TOM GINSBERG:
Thanks to all of you
for coming to what is
really one of the highlights
of our academic year here at
the University of Chicago Law
School-- the year's annual
Coase Lecture, named
after our former colleague,
our late colleague, who
is the only professor
on our faculty
ever to win a Nobel Prize.
And we couldn't
have a better person
to give the lecture
for this year
than one of our most
distinguished graduates,
which is William Hubbard.
William is a 2000 graduate
of the law school.
He then went on to practice
law for Mayer Brown
for several years before doing
a Ph.D. Across the midway
with Gary Becker, and
he the perfect person
to come give us a lecture
on law and economics.
He's a lawyer's lawyers,
an economist's economist,
and I think we're going
to find out if he's
the physicist's physicist.
William.
WILLIAM HUBBARD: Thank
you Dean Ginsberg,
and thanks to you and to Mike
Shield for the opportunity
to speak here today.
And thanks to all of you for
joining me for this event.
What I'd like to do today
is provide a very brief
introduction to some
basic principles
of law and economics.
But first what I'd like to
do is talk about physics.
And let me begin by
apologizing if there are
any physicists in the audience.
I'm pretty sure that
over the next hour,
I'm going to make a complete
hash of your life's work,
but I assure you that
it's for a good cause.
So let me begin by saying
that we're probably
all familiar from
grade school with some
of the basic concepts of
physics-- force, mass,
acceleration, the distinction
between energy and matter,
how certain types of energy,
such as light and sound,
travel in waves,
and how matter is
composed of constituent
particles known as atoms.
These are among the
fundamental principles
of what we call classical
or Newtonian mechanics.
Now, although
Newtonian mechanics
has been successful
at describing
the interactions of most of
what we see in the world,
it breaks down when we start to
look at the tiniest constituent
particles of the universe--
subatomic particles.
Once we no longer look at
matter in the aggregate,
but focus on its smallest
individual components,
the world starts
to look quite a bit
different from what the
classical model would predict.
Matter behaves like energy.
Energy behaves like matter.
Particles behave like waves
and waves like particles.
Or perhaps more accurately,
particles are waves.
Two things can be in the
same place at the same time,
and one thing can be in two
places at the same time.
Or perhaps more accurately,
nothing is anywhere
until you look at it
and then it's somewhere.
So here are three concepts
that are all fairly
fundamental to quantum physics.
I certainly can't
tell you much more
than that about quantum physics.
But here are three concepts,
and importantly, each of them
distinguishes quantum mechanics
from Newtonian mechanics
in a different way.
I will refer to them as
the uncertainty principle,
the correspondence principle,
and the quantum principle.
I'll start with the
uncertainty principle.
Now, probably the most familiar
term in all of quantum physics
is the Heisenberg
uncertainty principle.
Now, I'm actually not
going to talk about that.
What I'm going to describe
is something else,
but it's often mistaken for
the Heisenberg principle.
It's a more general uncertainty
principle that's also
important in quantum physics.
The uncertainty principle
states that it's
impossible to know
everything you'd like to know
about a particle's behavior.
It's because the mere act
of observing the particle
changes the
particle's trajectory.
To identify a
particle's location,
you have to observe
it, but to observe it,
you have to observe
it with something.
And that process of
observing, therefore,
requires an interaction with
the thing being observed.
So if you look at
this illustration,
there's an electron
traveling along
and you're trying to observe it.
So you're looking
at it with photons.
But the photons interact
with the electron,
changing the electron's path.
The basic idea here,
then, is that the very act
of observing a system changes
the system's behavior.
Next, the correspondence
principle.
The correspondence
principle recognizes
that Newtonian mechanics
does a pretty good job
of describing the world
that we see and inhabit.
Consequently, the
correspondence principle
states that quantum
mechanics should generate
identical predictions
to Newtonian mechanics
when the system being
observed is large.
Put another way and perhaps
more useful for our purposes,
the correspondence
principle means
that although
Newtonian mechanics is
wrong-- its assumptions
about the nature of matter
are not an accurate description
of the quantum reality--
it is nonetheless the case
that Newtonian mechanics is
an excellent approximation of
the quantum mechanical reality
when we're talking
about activity
at the scale of human society.
For example, a civil
engineer doesn't
need to know anything
about quantum mechanics
in order to build a dam.
Now, I can say this
with confidence
because our own professor, Todd
Henderson, was a civil engineer
and he did build a dam and
he doesn't know anything
about quantum mechanics.
He designed this-- this dam.
This is actually
a picture of it.
He designed the dam that formed
Diamond Valley Lake, which
is the largest man-made
reservoir in Southern
California.
And despite his exclusive
use of Newtonian mechanics
when designing the dam,
I'm happy to report
that it works quite well.
Now, this is not to say
that quantum mechanics is
irrelevant to everyday life.
Quite the contrary.
In fact, I'm confident that just
about everybody in this room
relies on quantum mechanical
engineering every day
of their life-- probably
more often than that.
Every five minutes
or however often
you check your smartphone.
The point here is twofold.
On the one hand,
quantum mechanics
has shown us that
many of the premises
and predictions of Newtonian
mechanics are wrong.
But on the other hand,
while individual particles
may behave in a way that
defies the predictions
of classical theory,
it is also the case
that when we aggregate those
individual particles up
to the level of our
familiar environment
here at the human scale,
classical physics still
gets the job done most of the
time, but not all of the time.
You don't need quantum
theory to build a dam,
but you do need some
quantum mechanics in order
to build a smart phone.
And now the quantum principle.
In our ordinary experience,
we perceive things
like time, space,
and energy as flowing
smoothly and continuously.
Likewise, actions can be
calibrated continuously,
like moving a slider
bar, rather than
only discretely, like selecting
one of a finite number of radio
buttons.
We can always move
a little bit faster,
think a little bit harder.
But at the subatomic
scale, actions
are discrete, not continuous.
Time, space, and motion
occur in indivisible chunks.
It's as if we moved
like this or like this.
Weee-- which would be
pretty cool I think.
But that's how things would
look at the quantum scale
that if we were able to
perceive them that way.
It's as if you could
move not at all
or you could move this much
but not any amount in between.
This is the quantum
principle-- the notion
that certain physical
phenomena occur only
in discrete quantities,
called quanta.
That's where the term quantum
mechanics comes from, in fact.
All right, let's sum up
before we turn our attention
to something that I actually
know something about,
like economics.
So quantum mechanics, it
provides the foundations
for physics at the nano scale.
The uncertainty principle
states that measurement--
the act of measurement--
affects the system
that you're observing.
The act of measurement
affects the observed particles
behavior.
The correspondence
principle suggests
that while Newtonian
mechanics is wrong,
it's none the less of a good
approximation of activity
at the scale of human society,
at least most of the time.
And most fundamentally,
the quantum principle
observes that actions occur
in discrete quantities.
So let's talk about
economics, and I'll
begin with
neoclassical economics.
The methodology of
most of the work that's
been done in law and economics
over the last half century,
and in particular, most
of the law and economics
that is associated with
the University of Chicago,
is sometimes called
neoclassical economics.
And I'll just highlight a few of
its most salient features here.
Perhaps the most central
characteristic-- certainly
the most often
criticized characteristic
of the neoclassical
approach-- is the assumption
that people behave rationally.
In formal, mathematical
models of behavior,
rationality often takes
the form of the assumption
that actors are
able to calculate
with infinitesimal
precision at zero cost
the optimal course of action.
This, obviously, is
unrealistic, but it's
important to understand
that this strong version
of rationality is
employed merely
for the convenience of
mathematical modeling.
It doesn't reflect any belief
on the part of the economist
that this is how
people actually think.
Rather, the concept
of rationality
that describes the
neoclassical economist's
understanding of
human psychology
is something quite a bit weaker.
It's basically that
a rational actor
is somebody who tends
to behave in ways that
will tend to make
them better off
and tends to avoid doing things
that would generally make them
worse off.
