Archive for February 15th, 2008

Using behavioral economics to improve regulation

February 15, 2008

I have pointed out earlier how behavior economic (BE) theories are being applied in macroeconomics and other policy issues (for instance see this on poverty and monetary policy).

I came across this superb paper from the Behavior economic stalwarts– Colin Camerer, Matthew Rabin, George Loewenstein and others. In this paper, they show how BE can be used for regulation.

 The main idea goes like this:

Regulation by the state can take a variety of forms. Some regulations are aimed entirely at redistribution, such as when we tax the rich and give to the poor. Other regulations seek to counteract externalities by restricting behavior in a way that imposes harm on an individual basis but yields net societal benefits. A good example is taxation to fund public goods such as roads. In such situations, an individual would be better off if she alone were exempt from the tax; she benefits when everyone (including herself) must pay the tax.

In this paper, we are concerned with a third form of regulation: paternalistic regulations that are designed to help on an individual basis. Paternalism treads on consumer sovereignty by forcing, or preventing, choices for the individual’s own good, much as when parents limit their child’s freedom to skip school or eat candy for dinner.

So what do they offer?

Our purpose in this Article is to argue that in many cases it is possible to have one’s cake and eat it too. We propose an approach to evaluating paternalistic regulations and doctrines that we call “asymmetric paternalism.” A regulation is asymmetrically paternalistic if it creates large benefits for those who make errors, while imposing little or no harm on those who are fully rational. Such regulations are relatively harmless to those who reliably make decisions in their best interest, while at the same time advantageous to those making suboptimal choices.

Read the paper for further details. It is very lucidly written and shows how BE can be used to make regulation more effective. Though some suggestions like for suicide are going to be very difficult to implement.

Highly recommended.

SEBI regulates art funds

February 15, 2008

The Art Funds have always be in vogue amongst prime investors.

SEBI has issued a statement to regulate these funds. It has specified that only those entities that are registered with SEBI as a Collective Investment Management Company can issue such a fund.

So how do these funds work? Just like any other fund, these funds pool finance from various investors. They invest the proceeds in buying paintings etc (frankly, I do not know what all is included in the art- like for instance, does it include, those statues, clay models etc). These paintings are like the various financial securities (or real assets) in a fund’s portfolio.

Sounds simple? Not really as these are highly illiquid securities. Moreover, unlike other assets, these art securities are limited and much depends on the reputation of the painter. So the market is very limited and is at best left to those who have a lot of money to spare.

Assorted Links

February 15, 2008

1. WSJ Blog discusseswhether Bernanke will be reappointed or not?

2. Krugman points that credit crunch is now hitting students

3. PSD Blog points to the valentine stimulus to the economy.

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