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Behavioural Economics and Legal Research

09 Nov, 2015 GENERAL LAW

CHAPTER IS concerned with the use of behavioural economics in legal research or, in other words, with the field of ‘behavioural law and economics’. This, of course, raises the primary question of what behavioural economics has to do with legal research.


If one takes the view that law aims to regulate human behaviour, one would expect legal scholars to take a natural interest in how people actually behave. Nevertheless, much legal scholarship typically relies on mere intuitions about human behaviour.1 This state of affairs is, while probably not entirely avoidable, problematic insofar as such intuitions based on personal experience are partial, highly subjective and therefore far from necessarily correct.2 From this perspective, behavioural economics, with its pronounced interest in actual human behaviour and, in particular, the approach known as behavioural law and economics, that is concerned with the possible implications of the empirical findings and theoretical insights of behavioural economics for legal issues, seem to hold considerable potential for providing legal scholarship with an empirically-based account of human behaviour. Or, as Donald Langevoort formulates it,



[n]early all interesting legal issues require accurate predictions about human behavior to be resolved satisfactorily. Judges, policy-makers, and academics invoke mental modes of individual and social behavior whenever they estimate the desirability of alternative rules, policies, or procedures. Contemporary legal scholarship has come to recognize that if these predictions are naive and intuitive, without any strong empirical grounding, they are susceptible to error and ideological bias. Something more rigorous is thus expected when normative claims are advanced, and the place of the social sciences has expanded in legal discourse to satisfy this expectation.3


At the same time, the findings of behavioural economics are often invoked against another type of legal scholarship, that is, law and economics scholarship. Although this branch of legal scholarship clearly does have an explicit model of human behaviour, as well as a theory on how people respond to legal rules, it is argued that it relies on overly stylised behavioural assumptions that, when tested empirically, frequently appear at odds with the way in which individuals actually behave. Behavioural law and economics could therefore be regarded as an approach that offers a fruitful middle ground between mere intuitive and strongly idealised behavioural assumptions.4


In discussing the use of behavioural economics in legal research, this chapter devotes particular attention to a distinctive difficulty for the field of behavioural law and economics, that is, the difficulty of translating the findings of behavioural economics to particularised legal settings. This problem is discussed largely through an example related to contract law (see section III.B. below). Also, the question of whether behavioural law and economics is in need of a normative theory of its own is briefly considered, although admittedly more as an afterthought (see section III.C. below). Before addressing these issues, however, it seems apposite to depict some of the main features of the fields of behavioural economics (see section II. below) and of behavioural law and economics (see section III.A. below) in somewhat more detail.


II.  BEHAVIOURAL ECONOMICS


A.  What is Behavioural Economics?


Without offering a strict definition, behavioural economics can be described through its concern with improving the explanatory and predictive power of traditional neoclassical economics (see section C. below) by providing it with psychologically more realistic assumptions on human judgement and decision making (see section B. below), based on well-documented empirical findings that are obtained through a variety of methods (see section D. below).


Behavioural economics has amassed compelling empirical evidence on human behaviour, indicating that individuals do not always behave according to the behavioural norms or predictions of neoclassical, rational choice-based economics. Quite the contrary, in their actual behaviour, a considerable percentage of people violate, in a systematic and predictable way,5 some of the axiomatic or working assumptions of neoclassical economics.6 Indeed, what makes behavioural economics of particular interest is that it does not content itself with stating that real people are much more complex than the model-man of traditional economics, but that it also collects empirical evidence showing in what ways people are more complex.7


B.  Topics and Themes


The research area of behavioural economics is typically divided into research on judgement and choice: how do individuals come to hold certain beliefs and how do they select among alternative options, taking into account the judgements they may have made?8 Within this research area, the main findings of behavioural economics are often roughly described as challenging three types of assumptions typically made in traditional economic models, namely the assumptions of full rationality, total self-control and exclusive self-interest.9


