Wednesday, February 24, 2016

Updated version of "Behavioral Regulatory Agencies"

I finished an updated version of the paper on "Behavioral Regulatory Agencies" that was presented in earlier versions at Bristol and Paris, and I uploaded it in my web page. Comments are very welcome. Here's how it starts:

"The analysis of the bounded rationality of agents involved in policy-making has recently enriched the literature on behavioral economics (see review in Section 2 below). Indeed, it would be an inconsistency to assume that agents behave with bounded rationality in a market context, but that they are perfectly rational when they intervene in the design and choice of collective solutions.
In this article, I apply this basic insight to a well-known problem in the literature on regulation: the time inconsistency of regulation in the face of sunk investments, and the associated potential solution of delegating into an independent regulator. This problem has been analyzed theoretically and empirically, and is recognized to shed light on public intervention in infrastructure industries such as transport, energy or telecommunications.  In their classic book on regulatory reform in the UK, Armstrong et al. (1994) argued that the task of regulators in these industries would be easy except for the presence of asymmetric information, potential regulatory capture and commitment problems. The recent literature suggests a fourth source of difficulty (which is complementary of the others): the behavioural biases of regulators.
There is a parallelism in the evolution from welfare economics to political economy and the evolution from behavioral economics to behavioral political economy. Traditional welfare economics was criticized by the Public Choice School because of the asymmetry between assuming self-interested market agents and benevolent policy-makers. However, this school broadly interpreted this asymmetry as providing a rationale for reducing to the minimum public intervention (Stern, 2010). A more agnostic synthesis was provided by the more general concept of political economy, where all agents have similar motivations but there is no bias in favour or against public intervention: quite generally, the assumption of self-interested agents changes, but does not necessarily eliminate, public intervention. It is precisely from political economy models that the suggestion to alleviate time inconsistency in policy with delegation emerged. In an analogous asymmetry, early analysis of public policy using behavioral insights assumed that bounded rationality only affected agents operating in market contexts, but not perfectly rational policy makers who could supposedly nudge the former into behaving in ways that were good for their long run selves (see among others Sunstein, 2006, Thaler and Sunstein, 2008, Thaler, 2015, and their critics such as Kahan et al., 2006). Some of the critics have been right in highlighting this asymmetry, but getting close to the risk of arguing that assuming boundedly rational policy-makers would justify removing public intervention in many contexts. Again, a more agnostic behavioral political economy would assume similar at least potential degrees of bounded rationality in all agents, which would most probably modify public intervention, without necessarily eliminating it (in some cases it might, in others it might increase the need for some collective intervention; in many cases, I conjecture that it would modify the intervention)."

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