Prof. Bryan Caplan

bcaplan@gmu.edu

http://www.bcaplan.com

Econ 410

Week 13: Systematic Bias Versus the Miracle of Aggregation

I. Return to the "Miracle of Aggregation"

A. Public choice economists, in trying to explain the failures of democracy, often point to voters' rational ignorance.

B. There can be little doubt that voters are highly ignorant.

C. But as discussed earlier, many assert that voter ignorance is quite compatible with well-functioning democracy!

D. Why? If we interpret "ignorance" as "random error," then the Principle of Aggregation kicks in. If you tabulate millions of random errors and take an average, the aggregate acts "as if" it were fully informed. That is the Miracle of Aggregation.

E. So far, so good. But why should we believe that voters' errors ARE random in the first place?

F. On the rational expectations definition of "rationality," non-random (or "systematic") errors are evidence of "irrationality."

G. But - contrary to many economists - merely defining systematic errors as "irrational" is hardly evidence that they don't exist on a wide scale.

II. Rational Ignorance Versus Rational Irrationality

A. What reasons are there to believe that the rational expectations assumption is true?

B. The main argument is that systematic errors are costly, so people try to:

1. Avoid them in the first place.

2. Learn from the systematic mistakes they do happen to make.

C. Big problem here: Some systematic errors are less costly than others, and some can hardly be called costly at all.

D. One of my main ideas: Just as economists think of agents weighing the costs and benefits of information, so too can we think of agents weighing the costs and benefits of rationality. Just as it is sometimes rational to be ignorant (have little information), it may sometimes be rational to be irrational (deviate from full rationality).

1. Psychological interpretation?

E. In other words, we can think of irrationality as a normal good. Why does anyone want this "good"?

1. Big reason: People derive comfort, security, and sense of identity from their belief structure.

2. Moreover, rational thinking is often hard, painful, discouraging work.

3. Indirect reason: Other people you depend on may treat you differently depending on your beliefs.

F. What is the "price" of irrationality? It is the material success that you give up in order to retain systematically mistaken beliefs.

G. Writing down an individual's "demand for irrationality" curve for a given issue is easy. Just put quantity of irrationality on the x-axis, and the implicit price of irrationality on the y-axis.

1. Neoclassical demand for irrationality

2. Near-neoclassical demand for irrationality

H. When the price of irrationality is high - as it often will be - people consume less. Perhaps they consume none at all - on at least some issues, they might be fully rational.

I. When the price of irrationality is low, people consume more. When irrationality is completely free, people stick with whatever belief makes them most happy, however crazy.

J. Remember our old friend, the probability of voter decisiveness?

K. Immediate implication: The expected price of voter irrationality is essentially zero, so we should expect voters to hold highly irrational beliefs!

L. Question: How is this different from expressive voting?

M. Answer: Expressive voting says that people don't really care if policies work. Rational irrationality says people believe their favored policies do work, but have irrational beliefs about what works!

1. Ex: The public reaction to WWI.

III. Irrationality as Political Pollution

A. Economists' efficiency calculations must count the consumption value of irrationality as a benefit. However, this hardly implies an efficient outcome.

B. Why? Voters enjoy the full benefit of their own irrationality, but pay only an infinitesimal fraction of the cost. Each voter subconsciously thinks "My irrationality makes no perceptible difference on policy, so I might as well believe whatever makes me feel best."

C. If enough voters rely on systematically biased beliefs to decide how to vote, disastrous policies may be adopted.

1. Ex: With enough protectionist voters, protectionist policies may prevail.

D. How does irrationality affect policy? Let's consider two simple cases:

1. Case 1: Voters are identical in all respects - including identical near-neoclassical demand-for-irrationality curves.

2. Case 2: Voters are identical except that they have different near-neoclassical demand-for-irrationality curves.

E. Case 1: Voters all want to maximize social income, but also want to believe that protectionism works.

1. On one graph, we can show the unbiased and biased estimates of the wealth-maximizing level of protection.

2. On the second graph, we can contrast the optimal and the winning platforms.

F. Case 2: Voters all want to maximize social income, but the median voter wants to believe that protectionism works.

1. On one graph, we can show the unbiased estimate and the biased median estimate of the wealth-maximizing level of protection.