As regards the assumption of full rationality, it appears that, when making probabilistic judgements, individuals do not always conform to the postulates of neoclassical economic theory. Rather than making assessments according to the laws of probability, people frequently rely on simplifying heuristics or rules of thumb. For instance, people tend to assess the likelihood of an event by the rate or ease with which they can imagine or recall such events, seem to be quite insensitive to sample size and insufficiently adjust from often arbitrary initial guesses. While these heuristics usually work quite well, they can sometimes lead to errors, typically referred to as ‘biases’.10 Moreover, individuals do not invariantly act as narrowly self-interested utility maximizers who make choices or decisions in view of a set of relatively well-defined, stable and coherent (pre-established) preferences. Often, people’s preferences appear to be constructed, rather than just revealed, by the way a particular decision problem is framed, by the procedure used to elicit preferences or by the presence of other, seemingly irrelevant, alternative options.11


Frequently, individuals’ preferences appear to be time-inconsistent, as people make choices they regret after the fact and struggle with problems of self-control.12 Finally, people seem to exhibit other-regarding preferences to a greater extent than is routinely assumed or accounted for in traditional economic models.13


In sum, in the words of Richard Thaler, ‘Humans are dumber, nicer, and weaker than Homo Economicus’.14


C.  Relation to Neoclassical Economics


In studying these limitations of traditional economic theory, behavioural economists do not, however, envisage a wholesale rejection of neoclassical economics. To the contrary, behavioural economists are interested in strengthening traditional economic theory. Insofar as some of the foundational or usually relied upon working assumptions of neoclassical economic theory may reflect an inaccurate view of human judgement and decision making, models based on these assumptions can yield erroneous predictions. By increasing the psychological realism of its assumptions, behavioural economists thus hope to enhance the predictive (as well as the explanatory) power of traditional economics.15 In so doing, so-called ‘second wave’ behavioural economics is pushing beyond merely compiling evidence of behavioural ‘anomalies’, but also aspires to develop convincing theoretical accounts of these observed behavioural patterns and, especially, to construct and test (the predictive power of) enriched economic models of behaviour based thereon.16


D.  Methods: Eclectic


Behavioural economists like to describe themselves as ‘methodological eclectics. They define themselves not on the basis of the research methods they employ but rather on their application of psychological insights to economics.’17 While a comprehensive review of these various methods is evidently beyond the scope of this chapter, a short remark on the use of experiments seems in order. Laboratory experiments are an important source of evidence for behavioural economists and continue to be heralded for their ability to control the conditions to which the subjects are exposed. Laboratory experiments are said to allow for specifically testing the variables of interest, while carefully controlling for other possibly intervening variables, so that the observed effect can be fairly confidently attributed to the variable under consideration. However, an oft-heard criticism pertains to the generalisability of experimental findings or their ‘real-world’ or ‘external’ validity. To the extent that this kind of criticism seems justified,18 the methodological eclecticism of behavioural economics appears as an important strength in that the experimentally obtained evidence is frequently combined with empirical studies using (more) naturally occurring data, such as surveys, field studies and field experiments.19 In this respect, the complementary nature of (laboratory) experimentation, field observation20 and theory21 should be stressed.


III.  BEHAVIOURAL LAW AND ECONOMICS


A.  What is Behavioural Law and Economics?


i. In General


As Christine Jolls, Cass Sunstein and Richard Thaler describe it, ‘The task of behavioral law and economics, simply stated, is to explore the implications of actual (not hypothesized) human behavior for the law.’22 Behavioural law and economics scholars are thus interested in the potential significance of the findings of behavioural economics for legal analysis, in extrapolating from and applying (experimental, field and other) evidence and insights generated by behavioural economics to legal issues. For these purposes, behavioural economics’ empirically-based understandings of human behaviour are regarded as instructive not only with respect to the behaviour of individuals as addressees of legal rules, but they are deemed relevant to illuminate the behaviour of all actors involved in the legal system, such as judges, juries, lawyers and legislators.23


ii. Relation to Neoclassical (Law and) Economics


Not unlike behavioural economists, behavioural law and economics scholars frequently define their research agenda in relation to neoclassical economics and more in particular to neoclassical, rational actor-based law and economics.24 In a similar vein, they often declare that behavioural law and economics is not intended to undermine traditional law and economics, but rather to strengthen its underlying assumptions in order to improve its predictive power.25 Not surprisingly then, many of the topics studied by behavioural law and economics scholars bear on topics or assumptions that have a long pedigree in law and economics scholarship.26


iii. Topics and Themes


As a rule, behavioural law and economics scholars are not the methodological eclectics behavioural economists affirm to be. To a large extent, they draw upon the empirical findings and theoretical insights of behavioural economics, rather than on its methods.27 Behaviourally informed legal scholarship generally hypothesises about the applicability of the findings of behavioural economics to legal settings and avails itself of these understandings of human behaviour as a means to understand the law and as arguments to support some prescriptive proposition or normative claim.


