Nudge Theory in Action: Behavioral Design in Policy and Markets

This collection challenges the popular but abstract concept of nudging, demonstrating the real-world application of behavioral economics in policy-making and technology. Groundbreaking and practical, it considers the existing political incentives and regulatory institutions that shape the environment in which behavioral policy-making occurs, as well as alternatives to government nudges already provided by the market. The contributions discuss the use of regulations and technology to help consumers overcome their behavioral biases and make better choices, considering the ethical questions of government and market nudges and the uncertainty inherent in designing effective nudges. Four case studies - on weight loss, energy efficiency, consumer finance, and health care - put the discussion of the efficiency of nudges into concrete, recognizable terms. A must-read for researchers studying the public policy applications of behavioral economics, this book will also appeal to practicing lawmakers and regulators.

• Language: English
• Publisher: Palgrave Macmillan
• Release date: Sep 28, 2016
• ISBN: 9783319313191

Book preview

Part I

Theory

© The Author(s) 2016

Sherzod Abdukadirov (ed.)Nudge Theory in ActionPalgrave Advances in Behavioral Economics10.1007/978-3-319-31319-1_2

Overview of Behavioral Economics and Policy

Mark D. White¹ 

(1)

College of Staten Island/CUNY, Staten Island, NY, USA

As philosophers have long recognized, human beings are imperfect and often make bad choices that have a negative impact on themselves and other people. Sometimes we recognize our own mistakes, and sometimes other people bring them to our attention. In the best case scenario we learn from our mistakes, but sometimes we need institutions to guide us to better ones, whether those come in the form of mentors to give us advice on how to live better lives or the state enforcing laws to protect citizens from each other.

In recent years, however, the emphasis of these institutions has changed in two significant ways. First, the focus has shifted from choices and their consequences to how we make those choices in the first place. Psychologists and economists have subjected the process of decision-making to new scrutiny, and their innovative and fascinating research revealed quirks and anomalies in how we process information and weigh options. Idealized models of rational choice are gradually being replaced by new conceptions of decision-making that incorporate empirical evidence of psychological imperfections. Put simply, we seem to know more about why we make bad choices as well as how we might make better ones.

Second, policymakers in government absorbed this new research and began to incorporate it into regulation and policymaking itself. Some uses were oriented toward public policy ends, such as making recycling bins more attractive (to promote proper disposal of waste) and painting flies in urinals (to reduce clean-up costs in public restrooms). ¹ But policymakers also began to use behavioral insights to help people make better decisions for themselves, which can be characterized as paternalistic and is therefore subject to disagreement from those who believe a government’s proper role is to protect citizens from others, not from themselves.

As Gerald Dworkin defines it, paternalism is the interference of a state or an individual with another person, against their will, and defended or motivated by a claim that the person interfered with will be better off or protected from harm. ² While this definition covers paternalistic acts by individuals, the focus of this chapter is on paternalistic interventions on the part of the state. The canonical statement against paternalism was provided by John Stuart Mill in what came to be known as the harm principle:

The only purpose for which power can be rightfully exercised over any member of a civilized community, against his will, is to prevent harm to others. His own good, either physical or moral, is not a sufficient warrant. He cannot rightfully be compelled to do or forbear because it will be better for him to do so, because it will make him happier, because, in the opinions of others, to do so would be wise, or even right.… The only part of the conduct of any one, for which he is amenable to society, is that which concerns others. In the part which merely concerns himself, his independence is, of right, absolute. Over himself, over his own body and mind, the individual is sovereign. ³

However, the new psychological insights into decision-making have led academics and policymakers to doubt that people regularly make decisions reliably in their own interests, which in turn motivated a more active role of government in helping people pursue those interests. ⁴

In this chapter, I will summarize the development, key results, and main applications of the new behavioral science to government paternalism. Then I will offer several criticisms of this new brand of paternalism, focusing on the lack of knowledge among policymakers regarding people’s true interests and the nature of the manipulation inherent in such behavioral interventions. Lastly, I will survey private uses of these psychological insights, including private alternatives to government interventions, the topic of many of the chapters in this book.

Behavioral Science and Choice

For decades, mainstream economics enjoyed a broad consensus regarding its model of individual decision-making, known as expected utility maximization or constrained preference-satisfaction. ⁵ This standard choice model allowed economists to explain and predict typical economic behavior such as consumption, production, and investment decisions, in addition to noneconomic topics such as marriage and childbearing decisions, criminal activity, and discriminatory hiring. ⁶ This model consists of several simple elements, which I will describe briefly before introducing recent behavioral critiques of them.