2. On the second graph, we can contrast the optimal and the winning platforms.

IV. Inefficient Unanimity Again

A. With expressive voting, recall that you can get 100% of people to vote in favor of inefficient policies.

B. The same holds when voters are rationally irrational.

A. Suppose voters are trying to ascertain whether their nation will be able to defeat a hated national enemy.

B. Each voter is willing to pay up to $100 in order to believe that "One patriot can lick twenty foreigners, so victory is assured" If they hold this belief, they vote Yes.

C. But if a majority votes Yes, and war is actually declared, the country will be thrown into a bloody conflict that costs each voter an average of $100,000.

D. So what does each voter decide to believe? Each person believes in his country's invincibility so long as .

E. As long as , then, they believe in invincibility, and accordingly vote Yes.

F. Since everyone is identical by assumption, it follows that as long as , 100% of all voters vote for war.

G. But what is the net per-capita social benefit of war? -$99,900!

H. How is this possible? There are massive externalities of irrationality. Just as all polluters can be better off if everyone polluted less, all voters can be better off if everyone consumed less irrationality.

V. Systematically Biased Beliefs About Economics

A. There are many subject matters where irrational beliefs may lead to inefficient policy.

B. But one subject matter that seems especially interesting for public choice is economics itself.

1. Most policy decisions of modern government have significant economic content.

2. Economists have written about economic misconceptions for hundreds of years - most famously, the French economist Frederic Bastiat.

3. I have done a lot of empirical work on this topic.

C. Data: the Survey of Americans and Economists on the Economy. 1510 members of the general public, 250 Ph.D. economists.

D. Standard method of testing for irrationality: Looking for differences in mean beliefs of laypeople and experts.

E. Complication: Critics of economists claim that it is the economists who are biased rather than the public!

1. Self-serving bias

2. Ideological bias

F. In my empirical work, however, I am able to show that large systematic belief differences persist controlling for self-serving and ideological bias.

G. What main clusters of systematic belief differences emerge?

1. Anti-foreign bias

2. Make-work bias

3. Anti-market bias

4. Pessimistic bias

H. What kinds of inefficient policies could each of these four categories explain?

VI. Availability Cascades

A. Cognitive psychologists have found that people frequently estimate probabilities based upon how easy it is to think of examples.

B. This frequently leads to systematically biased estimates. Psychologists call this "availability bias."

C. This bias is normally demonstrated in simple experiments. But how does it play out in the real world?

D. One fascinating answer (Kuran and Sunstein): The interaction between availability bias and the media leads to a never-ending sequence of mass hysterias. (They call these mass hysterias "availability cascades").

E. The cycle of hysteria:

1. The media gives massive coverage to shocking but rare events in order to get good ratings.

2. The public watches. Watching makes it easier for the public to think of examples of the events the media covers.

3. One effect: Public begins to think the problems are quantitatively serious, so it gets easier to sell the public similar stories.

4. Other effect: Politicians begin trying to solve the "problem" to win votes.

F. Examples:

1. Nuclear power

2. Genetically-altered food

3. Terrorism

G. It is easy to combine this with my rational irrationality approach. Mass hysterias provoke strong political responses but weak personal responses because the price of irrationality is lower in the former case.

VII. Application: Protectionism

A. Public choice economists have typically seen protectionism as a product of special interests taking advantage of the public's rational ignorance.

B. Big puzzle for this theory: Protectionism is popular!

C. My alternative theory: People hold rationally irrational beliefs about trade policy. Politicians offer protectionist policies to get their votes.

D. Empirical support: On the SAEE, the public is much more pessimistic about foreign trade than economists, controlling for everything else.

E. The real puzzle: Why isn't policy far more protectionist than it is?

VIII. Answering Wittman, II

A. To my mind, rational irrationality is the second key pillar of a thoughtful answer to Wittman.

B. Yes, public choice arguments frequently assume "extreme voter stupidity," as Wittman charges. But so what? Voters are in fact extremely stupid!

C. Voter irrationality is both:

1. Plausible in theory

2. Easy to detect empirically on a large scale

D. Key asymmetry between politics and markets: Incentives for rationality. In markets, ignorant actors do their best with what they know. In politics, they scarcely try.

E. Rational irrationality helps explain why politicians cater to voters' prejudices rather than trying to "educate" them. Voters like candidates who share their confusions, not pedants who lecture them.

F. Other supply-side implications?

I. Can rational irrationality breathe new life into old political failures?

1. Pork barrel politics

2. Concentrated interests

3. Bureaucracy

4. Political advertising and special interests