Look Back in Regret

How our fondness for instant gratification challenges conventional economic thinking.

Listener: 5 May, 2007.

Keywords: Health; Social Policy;

You go into the bar for a couple of drinks. The following morning you can’t remember how many you had, but your head and throat wish you had not.

What intrigues an economist is that while with hindsight you regret the outcome, you appeared to be making a rational decision at each purchase. It is not the regret you might have had if you were stopped for a breathalyser test on your way home. Economists assume there that you made a calculated gamble that you would not be stopped, and you lost.

In this case, despite having learnt nothing new, you regret the drinking decisions. Moreover, you knew when you walked into the bar that if you drank too much, you’d regret it.

We could label the behaviour “addictive” or the result of “instantaneous gratification”, but economists use the clumsier, though less judgmental, expression “time-inconsistent decision-making”. This is not the fickleness of someone who keeps changing their mind. The concern is when they regret their decision, despite having appeared to be rational when they made it, and there having been no new relevant information since.

Normally, we assume rationality: that one does not subsequently change one’s mind if there is no reason to do so. Provided nothing changes, the standard public decision procedure (cost-benefit analysis) gives exactly the same conclusion if it is made at a later time. Consider the mess if any decision depended on when it was made. Yet that seems to be what the remorseful drinker has done.

In recent years, economists have drawn on psychology to model time-inconsistency. The approach I like involves, in effect, two time-discounting rules, both of which are “rational” and time-consistent.

But together they result in time-inconsistency. It is almost like having two decision centres in the brain, one of which carefully judges long-term benefits while the other looks only at immediate returns.

Combining them leads to poor-quality decisions (no wonder drunks have headaches).

Time-inconsistency is not peculiar to drinking alcohol. If the economists’ theory is true, it must apply to a wide range of activities, not all of which are “sinful”; over-indulging in salted peanuts often appears in economists’ accounts. Were more economists female, perhaps it would be chocolate.

Intriguingly, the welfare of the time-inconsistent individual can be improved by taxing the over-consumed product. (Think how much physically better off you would be in the morning if a tax on alcohol had raised the price sufficiently to cut back your unplanned drinking.) This is different from the case for taxing alcohol to cover social costs not charged in the production price of the product. It applies to products for which there are no such “externalities” – even salted peanuts and chocolates.

This might suggest a case for taxing everything where there is instant gratification – which may be near enough to everything. I would be more cautious. Economists (and politicians and taxmen) are not that clever when it comes to making the detailed calculations that are required. (There is no evidence that economists are less prone to time-inconsistency.)

Generally, it is better to leave people to make their own mistakes, rather than Big Brother make them for them.

But some consumption has an investment aspect when the benefits (and gratification) take time to eventuate. In such circumstances, time-inconsistent decision-making would result in the regret of not consuming more in the past – of under-consuming. Examples include:
            • not putting enough effort into preventive health care (instead over-eating, not exercising, drinking too much and smoking);
            • under-investing in education (and later suffering from being insufficiently qualified);
            • not saving enough when one is working (so one’s retirement is very restricted).

The logic for subsidising under-consumption is exactly the same as for taxing over-consumption. So we have long subsidised education, and in recent years public spending on preventive health has become a priority.

People also seem to under-save (the complement of over-consuming). The government has recently begun addressing this failure. The KiwiSaver scheme being introduced in July has incentives to join (including a start-up subsidy) and to save systematically. The idea is to lock people into regular savings out of their earnings. With the benefit of hindsight, many will regret that the scheme did not start earlier.