Social Welfare and Economic Irrationality

Over at the Economist's Democracy in America:

MIKE Konczal writes:

One of the more curious behavioral responses is that people hate unemployment. They hate not being part of their productive community, they hate not contributing, they hate the loss of identity that one gets as someone who works. To an economist that’s b-a-n-a-n-a-s. Unemployment should be a pleasant vacation! But, last time I checked, it wasn’t (is that consistent with the latest frontiers in happiness research?).

Mr Konczal is contributing to a discussion that's kicked up recently over a paper written by libertarian economists Bryan Caplan and Scott Beaulier, arguing that behavioural economics provides a basis for critiquing government welfare policies. Karl Smith highlighted Mr Caplan's paper as a serious challenge to his neo-classical economic belief structure; other commentors replied that the paper had no data and no mathematical models; Mr Smith responded that often simple, data-free models can be extremely helpful in posing problems and presenting complex ideas intuitively, and cited the example of Paul Krugman's famous essay on the babysitting co-op with its crystal-clear workaday picture of how a Keynesian liquidity trap works; Mr Krugman jumped in with his favourite simple, low-on-data papers, including David Hume's thought experiment “Of the Balance of Trade” and Evsey Domar's paper grounding slavery and serfdom in land surpluses and labour shortages. (I love this stuff. Blogs are the greatest thing to happen to intellectual life in the early 21st century; one day we'll look back on them as a latter-day Bloomsbury.)

Mr Caplan is taking up a problem for conservative critics of the welfare state who take a neo-classical economic perspective. From a neo-classical perspective, he says, giving people more choices (by giving them money, preference in university admissions, health care and so on) always makes them better off. So how can welfare hurt the poor? He thinks behavioural economics, which shows us how people often (usually, even) make decisions that are irrational from a classical economic perspective, can provide the answer:

A simple numerical example can illustrate the link between helping the poor and harming them. Suppose that in the absence of government assistance, the true net benefit of having a child out-of-wedlock is -$25,000, but a teenage girl with self-serving bias [unrealistically optimistic and overconfident] believes it is only -$5000. Since she still sees the net benefits as negative she chooses to wait. But suppose the government offers $10,000 in assistance to unwed mothers. Then the perceived benefits rise to $5000, the teenage girl opts to have the baby, and ex post experiences a net benefit of -$25,000 + $10,000 = -$15,000.

Mr Konczal responds that the fact that people are economically irrational shows us precisely why government safety-net programmes are necessary.