WAEA Keynote Address Behavioral Environmental Economics: Money Pumps & Nudges

For the last twenty-five years I have worked on understanding the behavioral underpinnings of environmental policy. My work has explored how institutions, incentives, and nature interact, with the goal of finding tools to help provide environmental protection at lower cost. The research revolves around a Rule of One: one rational person can move society toward predicted market equilibria; one irrational person can move a game away from the predicted game-theoretic equilibria (Shogren, 2006). This razor’s edge matters for environmental policy because society allocates these resources in a sphere of missing markets or no markets at all. We cannot necessarily rely on one rational person—fictional or representative—in a market to move society closer to efficiency if allocation decisions involve strategic interactions without markets. Assuming rational behavior for environmental policy is problematic when nature’s goods and services lack the active market-like arbitrage needed to encourage consistent choice. Instead, we might need to revisit whether rational choice theory remains the most useful guide for understanding efficient environmental policy, a point long stressed by Jack Knetsch (1990). Perhaps the lessons emerging from the field of behavioral economics should play a bigger role in our work (e.g., Tversky and Kahneman, 1986). The practice of using rational choice theory to model decisions is vulnerable without the social context that either rewards consistent choice or overcomes any inconsistent choices in aggregation (Arrow, 1987). My research focuses on creating the missing institutional context, or “money pumps,” to create rational choice rather than on documenting biases and heuristics. These institutions are designed to help people help themselves by learning what it means to be the rational agents we presume inhabit our models (e.g., Cherry, Crocker, and Shogren, 2003). We designed these money pumps to either extract resources from inconsistent decisions or to lower the transaction costs of consistent