Nonetheless, there does
remain a very real danger
that the use of this stronger
version of rationality just
to simplify the math
results in models
that are worse at predicting
actual real-life human
behavior.
One theoretical prediction that
is safe from this criticism,
however, is the law of demand.
The law of demand
states that people
will consume more
of something when
its price is lower and will
consume less of something
when its price is higher.
And importantly,
price is not limited
to the money cost of
that thing, but it
could be a cost in terms of time
or effort or even reputation.
This notion that human
behavior responds
to the incentives created by
prices, broadly understood,
allows economists to generate
useful and consistent
predictions about a wide
array of human behavior,
not just in the realm
of markets, which
has been the traditional
scope of economic analysis,
but a wide range of social,
legal, and political
institutions.
Let me turn now to
behavioral economics.
Let me begin with an example.
Does anyone know why I have a
picture of Gollum on the slide?
Before he was Gollum and
before he had the one ring,
he was Smeagol.
And if you showed
him the one ring
and asked him how much he
valued this iteh-- ah--
he might say it
seems nice enough.
It's probably worth something.
If you gave it to me, I
wouldn't throw it away.
But then you give it to
him and it becomes his,
and soon it's no
longer just a ring.
It is "my precious."
Endow him with the ring
and he will pay everything
in order to keep it.
This is the endowment effect.
Endow a person with
something and suddenly it
becomes more valuable
to him than when
he did not possess it.
It's the most famous
behavioral bias
that has been identified
in the large literature
in behavioral economics.
What is behavioral economics?
Well, again, I'll just
highlight a few features here.
Behavioral economics, like
neoclassical economics,
studies human behavior,
and in particular, the role
of incentives in human action.
But behavioral economics
takes as its starting
point a fundamentally empirical
rather than theoretical
approach.
Drawing on the
methodologies of psychology
and other disciplines,
behavioral economists
have conducted a wide range
of experimental studies--
laboratory experiments,
generally, which
involve people using college
students as subjects.
Now, another notable
difference is
that while neoclassical
economics generally
attempts to identify
equilibrium in markets, firms,
and other social institutions,
most experimental work
in behavioral economics focuses
on the decision-making behavior
of individuals.
What this literature in
behavioral economics has found
is a large number of deviations
from what one might expect
a purely rational actor to do.
I've already given the example
of the endowment effect,
and there are countless others.
I'll describe some
of them later.
But we start to
see as we recognize
these deviations from
what we might expect
a rational actor
to do is the sense
in which behavioral economics
really is quantum economics.
Just as Newtonian
mechanics breaks down
when we look at the constituent
pieces of our universe,
neoclassical
economics breaks down
at the scale of the
fundamental constituent pieces
of our social universe--
individual human beings.
And just as quantum mechanics
provides the nano foundation
for all of physics,
behavioral economics
provides the nano foundations
for all of economics.
And in my view, that's not
the end of the analogy.
Some of the same principles
that motivate and organize
quantum mechanics can help us
understand quantum economics
as well.
Take the uncertainty principle.
Just as the active measurement
affects the observed particle's
behavior, in economics,
the act of measurement
may affect the observed
subject's behavior.
After all, laboratory
experiments
by their very design create
an artificial environment.
This artificiality, to
be clear, is desirable.
So the whole point
of what you're doing
is you're trying to focus
your attention on one
particular aspect or
factor while holding
everything else constant.
But precisely because
lab experiments
examine human behavior
in an artificial setting,
we have to be alert
to the possibility
that the act of
observing these subjects
will change their behavior.
Now, you can imagine there are
many, many reasons for this.
Some of them are more obvious
and some of them are subtle.
Subjects may attempt to
conform their behavior
to what they expect the
experimenter is looking for.
They may simply
feel self-conscious
and behave differently than
they would if they weren't
being observed, and so on.
There's also the
question of stakes.
One might be concerned that
in the laboratory setting,
the amount of money at
stake in the experiment
is too small to give the
experimental subjects the kinds
of costly trade-offs
that they would
face in a real-life situation.
There's a recent working
paper by Tess Wilkinson-Ryan
that looks at experimental
subjects willingness
to breach a contract when
breaching the contract
would allow them to
increase their pay
offs relative to
honoring the contract.
Now, as you probably
already recognized
from this description, what
this experiment is doing
is testing the
neoclassical prediction
of efficient breach, where a
party deliberately breaches
a contract because it's more
profitable to break the promise
than to keep it.
And this experiment entertains
the competing hypothesis
that moral considerations lead
people to keep their promises,
even when neoclassical
theory might predict
that it's inefficient to do so.
In this experiment, most
of the subjects, in fact,
did not breach their
promises, even when
it was in their financial
self-interest to do so.
But what was most
interesting to me--
what was most revealing
about this study--
was one of the reasons
given by a subject
for not breaching the contract.
This is what they
said, and I quote,
"betrayal, for the most
part, was not worth four
to 15 extra dollars."
And in fact, when the payoff
from breaking one's promise
reached the princely sum of
$24, over 72% of subjects
broke their promises.
In other words, while
it is surely true
that moral considerations
lead people to keep promises
that they would otherwise
profit from breaking,
even here we see the operation
of the law of demand.
People respond in
predictable ways
to the incentives
created by prices,
even the price of
a broken promise.
The uncertainty principle
for quantum economics,
therefore, is a caveat
about the external validity
of behavioral
experimental results.
Now, I'll also briefly mention
a second aspect of uncertainty
that arises in the context
of quantum law and economics.
It's simply an
uncertainty about what
it is that behavioral
economics predicts
about real-world situations
involving law and policy.
Without a unifying concept
like rational behavior
or the law of demand,
behavioral law and economics
today provides a wild array
of heuristics and biopsies
that have been identified in
many laboratory experiments.
And in fact, if
you go to Wikipedia
and look up the page called
"list of cognitive biases,"
this is what you get--
169 different biases, some
of them cutting in
different directions.
So the point here
is that great care
is required before moving
from the experimental setting
to the setting of law and
policy because we're not
quite sure what the prediction
is in terms of which way
behavior will be biased.
There's also a
correspondence principle
for law and economics.
In physics, it says that
Newtonian mechanics is wrong,
but it's a good approximation
of the scale of human society
at least most of the time.
For economics, we can say
neoclassical economics is
wrong, but it's a
good approximation
at the scale of human society
at least most of the time.
This presents both Newtonian
economics and quantum economics
with a crucial question-- what
happens when you aggregate
from the level of
the individual up
to the level of firms,
markets, and other aggregate
institutions?
The biases that we observe
at the individual level
may manifest themselves
at the aggregate level
or they may not.
Consider the following--
in a marketplace,
businesses who behave
rationally will do better
than those who are led by
irrational impulses, biases,
or inaccurate heuristics.
Does this mean that markets will
eliminate all cognitive biases?
Well, no.
And helpful here is
a study by John List
who is an economist here at
the University of Chicago.
He replicated one of the
most famous experiments
in the behavioral literature,
which was the coffee mug
study on the endowment effect.
This is where you give a
bunch of college students
a coffee mugs after
you ask them, hey,
you would you buy this
coffee mug for $6?
And they're like $6?
That isn't worth $6.
And then you give them the
coffee mug and say, hey,
now that you have
this coffee mug,
can I buy it from you for $6?
They say, no way.
Absolutely not.
We're keeping this coffee mug.
So that's what these
experiments find.
Now, what List does, though, is
it doesn't run them in the lab.
He goes out into the field.
And what he does is he went
to a collectibles convention
where people were buying
and selling baseball cards.
So there's a market
for baseball cards.
And in this market, some
people are sophisticated repeat
players-- they're baseball
card dealers who are constantly
buying and selling
baseball cards.
And other people are
more casual collectors.
They tend to hang
on to their cards,
but occasionally buy and sell.
Here's what he found.
The sophisticated repeat players
in the market-- the baseball
card dealers-- they didn't
demonstrate any endowment
effect.
They didn't have an
endowment effect with respect
to baseball cards.
Perhaps you might expect
because they're constantly
buying and selling them.