First, a person has a set of preferences, a ranking of states of the world over which he or she has some choice, such as which size of laundry detergent to buy, which company to invest in, and which job to take. These preferences are normally assumed to be given to the individual and do not change (an assumption arising less from a principled conviction and more from a desire for parsimony, as well as humility regarding our knowledge of the nature of preference change). ⁷ Furthermore, they are substantively empty: rather than stemming from a psychological state such as desire or need, they are ideally taken to be revealed by behavior, whatever their ultimate source may be. As long as a person’s preferences meet basic formal conditions such as consistency and completeness, they can be represented by a utility function that represents to what degree the person’s preferences are satisfied. ⁸

Second, persons are faced with certain constraints that limit satisfaction of their preferences. These normally take the form of material resource constraints, such as scarcity of wealth or capital, or limitations on the time available to spend on various activities (such as in labor supply decisions). Like preferences, constraints are often assumed to be exogenous, although some can be based on earlier choices; for instance, wealth is based both on initial endowments and later choices about work and investment.

Third, individuals are assumed to have sets of beliefs over the likelihood of various uncertain states of the world. These include beliefs about themselves, such as which options will satisfy their preferences, as well as beliefs about external events, such as whether it will rain on their cousin’s wedding day. Sometimes the two types of beliefs combine, such as whether a person will be able to adjust comfortably to living in a new city where she is considering taking a job. These probabilities, often based on subjective judgment about uncertainty rather than precise objective risk, are used in the decision-making process to discount the amount of utility a person will derive from each state of the world.

These three elements together define decision-makers’ problem: maximizing their expected utility, based on their preferences and beliefs, within their constraints. This model grounded nearly the entirety of microeconomic theory until theoretical and empirical research by decision theorists and psychologists questioned its real-world applicability. For example, in the 1950s, Herbert Simon introduced the concept of bounded rationality, which encapsulated the imperfections of and limitations on human rationality. As Simon described the standard model of choice, the agent

is assumed to have knowledge of the relevant aspects of his environment which, if not absolutely complete, is at least impressively clear and voluminous. He is assumed also to have a well-organized and stable system of preferences, and a skill in computation that enables him to calculate, for the alternative courses of action that are available to him, which of these will permit him to reach the highest attainable point on his preference scale. ⁹

As an alternative, Simon introduced the concept of satisficing, in which an individual facing a difficult choice lacks either the time or the mental capacity to select the perfectly optimal decision, and instead optimizes these scarce resources by making a decision that is good enough (or satisfactory). ¹⁰ In this way, the person meets some internal threshold of preference-satisfaction even though it may not be the choice he or she would make with infinite time and computing power. Now a significant topic of study by economists, psychologists, and philosophers alike, Simon’s concept of satisficing was the first major challenge to the standard economic model of choice, which was revealed to be an abstract mathematical ideal that neglected to consider or incorporate the limited decision-making capacities of real human beings. ¹¹

Simon’s bounded rationality emphasizes the limits of our deliberative and executive faculties: that our rationality and willpower are limited and do not always operate as predicted by textbook models of decision-making. Later, psychologists led by Daniel Kahneman and Amos Tversky added details and nuance to Simon’s ideas, supported by years of psychological experiments. ¹² These researchers identified a number of common cognitive biases, dysfunctions, and heuristics that cause decision-making processes to differ from the ideal textbook depictions. For example, the endowment effect describes the phenomenon by which people place more value on an item when it is in their possession than when it is not. This is also related to loss aversion, by which people feel more harmed by a loss of given magnitude than they are helped by an identical gain. So we would rather give up $100 that we never received than lose $100 we have, and we would demand more money to part with an item we owe than we would have paid to get it in the first place. Also, hyperbolic discounting explains why our preferences seem to change over time, and why an unpleasant event (such as a root canal) that a person has no problem scheduling six months from now seems much worse the day before it is set to happen; this is very useful to modeling weakness of will, especially with regard to procrastination. ¹³

These cognitive biases affect our preferences, from which, in the traditional model of choice, values are derived. Other findings from behavioral research address how we incorporate new information into our set of beliefs. Instead of simply updating our beliefs with any new information we acquire, we do so in a way that privileges some information over other. For example, confirmation bias implies that we give more attention and weight to new information that confirms our current beliefs (and less attention and weight to information that challenges them); this can be seen in choices of news sources, in which people often choose cable news stations that confirm their preexisting political positions. Optimism bias, as the name suggests, describes our propensity to maintain exaggerated beliefs about ourselves and our futures; this can be illustrated by the it can’t happen to me effect when hearing mortality rates about smoking, and the statistic that well over 50 % of people think they are above average drivers (which is unlikely if we assume a fairly symmetrical distribution of driving skill).

