate when the crisis started that the financial regulator had focused too much on this area and too little on looking at what the banks were doing. This is totally bogus. The financial regulator should be able to focus on both at the same time. The famous “tracker mortgage” adds aside, there is a lot about consumer financial behaviour in Ireland that contributes to financial instability. The regulation of institutions must coincide with an attempt to look at the consumer side also as they are two blades of the same scissors. As well as basic questions such as whether people have sufficient numeracy to process contracts, an ongoing literature is examing questions such as why people do not diversify and why they prefer to hold stocks in the company they work in, and so on. Researchers at the Irish regulator have released recent papers on this area (e.g. McCarthy 2010)
3. The pension framework will see the entire private sector auto-enrolled in 2014. This is one of the most important policy developments in Ireland in the next few years if they are serious about it. As yet, details are patchy about the default option and how the offers will be presented to people. Depending on whether it actually gets rolled out as planned, this is a potentially groundbreaking policy move. In the Irish case, people will be reenrolled every two years if they opt-out, which puts this on the paternalist side of the libertarian-paternalist spectrum. However, it is a potentially very innovative solution to a major policy problem, taking advantage of the mobilising role of the state while respecting people’s freedom to opt-out to some extent. However, it unleashes a lot of naive money into the system and this needs to be debated closely before the final decisions are made. There is now a large literature in the US examining the effect of defaults and presentation of options to people and the initial results are dramatic.
4. James Heckman and colleagues have been working on a large programme to integrate personality psychology and a theory of human development into economics. This is extremely important in terms of providing a theoretical and empirical basis for allocation of spending in health and education. Many of these papers are available on Heckman’s IDEAS webpage. Colleagues in Geary are involved in a collaboration looking at early childhood development. Some of these ideas are presented in accesible form on this website.
5. The programme for government has indicated a merger of the jobs training and employment benefit services of the Department of Social Protection and FAS. This potentially is a massive development if they try to do it right. There is a growing literature examining the self-perpetuating nature of unemployment. A lot of official Ireland have got stuck in a “sure the market has to sort this out” or “migration broadens the mind” approach to unemployment policy. This is deeply flawed and causing a major social and economic crisis in affected areas. A lot of recent research has begun to examine more closely the mechanics of what happens during job search from a more psychological perspective. Some of this research is explained in accessible form in this Brookings Institute publication
6. The Commission on Taxation examined a number of ways to improve the tax system. I don’t know anyone who disagrees with the view that the Irish tax system is too complex with too many loopholes that create distortions both for democracy and for business. There are many potentially improving and low-cost policies that can be made in this domain, particularly those involving simplifying tax communication and collection mechanisms (recent review here). However, it is interesting to note that a new literature is arguing that tax should not always be simplified as if it is too simple people do not process the trade-offs involved (e.g. Finkelstein)
7. An increasing literature has been examining the economic importance of ensuring good child mental health. This literature is helping us to understand better the interplay between poor child mental health and later economic outcomes. A recent PNAS paper by Goodman, Joyce and Smith gives a good indication of the type of research being conducted in this area. This is an extremely important area of research at the interface of psychology and economics.
8. More generally, the literature on well-being has been developing. The Stiglitz-Sen commission is becoming a standard reference on this topic and it is pretty comprehensive. Understanding how we go from the empirical literature in this area into meaningful indicators is an important direction for this literature.
This is, as noted, far from comprehensive. A number of papers have been released on the importance of identity and narrative for economic outcomes and fluctuations, and I have posted before on Akerlof and Kranton’s book on this. At European level, DG Sanco have been particularly active in this area, as summarised in a recent publication of theirs. A large literature is emerging examing psychological aspects of microfinance in development contexts and this is being flagged (including by the Economist last year) as being a major emerging area. The recent book “More than Good Intentions” summarises a lot of this work.
This literature partly emerged from the empirical and theoretical work of people like Kahneman and Tversky and its development by Richard Thaler and others. The integration of psychological realism into economic models has become a mainstream part of economics and is having implications for policy that are hard to keep up with. One of the big questions it already raises is the extent to which knowing about how people make decisions in areas like pensions and insurance influences the debate about whether to implement liberal or paternalistic policies in these domains. People like Thaler and Sunstein have used the phrase “Libertarian Paternalism” to get at the idea that it is possible to shape policy such to make it easier for people to make optimal choices from their own perspective (e.g. taking out a pension) without forcing them to do. The pension opt-outs are an example of this type of policy though in the Irish case, it is somewhat more forceful as you are opted back in every two years, a type of Catholic church style nudge.