On Behavioral-Environmental Economics Shogren, J. F. and L. O. Taylor (2008). About the authors Jason Shogren Laura Taylor • Stroock Professor of Natural Resource Conservation and Management, Economics & Finance, College of Business University of Wyoming • Prof., Environmental Sciences, Umeå University • research interests revolve around the private motives of public policy • Professor of Agricultural and Resource Economics, North Carolina State University • Director, Center for Environmental and Resource Economic Policy • CEnREP scholars advise and train policymakers and practitioners The authors’ purpose is to expand environmental and resource economics through behavioral economics The authors pose four main questions [p27]: 1. How can behavioral failures affect thinking about environmental policy? 2. When are behavioral failures relevant to the science of environmental and resource economics? 3. Is behavioral failure just another form of market failure? 4. Do we have a new behavioral-environmental second-best problem? How can behavioral failures affect thinking about environmental policy? Behavioral failure is analogous to market failure: Loss aversion Coherent arbitrariness Preference reversal Timeinconsistent Social preference for emotive ideas Bounded rationality, willpower and self-interest • Entitlements, fairness, endowment effects, self-serving bias etc. Externalities Nonrival goods Nonexcludable benefits Nonconvexities Asymmetric information The taxonomy of failures is used to design policies, rules and incentives to reverse the failure ? Liability rules Marketable permits Marketable permits ? ? Collective sharing rules ? Pigovian taxes ? Mechanism designs Behavioral economics explains deviations from “rational choice” theory. When markets are missing or constructed, behavioral failures affect policy outcomes.  Rational Choice Theory Behavioral Economics • Neoclassical framework • Equimarginal rule of efficiency (MC=MB) • WTP = WTA • Market-like arbitrage motivates rational behavior/reverse market failure • People can learn to be rational • Those with complete control offer nothing to others • Nonmarket valuation: WTA > WTP (endowment effect) • Conflict and cooperation: Rules affect/are affected by cognitive bounds • Willing punishers and conditional cooperativesUnderestimation of Risk • Control: In 40% of observed bargains, those in control share their wealth  Behavioral factors influence institutional designs and mechanism designed to manage market failures. • Policy-makers should be interested in how different bargaining rules and protocols affect behavior and outcomes. • Bounded selfishness (altruism) and Pigovian tax design (example on p33): Rational addiction Myopic and timeinconsistent addictive behavior Increased consumption of addictive good Externality resulting from increased consumption Optimal environmental tax > standard Pigovian tax When are behavioral failures relevant to the science of environmental and resource economics? Behavioral failures exist in the tails of the distribution, and potentially in systemic and institutional designs resulting in “nontrivial deviations” from efficiency.  • For relevancy to policy-making, anomalous behaviors ‘must be nontrivial’ • Observed laboratory behavior may not be great predictor of ‘naturally occurring’ behavior in non-lab settings. Rational behavior (?) Behavioral failure Behavioral failure Is behavioral failure just another form of market failure? Cognitive and behavioral biases are extensive. How you relate market and behavioral failures depends on your perspective. Continued market failure Behaviora l failure Market failure • Rationality is individually constructed, hardwired into our DNA. • Rationality is socially constructed through interactions with markets, and exchange institutions. • Rationality spillover perspective sees behavioral failure as a form of market failure. Do we have a new behavioralenvironmental second-best problem? Theory of Second Best: given 2 imperfections, correcting 1 failure doesn’t guarantee increased social welfare “In other words, the absence of any of the jointly necessary conditions does not imply that the next-best allocation is secured by the presence of all the other conditions. […] The second-best scenario may require that other of the necessary conditions for optimality also be absent—maybe even all of them.” Free Exchange (2007) The Economist Assuming market and behavioral failures exist simultaneously, without addressing both could see reduced social welfare, overall. Authors argue for adaptive regulatory schemes to adjust market-failure regulations for behavior failures, as they arise. Nearly impossible to correct all behavioral failures in one mechanism (separability assumption) In Conclusion… Researchers need to keep identifying instances where rational choice theory succeeds and fails. • Environmental and resource economics may suffer if it relies on the standard model of a rational actor, because that model excludes behavioral failures of human nature • BUT behavioral economics evidence is insufficient for a “wholesale rejection” of rational choice theory. Critiques • Are marketable permits really the most effective at correcting behavioral failures? • “Marketable permit systems, provided they are active exchange institutions, could be the most effective behavioral disciplining device, or at a minimum, the institutional design least affected by behavioral failures”  • Evidence may be insufficient for a “wholesale rejection” of rational choice theory- but their recommendation was more about increasing awareness/research and using a strong inference approach. Is this a sufficient response? • Discussion of new (soft) paternalism and related justifications for government intervention into personal choices. • Which behavioral failures that are the most relevant for environmental policy?