Budgets Behaving Badly By DAVID LEONHARDT

The New York Times
Printer Friendly Format Sponsored By

December 3, 2008
Economic Scene
Budgets Behaving Badly By DAVID LEONHARDT

WASHINGTON

Last week, on the same day the Treasury Department announced a brand new $800 billion program to stem the financial crisis, Barack Obama held a news conference to say that he was serious about getting the budget deficit under control.

To which a properly skeptical citizen might respond: Good luck with that.

The deficit in the current fiscal year could end up approaching $1 trillion, which is roughly equal to the combined budgets of the military and Medicare. Given the depth of the crisis, running a big deficit makes perfect sense. But the government also needs to have long-term plans to reduce it. And the sort of deficit we’re now facing will require some pretty creative plans.

Fortunately, there is a group of economists who are almost ideally suited to help Mr. Obama with this task — to come up with budget cuts that can reduce government spending without harming the quality of government services. They’re called behavioral economists.

Behavioral economics sprang up about three decades ago as a radical critique of the standard assumption that human beings behaved in economically rational ways. The behaviorialists, as they’re known, pointed out that this assumption was ridiculous.

Would-be weight losers pay $100 a month to belong to a gym they rarely visit. Borrowers get fooled into taking out a loan with an appealing teaser rate. Patients fail to follow even a basic regimen of prescribed drugs — a failure that can leave them with serious medical complications and Medicare with big hospital bills.

Thanks to insights like these, behavioral economics has entered the mainstream. In this year’s campaign, Mr. Obama signaled an interest in the field by surrounding himself with advisers who were quite sympathetic to it. Of course, this was before the financial crisis became so serious that it overwhelmed everything else. Today, it’s reasonable to ask whether the Obama administration will still have time for behavioral economics.

That’s why some economists are now talking about whether Mr. Obama should add a new kind of adviser to his team, one specifically charged with translating the lessons of the behavioral revolution into real-world policies. This person would work with Medicare officials to improve drug compliance. He or she would think about how mortgage regulations should be rewritten, how health insurance choices should be presented and how carbon emissions might be cut.

“The issues we struggle with today are inherently behavioral as never before,” Sendhil Mullainathan, a behavioral economist at Harvard, told me. “It’s impossible to think of the current mortgage crisis without thinking seriously about underlying consumer psychology. And it’s impossible to think of future regulatory fixes without thinking seriously about that issue.”

Behavioral economics may sound like an ivory tower subject, but it’s really the opposite. It’s the study of everyday life as it actually happens, not as some textbook says it should. It offers economic policy makers a new set of tools — a more subtle, psychological set — beyond tax rates, interest rates and other traditional tools.

And it can already claim one big policy success. In 2006, Congress passed a pension bill with a clause that came straight out of research on savings by Richard Thaler, a behavioral pioneer, and others. (Mr. Thaler and Cass Sunstein recently wrote “Nudge,” a book advocating behavioral policies, and both were informal advisers to the Obama campaign.)

The savings research had found that many more people saved money in a 401(k) retirement plan if they didn’t have to take active steps to join the plan. In one study, only 45 percent of a company’s new employees participated in the 401(k) when doing so required them to take some kind of action, like filling out a form. Eighty-six percent participated when doing so was the default option.

The new pension law gave companies a small incentive to make employees opt out of a 401(k), rather than opt in. The law doesn’t restrict employees’ choices in any way. It simply encourages a more sensible default. Peter Orszag, Mr. Obama’s nominee for budget director, has called the law “a tangible example of how economic research can be rapidly translated into concrete policy changes that should improve people’s lives.”

Mr. Orszag’s interest in behavioral work, together with the reach of the budget office, makes it the obvious place for a behavioral maven to be based. An outside committee of experts — a smaller-scale version of the financial crisis board that will be headed by Paul Volcker, the former Federal Reserve chairman — may also make sense. Mr. Obama’s aides have learned that they have a better chance of persuading him of an argument when they tell him that they’ve spoken with the top experts in a given field.

The group would have plenty of work. Take the current policies toward prescription drugs. Right now, Medicare separates hospital insurance and drug insurance into different programs. The insurers running the drug plans, Dana Goldman of the RAND Corporation points out, make more money when they have to cover fewer prescriptions.

The government, on the other hand, often loses money when people don’t take medications for chronic conditions like diabetes and hypertension. Later on, these people show up at the hospital, and Medicare foots the bill.

A more sensible policy would get rid of these perverse incentives and also take into account the reasons that patients fail to take their pills. Mr. Goldman suggests charging an annual fee for a drug, rather than the current system of charging people separately for each prescription refill, which gives them a reason not to get the refill.

To take another example, many laid-off workers remain unemployed for months at a time, out of a mistaken belief that they will be able to find a new job that pays as much as their old one. In the process, they often do permanent damage to their finances. Jeffrey Kling of the Brookings Institution says that the unemployment insurance system could help people get over this psychological barrier by temporarily subsidizing a new, lower-paying job.

A behaviorally savvy Social Security Administration, meanwhile, could help people make better choices about when to start receiving checks. (Many now do so at age 62, the earliest possible date, which is generally a mistake.) The Environmental Protection Agency could redesign fuel economy stickers so that they emphasized the long-term gasoline costs of driving the vehicle. Banking regulators could devise a standard, default mortgage that didn’t involve a teaser rate or other gimmicks.

During the campaign, some liberals criticized the Obama team’s interest in behavioral economics, saying that the field wasn’t ambitious enough to solve today’s biggest economic problems. And it certainly can’t solve the current crisis — or the deficit — by itself. But no one is arguing that the Obama administration bury itself in behavioral research instead of working on the crisis.

The promise of behavioral economics is that it can help create a better government, one that wastes less money and does more to improve people’s lives. That’s hardly a modest goal.

“Everybody is preoccupied, as they should be, with preventing the next Great Depression,” as Mr. Thaler, an economist at the University of Chicago, says. “But it will be important for the administration to have people tasked with thinking long term — like, once it’s not O.K. to spend $100 billion on a whim, how do you get our budget under control?”

E-mail: Leonhardt@nytimes.com