They didn't even have an
endowment effect with respect
to coffee mugs.
On the other hand, he
ran the same experiments
with the casual baseball
card collectors,
and he found something
very different.
With them, the laboratory
result appeared in the field.
With the casual collectors, both
with respect to baseball cards
and coffee mugs, there
was an endowment effect
in their behavior.
And that is the rub.
You don't need quantum
mechanics to build a dam,
but you do need
quantum mechanics
to build a smart phone.
The challenge for
law and economics
is figuring out when it is
we're dealing with a dam
and when it is we're
dealing with a smartphone.
So let me describe
now a couple of papers
that represent some of
the latest work that
bears on exactly this issue.
The first paper is a paper
on the endowment effect,
and it's by Jennifer
Arlen and Stephan Tontrup.
It's in the Journal of
Legal Studies, which
is published right here at
the University of Chicago.
It is a laboratory
experiment, very much
in the spirit of countless
laboratory experiments
in behavioral economics.
And it went something like this.
So the subjects
in this experiment
were each given
a lottery ticket.
The lottery ticket
had a 50% chance
of winning-- the flip of a coin.
Literally a flip of a coin.
Some of the lottery
tickets would
win if a coin flip yielded
heads and lose it yielded tails.
Others would win with
tails and lose with heads.
A winning ticket would
payoff eight euros--
this was done in Europe--
eight euros worth about $11.
And the losing ticket
would pay nothing.
Now, after each subject
was given the ticket--
after they were endowed
with the ticket--
they had a chance to trade
their ticket for a ticket
of the opposite type.
So in other words,
if I was given
a ticket that would
win with heads,
I was offered the opportunity to
trade that ticket for a ticket
that would win with tails.
And if I made the trade, I
would get paid a $0.25 bonus.
Doesn't matter
whether I won or lost.
I get paid either way.
It's free money if
you make the trade.
And of course, because
tails and heads
have exactly the same
probability of winning,
one might think a rational actor
would at least most of the time
be willing to make the trade.
On the other hand, the
behavioral prediction
might be that most
of the subjects
would not trade their tickets
because of the endowment
effect.
So what Arlen and Tonrtup found
was a dramatic confirmation
of the endowment effect.
Over 70% of the subjects
refused to trade their tickets.
They said, oh, free money?
No thanks.
I'm happy with my ticket.
Now, then they ran
a second experiment,
and they added a twist.
The lottery tickets
remained the same,
the payouts remained the same,
the bonus for making a trade
remained the same, but there
was one important change,
which was the
subjects themselves
didn't have the final
say on whether or not
their ticket was traded.
Instead, they had an
agent who would make
that decision on their behalf.
Now, the agent was
just another student
participating in the study.
The agents received
compensation as well,
but this compensation wasn't
sharing in the lottery
ticket or the 25% bonus.
They were paid separately.
And whether or not
they got paid was
based on an incentive scheme
that was chosen by the subject
herself.
The subject could choose
whether the agent got
paid if the agent traded the
ticket or if the agent got
paid only if the agent
didn't trade the ticket.
Now, given that we already know
that over 70% of the subjects
would not trade their
tickets, how many do you think
created an incentive for their
agent to trade the ticket?
Well, it turns out
over 75% of them did.
In other words, it's
as if the mirror
act of shifting final
responsibility for the decision
change the subject's behavior
from what the endowment
effect would predict to what
a rational actor model might
predict what they would do.
I think one of the things that
makes this result intriguing
is that the experiment is adding
what might be seen as not only
a little bit of complexity
to the experiment,
but a little bit
of realism as well.
After all, in real life, most
of the major transactions
in which we engage aren't
done-- we don't what
we don't do them on our own.
Rather, we have
agents who help us
to identify a
possible transaction,
negotiate that transaction,
or to consummate and finalize
the transaction.
And we see here the fragility
of this particular behavioral
prediction when one adds
a little bit of richness
to the experimental setting.
But behavioral
effects don't always
go away at the scale of
real-life institutions.
I want to take a look
at a second paper.
This is actually
by a JSD student
here at Chicago
named Adi Leibovitch.
Now, there's a
particularly puzzling issue
in criminal sentencing, and
one example of it I'll just
give here, which is that
in study after study,
researchers have found that
minors who are sentenced
in the juvenile
justice system rather
than in the regular
criminal courts
receive longer sentences
than those sentenced
in the regular criminal
courts for the same crime.
In other words, the
juvenile justice system--
an alternative mechanism
for sentencing of minors--
is actually leading
to harsher outcomes
for those minors
for the same crimes
relative to the regular
criminal justice system.
Now, how can this seemingly
bizarre effect arise?
Well, the hypothesis is
that behavioral economics
can explain this.
It's an example of
the contrast effect.
The idea here is that because
judges in the juvenile justice
system generally
encounter a baseline set
of cases that are relatively
mild in severity in contrast
to what they usually
see, those cases that
are on the borderline between
the juvenile justice system
and the regular criminal
system seem very severe
and are treated according.
On the other hand,
for judges who
are in the regular
criminal courts,
the baseline set
of cases that they
encounter on a regular basis
are relatively severe cases.
And so when they
encounter a case involving
a juvenile that's right on that
line between going to juvenile
court or going to the
regular criminal courts,
those cases seem
relatively mild.
Now, this is a
clever hypothesis,
but how do you test it?
Now, this is a hard question
to answer empirically.
If you simply look
at juvenile courts
and regular criminal
courts, there
are all sorts of differences
that might explain
this difference in outcomes.
For example, for all
we know, it could just
be that the kinds of people who
want to become juvenile court
judges are just
really mean people
and that's what's driving this
difference that we're finding.
It could be all sorts of things.
So what we would
really like to see
is something like an
experimental setting where
we can hold other
things constant
and just change one
factor, one attribute,
and see if that
makes a difference.
But because of the
uncertainty principle,
we worry about the external
validity of simply running
an experiment.
We'd rather look
at real-life data.
What we would want to
do if only we could
would be to take two
sets of judges who
are the same types of judges.
They work in the
same courthouses.
They see the same
sets of defendants.
They apply the same law.
And they differ only
in one key respect,
which is their baseline exposure
to cases of different severity.
So what Leibovitch does
is she takes judges
from the Pennsylvania
State Courts.
Now, these judges are
elected, and so she
focuses on the set
of judges who are all
elected at the
same time and they
serve in the same courthouses
and they apply the same law--
all Pennsylvania Law--
in the same communities,
drawing defendants from the same
potential pool of defendants.
But, and this is the key, during
their first few weeks or months
on the bench, just
by random chance,
some judges will happen
to get a mix of cases that
include more serious crimes.
And again, just
by random chance,
some judges will get a
mix of cases that happen
to have less serious crimes.
It's as if an
experimenter were randomly
assigning these judges
to higher or lower base
lines of criminal severity.
Now, of course, over time, as
they see more and more cases,
the case loads of each
judge will even out.
So once the case loads even
out, you can ask the question
does this early exposure
to either a high baseline
or low baseline change
the sentencing behavior
of the judges when two judges
with different baselines
have to sentence defendants
for the exact same crime?
Does having a different
baseline affect your sentence
for the exact same crime?
Well, the answer is no, and
it turns out in this data
that a judge who is exposed
to a higher baseline of case
severity will give
sentences that
are 25% shorter than judges
exposed to a lower baseline.
So this is an example
of the contrast effect
in action, not just
in the laboratory
and not even with baseball
cards or something like that.
We're talking about
the incarceration
of our fellow citizens.
These are just two papers, and
there's a tremendous amount
that is left to be
done to understand
the applicability and the limits
of the correspondence principle
in law and economics.
But it should be clear
from these studies
that the stakes are high.
The fact that much remains
to be done, of course,
only poses the question of
how to do it, and to this end,
I'll offer a
hypothesis of my own
that will make up the
third and final parallel
between the principles
animating quantum
mechanics and those
animating quantum economics.
What if we took the
quantum analogy seriously?
What if just as in
the physical world,
actions occur in
discrete quantities,
in economics, cognition,
effort, and attention
occur in discrete quantities.
