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Nudges – a Real Third Way

An influential book by Richard R. Thaler and Cass R Sunstein, “Nudge” looks into the science behind decision making and how it can be applied to policy formation.

By Narayan Sharalaya

Sometimes, even the best intended policies do not have the required effect. Why don’t people eat healthily, save wisely or become environment friendly even though incentives exist to do so? ‘Nudge’ provides answers to these questions using Behavioural Economics and proposes that the most simple and effective solution is the nudge. The book begins by explaining the rationale behind nudges and the authors’ guiding philosophy in using them. It then examines real life situations where nudges can or have helped.

Before going into further detail about nudges, it is important to look at some of the concepts used in the book.

  1. Libertarian Paternalism
    Coined by the authors, this term may seem somewhat oxymoronic but it is a guiding philosophy in this book. The authors wish to preserve the libertarian demand of the right to free choice but also advocate self-consciously guiding people towards a certain choice. It can be described as a kind of ‘soft’ paternalism. According to this concept, it must be cheap and easy to opt out of the nudges provided. For example, placing healthy food at eye level in supermarket displays would be following libertarian paternalism whereas banning all junk food would not.
  2. Choice architecture
    The way choices are presented to us influence the decisions we make.A choice architect organises the context in which people make decisions. The book shows how choice architecture can play a significant role in multiple scenarios ranging from organ donation to choosing an apartment. The authors also provide guidelines on how to select an effective choice architecture as this would ensure that people select the best choice available to them. For example, the Amsterdam airport managed to reduce spillage in its urinals by 80% by sticking a picture of a fly.

Urinal

  1. RECAP
    A frequent solution proposed by the book, RECAP stands for Record, Evaluate and Compare Alternative Prices. It is a mild form of government regulation where companies are required to post their prices publicly in an easy, readable form. While this imposes very little costs on the companies, it significantly helps in improving consumer decisions.

When do we need a nudge?

A nudge is needed when the decisions to be made are difficult (selecting the right mortgage), rare (buying a house), do not yield immediate benefits (eating healthy food) or are not fully understood (investing in retirement funds). A nudge in any of these situations helps improve decision-making drastically. The book also looks into the functioning of markets and whether they solve people’s problems. On this subject, the authors have a mixed view. Market competition ensures fair prices and welfare of the consumer but on the other hand, companies have a strong incentive to exploit human frailties and profit from them. In this case, the authors favour a nudge towards the favoured options.

Examples of Effective Nudges

  1. Savings
    The “Save More Tomorrow” campaign initiated by Tahler and Bernatzi in three private companies, successfully educated workers about saving for retirement. Participants were given an option of selecting between a default rate at which their salary increments would go towards their retirement fund or make their own savings decision. Workers that chose to enroll in this program showed much higher saving rates as shown in figure 2. The program followed libetarian paternalism by actively guiding workers towards a preferred option while retaining their freedom of choice.Save More Tomorrow
  1. Credit Markets
    The market for mortgages and credit cards are alike. They both involve making hard choices regarding fixed and variable interest rates, teaser rates, etc. They also tend to have dozens of hidden fees and charges most people are unaware of. The book proposes a form of RECAP, where companies will have to disclose the list of charges and fees they levy in an accessible format. This would help consumers make better choices while avoiding excessive regulation.
  2. Organ Donation
    Rather than have an ‘opt in’ option for organ donation, countries that have an ‘opt out’ policy for organ donation tend to have a higher number of donors than c. In other terms, a person’s consent to be an organ donor is presumed unless the person states otherwise. This is a good example of how choice architecture can have a direct bearing on subject behaviour. Another type of choice architecture that the authors suggest is a mandated choice. For example, where the grant of a license is dependent on people choosing between options.Organ Donation

The Real Third Way

Nudges can preserve freedom of choice while still guiding people to act in a certain way. The book emphasises the use of Nudges as a “third way” to influence behaviour which strikes a middle ground between the strict regulations favoured by the Left or the laissez faire approach championed by the Right. Furthermore, the scope of using a nudge is not limited to certain domains. With policy makers recognising the human frailties inherent in decision making, nudges are slowly finding their way into policy formulation.

Narayan Sharalaya is an intern at Takshashila Institution and is currently doing his Bachelors in Economics at NMIMS, Mumbai

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