In a recent special session on Superannuation at the Australian Conference of Economists, David Gruen — an economist working for the Australian Treasury and one of the authors of the Cooper Review (see here) reflected on the intellectual paradigm shift that informed its deliberations and recommendations (see here).
According to Gruen, and his co-author Tim Wong, the Wallis report was built on the fiction commonly referred to as homo economicus, that mythical animal that is able to make even complicated decisions optimally, or at least better than government. According to Gruen, the Cooper Review reflects the insight that for many financial products, consumers lack (and cannot efficiently obtain) the knowledge to make informed decisions and hence some good old-fashioned paternalism is justifiable: “Perhaps one way of understanding the differences between Wallis and Cooper reports is that, rather than treating these cases as ‘exceptions to the rule’, we in the Cooper Review considered them to be more widespread – indeed of central relevance when it comes to decisions about retirement savings.” (pp. 6 – 7)
Arguing that a substantial body of work has emerged in recent decades in the field of Behavioral Economics, Gruen then sells unabashedly that field’s alleged insights as the foundation on which to build the choice architecture of the Australian superannuation scheme.
The result is known: it is likely — if indeed the Cooper Review recommendations will be implemented in its essence, which seems likely at this point — that a mandated one-size-fits-all default option (“MySuper”) will be imposed on superannuation members. Gruen, clearly, see this as progress. After all, superannuation members still have the choice to opt out. Or so he argues.
The argument is problematic for at least two reasons.
First, the paternalism of the MySuper default might indeed save poorly informed consumers from themselves. Unfortunately, the existence of such a default option is also likely to result in consumers being poorly informed and disengaged with their supers in the same way as insurance without deductions leads people to be less careful about the things they have insured. Gruen acknowledges some version of this argument in a footnote on p. 16 but dismisses it in passing in a somewhat snotty manner. Well, like it or not, there is an endogeneity problem here. And to dismiss it out of hand is wrong-headed and troubling. Especially if it comes from as influential a person as Gruen. Recent evidence has shown that even optimal defaults may not be optimal and that, in particular when consumers are fairly heterogeneous, requiring individuals to make explicit choices for themselves may dominate optimal defaults (e.g., Carroll et al, Optimal Decisions and Active Decisions, Quarterly Journal of Economics 2009, pp. 1639 – 1674). The result by Carroll et al. is hardly surprising in light of what we know empirically about the — sometimes quite dramatic — effects of financial literacy and peer effects.
Second, it has become bad habit of highly visible policy and/or opinion makers to appeal to alleged insights from Behavioral Economics. None of the people I have in mind here has ever actually done an experiment and it is clear from their uncritical sampling of the evidence that they do not know the relevant literature or the controversies over the production of the — mostly – laboratory evidence that undergirds much of Behavioral Economics. The simple fact is that pretty much every cognitive bias that psychologists, and behavioral economists, have allegedly identified is contested in the relevant literature. (There’d be too many references to list here but feel free to ask me for the syllabus of my Behavioral Course.) Building the superannuation choice architecture on disputed evidence is problematic at best.
To summarize: Has there been an intellectual paradigm shift? Yes, probably. Is that a good thing? Maybe. People often are not particularly good at financial decision-making (and regulators and/or employers do not help them much). Are unreflected translations into policy decisions of alleged insights from Behavioral Economics the way to go? I doubt it. While Behavioral Economics does have some interesting things to say, much of the evidence it allegedly provides is contested. Plus the obsession with one-size-fits-all default options is likely to crowd out strategies that entice people to become engaged with their supers as well as the incentive-compatible design of disclosure and delivery systems that could actuallu be understood and used. The design and implementation of such systems better rely on standard economic theory about information asymmetries and mechnism design. It is surely reasonable to assume that homo economicus rules superbly on the supply side.