If the boy is father to the man, then I was raised by a profligate dunce. Even though I had learned the power of compound interest in high school, I foolishly squandered my trivial savings at a time when the “eighth wonder of the world,” as Albert Einstein called it, would have had the greatest impact. Had I invested a mere $2,000 in an index fund at the tender age of 22, I would now be $40,000 richer and well on my way to being a millionaire by the time I reach retirement. Economists might say my choice was rational, but it certainly wasn’t optimal.
Fortunately, I had a distant relative–Uncle Sam–that occasionally stepped in to save me from my own economic incompetence. For example, during my first week of Marine Corps boot camp I had to fill out a form in which I had the choice to “opt out” of the Montgomery GI Bill. If I did not check the box I would have $100 a month deducted from my pay for six months and in return I would have $36,000 to use for college. Although several of my fellow recruits chose not to participate, the majority of us took the lazy way out and left the box unchecked. That act of sloth made me $35,400 richer.
My experience was an example of an action taken by what The Economist refers to as the “avuncular state”: “worldly-wise, offering a nudge in the right direction, perhaps pulling strings on your behalf without your even noticing.” Advocates of this form of paternalistic governance include behavioral economists who term such approaches “asymmetric paternalism”, “benign paternalism”, “cautious paternalism”, or as Cass Sunstein and Richard Thaler, two University of Chicago professors who published an intriguing paper on the topic call it, “libertarian paternalism”:
The idea of libertarian paternalism might seem to be an oxymoron, but it is both possible and legitimate for private and public institutions to affect behavior while also respecting freedom of choice. Often people’s preferences are ill-formed, and their choices will inevitably be influenced by default rules, framing effects, and starting points. In these circumstances, a form of paternalism cannot be avoided. Equipped with an understanding of behavioral findings of bounded rationality and bounded self-control, libertarian paternalists should attempt to steer people’s choices in welfare-promoting directions without eliminating freedom of choice.
“Libertarians embrace freedom of choice, and so they deplore paternalism,” note Sunstein and Thaler. “Paternalists are thought to be deeply skeptical of freedom of choice and to deplore libertarianism.” The two groups would appear to be mutually exclusive but the authors argue for a “form of paternalism, libertarian in spirit, that should be acceptable to those who are firmly committed to freedom of choice on grounds of either autonomy or welfare.”
A few examples of how libertarian paternalism can be put into practice are:
* In an attempt to increase savings by workers, a company decides not to ask employees if they wish to participate in a 401(k) plan. Instead, the workers are automatically enrolled unless they specifically choose otherwise. (1)
* “Sin goods”, such as junk food, are often repeatedly purchased in small quantities for short-term consumption. Because people make numerous purchases over the course of their lives rather than, for instance, a single trip to the store to purchase a lifetime supply of potato chips, they can distort their long-term consumption decisions by giving in to small preferences for immediate gratification. A way to correct for this would be to impose a per-unit tax on potato chips to induce people to consume less, and return the proceeds to consumers via a lump-sum transfer or by lowering income taxes or taxes on some non-sin commodity, such as socks. (2)
*Another approach would be to induce people with self-control problems to make “prospective choices”, making choices now that influence their future in-the-moment incentives. One way to implement this would be to impose a high presumptive tax, and then sell licenses (or vouchers) that permit people to buy the good tax-free (or at a reduced tax) in the future. For example, rather than pay $2 per pack on cigarettes, a smoker could buy a “sin license” which might cost $5,000 and entitle the holder to an unlimited supply of cigarettes tax-free. Paying such an upfront fee would require a serious commitment to the habit. (2)
Although these examples are all monetarily based, other illustrations can be found of imposing self-constructed limits in order to increase awareness of choices. The Economist article mentions a program in Missouri that allows compulsive gamblers to add their names to a voluntary blacklist. If the gamblers breach this self-imposed ban by entering one of the state’s riverboat casinos, they face arrest for trespassing and the confiscation of their winnings. Another example is covenant marriage laws that allow couples the freedom to choose to be held to a higher level of marital commitment. Before being able to obtain a divorce, spouses who entered into a covenant marriage limit the reasons they can seek a divorce and often must agree to undergo marital counseling before the marriage can be dissolved.
Although these examples are relatively benign, some people may reject them out of a knee-jerk reaction to any forms of paternalism. Clinging to the naive notion that governments or corporations can be neutral on such matters, they prefer a pure form of libertarianism. But for freedom-loving moralists like me, libertarian paternalism offers an ideal combination of two concepts we normally deplore: libertarianism and paternalism.
If private and public institutions are going to attempt to influence people’s behavior (and they always will), why should they not do so in a way that, as Cass and Sunstein say, “steer people’s choices in directions that will improve their own welfare?” After all, humans are not the rational animals that economists have always presumed us to be. We are often willfully ignorant, intemperate, and prone to inertia. Libertarian paternalism offers a gentle correction; a non-intrusive means of influencing what Nobel-winning economist Thomas Schelling calls the “intimate contest for self-command.”
(1) “Libertarian Paternalism Is Not an Oxymoron”, by Cass Sunstein and Richard Thaler. The University of Chicago Law Review No.4, 2003 [PDF]
(2) “Optimal Taxes for Sin Goods”, by Ted O’Donoghue and Matthew Rabin. Journal of Public Economics, forthcoming.[PDF]