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Behavioural economics - Insights on consumer behaviour may be useful but they should not become a new ideology!

New ideology?

We have seen the ideological ferver which certain movements can take. There is a real danger that this trendy new area of economic thinking will become the fantastic new magic bullit for solving consumer problems in the area of financial services. Like the ideologies of financial literacy and microlending before it, there is a significant risk that public policy be a blinded victim of this new fad from the developing field of psychology.

Unforunately, 'consumer empowerment' is now becoming the underlying philosophy in policy making (one overreliant on the premise that consumers have a duty to discipline the markets!) and ECRC feels that appropriate consumer protection regulation could be potentially threatened if an overzealous overproportional importance is placed on the valuable (but marginal) insights that behavioural economics has to offer.

Below are examples of research explaining how behavioural economics can be called upon to improve regulation. The ECRC calls on moderation and welcomes a debate on the issue and whether is something that will actually help us in achieving responsible credit or responsible saving.

Behaviorally Informed Financial Services Regulation (New America Foundation – Barr/Mullainathan/Shafir, Oct 2008)

Mindspace (UK Institut for Government, 2010)

Behavioral economics: A methodological note (Etzioni, Journal of Economic Psychology, 2010)

Psychological biases may influence consumers to make choices that are neither fully rational nor optimal. These biases could include: mistaken beliefs (assuming penalties will not apply to them); over-optimism about their financial future; over-estimation of one’s financial capabilities (understanding of time value of money and the compound interest the concepts); false prediction of personal preferences into the future (projection bias); short-sightedness (hyperbolic discounting); impulse purchasing and weaknesses in self-control.

While we disagree that these biases could be corrected through solely improving financial literacy, we do see some role in improving the format, content, and context of information because of consumer sensitivity to its presentation. Nevertheless, this cannot be the answer to market regulation! A better understanding of consumer spending habits and design of financial education programs is useful yes, but consumer protection is about much more than only improving policies of consumer information and awareness. A consumer can never be expected to be as informed and as knowledgeable as a professional no matter how much training and education he receives – Financial services markets will always have an imbalance of power, information and resources in favour of the providers and consumers will always be placed at a disadvantage

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Limited usefulness?

The following recent paper Implications of Behavioral Research for the Use and Regulation of Consumer Credit Products (Elliehausen, Board of Governors of the Federal Reserve System FEDS series, 2010) shows how insights are only limited to fixing transparency and clarity issues. It admits that regulators can only learn from behavioural economics in terms of designing disclosures. It warns that just because evidence indicates that credit disclosures are often confusing and that many consumers do not understand them, that this does not imply that disclosure policies are not useful. The report goes on to claim that market failure is not pervasive and that behavioral research is in fact not useful in terms of protecting the consumer from market practices but to help avoid regulatory mistakes! It wrongly asserts that consumers are aware of APR and contradicts the promises of behavior economics by saying that there is only limited evidence suggesting that disclosures could be improved. It looks at the behavioral literature on inter‐temporal choice and decision making under uncertainty and assesses the evidence on behavioral influences affecting consumers’ credit decisions (i.e. that consumers often do not consider all information available in the market nor deliberately evaluate each alternative), and concludes that while cognitive errors and time inconsistent behavior occur, the extent to which these phenomena impair actual decisions in markets is not at all clear: “At this time, neither existing behavioral evidence nor conventional economic evidence supports a general conclusion that consumers’ credit decisions are not rational or that markets do not work reasonably well”.


ID: 46180
Publication date: 28/10/10
   
 

Created: 28/10/10. Last changed: 01/11/10.
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