Behavioural Economics and Irish Public Policy

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.

24 replies on “Behavioural Economics and Irish Public Policy”

Liam Delaney says on pensions,

However, it unleashes a lot of naive money into the system and this needs to be debated closely before the final decisions are made.

One could argue that about the money collected by the Irish government, and re-distributed back to its origins via different programs run through state agencies, major projects and grand visions. We are pretty used to the idea of naive money in Ireland. In fact, we seem to like our money ending up more on the naive end of the spectrum, than the other.

That is not to say, in recent history that the naive money in the public sector side of the Irish economy was any different to that in the private sector side. But I would say the money in the private sector side was running scared into bricks and mortar, than identifying real opportunities and using them. In 2011, we still do not expect the private money to have much more intelligence than it did five years hence.

The one thing I will say about private sector money in Ireland though, was it got a lot of working over, to ensure it did not clash in any way, overlap, or double up, on what the naive public sector money was doing. Very much the opposite in fact. Because, in the smartest of the smart private sector money, it got the naive public sector equivalent to do the heavy lifting. All the private sectore money had to do was shown up and accept the actual prize. A bit like a middle class high school student in north America paying some developing world kid online to do math homework. You see my point. BOH.

This portion of Liam Delaney’s deserves my attention also, while I am here.

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.

We are now in the third decade after the decade of the 1980s generation in Ireland that we trained and education and saw leave on boats and planes. Surely after 20+ years of studying the problem, creating initiatives, setting up agencies, taskforces and producing documents, we have zero-ed in a small bit on the specific nature of the Irish unemployment issue. That is, the rate at which we can produce trained professionals exceeds the rate at which our economy can absorb and fully utilize the same.

This is my broader question about Ireland. When we see something, we identify it as a major problem: Do we then have the organizational capacity to tackle and get to gribs with some solution instead of two or three decades?

The worst thing about the Celtic Tiger, aside from the huge hangover, is the annoying realisation that a major problem we all thought we had whipped for good, under-utilisation of our human capital, has come rearing back out of the grave, like one of those zombie creatures in Michael Jackson’s Thriller video. After how many years, and how much squandered trying and put a dent in the problem? Is the unemployment problem in Ireland, the equivalent of the war on drugs in north America? We pump money in, and nothing comes out. BOH.

The inability of economies to put to productive use the output of post secondary institutions is a problem shared by all the developed countries. When the middle class are pressured they respond and in the USA where the problem first became evident 20 to 30 years ago the following coping mechanisms emerged. Raise the price of tuition, reduce scholarships, retrain graduates for semiskilled and skilled manual labour jobs. The main obstacle to post secondary education now is not good grades it is poverty. There was a time when completion of primary school conferred an advantage, that became secondary school, it then became a 3 year degree followed by a 4 year degree. Now it takes two hard applied science degrees or an MSc. or Phd in subjects that are in demand. I might add that one or two foreign languages in addition to the foregoing are also useful. The days of Political Science, Psychology, Sociology Fine Arts, English and unilingualism conferring an advantage are dead and gone.
The Germans with their early streaming system where mothers boast that their child got a machinist apprenticeship at Mercedes and the mothers of the budding lawyers stay quiet bears examining.

Pensions! The system that works is for the state to provide pensions of 25% to 30% maximum based on base salary. Deductions would be made from wages to fund the system, typically 50-50 sharing by employers and employees. Anything in excess of 25-30% would be optional and a private sector matter. The usual supports such as health care, subsidised housing and nursing homes would be provided when necessary (means tested) to the over 65-70. Ireland is now in a position where the gov’t will be forced to trim payment of all kinds including pensions and statutory expenditures. Cutting suits according to the cloth available is a skill that will be in demand. Defined contribution pension plans are now pushing out defined benefit plans. The private sector is largely DC while gov’ts are still DB the reason is gov’ts have stable work forces and the schemes are sustainable on a pay as you go basis (no fund) while the private sector is unstable and has to have a fund to reduce risk. All gov’ts do the book keeping entries to determine the size of the pension fund, beyond the entries there is no substance. And we thought fiat currency was strange.

@Liam Delaney,

Many thanks for highlighting these important areas of research. Your focus, understandably, is on the potential public policy applications of this research. My fear is that, should it charge ahead in this direction, a large part of the economics discipline will risk capture in the same way that ‘freshwater’ economists were captured by the Neocons in the run-up to the current financial and economic blow-out.

My sense is that large corporations are way ahead of any government in their understanding and application of many of these insights and are major funders of research in these areas. As third-level education in all developed economies becomes more reliant on external (non-state) funding in all developed economies, he who pays the piper will call the tune. Governments and parliaments everywhere are either unwilling or unable to finance and commission the research to counter the malign impacts of the application of this research by large corporations and to promote policies that may constrain the activities of these corporations in the public interest.

