Obamacare and Rational Expectations

Mario Rizzo*

At first glance this may seem to be an unlikely combination of topics. But the puzzle is this. Obama effectively promised Americans a free lunch. Everyone could keep their insurance coverage as it is if they liked it, but new benefits would magically spring from the legislation (See Richard Epstein’s post below.) There would be better coverage (as defined by the government), no exclusion for pre-existing conditions, coverage for “children” on their parents’ policies up to the age of 25, and the abolition of life-time caps of coverage, among other things. In effect, the American people were told that these benefits are free – presumably many thought they would come out of the profits of greedy insurance companies. Of course, now that the costs are beginning to be manifested, many people are shocked. (As a political strategy side-point, didn’t Obama realize that at least some of the costs would be revealed once the scheme got going?)

This is not the first time many Americans have fallen for the free lunch illusion, although given the relative unpopularity of Obamcare many have not in this case. Yet the puzzle remains: Why are people fooled again and again? Where are rational expectations when you need them?

My answer is in two parts. First, the political arena is not the market. In the political arena, the cost of errors made by an individual is zero to that individual. Since, generally speaking, my individual vote or publicly manifested opinion counts for almost nothing in determining whether legislation is successfully passed, my personal errors in understanding the legislation do not affect the costs that will ultimately be imposed upon me. It is very different in the marketplace because if I make a mistake in understanding which washing machine or refrigerator is best for me, I will suffer costs individually.

Second, legislation is often complex – Obamacare is among the most complex laws ever passed. Companies have arisen to help employers understand the implications of the law.  (Of course, they charge for the service.) Relatedly, each promise of a free lunch is different. The patterns of interaction and cost shifting are not exactly repeated in all cases in which the voter is fooled. The rational expectations hypothesis, however, assumes that the structure of the world remains unchanged period after period. If you are experiencing exactly the same “game” over and over, you may eventually learn the structure of the underlying mechanism that producing the outcomes.  But this is not what is happening. The politicians are, in turn, smart enough to complicate matters.  Even when repeated patterns do exist (which they always do at some level), the costs of piercing complexity to find these patterns are high for the typical citizen.

The bottom line is that it is vastly more likely that the public will fall for the free-lunch fallacy in the political arena than in the market place, however imperfect people may be in all aspects of life.


*Dr. Mario J. Rizzo is associate professor of economics and co-director of the Austrian Economics Program at New York University.  He received his BA from Fordham University, and his MA and PhD from the University of Chicago.  He was also a fellow in law and economics at the University of Chicago and at Yale University.  He currently lectures for the Institute for Humane Studies and is an adjunct scholar of the Cato Institute. Professor Rizzo is also a member of the NYU Journal of Law & Liberty's Board of Advisors.