Behavioral Economics and Federal Government Policy

Other External Scholars:
Sendhil Mullainathan, Harvard University
Project Date:
Jun 2009
Award Amount:
$26,055
Project Programs:
Behavioral Economics

On November 19, 2008, Russell Sage Foundation and the Sloan Foundation held a meeting to discuss the application of behavioral economics to the design of regulatory policy. With support from both foundations, economist Sendhil Mullainathan of Harvard University will continue this initiative by establishing a steering committee that will use behavioral economics to identify and reform key areas of federal policy. Members of the steering committee will include Jeffrey Kling, Senior Fellow and Deputy Director of Economic Studies at Brookings; Eldar Shafir, Professor of Psychology and Public Affairs at Princeton University; and Richard Thaler, Ralph and Dorothy Keller Distinguished Service Professor of Behavioral Science and Economics at the University of Chicago.

The two teams working on this project will focus on consumer finance and on labor markets. The behavioral approach to decision-making recognizes that consumer financial products are complex and consumers can make mistakes—even with all of the data in front of them. Buyers often make their decisions based on irrelevant information. For example, when potential investors choose among S&P 500 index funds (all with the same returns), these buyers do not focus on minimizing fees and instead pay attention to the funds’ historical performance, which can vary with the funds’ starting dates in ways that should have no bearing on the investment decision. Building on examples like this, the behavioral model demonstrates that information alone does not insure understanding. These insights imply that regulating disclosure of data in and of itself is not as fruitful as changing how the information is managed and presented to consumers. The consumer finance team will be led by Susan Woodward, chairman of Sand Hill Econometrics and former chief economist of the Securities and Exchange Commission, chief economist of the Department of Housing and Urban Development, and senior staff economist for Financial Markets and Institutions at the Council of Economic Advisers, and will also include John Campbell, Harvard University, Mullainathan, and Richard Thaler.

The other team will focus on labor markets. In the past fifteen years, the workforce development system has shifted to provide vouchers for job training and much more leeway for the unemployed to choose among programs but less guidance about how to search for jobs. Behavioral economics suggests modifications to this approach by recognizing that a job search is a psychologically intense activity. For instance, individuals may form overly optimistic expectations about what wage to expect at a new job, thus discouraging reemployment. So, a behaviorally informed reemployment program, added to existing employment and job search assistance services, could provide information about labor market conditions and counseling services that directly assess wage bias. Also, wage-loss insurance could be created, which would replace a portion of the difference between the wage at the old job and wage on the new job. This could overcome some of the expectation biases that lead to long spells of unemployment by bringing effective wage offers in line with expectations. The labor markets team will be led by Lawrence Katz, Harvard University and former chief economist at the Labor Department; Linda Babcock, Carnegie-Mellon University; Kling; and Mullainathan.

The project will produce short papers from each team, which will serve as the materials for meetings with policymakers. These will include a one-page summary of motivation, recommendations for immediate action, and recommendations for ideas deserving future investigation. The papers will also contain background information, details about scientific grounding of the recommendations, and detailed suggestions for new research needed to make progress on issues where the science is underdeveloped.

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