In terms of the behavioural, psychological and evolutionary approaches to economics I wouled very much like to see more influential research on the acquisition, exercise and retention of economic and political power.

As JK Galbriath once observed, a focus on markets provide capitalists with a very convenient functional anonymity.

Its curious the literature cited Minsky, Farmer et al form a macroeconomic approach to economics whereas you highlight the importance of the micro economic side. My view is we’ve been largely misled in this country by an over emphasis on the micro economic approach which has used inductive reasoning at the expense of rigorous deductive reasoning to lead government policy. Even today if you listen to the news commentary on Howlin meetings with IMF officials in Dublin, the topics will be the micro topics of reduced growth rate, further cuts in public expenditure to account for this, further austerity and reduced pay arguments induced as counter response to our macro problems. The macro deductive approach is avoided in favour of micro quasi spoon feeding that austerity is working. Claims that further austerity eg wage cuts, job losses = bigger losses for the banks and taxpayer are made on a micro level without regard to the bigger picture. Fact is empirical evidence shows we now pivot between structured default and outright default, cuts are eating away at our economy making it unproductive and ready to fail because of massive exposure to debt: if the macro evidence of declining growth locally and internationally is to be believed, as it should be. The IMF in town speaking to Howlin today should very well know, we’ve passed the tipping point leading to default, any further cuts can only accelerate the inevitable path to default for Ireland. So, lets focus on the default ‘bigger picture’ that might sensibly put out the fire before we concern ourselves with the micro psychology of people’s behaviour inside the house on fire. On the macro side, for example, we have the Global Debt Crisis GDC not being tackled by Trichet and G20. They should be tackling Greenspan deregulation and its outcome of global debt mountains burning economies such as our own, instead micro tinkering only is allowed, that is blind to the coming default:(
We should be in emergency mode on the macro level and we cannot afford
to lose sight of these problems in analysing the eggs, when we should be looking at the goose that laid the golden egg:)

McKillen just won in the supreme court on the fair procedures point – lost on the constitutional challenge

SC finds that NAMA interferes with his property rights because they take greater rights than a private purchaser of his loans would – therefore the act must be interpreted as providing for fair procedures – therefore entitled to make representations to NAMA before they take his loans into NAMA

definition of eligible assets upheld as constitutional

John, thx for fascinating link, few remarks: must try and get hold of Summers paper on ” scientific illusion in empirical macro economics “. Liked his play on words towards the end: “expansionary contraction oxymoronic, consequences serious for the countries involved, subsidy, improved fiscal hygiene that veryone will feel better, …..experiment not going to work well ”
Suspect he was having a dig at both UK and Ireland austerity experiments designed to “oxymoronic” ally lead to growth. Fascinated by his remark, Lehmans demise covered less than 2% of the US financial system, Lehman’s didn’t breach the scope of too big to let it go” Pity we didn’t do the Math and let Anglo go. Given Summers is Director of the White House National Economic Council for President Barack Obama, we should be very worried he’s very soft on regulation and financial innovation especially his remarks that factories creating pollution run by governments do not necessarily lead to a reduction in pollution.

Its fairly obvious not only Stiglitz but Summers and Co even with the depth of their support of American banks through QE are deeply critical of Trichet’s austerity approach to Ireland….

@ Michael Hennigan

Thx for that, re “President Obama is due to propose major spending cuts and tax increases for folks on $250,000+” Its a course should have been pursued long ago. Consider this, factor in Gene Kerrigan of Sunday Independent call for a cap on salaries at €100k +, burden sharing for the well paid. At this point, even that won’t work, we’ve €6 bn of cuts to make over the next tree years…all to pay for the €70 bn – €100 bn we’re gifting the banks. Perhaps we’re not able to micro manage our economy anymore because we’ve become used to the binge spending of borrowed money on the banks, money we don’t have and we certainly can’t tax for. Can I predict following IMF meeting with Howlin Noonan today the phrase ‘asset sale’ to become more frequently heard over the coming weeks. Lets see, asset sales plus austerity followed by default, we deserve our delinquent reputation and these austerity measures without burden sharing from the banking sector only add to it!! Hindsight is 20:20 but here’s Gordon Brown on the FSA at Bretton Woods or how the regulators got it wrong. Not to worry, Irish taxpayers will pay for these mistakes, restore the reputation of Irish banks, save the euro, elevate the reputation of our political leaders into political and economic gurus and save all bondholders as well:) But we all get things wrong at times, for example, I predicted Irish default for Paddy’s Day last, but we’re struggling blindly on….:) May as well laugh.

@John McHale,

Thanks for the link. It’s always good value to see folks of Summers’s and Wolf’s calibre having to sing for their supper – or, at least, immediately after it. Unfotunately Summers is too deeply implicated in the Neocon advance and ascendancy to offer much that is of any use. It has been sad to see people with a genuine liberal predisposition and prodigious intellectual capability, such as he and the late Fred Kahn, being taken for a ride by the Neocons.

