Good Be­hav­iour, Bet­ter Pol­icy

The Economic Times - - Breaking Ideas - Ram Singh

Main­stream eco­nom­ics em­ploys fairly so­phis­ti­cated mod­els to ex­am­ine and pre­dict in­di­vid­ual de­ci­sions. Yet, these mod­els do not do a very con­vinc­ing job on sev­eral counts. For in­stance, sev­eral state gov­ern­ments in In­dia do not al­low the sale of liquor on the first day of the month, even though its sale is per­mit­ted on most other days.

Can such a se­lec­tive ban pro­mote so­ci­etal in­ter­est? More re­cently, the Supreme Court has im­posed a ban on the sale of liquor along na­tional high­ways. Is the ju­di­cial or­der so­cially de­sir­able?

The main ar­gu­ment runs like this: af­ter re­ceiv­ing their salary on the first of the month, many peo­ple will line up at liquor shops and drink away their hard-earned in­come, leav­ing their fam­ily pen­ni­less for the rest of the month. Sim­i­larly, it is be­lieved, easy ac­cess to al­co­hol on high­ways con­trib­utes to drunken driv­ing and raises the count of fa­tal ac­ci­dents. Since it is rather dif­fi­cult to tie the hands of salary-earn­ers and driv­ers, it’s best to take the sirens — in this case, the liquor shops — out of the pic­ture. Or, at least, that seems to have been the logic driv­ing such de­ci­sions. Which is where Richard H Thaler — this year’s win­ner of the No­bel Prize in Eco­nom­ics, and ac­claimed for bring­ing in­sights from psy­cho­log­i­cal re­search to mod­els of in­di­vid­ual de­ci­sion-mak­ing — en­ters the scene. Con­trary to the as­sump­tion of ra­tio­nal in­di­vid­u­als in eco­nomic mod­els, Thaler has ar­gued that peo­ple lack self-con­trol and en­gage in self­de­struc­tive choices: re­gard­ing food and drink, smok­ing, sav­ing for re­tire­ment, and other fu­ture goals.

Ac­cord­ing to the Uni­ver­sity of Chicago econ­o­mist, cog­ni­tive lim­i­ta­tions and other hu­man frail­ties lead to sub­op­ti­mal de­ci­sions. They were, be­lieves Thaler, a ma­jor cause be­hind the US sub­prime cri­sis of 2008-09.

While shop­ping at su­per­mar­kets, peo­ple tend to buy those prod­ucts that first catch their eye, rather than weigh­ing all the op­tions and choos­ing the best deal avail­able. It is for this rea­son that pro­duc­ers of con­sumer goods vie for the most prom­i­nent dis­play spots for their prod­ucts. Mar­ket­ing sta­ples such as ‘Buy one, get one free’ are de­signed to ex­ploit pre­cisely this ‘ir­ra­tional­ity’ of con­sumers.

In con­trast, stan­dard eco­nomic mod­els pos­tu­late that peo­ple don’t need to be saved from them­selves. They are as­sumed to be the myth­i­cal Homo eco­nomi­cus, ‘ra­tio­nal’ folks who make the best pos­si­ble choices by fac­tor­ing in all avail­able in­for­ma­tion and po­ten­tial con­se­quences — im­me­di­ate or in the re­mote fu­ture.

Another strand of Thaler’s re­search high­lights the im­por­tance of the de­fault op­tion: the op­tion that will ap­ply un­less you ac­tively choose some­thing else. Man is a lazy crea­ture, often stay­ing put even when the al­ter­na­tive is more de­sir­able. For ex­am­ple, the chance of choos­ing health in­sur­ance and pen­sion schemes grows sig­nif­i­cantly when they are ‘opt-out’ rather than ‘opt-in’ by de­fault. The seem­ingly gen­er­ous ‘free one-month trial’ ex­ploits such be­hav­iour.

En­ter­tain­ment providers like Ama­zon Prime, Net­flix and Ap­ple Mu­sic of­fer free tri­als that de­fault to an au­to­matic ex­ten­sion, or re­newal, at the end of the trial pe­riod — know­ing well that most won’t bother to can­cel. Stud­ies show that such of­fers re­sult in a sub­scrip­tion rate of as high as 80%. Ad­di­tion­ally, credit card com­pa­nies, in­sur­ers, banks, pro­duc­ers of risky prod­ucts, in­ter­net providers and soft­ware com­pa­nies often use te­dious and in­de­ci­pher­able terms of agree­ment, not just to save them from li­a­bil­ity but to choose a de­fault that favours them.

In their fa­mous book, Nudge: Im­prov­ing De­ci­sions About Health, Wealth, and Hap­pi­ness, Thaler and Cass Sun­stein ar­gue that cog­ni­tive bi­ases can be rec­ti­fied by a suit­able choice of de­fault rules.

The choice of de­fault rules by pri­vate en­ti­ties — credit card com­pa­nies, and in­ter­net and tele­com ser­vice providers — can be reg­u­lated to pro­tect con­sumers’ in­ter­ests. Pub­lic au­thor­i­ties can choose de­faults to shift the di­rec­tion of in­di­vid­ual de­ci­sion-mak­ing as they see fit. This ap­proach, though pa­ter­nal­is­tic, can be sub­tle and non-co­er­cive.

In the In­dian con­text, there is scope to set bet­ter de­fault rules for in­sur­ance con­tracts, in­clud­ing crop and third-party in­sur­ance, and pri­vate loans. The tax au­thor­ity could choose a de­fault in which they de­ter­mine tax obli­ga­tion to the ex­tent pos­si­ble through of­fi­cially avail­able sources, sub­ject to cor­rec­tion by the tax­payer. Such steps can po­ten­tially have out­sized im­pacts on both tax com­pli­ance and rev­enue.

This ‘lib­er­tar­ian pa­ter­nal­ist ap­proach’ has been well-re­ceived by pol­i­cy­mak­ers, in­clud­ing those in Bri­tain and the US. It has led to the set­ting up in sev­eral coun­tries of ‘nudge units’: agen­cies that aim to re­form pub­lic ad­min­is­tra­tion us­ing in­sights from be­havioural eco­nom­ics.

At the same time, Thaler’s ap­proach to pol­icy has raised con­cerns. In aca­demic cir­cles, the ‘lib­er­tar­ian pa­ter­nal­ist’ ap­proach has been crit­i­cised as a new form of ma­nip­u­lat­ing the masses. Some lead­ing psy­chol­o­gists in Europe have ques­tioned the wisdom of sub­sti­tut­ing the men­tal short­com­ings of peo­ple for the men­tal short­com­ings of the State.

From a pol­icy per­spec­tive, the mil­lion-ru­pee ques­tion re­mains: who will nudge the nudger?

The writer is pro­fes­sor, Delhi School of Eco­nom­ics

One more way to nudge and change pol­icy

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