What if people have
only a finite set
of packets of attention
or cognitive energy
that they can deploy?
They cannot divide these packets
among tasks as tasks multiply.
So here's one of my favorite
images from the television show
The Simpsons.
It's Monstromart, where
shopping is a baffling ordeal.
You know, I think this
is funny because it
taps into one of the strange
ironies of modern life.
How can having more
choices seem oppressive?
The quantum principle
suggests that the notion
of the tyranny of choice
can be a very real thing.
As options multiply, we cannot
simply divide and further
subdivide our attention
and cognitive effort among
an ever-growing
list of priorities.
There's a minimum indivisible
quantum of attention
that we can employ.
As a consequence, some tasks,
some options, some choices,
some threats, some risks
receive our attention--
maybe more than they deserve--
while others are ignored.
Even if in a Newtonian world
we would more optimally
divide our attention among all
of these competing concerns.
Now, one manifestation
of this quantum principle
might be the certainty
effect, which
was identified long ago by
behavioral pioneers Amos
Tversky Daniel Kahneman.
People would rather
eliminate a small risk--
so if you look at risk
one in this illustration,
you're taking that
short bar and taking it
all the way down to zero.
You're eliminating a small risk.
You'd rather do that
than reduce but not
eliminate a very large risk.
So if you look at risk
two, it's a large risk.
You're reducing it by much
more, but you're not completely
eliminating.
Now, given that our
overall objective
is to minimize the
amount of danger
that we're exposing
ourselves to,
this is a terrible preference.
And when thinking about making
choices for regulatory policy
or safety policy, this is
a terrible, terrible policy
preference.
But you can kind of see
the logic to it, can't you?
After all, reducing
the big risk,
even if by a large
amount, still leaves us
with the same number of
risks to worry about.
Eliminating that
small risk means
there's now one less thing
to worry about in the world.
Life has become slightly
less of a baffling ordeal.
More generally, the idea here is
that the cognitive load imposed
by decision making
and multitasking
may be deceptively high.
It's a kind of
internal transaction
cost that introduces friction
into human decision making.
Let me summarize
briefly before I
turn to talk just a little
bit about relativity.
So behavioral economics provides
the foundations for economics
at the nano scale.
The uncertainty principle
for law and economics
is that the act
of measurement may
affect the observed
subject's behavior.
It's a caveat about
the external validity
of experimental results.
The correspondence principle
for law and economics
recognizes that neoclassical
economics is wrong but maybe
a good approximation at the
scale of human activity most
of the time but not
all of the time.
Our challenge is
identifying when
to deploy quantum
economics and when
to deploy Newtonian economics.
And the quantum
principle, I suggest,
may be that cognition, effort,
and attention all occur,
all exist, in
discrete quantities,
and that this may help begin
to rationalize or explain
some of the biases
that we've observed
from behavioral experiments.
Now, just as classical physics
breaks down at the very
smallest possible scales
of matter and energy,
it also breaks down at the
very largest possible scales.
Now, in the interest
of time, I'm
going to talk about
just one concept
from general relativity.
All right, this is Smiley.
It's an image of a
galaxy cluster taken
by the Hubble Space Telescope.
Now, you can see
the bright curves
that seem to form the outline
of the smiley face in the sky.
Those are the distorted
images of distant galaxies.
They've been warped
by a phenomenon known
as gravitational
lensing, which is
a prediction of the theory
of general relativity.
Now, as you may know,
general relativity
holds that mass distorts
space and time itself,
such that gravity can bend
even the path of light.
So if you have a very
distant bright object
like a far away galaxy and
you have a massive object
like a black hole in front
of it relative to your view,
the light from
that distant galaxy
is bent by the
intervening black hole
all around it, creating a warped
image of the far away galaxy.
So to give a more concrete
illustration of lensing,
here's an example
of optical lensing.
If you place the base
of a wine glass in front
of a candle, what you see is
the single image of the candle
becomes distorted
and ultimately you
see a ring of bright
light surrounding
a dark center, which
is of course actually
where the candle is.
This is basically what
gravitational lensing does.
Now, I mentioned black holes,
and as you may already know,
general relativity predicts
the existence of black holes--
objects with gravity so strong
that nothing, not even light,
can escape.
Now, here's an
artist's rendition
of what a large
black hole might look
like if it blocked our view
of more distant galaxies.
Now, if you just attend
to the pattern here,
there's a dark
blotch in the center,
while there are bright
areas above and below.
Now, of course, this is
merely a simulated image
of a black hole.
Of course, we might want
to look for black holes
in the real world.
And so we'd search for
images from satellites.
And here's a satellite
image courtesy of NASA.
Does anyone recognize
this black hole?
This is North Korea.
Does everyone see that?
That's South Korea, that's
China, that's the ocean,
and that thing that looks like
the ocean in the middle, that's
North Korea.
Now, what does North
Korea have to do
with the theory of
general relativity?
Just as Newtonian
mechanics does a good job
of explaining how
things work on earth,
but it doesn't do a good job of
explaining why some stars give
us earth while other stars
collapse into black holes
from which no light can escape.
Newtonian law and economics
does a pretty good job
of explaining how markets work
in well-functioning market
economies, but frankly,
it does a terrible job
of explaining why
some places turn
into well-functioning market
economies and other places
collapse into black holes from
which no light can escape.
And it's not just the
striking visual analogy
that makes Korea useful here.
Just like how the
judges in Pennsylvania
provided a real-life setting
in which researchers could look
at the world as if it were
a controlled experiment,
Korea provides us with the
best and perhaps only such
experiment at the scale
of entire economies.
The great tragedy
of the division
of Korea into two countries
after World War II
has provided to social science
perhaps the most valuable data
point on the question
of why nations succeed
and why nations
fail, to use the name
of a book on
exactly this subject
by Daran Acemoglu
and James Robinson.
So a little bit of history.
Prior to 1948, Korea
was a single country.
It was composed of an
almost perfectly homogeneous
population in terms of
language, ethnicity, history,
and culture.
But in 1948, after the
end of World War II,
Korea was chopped
in half arbitrarily
down the 38th
parallel of latitude.
The line was the product of
a political compromise struck
by the Soviet Union
and the United States.
But for the human beings
actually affected by this,
it might as well have been
random chance-- an experiment.
People on one side
of this line got
one set of legal and
economic institutions.
People on the other
side got a different set
of legal and economic
institutions.
Neither set was chosen
by the people themselves.
Thus, if there's any difference
between North and South Korea
today, the difference
is attributable
to legal and economic
institutions,
and that difference can
be seen quite literally
from outer space.
So if there is
one thing we know,
it is that institutions matter.
Institutions matter to economic
and social development.
Institutions matter
to global poverty
and international human rights.
But make no mistake, there
is no theory of relativity
for law and economics.
There's no theory that
tells us how we get to Earth
and how we get black holes.
We know that institutions
matter, but which institutions?
That's the hard question.
And that is the search for
the theory of relativity.
Take a look at this map.
Our own Adam Chilton and his
co-author [? Mila Vestig ?]
put together this map,
and it shows the extent
to which different countries'
constitutions innumerate
political rights-- things like
freedom of speech and so on.
Darker blue means
more political rights.
Now, legal institutions
may matter,
and constitutional rights are
one type of legal institution.
But I think this map
makes pretty clear
that constitutional
rights standing alone
don't do much work.
Venezuela's constitution
offers more rights
than the United States.
Zimbabwe's constitution offers
its citizens more rights than
Australia's.
And our old friend North
Korea's constitution
protects its citizens with more
political rights than Norway.
In short, while
economists and lawyers
are increasingly convinced
that law and legal institutions
matter-- they matter to
economic development,
they matter to human
rights-- this search has only
begun for answers
to the question
of law's role in development.
All right, I'll just take
a few minutes to reflect.
I think an important lesson
from our examination of quantum
and Newtonian economics
is that all economics
is behavioral economics.
Indeed, behavioral economics
brings economics back
to its roots.