Thanks for a great article.

Strangely, I must add that I find your final line particularly interesting:

“…a type of Catholic church style nudge.”

Within the realm of behavioural finance, I believe religious culture is vastly overlooked, but vitally important when it comes to analysing how and why individuals make the decisions they do. Perhaps not so much so in Ireland these days, but with increasing power and responsibility in the global political economy shifting to the likes of India and China (amongst others), the role of religion in how an economy is structured and in how policy makers form their policy, is going to become a big deal.

Many of the ‘new powers’ practice their cultural beliefs much more fervently than how the West practices the application of Christain doctrine (or, at least, a culture that draws its moral code and ethics of right and wrong from a history of Christiandom).

Essentially, what I’m saying, I guess, is that I totally agree with you!

Behavioural finance will be (and is) the most important arena in which we aim to understand how the new global economy will be restructured, reformed and retained in an increasingly diverse global community.

A post on religion and economics here would be good at some stage Ryan. Have read a lot of work on this. Not mad about the url address but Larry Iannaconne and colleagues have done some extremely interesting work and it is collected on the webpage below. In my case, the reference to religion was tongue-in-cheek but you are right that there is a lot in there.

That’s what I thought was interesting Liam, that your tongue-in-cheek comment was just as insightful and relevant to your article as the main body was!

I actually used a bit when writing my masters dissertation a couple of years ago. In fact, I finished my paper with an Iannaccone quote:

“…religion remains a fundamental feature of human life and culture, a fact that social scientists ignore at their peril.” Iannaccone (1994b: 10).

I guess great minds think (and fools seldom differ), but you’re right – the url could use a little work!

Many thanks for re-directing me to it though, its been too long since I perused its pages…

@Colm Brazel – yes, you are right that the Farmer work is macro, albeit part of an ongoing attempt to give psychological microfoundations to macroeconomics. A big ommission from my post was the work that Laibson and others have been doing on this type of area. Some of this is available below, particularly the paper referenced. I know at least one person who is trying to do something on this area with relation the Irish economy and I will post it when the paper is out.

Andreas Fuster & David Laibson & Brock Mendel, 2010. “Natural Expectations and Macroeconomic Fluctuations,” Journal of Economic Perspectives, American Economic Association, vol. 24(4), pages 67-84, Fall.

@Paul Hunt – I will think about your point about work on power and corruption. The book by Fishman and Miguel is a good lay summary of some of the recent work. There is a lot of overlap with the behavioural literature as there is an ongoing debate about the role of non-pecuniary and cultural factors in power relations and corruption.

There is obviously also a neo-Marxist tradition in economics that uses power and class as core constructs but I am not in a good position to summarise it.

@Paul Hunt – the list of journals on the website below is extremely comprehensive if you are interested in outlets that focus explicitly on questions like class, power etc., Many authors in this area claim, like you, that the main economics journals and teaching programmes do not give sufficient attention to power and related factors.

@Liam Delaney

Very useful stuff Liam … and a direction that Irish academia, and policy makers, needs to take more notice of and follow …… and provide more resources for. In other words, it is REAL …. and capable of positive impact on real lives.

Shiller & George Akerlof’s Animal Spirits now added to my reading list – we have had more than enough of the Leuder_Lemons of the so called ‘free market’ variety as we crunch our way through a decade of bitter_banking lemons ………

Continue to lead in this area …….. badly need more followers … I’m no expert in this area but it is clear to me, following my ‘indenture’ on the blog, that psychologicl/behavioural economics is the branch that must have a future. And one worth considering and incorporating into my own interdisciplinary view of ‘real life’ as lived.

Ok, thanks David. It is an area worth following. Probably becoming increasingly incoherent to post on it as an area as the subareas themselves are now so large but no harm in flagging this as something new for the Irish policy landscape.

Read a paper by Bruno Frey a few yrs ago …… on citizen participation in local elections etc across Europe ……. and why participation in cantons in Switz so high ……….. and plausible reason that local cantons set local tax rates ….. great incentive for citizens to get involved in elections – and in making decisions on how this tax is spent, where it is spent, and who it is spent on …… a little behavioural digging here proved very enlightening ….. & making comparision with Irish local elections of little meaning ……. as local gov in Ireland reliant on the centre etc for most of its funding …….. and up to recently in local gov’s interest to keep zoning land as it increased their local revenues …. linking back to present mess but no time or funds to further explore….. behavioural has it uses – and Frey’s paper was on ‘democracy’ ……….. ‘deliberative democracy’ being one of my interests …

Irish Public Sphere needs a good open Psychological/Behavioural Economics Blog/Content Site …….. take your time . (-;

Like the hetecon link ………. later. Don’t suppose The New School thinking of opening in Dublin (-;

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