By David Henderson
Bad government is itself a product of phishing and phoolishness, for “we are prone to vote for the person who makes us the most comfortable,” even when that person’s decisions are effectively bought by special interests.
This is a quote from Cass Sunstein’s “Why Free Markets Make Phools of Us,” his review of Phishing for Phools: The Economics of Manipulation and Deception, by George A. Akerlof and Robert J. Shiller, in the New York Review of Books, October 22, 2015.
I posted last week on Arnold Kling’s critical review of the book.
Why do I highlight this passage? Here’s why. My Facebook friend Michael Makovi writes:
So basically, Sunstein implies, private individuals acting through markets are likely to make poor, irrational decisions, but voters are just as irrational. It turns out that voters and politicians are subject to all the same cognitive biases as market buyers and sellers.
The difference is that in a market, there are feedback signals, albeit possibly attenuated. If a vendor cheats his customer by holding back information about his product, at least the customer will learn about the product’s faults after he purchases it, and he will buy from someone else next time. The consumer may have cognitive biases, but at least he has the opportunity to learn from his mistakes.
By contrast, there are fewer feedback signals in politics and even fewer opportunities to act on that feedback. One vote barely counts, and an individual must vote for a politician with a range of policies instead of voting for a specific policy. In the market, people can split their “dollar votes” and vote only for those specific products they want. In politics, the vote cannot be split, and a person must take or leave everything. So politicians are more free to continue to peddle shoddy products when they know voters have fewer opportunities to learn from their mistakes.
Meanwhile, markets tend to concentrate benefits AND costs on the consumers who use a specific product. This internalization of costs and benefits promotes learning and feedback. In a market people must bear the consequences of their own actions. By contrast, in politics, benefits are concentrated on those whom the politician wishes to favor – such as financial donors and special interests whose attention is narrowly focused – while costs are dispersed among those whose attention is elsewhere, so that they won’t notice the burdens being imposed on them. The combination of rationally ignorant voters and informed special interests encourages rent-seeking [DRH note: See “Rent Seeking” in The Concise Encyclopedia of Economics for why I think a better term is privilege-seeking] behavior, whereby special interests obtain protection and bounties, with consumers and ordinary voters footing the bill. Private benefit and social cost diverge as the political process encourages the creation of new externalities. Whereas markets promote internalization, politics encourages externalities, and this means there is less feedback and less correction of mistakes.
In fact, in politics, almost everyone bears the costs of government policies that they had no individual influence on. There is virtually no connection between an individual’s actions in the political sector and the costs he or she bears. The public finance is a tragedy of the commons . . .
So yes, consumers are often “irrational” and deceived and make mistakes. But this is true in both politics and markets, as Sunstein himself tells us. The question is, which institutional environment is more likely to promote learning from those mistakes?