All the way back
to Adam Smith, who
grounded his economic reasoning
in thoughtful observation
of the real world.
Not only of the
rational, but also
of the moral and emotional
aspects of human action.
His contribution of
behavioral economics cannot be
understated.
In the latter half
of the 20th century,
some aspects of
neoclassical economics
became so obsessed with
sophisticated mathematical
modeling that one
would be forgiven
for mistaking economics for a
branch of applied mathematics.
Of course, there were some
neoclassical economists
who never made this mistake.
The University of
Chicago's own Gary Becker,
one of the greatest
economists of the last century
or of any century, used
neoclassical models.
But he never forgot that the
purpose of economic models
was to understand
real-life human behavior.
In the view of Becker and
his countless proteges--
and I include
myself among them--
homoeconomicus is altruistic,
yields to peer pressure,
makes mistakes,
feels loss aversion,
and even succumbs to addiction.
Indeed, Ronald Coase, the
namesake for this lecture,
would have been the first to
say that the messy reality
of transaction costs would lead
real-world behavior to deviate
from the predictions of
simplistic mathematical models.
And in fact, he was
the first to say this.
He said this is the nature
of the firm and other work,
and he won a Nobel Prize for it.
Now, this fact is obscured
by an out-of-context focus
on the so-called Coase
theorem, which is often
stated along these lines-- in
a world of zero transaction
costs, the initial allocation
of legal entitlements
does not matter from an
efficiency perspective.
Now, behavioral law
and economic scholars,
including those as eminent as
our own former law professor
Cass Sunstein, have claimed
that Coase won a Nobel Prize
for the Coase theorem and that
behavioral law and economics
shows that the Coase
theorem is often wrong.
Now, this is unfortunate.
It's unfair to Coase as Coase
won his Nobel Prize, as I said,
for his work on property
rights and theory of the firm.
And in fact, Coase did not even
come up with the Coase theorem.
The author of the Coase
theorem was George Stigler.
Now, this is an example of
Stephen Stigler's law, which
is that no scientific
discovery is named
after its original discoverer.
And in case you're wondering,
Stephen Stigler's law
was discovered by Robert Merton.
More importantly, though, this
claim that behavioral economics
refutes the Coase
theorem misunderstands
Coase's contribution.
Coase had no interest in a
world of zero transaction costs
anymore than he had an
interest in a world of unicorns
and leprechauns.
These worlds don't exist.
Rather, the thrust
of his insight
was that we can
understand deviations
from efficient market structures
and efficient private ordering
if we understand
transaction costs.
And we can sometimes
improve markets
and improve social welfare by
reducing transaction costs.
But what are transaction costs?
What are the costs that
prevent the reallocation
by contract of
initial entitlements
to their most valuable uses?
Well, of course, there are
some obvious ones that we've
known about for a long time.
It takes time and money to find
a contractual counterparty,
to find a buyer or a
seller, but that's not all.
Other factors loom
large, and this is where
behavioral economics comes in.
Cognitive phenomena, such
as the endowment effect,
can inhibit
value-increasing exchanges.
To this extent, therefore,
behavioral economics
is not a refutation
of Coasian economics,
it is Coasian economics.
Now, consider the following--
sophisticated intermediaries
play a crucial role in
the proper functioning
of robust markets, I assert.
And this is so precisely
because intermediaries
attenuate behavioral biases.
Now, think back to that study
with the lottery tickets
where you've got the agent
and you got the bonus
if you traded the ticket.
This study shows that even
unsophisticated agents
performing trivial tasks
can have a dramatic effect
on removing what would otherwise
appear to be a behavioral bias.
Now, of course, in
real life, transactions
are much more complex
than in that experiment.
But then again, in
real life, agents
are vastly more sophisticated
than in that experiment.
And who are these vastly
more sophisticated agents?
They're lawyers.
Isn't that why we're here?
Aren't we here because we
believe that as lawyers we
can do something to improve
the performance of our society,
of our markets, of our
government, of our economy?
Let me say that our
challenge as lawyers-- and we
are the lawyers who will
make the future of law
and economics-- is
to apply to the law
the lessons from
quantum economics
and Newtonian economics
with careful regard
for the principles that
explain their limits
and their application,
such as the uncertainty
principle, the correspondence
principle, and the quantum
principle.
And it also falls upon
us to piece together
a theory of relativity that can
make sense of the role of law
and lawyers, not
just for our society,
but for the future
of this world.
Now, I hope this last hour has
not been a baffling ordeal.
Thank you very much.
PROFESSOR: So we have about 30
minutes or so for questions,
and William, I'll let you
take your own questions.
Please.
STUDENT: So essentially you're
saying efficient markets
eliminate all this behavioral
stuff and [INAUDIBLE]
stuff and the [INAUDIBLE] has
principal in asset pricing, so
arbitrage.
So if you have an
efficient market, that
ought to eliminate
arbitrage opportunities,
you have some cognitive biases.
Just pricing some asset,
the more efficient guy--
the smarter person--
[? coming down ?]
and you have more efficiency
and all the behavioral stuff
will go out the window.
Or not.
WILLIAM HUBBARD: There's a
vigorous debate going on right
now about understanding
financial markets in exactly
this context, which is
you have a set of fairly
crisp predictions
from what I'm calling
the Newtonian or the
neoclassical model,
which is that the
transaction costs--
the traditional
transaction costs, so
the cost of transmitting
information,
the cost of looking
up prices, and so
on-- if those
things are very low,
you might expect the
market to approximate
very closely the prediction
of perfect efficiency
and for things like
irrational biases
and so forth to be
ironed out very quickly
by rational players who
are able to take advantage
of such irrational behavior.
And people who are trading
in an irrational way
will consequently lose
money, and they'll
be crowded out of the market
by people who can make money
by behaving more rationally.
Having said that, ultimately
it is an empirical question,
the extent to which behavioral
biases affect the operation
of financial markets.
And I think it's for
exactly the reason
that I tried to highlight
at the end of my talk, which
is even if the traditional
transaction costs as we think
about them are exceedingly
low in many financial markets,
we have to think about
transaction costs
perhaps more broadly.
And to the extent
that we see attempts
to reduce the computational
or cognitive cost of making
decisions in these contexts
through reliance on signals
from other market
participants, one
of the things that
you tend to see
is herding behavior, for
example, in some markets.
And that can lead to, at least
in the short run-- I don't
think this is necessarily as
big a problem in the long run--
but at least in the
short run, fluctuations
that might be greater than
one would otherwise expect.
But it's exactly
that kind of question
that I can't hope to answer but
that many people are working on
right now, not just
looking at the effect
of whether the market
is efficient in terms
of having low money
transaction costs,
but the extent to which the
computational or cognitive
costs of transactions
are actually affecting
the efficiency of these
markets, especially
in short time frames.
Yes.
STUDENT: So I like that
analogy [INAUDIBLE] small scale
to large scale from quantum
to Newtonian, from behavioral
to neoclassical.
But I wonder if there's
another transition that occurs.
So when I looked at the North
Korea picture you put up,
I thought, yeah, it's
true that on a macro scale
we have a lot of trouble
in neoclassical economics
explaining [INAUDIBLE] we can't
predict which institutions
show up where.
It's random.
So [INAUDIBLE]
the United States.
But I bet you if I
were to be able to walk
around North Korea, I would
see markets everywhere.
And neoclassical
economics would tell me
a lot about what's going on.
So I think what might be a
more accurate description--
and maybe it's also
true about physics
too because the way things
work at a cosmic scale
is a little bit different than
they were at a human society
scale-- is that neoclassical
economics is really good
for that mid level,
where you're just
talking about a bunch of people,
about maybe even a few million
people.
But when you're talking about
a very small number of people
where there's lots of
frictions, behavioral is good.
And at a macro scale, we need
something else entirely--
some theory of institutions
or international relations
or something like that.
Yeah, that's exactly right.
That's exactly right.
And that's exactly
where I feel like we
have to head as an
academic community,
as a legal community.
