The Atlantic reviewed Cass Sunstein’s latest book on using public policy to redirect individual’s choices. Some complain that the government shouldn’t be influencing daily life in this manner. However, we already have many other private groups, most businesses, attempting to redirect daily decisions in their favor. But there at least good reasons why we might decide as a larger society to instill counter nudges that lead to overall improved economic decisions and outcomes.
The first is moral hazard where two parties have different amounts of information or levels of incentives. A classic example is a real estate agent and a home buyer. The agent is paid on the percentage of the house price and knows much more about the local market. These conspire to lead to a higher house price on average than would occur in a frictionless market.
The second is the principal-agent problem. In this case, the economic decision-maker is not the actual consumer or producer in the transaction. The health care industry is one classic case where patients defer most of their decisions to a physician, who also happens to be the benefiting service provider. Another case is the split-incentives in the rental housing market where the landlord could make energy-efficiency investments that reduce a tenant’s energy bill, but the tenant actually pays the bill. (I’ll write more on this in a future post.)
Some of this might not be needed with acted like the mathematical automaton that Milton Friedman envisioned, but we do have significant limitations on our abilities to make rational economic decisions. A decentralized price system is probably the best means of allocating use of scarce resources among us. Yet that doesn’t mean that society, through its government, shouldn’t agree to manipulate that price system to arrive at a more preferred set of individual decisions. Thus we should nudge and counter nudge as Sunstein suggests.