Helping People Help Themselves: The Use of Behavioral Economics in Public Policy

Notes Week 1: Helping People Help Themselves” and “The Use of BE in public policy shows promise” Assoc. Prof. Giddings

Notes on “Helping People Help Themselves” by Tritch • Remember that term “paternalistic libertarian” we talked about on Tuesday? • “Paternalistic”: the system, principle, or paractice of managing or governing individuals, businesses, nations, etc., in the manner of a father dealing benevolently and often intrusively with his children. • “Libertarian”: a proponent of libertarianism, the group of political philosophies that advocates minimizing coercion and emphasizes freedom, liberty, and voluntary association. • The moral view that agents initially fully own themselves and have certain moral powers to acquire property rights in external things. • IS this concept an oxymoron????

A Bit of background • BE emerged over 30 years ago. • Prominent early researchers: Tversky and Kahneman (new book: Thinking fast and slow by Kahneman is a great review of their work with some personal anecdotes sprinkled in, but it is dense) • They won the Nobel Prize in Economics in 2002 for their contributions to BE

BE and Public Policy: Pension Reform 2006 • Background on retirement in the US: ways to save and how they work • Social Security: • funded through payroll taxes • Young pay for old • Expected bankrupsy? • 401(k) • Pre-tax savings up to a yearly limit • Sometimes get employer match

BE and Savings • The problem? Americans don’t save for retirement.

The solution: pension reform law of 2006 • Pension reform law addresses three behavioral problems that people have, as identified by behavioral economists. NOTE: we will discuss these in greater detail in the course, but I wanted to introduce you here. • 1. “Status Quo Bias”: this is the tendency to do what has always been done. • Examples: the ringer on your cell phone, the background picture on your computer, etc. Can anyone think of other examples? • 401k system is usually an “opt-in” program • This plus procrastination and American’s don’t save.

Opt out versus opt in • Solution? • Make the 401k system an automatic opt-in • People can choose to opt out but it takes more effort and deliberateness • Note that this circumvents the status quo bias but does not usurp choice! (Hence paternalistic libertarianism)

Problem 2 • “Loss Aversion”: people feel the pain of loss more acutely than they feel the joy of gain. • So, even if people have joined the 401k scheme, they don’t increase payments toward it (you can, at the moment save up to $16,000 in pre-tax income per year). • Most people don’t max. • Increasing your contribution feels like a loss.

Solution? • Automatic Escalation: employers who automatically enroll their employees are also allowed to regularly boost employee’s contributions levels • Automatically increase contribution when you get a raise

Loss Aversion is related to the “Endowment Effect” • People “endow” their possessions, including their paychecks, with an inordinately high value, simply because they possess them. • When it comes to savings behavior, the endowment effect predisposes people to value every dollar currently in their pocket far more than the opportunity to save some of those dollars for the future • If we automatically escalate, we avoid the endowment effect

Problem 3 • “Decision Paralysis”: people have a tendency, when faced with too many choices, to decide not to decide. • If choosing is unavoidable (and complicated) and the stakes are high many people will opt to play it safe by putting their money in low-yielding, low-risk accounts.

Other applications • Labor relations and the importance of fairness in setting wages • Anchoring and monetary rewards offered by juries (the mere mention of a plaintiff’s potential award, say $10 million, has been shown to influence juries’ ultimate decisions) • Consumer protection: when conditions make it difficult to perceive the true value of a product or service, people have trouble making good decisions. Examples: roaming rates on cell phones, when there is a disconnect between consumption and payment, or when rules change.

What do we do? • We tend to resort to shortcuts or “heuristics” • Sometimes heuristics work, other times they don’t. But behavioral economists can suggest policies that could help people make better decisions.

Example • Maybe companies should show the full estimated cost of owning a product rather than the cost of just buying it. • Hewlett-Packard Deskjet 3747 Color Inkjet printer • Retail value: $29.99 • Four-year cost: $2,400 (includes ink for about 20 black and white copies per day). • Should that information be prominently disclosed?

Example • Cars: should they display miles per gallon or gallons per mile?

Example: smoking and hyperbolic discounting • How do we discourage cigarette smoking? • High taxes? • Human problem: hyperbolic discounting. This is when we give too little weight to the future effects of current decisions. • Here we can really think of the rational economic model versus the behavioral model when we consider how to change behavior. • If smoking is rational, there is little justification for government intervention beyond preventing harm to others. • But what if people would like to quit but can’t? BE’s say that successful incentives must take into account biases that defeat rational commitments.

Some behavioral solutions for smoking • The government could require special identification cards to buy cigarettes. The cards are free but the need to apply, to carry the card and to present it when buying cigarettes imposes delays and other costs.

Notes on Use of BE in public policy shows promise • David Cameron joined with Richard Thalerhas established a Behavioral Insights Team in the UK nicknamed The Nudge Unit. • Here is David Cameron’s TED talk about shifting policy toward behavioral economics (14 minutes)

What is a “Nudge”? • Authors of the book Nudge (Cass Sunstein and Richard Thaler) talk about “choice architecture”: this is the idea that decisions are influenced by what in a rational perspective SHOULD be irrelevant features of the decision-making context. • A “nudge” changes the choice architecture in a certain way that yields certain decisions. • If X is a nudge it: • Alters the decision maker’s behavior in a predictable way • Does not limit the choice set, i.e. the available options to the decision maker • Does not significantly alter the decision maker’s incentives, in terms of payoffs- and utility increase from the perspective of a rational agent

A famous Nudge • Urinal fly versus 100 euro fine….

The Nudge Unit’s Experiments • In one trial, a letter sent to non-payers of vehicle taxes was changed to use plainer English, along the line of “pay your tax or lose your car.” In some cases the letter was further personalized by including a photo of the car in question. The rewritten letter alone doubled the number of people paying the tax; the letter with the photo tripled it. • A study into the teaching of technical drawing in French schools found that if the subject was called “geometry” boys did better, but if it was called “drawing” girls did better • Study in Britain on energy efficiency: “goal substitution” replacing lower energy use with cleaning out the attic. Even if offered free insulation, the pain of cleaning the attic made people avoid it.

Danish Nudge Unit • One experiment put green arrows pointing to stairs next to railway-station escalators hoping people would choose the healthier option. Almost no effect • Another had a series of green footprints leading to rubbish bins. These signs reduced littering by 46%. • They concluded that social norms about littering helped this trial.

Let’s Hear Dan Ariely Explain BE • Dan Ariely: Are we in control of our own decisions?

Helping People Help Themselves: The Use of Behavioral Economics in Public Policy