Behavioral Economics and Perverse Effects of the Welfare State

SUMMARY

Critics often argue that government poverty programs perversely make the poor worse off by encouraging unemployment, out-of-wedlock births, and other ‘social pathologies.’ However, basic microeconomic theory tells us that you cannot make an agent worse off by expanding his choice set. The current paper argues that familiar findings in behavioral economics can be used to resolve this paradox. Insofar as the standard rational actor model is wrong, additional choices can make agents worse off. More importantly, existing empirical evidence suggests that the poor deviate from the rational actor model to an unusually large degree. The paper then considers the policy implications of our alternative perspective.