When you're dealing with
very small numbers of people
or individual decision
makers or people who
are behaving in
an atomistic way,
where they're not
participating in a market,
even if many people are doing
the same thing simultaneously,
you really worry about
this quantum type behavior.
You want to think in terms
of quantum law and economics.
When you're dealing with
markets or communities,
you want to think in terms of
Newtonian law and economics.
And yet, within North Korea,
you can use Newtonian economics
just fine to understand
the kinds of behaviors
that you observe, just
like within South Korea
you can use Newtonian
economics to study markets
and market-like behavior,
the role of prices,
the law of demand, and
so forth just fine.
The analogy there I
think is to relativity
theory is within a
frame of reference--
so you talk about
different frames moving
relative to each other in
a theory of relativity--
within a frame, you can
use Newtonian physics
to explain motion very well.
Where relativity
really comes into play
is when you're talking about
Newtonian frames moving
relative to each other.
So a spaceship moving
at the speed of light
versus somebody remaining
on earth, for example.
Within the spaceship, Newtonian
physics works just fine.
On earth, Newtonian
physics works just fine.
But of course, what happens
is when the people on Earth
look at the spaceship, things
seem to behave very strangely.
And so the idea, the analogy
that would apply here
is exactly the same one.
You can use
neoclassical economics
to explore the way in
which markets arise even
in a totalitarian
state like North Korea.
But in terms of explaining
how do we get countries that
are currently not as prosperous
as we are from there to here,
that's a question that
neoclassical economics really
has struggled with, and I think
that's an area where there's
a lot of work to be done and
new methods may be required.
All right, here's somebody
who probably knows a lot more
about physics than I
do, so I'm worried.
PROFESSOR: Question whether the
analogy can be pushed too far.
I like the analogy, but
here's two worries about it.
One is that quantum mechanics
actually has a theory,
and as your slide with
149 behavioral biases,
there's not really a theory
in behavioral economics.
As you said, it's
really empirical.
You're right.
So the analogy kind
of breaks down there.
The other place where you
might say you pushed to
far is Newtonian
economics, [INAUDIBLE]
had a theory of individual
behavior, namely game theory
and [INAUDIBLE].
And so it has
attempted to explain
that individual interactions,
through that mechanism,
it's not behavioral.
And maybe it fails, but
sometimes it works, and so
it's not the case that
it's truly Newtonian.
It is [? autonomously ?]
as well.
WILLIAM HUBBARD:
Great, thank you.
One of the things I didn't
address in this talk
certainly is game
theory, which you're
right, does model individual
interactions in a way that
relies on what I've
called the Newtonian
or the neoclassical assumption
of rational behavior
but looks at it at a
very individualized scale
rather than at the
scale of entire markets.
I guess what I'll say
about your first point
is I think that's kind of
where I was starting to go
and I didn't want to
spend too much time on it
because I already
had a very long talk,
but I think that's
exactly what the future
of behavioral economics
needs to include,
which is the development
of a theory in the same way
that quantum mechanics
has a theory.
It's not just a
bunch of, wow, look
at these crazy wacky
things that happened.
It's actually,
look, here's a model
that makes
predictions about what
happens at the quantum scale.
And in fact, this
model is so good
that if you-- and this is the
correspondence principle--
if you apply the model
to the macro scale,
it generates the right
predictions as well.
And we're not there yet in
terms of behavioral economics,
but hypothesis-- it's nothing
more than that-- of the quantum
principle is an attempt
to say are there
certain assumptions that we can
make about human behavior that
allow us to generate a
consistent set of predictions
that incorporate a large
number of individual empirical
findings into a
coherent framework
so that we can actually generate
out of sample predictions?
In other words,
predictions that go beyond,
well, we know for
sure that if you
do this with this group of
students with this many coffee
mugs you get this
result, and can say, no,
this is actually how
we should run things.
And that requires both very
rigorous empirical testing,
which has been
traditionally the strength
of behavioral economics
in the laboratory setting,
but also a theory that
gives us a framework for how
we extrapolate from
individual findings
to predictions about
policy and so forth.
So I think in order to
complete the analogy,
I think we need to
demand that there be more
theory on the behavioral side.
And I think in some
sense, the future
is going to have to
be bringing together
some of the tools from
neoclassical economics
with some of the
results that have been
found in the behavioral area.
STUDENT: Thank you
Professor Hubbard
for this thorough report.
I think it was probably
the most educational hour
I've spent at this law
school, and there's
a lot of competition.
So you qualified the
simplistic perhaps opposition
of neoclassical and
behavioral economics,
and I was wondering if you
could elaborate on your points
at the end of the talk
about some of the policy
implications.
Is the sort of [? sunset era ?]
in terms of regulatory policy
broadly correct based
on what you're saying?
Are we supporting
both the cell phones
and non-bursting any dams with
nudging architecture of choice
type approach, or
maybe we need some
more re-emphasis on
command and control
regulations in some cases.
Or perhaps, like you
said, this intermediation
might be going to far
in some instances.
What are some of your
earlier thoughts on this.
WILLIAM HUBBARD:
Wow, I mean that's
a whole other
conversation-- obviously,
a very important set of
questions that all of us
need to spend a lot of
time thinking about.
I certainly can't
offer any specifics,
but I guess what I will say
is that there's two-- in terms
of just the broadest
strokes, I think
that there are two competing
considerations that
cut against each other
in terms of thinking
about the role of
regulation given
the findings of
behavioral economics.
On the one hand, I think there's
this very important insight
which is reflected in Nudge,
you mentioned, and in other work
that choice architecture
is very important.
And this I think
goes to the quantum
principle and the
certainty effect
and so on-- the
number of choices
and the order of the choices,
the structure of the choices
that you present to people will
affect the decisions they make.
The default rules
that you choose
will often determine behavior.
If you change the default rule,
you will change the behavior.
And as a consequence,
it's unavoidable
that people in
positions of power
will have to act as
choice architects
and will have to take
into consideration
these behavioral
economic insights.
And I think most
people often perceive
the insights of behavioral
economics as nudging us,
no pun intended,
in the direction
of greater paternalism
or regulation.
But I think there's
another insight
from behavioral economics
that actually pushes
us a little bit in
the other direction,
and I think that's
typified by the example I
gave of the
Leibovitch paper here,
which is isn't it interesting
that the example that I use
of when the behavioral
effects appear
on the macro scale, the
actors were government agents.
And the concern
that we might have
is that in the context
of government action,
unlike the context
of market action,
there isn't competition
for more rational actors
that can crowd out the
irrational or biased
individuals.
By definition, government only
works if it has a monopoly.
And if there's no
one disciplining you
against the use of irrational
behavior-- and that's
kind of what we worry
about in the judge's paper.
The judges are doing
their level best.
But this is just
a cognitive bias,
and so this bias is manifesting.
itself.
Because there's no forces
that are disciplining
this exercise or this bias.
So on the one hand, there's a
greater need, in some sense,
for paternalism.
But on the other
hand, we have to be
very cautious, because the
government, it's people too.
The government are people too.
And we have to keep
that in mind as we
think about the role of
government and regulation.
Yeah, mm-hm?
STUDENT: Yeah, I also
thought your analogy
was quite stimulating.
But I just want to
point out that, at least
in financial economics, there's
like a Heisenberg Uncertainty
equivalent in
Goodhart's law, which
says that any financial
measure that is also a target,
loses its usefulness
as a measure,
loses its informativeness.
And that is explicable, I
think, by rational behavior,
by regulatory arbitrage and
not by behavioral economics.
So I just wanted to throw that
out as a possible complication
here.
And--
WILLIAM H.J. HUBBARD: Sure.
And I guess I should add, there
are plenty of behavioral biases
that you might say
yourself, look, yeah.
This seems like a real bias.
But as you aggregate behavior
up to the level of markets,
you might say, well, you know,
for an individual it's a bias.
But the bias is
kind of white noise
when we move up to
the level of markets.
And it turns out the
neoclassical models
do very well at explaining
what would otherwise seem
to be something mysterious.
