Good Behaviour, Better Policy
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