Exit, Voice and Misbehavior

Publication of Richard Thaler's Misbehaving has brought renewed attention to behavioral economics and to the "Libertarian Paternalism" advocated by Thaler and his co-author in their 2008 best-seller, NUDGE. In an earlier post, Libertarian Paternalism and the Pantomime of the Rational Actor, Sandwichman expressed deep reservations about the conceptual coherence of the LibPat argument. He compared the incongruous pastiche of rational choice and nudging to a parallel mash-up that occurred in Marxism, as criticized in the late 1940s by Harold Rosenberg.

My co-blogger, Barkley Rosser, claimed that my argument was "substantially the same" as the anti-paternalist libertarian case advanced by Mario Rizzo and Douglas Whitman. Having now read their "Little Brother Is Watching You: New Paternalism on the Slippery Slopes," I can affirm that I am "in league with" those authors' views when they write, "Our claim is not that slippery slopes are the only objection to the new paternalism." Beyond that, my main objections to LibPat are fundamentally different than Rizzo's and Whitman's. I part company with the latter authors at a point where they are still in consensus with Sunstein and Thaler.

Rizzo and Whitman state that their main problem with the libertarian paternalist framework is that "it defines freedom of choice (and libertarianism) in terms of costs of exit, without any attention to who imposes the costs and how [emphasis in original]." The go on to make it clear that they define choice as corresponding to property and personal rights and public policy as a coercive abridgement of those rights.

In other words, Rizzo and Whitman agree with Sunstein and Thaler's narrow framing of choice exclusively in terms of the cost of exit. This is essentially a marketplace definition of choice, as Albert Hirschman pointed out in Exit, Voice and Loyalty. Neither Sunstein and Thaler nor Rizzo and Whitman address the other element of choice: voice.

Turning to Hirschman's classic to borrow his definitions of exit and voice, I realized that Hirschman framed his discussion explicitly in terms of the misbehavior of economic agents. The following passage from the introduction to Exit, Voice and Loyalty proposes a much more satisfactory approach to the "misbehaving" of humans than does the technocratic framing fix of Nudge:

Under any economic, social, or political system, individuals, business firms, and organizations in general are subject to lapses from efficient, rational, law-abiding, virtuous, or otherwise functional behavior. No matter how well a society’s basic institutions are devised, failures of some actors to live up to the behavior which is expected of them are bound to occur, if only for all kinds of accidental reasons. Each society learns to live with a certain amount of such dysfunctional or misbehavior; but lest the misbehavior feed on itself and lead to general decay, society must be able to marshal from within itself forces which will make as many of the faltering actors as possible revert to the behavior required for its proper functioning. This book undertakes initially a reconnaissance of these forces as they operate in the economy; the concepts to be developed will, however, be found to be applicable not only to economic operators such as business firms, but to a wide variety of noneconomic organizations and situations. 

While moralists and political scientists have been much concerned with rescuing individuals from immoral behavior, societies from corruption, and governments from decay, economists have paid little attention to repairable lapses of economic actors. There are two reasons for this neglect. First, in economics one assumes either fully and undeviatingly rational behavior or, at the very least, an unchanging level of rationality on the part of the economic actors. Deterioration of a firm’s performance may result from an adverse shift in supply and demand conditions while the willingness and ability of the firm to maximize profits (or growth rate or whatever) are unimpaired; but it could also reflect some “loss of maximizing aptitude or energy” with supply and demand factors being unchanged. The latter interpretation would immediately raise the question how the firm’s maximizing energy can be brought back up to par. But the usual interpretation is the former one; and in that case, the reversibility of changes in objective supply and demand conditions is much more in doubt. In other words, economists have typically assumed that a firm that falls behind (or gets ahead) does so “for a good reason”; the concept — central to this book — of a random and more or less easily “repairable lapse” has been alien to their reasoning. 

The second cause of the economist’s unconcern about lapses is related to the first. In the traditional model of the competitive economy, recovery from any lapse is not really essential. As one firm loses out in the competitive struggle, its market share is taken up and its factors are hired by others, including newcomers; in the upshot, total resources may well be better allocated. With this picture in mind, the economist can afford to watch lapses of any one of his patients (such as business firms) with far greater equanimity than either the moralist who is convinced of the intrinsic worth of every one of his patients (individuals) or the political scientist whose patient (the state) is unique and irreplaceable. 

Having accounted for the economist’s unconcern we can immediately question its justification: for the image of the economy as a fully competitive system where changes in the fortunes of individual firms are exclusively caused by basic shifts of comparative advantage is surely a defective representation of the real world. In the first place, there are the well-known, large realms of monopoly, oligopoly, and monopolistic competition: deterioration in performance of firms operating in that part of the economy could result in more or less permanent pockets of inefficiency and neglect; it must obviously be viewed with an alarm approaching that of the political scientist who sees his polity’s integrity being threatened by strife, corruption, or boredom. But even where vigorous competition prevails, unconcern with the possibility of restoring temporarily laggard firms to vigor is hardly justified. Precisely in sectors where there are large numbers of firms competing with one another in similar conditions, declines in the fortunes of individual firms are just as likely to be due to random, subjective factors that are reversible or remediable as to permanent adverse shifts in cost and demand conditions. In these circumstances, mechanisms of recuperation would play a most useful role in avoiding social losses as well as human hardship. 

At this point, it will be interjected that such a mechanism of recuperation is readily available through competition itself. Is not competition supposed to keep a firm “on its toes”? And if the firm has already slipped, isn't it the experience of declining revenue and the threat of extinction through competition that will cause its managers to make a major effort to bring performance back up to where it should be? 

There can be no doubt that competition is one major mechanism of recuperation. It will here be argued, however (1) that the implications of this particular function of competition have not been adequately spelled out and (2) that a major alternative mechanism can come into play either when the competitive mechanism is unavailable or as a complement to it. 

Enter “Exit” and “Voice”

The argument to be presented starts with the firm producing saleable outputs for customers; but it will be found to be largely—and, at times, principally—applicable to organizations (such as voluntary associations, trade unions, or political parties) that provide services to their members without direct monetary counterpart. The performance of a firm or an organization is assumed to be subject to deterioration for unspecified, random causes which are neither so compelling nor so durable as to prevent a return to previous performance levels, provided managers direct their attention and energy to that task. The deterioration in performance is reflected most typically and generally, that is, for both firms and other organizations, in an absolute or comparative deterioration of the quality of the product or service provided. Management then finds out about its failings via two alternative routes: 

(1) Some customers stop buying the firm’s products or some members leave the organization: this is the exit option. As a result, revenues drop, membership declines, and management is impelled to search for ways and means to correct whatever faults have led to exit. 

(2) The firm’s customers or the organization’s members express their dissatisfaction directly to management or to some other authority to which management is sub ordinate or through general protest addressed to anyone who cares to listen: this is the voice option. As a result, management once again engages in a search for the causes and possible cures of customers’ and members’ dissatisfaction.