So I certainly
don't dispute that.
And I thank you
for the suggestion.
I'll have to look up
that particular example.
So, Richard?
STUDENT: Yeah, I'm
curious as to why
you'd choose quantum mechanics
instead of dominion biology.
And the explanation
would be as follows.
The biological theory says
that self-interest is not
an accurate model.
There's the literature on
inclusive fitness about how
genes and people interact.
These things
systematically explain
deviations from individual
rational-- like,
the family and small level.
But as you get
larger and larger,
the effects get
smaller and smaller.
So that when you're
dealing with strangers,
it's an ordinary bargain.
And then, you
distribute the wealth
between the family in accordance
with other principles.
And that seems to have
a translation that you
could actually organize.
Whereas the Heisenberg
stuff, you're
going from 10 to the minus 34,
which is Planck's constant,
up to god knows--
[INAUDIBLE] 100 orders
of magnitude in there
on the difference.
It would seem to me
that you'd probably
do better off in trying to
figure out whether or not
biological tendencies
of one kind or another
survive or don't survive
in organized markets.
And I think it would
actually conform pretty well
to what estate planners
think on doing this stuff,
the way in which marriage
markers start to work,
kinship relationships
and so forth.
And so, I'm curious, if you
ever came back for a reprise,
whether that would be a title
that you would want to--
WILLIAM H.J. HUBBARD:
Darwinian law and economics,
and creationism,
law and economics.
[LAUGHTER]
No-- so I'll just say this.
In fact, many economists,
both behavioralists
and neoclassical
economists actually,
have thought about the role that
evolutionary forces might have,
both in the development
of human cognition
and as an analogy
to economic forces.
So I think that's something
that people are thinking about.
And I think it may
be a rich field.
I'll also say something
else which, again,
I didn't include in
the lecture for time.
But beyond behavioral economics
and neoclassical economics,
there are other emerging
methodologies in economics that
may or may not be promising.
But they're certainly
quite interesting.
And one of them might be
called complexity economics
or something like
that, where it looks
at, basically, myopic
interacting agents, whose
interactions lead to
emergent behavior that's
much more complex than
the individual agent's
individual behavior.
And that draws very
self-consciously
from this analogy to
natural selection.
And one of the reasons
why this area of research
might be particularly
relevant to the material today
is this theory of
relativity concept.
How do we get where
we get when the time
scales are extremely large?
And the communities
of individuals
are extremely large?
It may be that models that rely
on simplistic myopic behavior
but large scale interactions
that lead to complex patterns
may be or may not be--
this is the question,
it's all very new-- a
potentially fruitful area.
Yeah, go on.
STUDENT: I want to go
back to David's question
about the unified theory
underlying behavioral
psychology.
I guess, it's well,
I think, to beware,
lest one accept prematurely
a simplifying theory.
We know what happened in the
heyday of the [INAUDIBLE]
groups.
Everyone thought, yay!
We've got the theory
of human behavior.
And it was comforting.
Because it seemed like we
didn't really have much choice
and know how things
worked and so on.
And so, I think
it was comforting
both because it was
simplifying and because it
made the [INAUDIBLE]
that human beings really
don't have much choice.
And so, of course, a
lot of people in the law
went through that wholesale.
And today, of course,
evolutionary tendencies
have taken the place of that.
But I would say, having read
quite a lot of the psychology
of human epics, that
the state of the art
really is that there's very
little that evolution gives us.
It gives us tendencies.
But that those are
interacting with culture
at a very early age.
And the more we know about
the perceptual capacities
of human infants, the
more we will [INAUDIBLE]
cultured impinges.
So the number of
experimental results that
are robustly cross-cultural
is fairly small
and what someone like
Paul Bloom at Yale,
for example, would
say it's, well, we
can tell you about tendencies.
But pretty much
everything interesting
is culture and what we choose.
So I guess I think
there's need for caution,
lest one even assume
prematurely that there would
be such a unifying theory.
And this might be
a little remiss.
WILLIAM H.J. HUBBARD: It's true.
There may be no unifying theory.
Or it may just be that
the unifying theory
is extraordinarily complex.
I tried to look up
the very basic outline
of the standard model
in quantum physics.
And there's nothing
simple about it.
And it may just be that
quantum law and economics,
there's nothing simple
about it either.
I will say that an
important distinction that
draws the line between
behavioral psychology
and behavioral
economics, in my view,
is that part of what psychology
offers that economics doesn't
offer, or at least
shouldn't pretend to offer,
is the ability to explain what
really make individuals tick.
Because so much goes into
what makes individuals
tick that it would
simply be a farce
to be too reductionist about it.
On the other hand, even
if all you're able to do
is extract tendencies,
when you're
talking about the
patterns of behavior
across large numbers of
people, even a tendency
can have a very big effect
on what the aggregate outcome
looks like.
And so, I think economists,
relative to psychologists,
are on their surest footing
when they're talking about,
exactly as you say, tendencies
across large groups of people,
rather than trying
to explain anything
at a highly granular level.
I think, in general,
economics has consistently
done poorly in that respect.
And I think that,
in some sense, it's
simply beyond the
realm of what economics
can attempt to capture.
Mm-hm, yeah?
STUDENT: Well, I
enjoyed the talk.
Thank you.
Physics talk actually has a
very long history in economics.
In fact, it's referred to
as physical [INAUDIBLE].
And one theory is it
speaks to the anxiety
that economists have about their
theories not being [INAUDIBLE]
and predicting as
theoretical physics.
In fact, [INAUDIBLE] in which
he talks about how economics
wholesale-lifted concepts
from physics into economics.
But some of the areas in which
both neoclassical economics,
behavioral economics-- maybe
these approaches probably
could benefit from a
little Darwinian insight.
It could be in no
longer thinking about,
the root of behavior is being in
these atomistic individuals who
are all identical,
whom we can look
at one or some sample of people
and make predictions from them.
Because of the ways
in which humans
live in family relations
where, in fact,
through social norms,
gender roles, and so forth,
there are actually described
sorts of differences
in patterns of behavior,
which then interact with law
and institutions and so forth
and, depending upon context,
will lead to different
types of outcomes.
Which probably just
can't be reduced
to a kind of [? has some ?]
unified theory that
is based on some sample of
how individuals might behave
in certain circumstances.
WILLIAM H.J. HUBBARD: That's
a very interesting set
of observations.
And I guess my response
is kind of yes and no.
And I'll say this, which
is I think, in some sense,
this is an area in which both
neoclassical and behavioral
economics has been
relatively weak.
Many people criticize
neoclassical theoretical
approaches for
being unrealistic.
And yet, if one turns
to behavioral laboratory
experiments, well,
laboratory experiments,
by their very design,
are unrealistic.
And so, the question becomes,
how do we incorporate things
like the effect of social norms
or peer pressure or culture?
And the interesting
thing here, I think,
is it's worth noting
that there are
both behavioral and
neoclassical economists who
are working on trying to
provide exactly that richer
picture of human interaction
that's not purely atomistic
or based on a representative
agent behaving
in a way that purports
to represent a larger
group of people.
In fact, as I mentioned earlier,
some of Gary Becker's more fun
work is about exactly this.
His methodology is neoclassical.
But the questions that
he asked were, well,
how might things
like social pressure
affect the way
that people behave?
He had this kind
of fun paper that
was inspired by-- he went out
to go to eat at a restaurant.
And he saw this long
line at the door
of this very trendy restaurant.
And of course, being the
good neoclassical economist,
he said to himself,
well, that's irrational.
This restaurant should
just raise its prices
and not have a
line out the door.
It could increase its profits.
And the market
would still clear.
So then, he thought to himself,
now, well, wait a minute.
They probably know more
about running a restaurant
than I do-- which is, I think,
the kind of humility that's
appropriate for an economist.
[LAUGHTER]
And so, he took it
upon himself to ask,
can I explain this as
potentially rational?
How could it be that a
restaurant would intentionally
create a line out the door,
rather than simply raise
prices and get a smaller crowd?
