Alberto Mingardi  

Nudging consumers and regulators

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About one year ago, the British Financial Conduct Authority (FCA) -- which also regulates consumer credit -- published an Occasional Paper aimed at explaining how it is going to take advantage of the insights of behavioral economics. For one thing, the paper wasn't ambiguous at all. Its starting point was the notion that "people often make errors when choosing and using financial products, and can suffer considerable losses as a result," which thus justifies regulation as "market forces left to themselves will often not work to reduce these mistakes."
We're bound to make mistakes, that may be due to present biases, overconfidence, over-extrapolation (i.e., extrapolating from a few years of investment return to the future) or the inherent imperfections of our preferences. So, the FCA argues, regulators should intervene by forcing firms to provide information, "adjust how choices are presented to consumers," "require products to be promoted or sold only through particular channels or only to certain types of clients" and, eventually, "control products": i.e., ban some specific products or products' features.
The underlying idea is that consumers make mistakes "persistently and predictably" - and thus regulators can find a fix, to allow them to understand what is truly their interest.
Today a new paper has been released, by the newly established Regulatory Conduct Authority (RCA). The RCA shall implement the same basic insights of behavioral economics, to the very field of regulation.
Yes, consumers can act over present biases, overconfidence, over-extrapolation etc. But so can regulators. They are affected by present biases (eg., they may introduce a new regulation for immediate gratification, including headlines on the press and TV interviews); by reference dependence and loss aversion (they may believe an additional obligation added to an existing regulation does not entail costs, because the existing provision is very extensive); by regret and other emotions (over-regulation can be pursued for the sake of obtain the peace of the mind). Regulators are often over-confident (they entertain extravagant notions of their own ability to identify mistakes made by businesses and consumers), over-extrapolation (they may extrapolate from just a few years of their own regulatory experience to the future) and projection biases (they might impose a price reduction without considering revenue difficulties that may rise in the future).
The RCA has, not differently than the FCA, selected a few strategies to lessen the impact of regulators' biases: force regulators to provide information; adjust how choices are presented to regulators; "require policies to be promoted only through particular channels or only to certain types of licensees." The RCA knows that "Regulatory psychology is nuanced, however, and specific interventions can succeed or fail based on small details."
According to Sir Ian Byatt, former Director General of Water Supply , "This RCA Paper should be on the desk of every regulator."
To err is human, but regulators aren't a bit less human than consumers. Consumers' humanity can endanger them, so can regulators'. It is time to act!


P.S. One the two papers mentioned above was purposefully released on April 1st.


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COMMENTS (3 to date)

The next logical step after examining the cognitive biases of people examining cognitive biases is examining the cognitive biases of people examining the cognitive biases of people examining cognitive biases and so on up the ordinals ...

Can we get to ε-zero?

Tracy W writes:

I've always had this problem with the scientists who do research into cognitive errors as well as regulators. I keep finding myself thinking that the more I believe them, the less I should believe them. Particularly as they state that a greater level of education and experience doesn't protect against these cognitive errors.

Mike Rulle writes:

While, I always found the Kahneman Twersky writings entertaining, I rarely felt confident extrapolating it to the broader society in a meaningful way. There is evidence, for example, that investors routinely "buy high and sell low", thus tending to underperform just by and hold. But this holds true for the most sophisticated investors as well. That never struck me as unusual---in fact it shows fear of losses is higher than fear of gains foregone. Why would that be irrational, and by whose standards?

I think JH and TW above also have it right. When can we just stop trying to "fix" imaginary problems?

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