Thursday, April 3, 2014
I quit (or took a break from) smoking about half a month ago. During that time, I’ve come to understand some of the dynamics of pubs that allow smoking versus those that do not. I’ve realized that these places provide an informative case study for crystallizing a frequent confusion that arises in law and economics discussions, namely the labeling of paternalistic arguments as externality based arguments.
[For those readers who are not familiar with these terms, here are brief and informal definitions. Paternalism essentially refers to the limiting of people’s freedoms to act under the theory that without such limitations these individuals will act in ways that are contrary to their self-interests. Negative externalities refer to costs incurred by (third) parties who did not engage in the activity that caused those costs.]
In my law and economics class, when I ask my students to question whether there is a utilitarian justification for a given rule or practice, they rarely rely on paternalistic arguments. There’s a simple reason for this: I do not teach them much about paternalism, and I do not provide them with any analytical tools to study paternalism. (I explain the concept and discuss how it may affect analyses etc., but never formally cover it.) However, I do teach them about negative externalities.
I have noticed over the last few years that some students, and unfortunately also some law professors, mistake paternalistic arguments as arguments based on negative externalities. Some may call this an unimportant semantic problem; I believe that this problem not only makes it hard for two people to communicate with and understand each other, but it also disguises an argument that relies on the existence of some behavioral problems as one that could exist in a world where every individual is acting completely rationally. Due to this ‘disguising effect’ the rule for which the justification is provided appears to be desirable under a broader set of circumstances than is actually the case.
The policy of banning cigarettes or smoking in pubs provides an excellent example to illustrate this point. Consider two potential rules: (i) the owner of the pub gets to decide whether or not people can smoke in the pub, and (ii) smoking is prohibited in pubs. Imagine that I ask my students to provide an efficiency based justification for rule (ii). That is, are there any reasons to believe that rule (ii) would generate higher social welfare than rule (i)?
The following (hypothetical) dialogue is close to what I had with some of my students in the past (S=student, M=Murat)
M: “Is there a good justification to choose rule (ii) over rule (i)?”
S: “By banning smoking in pubs we’re eliminating the negative externality that smokers impose on non-smokers in those pubs where the owner would otherwise allow smoking.”
M: “Okay. So, let’s step back a second. What is the pub-owner presumably trying to maximize?”
M: “Under rule (i) will he not choose that policy that maximizes his profits?”
S: “I guess so.”
M: “If the negative externalities imposed by smokers on to non-smokers are sufficiently high, would you not, as a profit maximizing pub-owner, choose to compete with smoker-pubs, by opening up a non-smoking-pub, and attract all individuals who suffer great negative externalities in smoker-pubs?”
M: “So under rule (i), if we observe pubs that allow smoking, does this not imply that (1) non-smokers who go to those pubs do not suffer great negative externalities, and/or (2) the competitive process leads to a good distribution of smoker/non-smoker pubs in town?”
S: “Maybe. But, you are making an implicit assumption that need not be true.”
M: “Most likely. What is that assumption?”
S: “That people can accurately tell how much negative externalities they suffer. And more importantly, when there are smoking-pubs, more people tend to become smokers. We’re incentivizing bad-habits.”
M: “Those are excellent points. But, both of these points rely on people not accurately knowing themselves. The first point you raise is basically that people do not accurately estimate the cost of becoming a second-hand smoker, and the second point is that people do not accurately estimate the cost of being a smoker. Is that right?”
S: “Sounds right.”
As this dialogue demonstrates, the hypothetical student starts off by making a negative externality argument and then quickly switches to a paternalistic argument. The distinction is important. Negative externality arguments are valid to the extent that we believe regulatory responses are legitimate ways of protecting people from others. Furthermore, negative externalities can exist in situations where all individuals are rational. Paternalistic arguments, on the other hand, are valid to the extent that we believe regulatory responses are legitimate ways of protecting people from themselves. Perhaps more importantly, problems that give rise to paternalistic arguments commonly require individuals who act irrationally.