Second-Order Rationality

Second-Order Rationality

Description

For much of my academic career I have defended a version of libertarian theory of limited government, a government whose central function is protection of private property and voluntary exchange against force and fraud (see Epstein 1985, 1995, 1998, 2003). This recognizes a role for taxation and eminent domain, not only for the common defense but also for creating infrastructure and controlling and regulating monopoly power. The battle between rational choice theory and behavioral economics—and the common errors shared by both—often calls that classical liberal theory into question on two key issues. The first is the level of rationality, coherence, and stability in the formation of human preferences. The second is the relative strengths of egoism and altruism in human affairs. In this chapter I confine myself to the first of these two inquiries, which spawns two further lines of investigation. One involves the formation of political order in a state of nature. The other swirls around the contemporary debate over the scope of government regulation of economic activity once that political order is secured, often with the view of placing a minimum safety net under individuals that protects them not only against the bad behavior of other individuals but also against the vicissitudes of nature and, most relevant for this exercise, their own bad judgment and limited capacity. This explicit behavioral rejection of libertarian assumptions has profound consequences for the role of government in social and economic life. Starting from the behavioralist baseline makes it much more plausible to insist on a variety of paternalist regulations whose main purpose is to protect individuals from their own biases and excesses. For example, Oren Bar-Gill has suggested that such legal controls might be appropriate in credit card transactions, on the grounds that individual borrowers suffer from a set of biases that includes “weakness of the will,” which leads them to underestimate their level of self-control (Bar-Gill 2004, 1373, 1375), and “optimism bias,” which leads them to underestimate the risk of adverse events, such as loss of job, which in turn leads them to borrow more than they ought (1375– 76). Likewise, in dealing with pension plans and retirement, libertarianism generally allows individuals to make their own choices and opposes government mandates to make contributions into plans such as Social Security or Medicare. Yet Social Security has many defenders, some on the grounds that ordinary individuals do not save adequately on their own (see chapter 10 this volume; see also Diamond and Orszag 2004). This point is subject to dispute, and greater difficulties with Social Security arise from a different quarter. The public choice context gives political leaders powerful reasons to engage in massive wealth transfers, which work best when concealed from public view. In this context, the cognitive biases of ordinary people are likely to kick in because they will be exploited by political actors operating in settings where the institutional correctives are likely to be weaker than in private market settings.

Source Publication

Behavioral Public Finance

Source Editors/Authors

Edward J. McCaffrey, Joel Slemrod

Publication Date

2006

Second-Order Rationality

Find @ NYU

Share

COinS