Policy- makers are all in our minds

A breakthrough field that combines psychology and economics, behavioral economics has achieved a level of influence over U.S. policy that hardly any of its practitioners could have imagined only a few years ago.

President Obama's administration is loaded with behavioral economists. "Believers" at the Office of Management and Budget include its director, Peter Orszag, regulatory czar Cass Sunstein, and Harvard professors Jeff Liebman and Sendhil Mullainathan (who is also at Treasury). Outside OMB, proponents include White House economic adviser Austan Goolsbee as well as Treasury's Alan Krueger and Michael Barr.

Time magazine has dubbed it "the behavioralist takeover." The Washington Post remarked on the field's "powerful foothold" in the administration. The behavioralists' meteoric rise was, of course, helped mightily by the financial collapse, which could not have been a better "marketing campaign" for the discipline, as one of its practitioners noted.

For 30 years, neoclassical economics successfully defended the notion that rational people making decisions based on their self-interest create efficient markets. But behavioral economists have shown that the way a choice is presented, or "framed," significantly affects decisions, and that psychological vulnerabilities in decision-making can result in a "race to the bottom" and failed markets.

That framing affects choice is no surprise to marketers or entrepreneurs, who have always exploited the quirks in human psychology to make money, as Robert Cialdini detailed in his best-seller Influence.

Turning to government applications of the study, Obama's behavioralists have two goals: to regulate products such as mortgages, where psychological weaknesses - in this case, an aversion to complexity - can lead to failed markets; and to harness psychological quirks for beneficial rather than exploitative ends, promoting the general welfare.

Behavioralist-influenced proposals have ranged widely. They have included a controversial attempt to mandate that financial-services companies offer straightforward, or "vanilla," products; energy reform; automatic enrollment in 401(k)s and pension plans; and aggressive rules for clarity in health-care plans. As Orszag told Time, behavioral economics "applies to all the big areas where we need change."

Obama's February stimulus package, for instance, dispersed payroll-tax cuts over time instead of paying them in lump-sum checks to taxpayers. This was meant to encourage spending of the extra money. Behavioral research shows that people are more likely to save a large sum received at once, while they are more likely to spend smaller sums received over time. Of course, this also means that Americans would have more savings if the policy had not been designed to manipulate them into spending.

Some question whether government should be involved in such psychological coercion. Unsurprisingly, behavioralists continue to face fierce resistance for several reasons.

For one, their ideas are easily distorted. Before Sunstein's confirmation, Glenn Beck accused him of believing "everyone must be an organ donor." Actually, Sunstein had only pointed out that making organ donation the "default" option - so people would have to "opt out" of it rather than "opt in" - would save lives.

Libertarians fear a coming surge of paternalism. Free-market advocates such as Terence Corcoran of the Financial Post tend to repeat a standard defense of neoclassical theory: Behavioral economics, Corcoran wrote, is based on "the idea that people are too stupid, too emotionally and intellectually screwed up, to be trusted with their own money."

Obama's behavioralists have also been accosted from the left. Alan Wolfe, a professor at Boston College, recently attacked the field as a threat to liberalism, warning that it could "play havoc with the American Constitution." Liberalism is based on "autonomy and equality," Wolfe has written, and by citing "genetic makeup" as a factor in decision-making, behavioral economics reduces "who we are."

As Wolfe sees it, "The underlying vision of human purpose contained in behavioral economics is ... far more depressing" than that of neoclassical economics. He compares these "choice architects" - a reference to behavioralists' "building" of frames for decision-making - to the Bolsheviks.

Wolfe is right that behavioral economists and psychologists have fundamentally challenged accepted conceptions of choice. The problem for him and other critics is that the behavioralists are correct.

And, as Sunstein and Richard Thaler point out in their book Nudge: Improving Decisions About Health, Wealth, and Happiness, all choices already have contexts that push people toward certain outcomes. The behavioralists are merely quantifying how existing frames affect choice and trying to improve decision-making contexts - often by making choices simpler.

In other words, there is no neutral alternative. Like a new technology, these insights are here to stay, with all of their moral complications.

Finding the proper balance between a "nanny state" and ethical, innovative policies will be the point of contention in one of the next great economic debates - and the behavioralists' formidable challenge.