Most relevant for the discussion of nudges, behavioral studies also demonstrate the power of framing in influencing how we make choices, which implies quirks in how both our preferences and information are affected. For example, patients are more optimistic when told that a procedure has a survival rate of 90 % than when they are told that it has a mortality rate of 10 %, a result that reflects the emotional impact of how a choice is framed. We see this also when there is a widely publicized plane crash and more people take road trips, despite the much higher mortality rate on the highway, because of the visceral impact of the news. Finally, marketers are testaments to framing effects, expert at promoting products in order to increase sales. ¹⁴

Behavioral Economics and Nudge Policy

In recent years, behavioral economists have been incorporating the numerous insights of Kahneman, Tversky, and their colleagues into standard models of choice and experiments of their own. One of the pioneers of behavioral economics, Richard Thaler, explained a number of anomalies in economic behavior with the new behavioral science, and also developed the area of behavioral finance, showing how financial decision-making is affected by psychological quirks that interfere with the flawless mathematical precision previously assumed to be the hallmark of finance. ¹⁵ Other behavioral economists examined how procrastination arises from rational actors acting under the influence of various cognitive flaws and dysfunctions. ¹⁶ Finally, experimental economists such as Vernon Smith have tested the predictions of many mainstream models of choice and observed results consistent with behavioral economics, particularly when it comes to the pursuit of self-interest. In the realm of game theory, for instance, participants in situations such as the Ultimatum game are supposed to reveal self-interest but instead display altruistic behavior, even toward other players who are strangers and are not expected to reciprocate. ¹⁷

It did not take long for the models of behavioral economics to be applied to the policy realm, initiated by legal scholars working in the hybrid field of behavioral law and economics. ¹⁸ Scholars in this field studied not only how the various cognitive biases and dysfunctions identified by psychologists affected legal outcomes, such as jury decisions, contract formation, and even judges’ opinions, but they also suggested ways that those same decision-making anomalies could be harnessed to improve outcomes in all areas of policy, including both general outcomes, such as recycling efforts and organ donation, as well as more individual-focused efforts, such as retirements savings and weight loss.

In 2008, behavioral economist Richard Thaler and legal scholar Cass Sunstein published their book Nudge, presenting their earlier academic work on behaviorally based policy interventions to a broader audience. ¹⁹ According to them:

It is legitimate … to try to influence people’s behavior in order to make their lives longer, healthier, and better. In other words, we argue for self-conscious efforts, by institutions in the private sector and also by government, to steer people’s choices in directions that will improve their lives. ²⁰

In this spirit, Thaler and Sunstein advocate for nudges, which they define as any aspect of the choice architecture that alters people’s behavior in a predictable way without forbidding any options or significantly changing their economic incentives. ²¹ As opposed to traditional paternalist tools such as mandates, bans, taxes, and subsidies, which affect the material availability or price of choices, nudges are changes to the choice environment (or choice architecture) around options, using the same cognitive biases and dysfunctions that motivate them to steer people toward choices that better serve their interests. Because choices themselves are not affected, nudge advocates regard their brand of paternalism as libertarian in the sense that it is more respectful of individual autonomy and liberty because people are free to make the same (allegedly inferior) choices they would have made without the nudge.

Thaler and Sunstein give many examples of nudges in their academic and popular work, but there are several well-known examples they emphasize throughout. In one, a manager of a cafeteria in an office building is tasked with arranging the food items. ²² To promote healthy eating among the workers in the building without foreclosing any options, the manager chooses to put healthier options at the front of the shelf and in the best light, to take advantage of people’s propensity toward laziness and the illusion of well-lit items as being tastier. While customers are free to take the poorly lit and hard-to-reach puddings, the manager takes advantage of their behavioral quirks to guide them toward healthier choices.

In another example, employers (or policymakers acting through them) are concerned that employees are not saving enough for retirement—in particular, they are not taking advantage of 401(k) plans, contributions to which are not only tax exempt but are often matched by employers. ²³ The forms that new employees fill out at human resources typically require active choice to enroll in such a program; in other words, the default choice is nonenrollment (also known as opt-in). Because studies show that people often defer to the default choice on a form (either through active or passive choice), employers who want to promote savings can switch the default choice to enrollment (also known as opt-out). In doing so, they leverage people’s unthinking acceptance of the default choice by switching the default to the option that they believe is in people’s best interests.