On a descriptive level, some scholars invoke the findings of behavioural economics as a way to illuminate the content of the law, interpreting existing legal rules or doctrines as responding to or accounting for certain behavioural phenomena.28


Most behavioural law and economics scholarship is particularly interested in evaluating existing or proposed legal rules in view of how individuals actually behave. Taking into account understandings of how people actually behave can indeed cast a different light on how or whether a particular rule will achieve its intended goals. In this spirit, it is frequently claimed that rules or prescriptions that would seem efficient or effective from a law and economics perspective (based on idealised assumptions on human behaviour) may very well turn out to be inefficient when dealing with real people.29


Finally, many behavioural law and economics scholars seem to regard the findings of behavioural economics as supportive of paternalistic interventions. The gist of the argument is that if people are prone to predictable cognitive errors, if their preferences are constructed so as to become susceptible to manipulation, if they make choices they later regret, then the traditional law and economics’ aversion toward legal intervention may be called into question. This theme is also emerging within the behavioural economics literature itself. While this so-called ‘anti-anti-paternalism’ defended by early behavioural (law and) economics scholars remained a fairly moderate claim,30 recent proposals tend to be more explicitly in favour of paternalistic interventions. In so doing, most behaviourally informed scholars adhere to a kind of ‘light paternalism’31 that is not too restrictive on individual choices and mostly accounts for the fact that the judgement or decision making errors they intend to correct are not universally displayed by all individuals to the same degree,32 such as, most famously, ‘asymmetric paternalism’,33 striving for large benefits for boundedly rational individuals, while imposing little or no costs on fully rational individuals, or ‘libertarian paternalism’,34 endorsing legislative intervention that steers people toward choices that leave them better off, yet without coercion.35 In particular in the area of judgement errors, suggestions are made to deploy the law as a means to ‘debias’ individuals, so as to reduce or eliminate such biases, if possible, rather than to positively interfere with the choices people make.36


B.  Lost in Translation?


i. In General


As mentioned above, behavioural law and economics scholars typically hypothesise about the relevance of the insights on human behaviour generated by behavioural economists to some legal setting in order to evaluate existing or proposed legal rules in view of these behavioural patterns.


However, as Russell Korobkin and Thomas Ulen have observed,



[i]n the early stages of the movement, legal scholars have been able, by and large, to make important strides by hypothesizing that empirical and experimental findings published by social science researchers apply to actors subject to legal commands. To progress beyond the current initial stage of scholarship, legal scholars will have to conduct more empirical and experimental work of their own to test whether these hypotheses are in fact true in the particularized setting they study.37


Indeed, as a rule, research in behavioural economics is not tailored to suit the particular interests of legal scholars.38 As a consequence, the findings of behavioural economists are not necessarily readily usable for legal scholars, especially since contextual factors have been shown to exert an important influence on decision making. Therefore, as regards the evidence on human behaviour obtained in laboratory settings, the high degree of decontextualisation that is often strived for in laboratory experiments39 raises the question as to whether the studied behavioural patterns will play out in the same way in legal settings that are rife with context.40 Similarly, empirical evidence obtained in a given field setting does not as such readily carry over to particularised legal settings. Hypothesising about their applicability in specific legal contexts by mere extrapolation of the experimental/empirical findings of behavioural economics can therefore be hazardous, notably in the absence of more refined theories on when, why and subject to what conditions the behaviour in question is likely to occur.41


In the next section, these problems are illustrated, focusing on a particular example related to contract law, that is, the study by Russell Korobkin on ‘the status quo bias and contract default rules’.42


ii. Example: The Status Quo Bias and Contract Default Rules


In this study, Korobkin is concerned with the question whether the status quo bias and related findings of behavioural economics are also operative in the context of contract default rules, ie terms that will govern the parties’ contract by operation of law if the parties do not contract around them.


a. Potentially Relevant Behavioural Findings


The behavioural findings that are of potential interest to the study are the related findings on the endowment effect and the status quo bias.


