Thaler and Sunstein's latest piece provides a perfect illustration of what's wrong with "sophisticated" critiques of laissez-faire. They begin sensibly enough:
In the past 20 years, there has been a growing interest in cutting-edge research that has come to be called "behavioral economics." In behavioral economics, the robot-like creatures who populate standard economic theories are replaced with real human beings.
So far, so good; who wouldn't prefer theories with real human beings to models with "robot-like creatures"? Thaler and Sunstein then provide a vivid example:
In a standard economic analysis of the mortgage market, the working hypothesis is that borrowers are capable of choosing the best mortgage for their financial circumstances.
This assumption might have been reasonable back in the days when nearly every mortgage was a simple 30-year fixed-rate loan. It is now preposterous.
I'm still on board. After all, I've got a Ph.D. in econ, and I opted for a simple 30-year fixed-rate loan precisely because I thought that other offers were too hard to evaluate.
But with their next passage, Thaler and Sunstein lose me:
[I]t is crucial to design policies that will prevent similar problems in the future. Behavioral economics provides specific suggestions not just for mortgages but also for credit cards, cellphone plans, prescription drugs, and student loans. The basic idea is that for complex financial products, the government should strive for what might be called "simplified transparency."
Here's the thing: I've been through the whole mortgage process, and seen what government actually does. We don't have laissez-faire now. Instead, we have a grotesque web of regulations and lawsuit avoidance that already make the mortgage process ridiculously complicated. I had to hear a dozen mandatory mini-lectures and sign or initial at least twenty pages because the government wanted to "protect" me. And if I didn't understand half the stuff I was signing, how many "real human beings" did?
In short, government long ago took up the burden of helping consumers, and the result is a mess.
The problem with behavioral economics is that it's more sophisticated than standard econ, but not nearly sophisticated enough. Thaler and Sunstein may have a more realistic view of borrowers than the average economist, but they have an even less realistic view of the political process. As I argue in The Myth of the Rational Voter:
Before we emphasize the benefits of government intervention, let us distinguish intervention designed by a well-intentioned economist from intervention that appeals to noneconomists, and reflect that the latter predominate. You do not have to be dogmatic to take a staunchly promarket position. You just have to notice that the "sophisticated" emphasis on the benefits of intervention mistakes theoretical possibility for empirical likelihood.
Additional regulation of mortages isn't going to help real human beings cope with complexity. Democracy already gave us a pile of inane "pro-consumer" regulation, and reform will probably just give us more of the same.
So what would I recommend? Abandon the vain effort to protect consumers from themselves, and switch to a message simple enough for real humans to understand:
1. You're an adult; if you screw up it's your problem.
2. If you're baffled by the complexities of mortgage markets (or anything else), stick with the simple, standard options that you actually understand.