Other nudges take the form of providing information, which works on several levels. One popular instance of this is mandatory nutritional labeling in restaurants. On the one hand, this provides information, which does not make use of cognitive biases or dysfunctions but rather enhances rational deliberation over choices. On the other hand, the specific nutritional details that are emphasized are implied to be the most important, triggering the availability bias that gives more weight to readily available information; a focus on fat content, for instance, may distract a food consumer from carbohydrate content, which he may regard as more important. A related example is the familiar nutritional labels on packaged food products, listing the amount of fat, carbohydrate, and other contents, which health advocates argue should be made more prominent and colorful, making use of cognitive biases behind framing effects to both grab consumers’ attention and make information easier to digest. ²⁴

Problems with Nudges

The reasons to be concerned about nudges can be split into three categories: epistemic, ethical, and practical. These categories overlap to some extent, and the epistemic problems are the primary ones that lead to the most significant ethical and practical problems. All three, however, combine to paint a different picture of nudges than the one offered by advocates of this new brand of paternalism. ²⁵

The epistemic problem with nudges derives from the inability of policymakers to know the true interests of the people being nudged. Certainly, nudge designers have some idea of the interests they wish to promote with behavioral interventions: in Thaler and Sunstein’s examples, cafeterias are designed to promote healthy eating and default enrollment in retirement plans is meant to promote savings. Policymakers do not know, however, if these nudges promote the true interests of any given individual, much less that of the population in general. Health and wealth are of interest to all in a very general and trivial way, but each person interprets them and combines them in different ways with other important interests, reflecting a complexity about which policymakers have no knowledge. Based on economic models of choice which normally posit a single end or goal, policymakers have a narrow, myopic view of interests that individuals pursue, which in turn limits the goals of nudges.

Whereas nudges focus on promoting one vague interest, such as health or wealth, individuals have a multiplicity of interests that combine in various ways according to the context of each choice situation. They care about material prosperity in some way, but each has his or her own goals with respect to wealth as well as ways they prefer to pursue it; the same goes for health or any other general goal assumed by policymakers.Furthermore, they have other interests that coincide or compete with pursuing their individual conceptions of wealth or health. Some are very personal interests, such as other individual goals that may represent success more than wealth does, or simply a desire to live life to the fullest, even if that compromises a single-minded focus on simpler goals. People also have interests in other people’s well-being, happiness, and success, and often sacrifice their own personal interests to help others. Finally, individuals have interests in principles and ideals, whether personal or societal. People limit their pursuit of self-interest according to their moral codes, refusing to lie or steal even when it would benefit them (or others). They also sacrifice their own well-being—and sometimes even their lives—in the service of ideals such as justice, equality, or freedom. The variety of interests that individuals pursue reflects their multifaceted nature, and the ways that they combine in different circumstances shows their overall complexity. While people may have many interests of different kinds, they do not necessarily pursue all of them in every decision-making context. Sometimes they make decisions according to simple preferences, and other times they take the wider social impact of the decisions into account.

As a result of the multifaceted and complex nature of interests, nudges designed to promote one interest, even if it is an interest held by an individual, will have unintended and possibly adverse effects on other interests that the individual may value just as much—if not more—than the one targeted by the nudge. Interventions to increase retirement savings, for example, may negatively affect individuals’ other goals, financial or otherwise. Nudges to lower fat intake may end up increasing individuals’ consumptions of sugar, which may be of greater concern to them. It is easy to say that people can simply avoid nudges that are not in their interests, but the subtle way that nudges work makes this difficult (as we will discuss below). Without an appreciation of the complexity of individuals’ interests, a policymaker cannot anticipate how a nudge in one area will affect other parts of their lives.

Even if policymakers did appreciate the complex and multifaceted nature of interests, they have no access to information regarding them because interests are inherently subjective. Choices that they see as imprudent or mistaken may very well advance the true interests of the people making them. People themselves are often unaware of the full range of their interests; many recent studies suggest that people are poor estimators of their own well-being or of how much satisfaction they will derive from various choices. ²⁶ Nonetheless, individuals have a firmer grasp on the various interests on which they make decisions than an outside observer does, especially disinterested ones such as researchers or policymakers who have no way to know any person’s true interests. John Stuart Mill put this well when he wrote:

The strongest of all the arguments against the interference of the public with purely personal conduct is that, when it does interfere, the odds are that it interferes wrongly, and in the wrong place. On questions of social morality, of duty to others, the opinion of the public, that is, of an overruling majority, though often wrong, is likely to be still oftener right; because on such questions they are only required to judge of their own interests; of the manner in which some mode of conduct, if allowed to be practiced, would affect themselves. But the opinion of a similar majority, imposed as a law on the minority, on questions of self-regarding conduct, is quite as likely to be wrong as right; for in these cases public opinion means, at the best, some people’s opinion of what is good or bad for other people. ²⁷

Because of this ignorance of people’s true interests, policymakers who judge that people’s choices are mistaken are basing this judgment on interests they have decided are appropriate or obvious. Furthermore, these are the same interests that form the basis for nudges designed to correct these bad choices, interests that are defined vaguely enough to be of some possible relevance to most people but closely correspond to no one’s true interests, much less to the degree that they matter to any one person.

