Traditional Chicago Economics Under Pressure: Thaler-Posner Debate

Richard Posner is against the proposed new Consumer Financial Protection Agency [CFPA]. This is, of course, not a surprise. Posner has always been an articulate advocate of the view most often associated with economics at the University of Chicago: market-based outcomes are invariably better than the alternatives, and anything that interferes with consumer choice is a bad idea.

Posner wraps this opposition to the CFPA into an odd attack (near the end of his WSJ op ed) on the personal decision-making abilities of Richard Thaler – a leading economist on consumer choice, misperceptions, and mistakes. (More on Thaler here.)

Thaler, also of the University of Chicago, hit back hard yesterday. He is right that Posner mischaracterizes the CFPA proposal, and points out that his agenda – and that of Cass Sunstein, formerly of Chicago and now a czar in the adminstration – is simply to provide consumers with a framework for better decisions. He implies that Posner defends defective baby cribs and their equivalent.

I would go further.

Think of it this way. We’ve learned a great deal about how consumers make decisions, including when they get things right and wrong. Behavioral economics, marketing, and related social science have made big strides (e.g., follow the work of Dan Ariely).

But all of this research is also available to companies. Perhaps they knew some of this before from trial-and-error, but there is no question that many of the techniques corporate America uses – and we as consumers find ourselves “up against” – is cutting edge manipulation of our decisions.

We worry a great deal about how corporations lobby to shape their regulatory environment. This is a struggle that is at least 150 years old in its modern form (e.g., railroad concessions), and much older if we think about powerful people bribing their way into advantageous relationships with the state.

In addition, companies now have powerful new tools to shape how we perceive our potential choices. Some of these tools might be good for us also – I’m open to argument on this. But within some particular spaces, including financial products, it’s clear that many of these “innovations” are actually clever ways to extract value from consumers.

Traditional Chicago economics always had its weaknesses – particularly when you focus on the fact that the “rules of the game” are often shaped by the more powerful. Thaler and Sunstein (and others) are trying to modernize this view more generally, while keeping the element of consumer choice as central.

But if the balance of power has shifted – due to technological innovation in social science – further towards corporations and away from consumers, then the task ahead is much harder.

Unless companies are compelled to keep their offerings “simple enough to understand”, we will face repeated rip-offs and crises – both macroeconomic and personal – arising from our financial sector.

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