Why law and economics' perfect rationality should not be traded for behavioral law and economics' equal incompetence

ABSTRACT

The emerging movement within legal scholarship known as behavioral law and economics seeks to replace the perfect rationality assumption found in law and economics with an equal incompetence assumption. Drawing on empirical research in psychology and behavioral economics, behavioral law and economics scholars assert that all people systematically fall prey to biases and errors in their judgment and decisionmaking and that these biases and errors lead to predictably irrational behavior. In adopting this equality of incompetence view, these scholars argue for changes across virtually all areas of the law and offer new justifications for legal policies that would be deemed paternalistic and inefficient in a system of rational legal actors. Unfortunately, this equality of incompetence view overlooks substantial empirical evidence that people are not equally irrational and that situational variables exert an important influence on the rationality of behavior. A review of the empirical evidence on individual and situational variability in rational behavior reveals that behavioral law and economies' assumption of uniformly imperfect rationality is no more plausible than law and economics ' assumption of uniformly perfect rationality. An empirical approach to rationality places the concept between perfect rationality and equal incompetence. While this middle ground position makes general theory development more difficult, it illuminates ways by which the legal system may foster rational behavior or counter irrational behavior.

INTRODUCTION

A. COMPETING MODELS OF RATIONALITY

A fundamental assumption within the law and economics movement is that "individuals are rational maximizers of their satisfactions in their nonmarket as well as their market behavior."1 In contrast, a fundamental assumption of the new behavioral law and economics movement is that individuals systematically fall prey to a host of "cognitive illusions" that lead to predictable nonrational behaviors both inside and outside traditional markets.2 Thus, whereas law and economics treats all legal actors in all situations as if they were perfectly rational, behavioral law and economics treats all legal actors in all situations as if they were equally predisposed to commit errors of judgment and choice.

Law and economies' perfect rationality assumption is drawn from neoclassical microeconomic theory and is refutable as an empirical matter because empirical studies often find participants whose behavior systematically deviates from economic definitions of rationality. Proponents of law and economics acknowledge this descriptive inaccuracy but retain the assumption for lack of a better alternative for prediction and policy analysis.3

Behavioral law and economies' equal incompetence assumption is drawn, not surprisingly, from behavioral studies of judgment and decisionmaking and arguably reflects the empirical state of the art regarding rational behavior.4 Research from psychology and behavioral economics studies reveals that human judgment and decisionmaking necessarily rely on imperfect psychological mechanisms that cause systematic departures from rationality.5 Because these irrational tendencies are supposedly uniform, pervasive, and predictable, they can be incorporated into behavioral models and used in policy analysis.6 Behavioral law and economics, with its model of bounded rationality, thus promises that superior alternative model so long missing from law and economics-"a more accurate description of human choice than the law otherwise has available, which in turn should improve both positive and normative legal analysis."7

However, the greater realism of behavioral law and economics is more illusion than reality. In fact, as this Article will show, the equal incompetence assumption is not faithful to the empirical data on judgment and choice and, moreover, cannot lay claim to empirical validity superior to that of the perfect rationality assumption. Behavioral law and economics bases its model of bounded rationality on a very limited set of empirical data and draws unsupportable conclusions about human nature from this partial data set. Behavioral law and economics scholars simplify and overgeneralize findings on human cognition and rationality to make these findings seem simultaneously important and simple enough to be incorporated into legal policy. Remarkably, despite the amazing breadth and boldness of many of the empirical claims made by advocates of behavioral law and economics, the validity of these empirical claims has largely gone untested within the legal academy.8

This Article brings to bear a much more complete set of empirical data than that relied on by the behavioral law and economics scholars to demonstrate the dubious empirical status of the equal incompetence assumption and, by implication, the dubious status of the behavioral law and economics movement as currently conceived.9 This more complete data set reveals that individuals differ greatly in their propensities to act rationally and that situations differ greatly in their propensities to elicit rational behavior from individuals. For instance, cognitive performance on particular tasks varies predictably with the decision-maker's emotional state and educational background, and the quality of cognitive performance often depends on the material and social consequences attached to particular decisions.10 This evidence of individual and situational differences in rational behavior argues strongly against the substitution of the equal incompetence model of behavior in the place of the perfect rationality model.