This imposition of interests is one of the key ethical problems with nudges: it violates a core principle of modern democracies, liberal neutrality, which maintains that individuals have the right to pursue their own ideas of the good life, provided they do not wrongfully interfere with the rights of others to do the same. Again, John Stuart Mill provided the definitive statement:

As it is useful that while mankind are imperfect there should be different opinions, so it is that there should be different experiments in living; that free scope should be given to varieties of character, short of injury to others; and that the worth of different modes of life should be proved practically, when any one thinks fit to try them. It is desirable, in short, that in things which do not primarily concern others, individuality should assert itself. ²⁸

At its most essential, liberal neutrality implies a person’s right to make choices in his or her own interests as the person understands them, not as a policymaker defines them. Paternalism of any type violates liberal neutrality and the personal autonomy it protects; as philosopher Dan Brock wrote,

Paternalistic interference involves the claim of one person to know better what is good for another person than that other person him- or herself does. It involves the substitution by the paternalistic interferer of his or her conception of what is good for another for that other’s own conception of his or her good. If this involves a claim to know the objectively correct conception of another’s good—what ultimate values and aims define another competent individual’s good, independent of whether that other accepts them—then it is ethically problematic. ²⁹

This is widely recognized as a criticism of traditional paternalist policies such as bans or taxes that limit or modify choices, but nudge advocates argue that it does not apply to mere alterations to choice architecture, such as changing arrangement of options or default choices that do not foreclose choices.

However, this argument ignores the way that nudges work: by making use of the same cognitive biases and dysfunctions that motivated them in the first place. For example, enrolling new employees in retirement plans by default is effective at increasing savings because default choices have an outsized impact on choices, not because it inspires better decision-making. Another choice is still possible, but the cognitive defects on which nudges rely make other choices more difficult to make. Furthermore, this is not an incidental effect of nudges but the basis on which they operate, as demonstrated by their success in altering choices. For example, Thaler and Sunstein point to the enormous increase in 401(k) enrollment under an opt-out plan. ³⁰ This cannot be taken as evidence that people are making better choices in their true interests, but merely a testament to the effectiveness of designed defaults at influencing choice.

In this way, nudges threaten autonomy on two different scales: by imposing policymaker’s idea of interests for people’s own, thereby interfering with people’s long-term pursuit of their vision of the good life, and also by influencing their smaller day-to-day decisions and the way people make them. While traditional paternalism may affect choices, such as by increasing the cost of certain options, it leaves people free to make their choice without interfering with their decision-making process itself. Nudges do not engage people’s rational deliberative faculties, however, but instead subvert them, relying on cognitive biases and dysfunctions to circumvent rational choice. The cafeteria manager’s rearrangement of food items is not meant to convince her customers of the importance of making healthy choices; it relies on subtle psychological effects to steer them toward choices she thinks are better for them. This can be seen even more directly in the manipulation of default choices, which takes advantage of simple laziness and inertia to guide choice rather than inspiring deeper consideration of the various options. In this way, the interference with choice is not simply in terms of results but also process, which, as we will see, has longer-term ramifications for our cognitive abilities themselves.

Finally, the epistemic problem implies that, in practical terms, nudges cannot do what they claim: to help people make better choices in their own interests. Policymakers may sincerely want to help people improve their lives along some general measures such as health or wealth, but they cannot promote the true complex and multifaceted interests of which they have no knowledge. As Mario Rizzo and Glen Whitman wrote, comparing the knowledge problem in nudge policy with Friedrich von Hayek’s arguments against government planning based on similar issues:

If well-meaning policymakers possess all the relevant information about individuals’ true preferences, their cognitive biases, and the choice contexts in which they manifest themselves, then policymakers could potentially implement paternalist policies that improve the welfare of individuals by their own standards. But lacking such information, we cannot conclude that actual paternalism will make their decisions better; under a wide range of circumstances, it will even make them worse. ³¹

Furthermore, by promoting the interests they have chosen, policymakers are interfering with individuals’ pursuit of their own interests in ways that cannot easily be resisted, given the subtle methods by which nudges