Impression III, Wassily Kandinsky, 1911 (Courtesy: The Lenbachhaus, Munich)
Ideas for Leaders #677

Behavioural Economics: A Power that Goes Beyond Nudges

This is one of our free-to-access content pieces. To gain access to all Ideas for Leaders content please Log In Here or if you are not already a Subscriber then Subscribe Here.

Key Concept

Behavioural economics solutions to societal problems mostly take the form of economic ‘nudges’ — such as defaults to increase retirement plan enrolments. However, the potential for behavioural economics to help resolve societal problems is far greater than the common nudges. A new paper explains how policy makers have failed to take full advantage of behavioural economics solutions.

Idea Summary

In pure economic theory, policy making involves applying economic levers — taxes, regulations and economic incentives — to problems that have economic roots. These problems can take the form of:

  • Externalities — when people are impacted through no fault of their own (e.g. second-hand smoke) 
  • Misaligned incentives — when people are impacted because the interests of others clash with their own interests (e.g. corporate interests that might hurt society) 
  • Information asymmetries — when people don’t have the information necessary to judge the competence of professionals (e.g. investors who must trust their investments professionals with the disposition of their money)

Thus, for example, traditional economic theory shows that cigarette smoking has economic consequences — specifically externalities, such as additional health care costs that are borne in large part by on-smokers. The response is also economic, notably the imposition of taxes and regulations to reduce the sale of cigarettes.

In the early years of this century, economists began applying behavioural economics to policy issues, focusing mostly on issues that involved behavioural factors. Behavioural factors are assumed to reflect limitations in human decision-making, such as present bias (focusing on the impact of a decision in the present without considering any future impact). These limitations and biases result in internalities — unintended consequences resulting from someone’s actions. As with externalities, internalities can be both positive and negative (e.g. a person running to lose weight is also preventing heart disease in the long term, which is a positive internality).

Behavioural economics solutions help overcome negative internalities. For example, people influenced by present bias are less likely to save for the future; a behavioural economics solution is the use of defaults (i.e. people essentially take action without actually having to do anything) to increase enrolment in defined contribution retirement savings plans.

An enrolment default is an example of what is commonly known as a ‘nudge’ — that is, behavioural economic solutions that nudge people to take actions in their own interest. Nudges have become synonymous with the application of behavioural economics to public policy issues. 

While acknowledging the value of nudges, George Loewenstein of Carnegie Mellon University and Nick Chater of Warwick Business School argue in a May 2017 Behavioural Public Policy article that behavioural economics offers a much broader range of responses. Instead of adhering to a rigid dichotomy of economic solutions for economic-related problems and behavioural solutions to behavioural-related problems, Loewenstein and Chater argue that policy makers should recognize that economic-related problems may have behavioural solutions and that behavioural problems may have economic solutions. 

In other words (to use their specific terms), while the rationale for policy makers to intervene might be economic, that does not mean that the intervention needs to be economic — and likewise, a behavioural rationale for intervention does not necessarily call for a behavioural intervention.

For example, the economic interventions (e.g. taxes) to reduce smoking may have economic rationales (e.g. health care costs), as discussed above. However, the rationale for efforts to reduce smoking can also have behavioural roots — for example, present bias prevents smokers from realizing the long-term consequences to their health. Therefore a tax on cigarettes can also be considered an example of an economic solution for behavioural problems.

One step taken by regulators related to smoking was the requirement for graphic warning labels on cigarette packs. One could argue that such labels, which target people’s emotions, are in fact an example of a behavioural intervention, which further illustrate the blurred lines between behavioural and traditional economics: in this case, a behavioural solution (graphic warning labels) is offered for an economic problem (smoking-related health care costs).

The bottom line — which the authors illustrate using examples from smoking, obesity and retirement savings, as well as the broader societal problems of climate change, income inequality and the changing nature of employment — is that policy makers have been dramatically limiting the potential for ground-breaking policy solutions by relegating ‘pure’ traditional economics and ‘pure’ behavioural economics to their separate corners. They further illustrate that policy makers should not only recognize potential economic solutions to behavioural problems and the reverse, but should also recognize the existence of hybrid economic and behavioural rationales for interventions — and, likewise, hybrid economic and behavioural interventions. 

Business Application

Business and industry have adjusted to the emergence of behavioural nudges from policy makers. However, the potential for behavioural economics to influence policy is only beginning to be realized. In the future, especially as technology and automation lead to societal upheavals that must be addressed, policy makers can broaden the application of behavioural economics to minimize the potential for disruption and pain. Business can play a role in this effort, but it, too, must recognize the full power and opportunity of behavioural economics — a power that extends far beyond nudges.

Contact Us

Authors

Institutions

Source

Idea conceived

  • May 2017

Idea posted

  • October 2017

DOI number

10.13007/677

Subject

Real Time Analytics