The endowment effect or ‘willingness-to-pay (WTP) – willingness-to-accept (WTA) disparity’ pertains to the observation that people frequently are willing to pay significantly less to obtain a particular object than they demand for accepting to give up that same object.43 This finding is usually taken to suggest that people value goods more highly when they are part of their endowment than when they are not part of their endowment – hence the label ‘endowment effect’.44 This finding runs counter to the neoclassical (or even intuitive)45 assumption that, absent wealth or income effects, the maximum amount an individual is willing to pay to obtain a particular good should be approximately the same as the minimum amount the individual would demand in order to give up that same good.


Not only does the endowment effect appear to be one of the most robust phenomena observed by behavioural economists,46 but it bears additional significance for legal analysis insofar as it challenges a centrepiece of law and economics, the Coase Theorem,47 which holds that, in the absence of transaction costs, the initial allocation of an alienable entitlement should not matter for its final distribution, since people will bargain for it, so that the entitlement will end up with the person who values it the most – thus resulting in an efficient allocation.48 However, if the initial allocation of an entitlement affects people’s preferences for it, the ‘invariance claim’ of the Coase Theorem, as well as the host of legal prescriptions that rely upon it may need re-examination.49


The endowment effect is often connected to the so-called status quo bias. The status quo bias refers to the experimental finding that in choosing among alternatives, individuals display a strong tendency to remain at the status quo.50 From this status quo bias, it has been conjectured that, in cases where there is no status quo, people may be inclined to exhibit a preference for the option that is (framed as) the default choice.51 This ‘stickiness of the default option’ has indeed been observed in real-life situations.


An oft-cited example of such a ‘natural experiment’ relates to the different default options adopted by the states of New Jersey and Pennsylvania when they changed their automobile insurance legislation. Both states offered drivers a choice between a cheaper insurance policy with limited rights to sue and a more expensive insurance policy with more expansive rights. New Jersey set the limited rights-policy as default, while in Pennsylvania the more extended rights-policy was the default choice. As reported by Eric Johson et al, at the time of their study, only 20 per cent of New Jersey drivers chose to adopt the extended-rights policy, while approximately 75 per cent of Pennsylvanian drivers retained the extended-rights policy; a finding these researchers also replicated experimentally.52


Another famous observation that is typically referred to as confirming the stickiness of default options, is the study by Eric Johnson and Daniel Goldstein on the percentage of people registered as an organ donor as a function of the default rule across 11 European countries.53 Comparing the part of the population enrolled as organ donors in countries where people are organ donors unless they register not to be (presumed-consent countries) and in countries where people are not organ donors unless they register to be (explicit-consent countries), these scholars observed a registration rate as a donor of almost 98 per cent in the presumed-consent countries, compared to only about 15 per cent in the explicit-consent countries.


These findings on the endowment effect, the status quo bias and the stickiness of default options are often linked as they are generally all understood to represent instances of loss aversion.54 Building on the notion that people evaluate their options in decision problems as changes relative to a reference point, loss aversion expresses the idea that people are more averse to changes that are coded as losses relative to the reference point than they are positively attracted by equal-sized changes that are coded as gains, or simply stated, that losses loom larger than corresponding gains.55 As Camerer observes, the endowment effect, the status quo bias and the stickiness of default options can all be seen as consistent with aversion to losses relative to a reference point: endowing someone with a good, making one option the status quo or default rule seems to establish a reference point people move away from only reluctantly.56


b. Applicability to Contract Default Rules?


However, do these effects also operate in the context of contract default rules? As Korobkin himself notes, the behavioural evidence mentioned above is potentially, but not necessarily, relevant with respect to contract default rules.57 There are two related reasons for this.


First, as an empirical