And the explanation
he came up with
was actually social
effects, peer effects.
Which is that your
demand for a restaurant
depends on other people's
demand for the restaurant.
And there's this
reinforcing effect
of seeing what other
people do and, then, them
seeing what you do.
And with a low enough price,
if there's enough demand,
the fact that other
people are demanding it
increases your demand for it.
And that's why there's
a line out the door.
But if you raise the price,
demand starts to go down.
That's the law of demand.
But of course, because
demand is going down.
You don't like the
restaurant quite as much,
because it's not quite as
popular as it was before.
And we see kind of a death
spiral for the restaurant
at that point.
And so, the details of the
theory aren't important.
But I think the spirit of
that model is very important.
Because it's saying, we
want to take seriously
the social, the intuitive, the
social, the visceral aspect
of human behavior that's
affected by culture
and community and not just
the dollars and cents,
which is often how neoclassical
models are perceived.
Yeah?
STUDENT: So that
observation leads
me to wonder a
little about, if you
can imagine this kind of
story told about lawyers.
So let's suppose
you're right-- and I
think you are-- that
lawyers push people
toward being rational actors.
Is that necessarily
something that we ought
to unreservedly celebrate?
So to take another
example you didn't use,
but a famous result for
behavioral economics--
if you look at the
way people actually
behave in ultimatum
game situations,
they don't behave
as rational actors.
And my own view is it's really a
terrific thing that they don't.
And if lawyers
are pushing people
toward behaving as rational
actors in situations
like ultimatum games, isn't
that a problem with lawyers?
WILLIAM H.J. HUBBARD: Yeah, OK.
Great question.
So let me begin by
saying, if you actually
look at ultimatum games in the
field rather than in the lab,
neoclassical economics is a
pretty darn good job actually.
STUDENT: Well, that's
a shame though.
WILLIAM H.J. HUBBARD:
No, it is a shame.
I agree.
I think that's a very
important distinction to make
is just because people do
act a certain way doesn't
mean they should.
And to the extent that we
as lawyers are in a position
to influence norms, and if
norms actually affect behavior
in the long run, we
should care about this
"should," not just the "is."
And I think ultimatum
games and dictator games
are a great example.
In the lab, you
give a person $1.
And you say, look, you can
divide this dollar between you
and your partner
any way you like.
And guess what?
Your partner can't
do anything about it.
This is the simpler version.
It's the dictator game.
Your partner can't
do anything about it.
You just decide.
That's the end of the game.
Period.
Full stop.
And what you see is people
giving $0.25 or $0.40
to the other person
out of every $1.
And the result is, hey, look.
People are altruistic.
People aren't these
selfish automatons
like neoclassical
models predict.
But my question is this,
in the real world, whenever
any one of you gets
$1, how much of it
do you give to a stranger?
The next person you
see on the street?
I don't think you
give $0.25 of $0.40.
And I think that's an example
of the uncertainty principle,
the observer effect, in action.
But boy, wouldn't it be great
if these results from the lab
actually showed up in real
life a little bit more.
And I think that
that normative aspect
is an important question.
Now, with respect
to the kind of work
that lawyers do on a more
everyday basis, consummating
contracts and that
sort of thing,
I think the [INAUDIBLE]
experiment is actually
helpful in that respect.
Which is, the
subjects themselves
got to choose what the
incentives of the agent were.
And it's almost
as if the mere act
of giving final
responsibility to someone else
made them think about their
own situation a little bit
differently.
And they say, yes.
I want you, the agent,
to make the trade.
And so, it wasn't necessarily
that the agents were
overriding the subjects belief.
Quite the contrary.
The agents were, in some sense,
consummating some preference
that the subject herself,
in some sense, had.
And the fact that
you have this agent
allows you to overcome the bias.
Having said that,
nonetheless, it
is true that, in some respects,
I do wish, in real life,
I acted more like the
behavioral lab experiments
predict than
neoclassical models.
And I think those normative
questions don't go away,
regardless of what
theoretical system
you use to describe reality.
Yeah?
STUDENT: So the more I listen
to you, the more confused
I get about what worked
this basic distinction
between Newtonian
and quantum physics.
And so, it seems to me there are
three or more dimensions going
on here.
One is the
rationality assumption
in neoclassical economics.
And then, behavioral
economics abandons that.
And in that sense, Becker
really is neoclassical.
And I think [INAUDIBLE] is.
Another is the methodology.
So behavioral, as you said,
it's based on experiments.
Now, neoclassical
doesn't use experiments,
although there's a big
empirical component of it.
And then, there is this
scale, or something
like that, where
you think that--
and here, I'm quite conducive.
It sounds like [INAUDIBLE]
neoclassical economics
explains a kind of middle
scale, not individual behavior
very well, but also not macro
behavior, the North Korea
example.
But in the end, it
just seems to me
that there are a lot of things
that you're trying to explain.
And there are these
different insights that
are more or less productive.
And I want to add that there's
this constant undercurrent
of criticism of the
behavioral side.
So you're actually skeptical
about these experiments,
you said.
Although, except like the
[INAUDIBLE] experiment,
which invalidates the
neoclassical view.
So what is this
distinction actually doing?
And I guess my last point
of behavioral economics
is Coasian economics.
All the Coase I read--
and this was back
in-- so I may not remember it.
Coase' whole point is that
he's attacking [INAUDIBLE],
because he ignores bargaining.
And in all of the
Coasian examples
and in some of this
qualitative empirical work
is bargaining, at least
to the efficient outcome.
He doesn't worry about
behavioral biases or anything
like that interfering
with bargaining leading
to the efficient outcome.
So it's a little
unfair now, whether you
think Coase is whatever,
quantum or Newtonian or both
or a spectre of both
or-- how should we
think about these guys?
WILLIAM H.J. HUBBARD: Well, my
goal here isn't to classify.
I think, ultimately,
physics is just physics.
It's just that we find certain
tools more valuable, more
useful, in certain
contexts than others.
And our use of
these tools should
be guided by
principles that allow
us to deploy the
tools in ways that are
more effective, rather
than less effective.
And really, that's my view
about behavioral economics
and neoclassical
economics as well.
It's not really
about choosing sides.
And one of the motivations
for this lecture,
frankly, is I talk to a
lot of students who are
very interested in economics.
And they say, well,
I'm interested
in behavioral economics.
And I think the idea is,
look, here's Goliath.
It's neoclassical economics.
And here comes David
to take down Goliath.
It's behavioral economics.
We're going to show that
the bad guy is wrong.
And I don't have that view.
Ultimately, it's
all just economics.
And it's all
behavioral economics,
because economics
is about behavior.
And to the extent that
behavioral economics tells us
things that are true, actually
true about human behavior,
then neoclassical economics
has to account for that.
And to the extent that
neoclassical economics offers
methodologies that
allow us to make better
out-of-sample
predictions, then I
think behavioral economics
should incorporate
those elements as well.
So my view is this analogy
is useful for thinking
about the differences
between these
and the features of these
approaches to economics.
But ultimately, just as
is the case with physics,
it's all just physics.
The world works as
the world works.
And we should use the best tools
we can to describe the world.
I would say the same
thing about the economy.
We should use the best
tools that we have
to understand economic life.
And sometimes, very
often, those are the tools
of behavioral economics.
And other times,
very often, those
are the tools of
neoclassical economics.
And I think we have to be
sensitive to the limitations
of each of those approaches.
And I talk about those
a little bit here.
But that's the ultimate
goal, the way that I see it.
[APPLAUSE]
PROFESSOR: So it's part of the
tradition of the Coase Lecture
to introduce the ideas
of law and economics
to the first-year students,
among other things.
And I think
Professor Hubbard has
given the first-years much food
for thought, given all of us
food for thought.
It is now your task,
first-year law students,
to go out and discover
the theory of relativity
and name it after
Professor Hubbard.
[LAUGHTER]
[INTERPOSING VOICES]
But before you go do that,
join us in a reception outside.
Thanks and [INAUDIBLE].
[APPLAUSE]
