Richard Thaler Explains Behavioral Economics & Public Policy

*H/T Farnam Street For finding this

Richard Thaler outlines how principles from behavioral economics can help policymakers — and managers — achieve better outcomes.

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Q: Could you explain some of the key ideas in Nudge: nudges, choice architecture, and libertarian paternalism?
“Libertarian paternalism” suggests that these two seemingly contradictory terms can actually define a non-contradictory and attractive policy alternative. By “libertarian” we simply mean respecting people’s right to choose, whenever possible. And by “paternalism” we mean caring about the outcomes for people, as judged by themselves. So we would like to create environments where people are more likely to choose things that they, themselves, think are good for them.

Now, the person who is in charge of that choice environment is somebody we call a “choice architect.” There are choice architects in virtually every environment. When a professor teaches a course, he is the choice architect. When somebody puts this magazine together, they will decide in what order the articles appear and what illustrations and photos accompany them that may or may not attract people’s attention. That’s a good example, because people are free to throw the magazine away. They are free to read whatever they want, but the magazine designer will have some influence on which articles they read, and in which order. And what we know is that all kinds of small things, like whether there is an illustration that accompanies an article, will influence whether people read that article. And those small things are what we call “nudges.” So a nudge is any small feature of the environment that attracts people’s attention and alters their behavior but does so in a way that doesn’t compel.

Q: Could you give some examples of where nudges have influence?
Probably the areas that have received the most attention so far are savings and investment. The simplest example of a successful nudge is the default option. A default option is simply what happens if you do nothing. Normally, nothing happens, but sometimes even when you do nothing, something happens. So while I’m sitting here talking to you, if I do nothing on my computer long enough, pretty soon the screen saver will come on. How long it is until that happens was itself a default option that came with my computer that I never changed. What we know is that default options are extremely powerful. Many people just go with the flow and take whatever the default is. That means that the choice architect has immense power by choosing the default, sometimes knowingly and sometimes unknowingly.

A good example is in the area of pension policy. In many 401(k) plans, the default option is not to join. If you are going to join, you have to fill out some paperwork. Some companies have tried the opposite default, which is that you are enrolled unless you fill out some paperwork. We know that speeds enrollment greatly and doesn’t really cost anything. Shlomo Benartzi and I have added to that a policy called Save More Tomorrow, where people are invited to join a plan in which they agree to increase their savings contribution every time they get a raise. That’s another good example of libertarian paternalistic policy. No one is forced to join it. People sign up of their own free will, but in the first company where we did this we more than tripled savings rates.

Q: How is it that nudges haven’t been the norm all along?
They are the norm. We’ve been nudged forever. Eve and the serpent nudged Adam. Religions have been nudging us for thousands of years. Marketers nudge us. Ads are nudges. We can be nudged for good or for evil. There is a company we talk about in the book that pipes the sweet-smelling aroma of their extremely fattening cinnamon buns out into the hall, which acts a bit like the sirens in The Odyssey in terms of drawing people in.

We don’t claim to have invented nudges. What we are suggesting is that in lots of domains, people aren’t thinking about them as much as they should be. Marketers do think about them, but economists are often in charge of many aspects of public policy and they could think about them more.

In the book we distinguish between two types of creatures: humans and Econs. Humans are the people we interact with every day, and Econs are these strange creatures only found in economics textbooks that are unemotional, really smart, and never have self-control problems. If you want to design policies that will work, you want to design them for humans unless you live in a world of Econs, which, if you do, you have my sympathy.

A simple example of a nudge in the politics domain is the brilliant strategy of the Republicans to rename the inheritance tax the “death tax.” Polls show that a majority of Americans are opposed to the death tax and in favor of an inheritance tax. Econs would know that the death tax and the inheritance tax are the same thing. But humans might be in favor of one and against the other. So if you want to repeal the inheritance tax, it’s very smart to call it a death tax.

Q: How do defaults get set poorly in the first place?
The status quo is typically the default. And the choice architect typically doesn’t think very carefully about this. Let me give you an example. In most companies now, there is a period of open enrollment, typically in November, where you get to rethink your benefit package. And at least at the University of Chicago, you’re required to do this online. Of course, some people are going to forget. And the choice architect has to decide what to do with the people who forget. Now, typically there are two options to consider. I call them “same as last year” and “back to zero.” For your healthcare plan, back to zero is pretty harsh. So most places go with “same as last year.” But for flexible spending accounts, where you lose that money if you don’t spend it, many places say, well, I don’t want to presume that people want to put money away since they would lose it if they don’t spend it, so we’ll make that one “back to zero.”

Now, at Chicago I had scheduled a meeting to talk to some of the top administrators at the university about changing the default on the supplemental savings account where you could put in money on top of the usual pension. The default was “back to zero,” and I was suggesting changing it to “same as last year.” It turned out that that meeting occurred on, just by coincidence, the last day that people had to log on and re-enroll, and none of the people at the meeting had yet done that. And that made my case extremely easy.

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