Behavioral Economics and Public Policy 102: Beyond Nudging

Author(s): Saurabh Bhargava and George Loewenstein

Source: The American Economic Review , MAY 2015, Vol. 105, No. 5, PAPERS AND
PROCEEDINGS OF THE One Hundred Twenty-Seventh Annual Meeting OF THE
AMERICAN ECONOMIC ASSOCIATION (MAY 2015), pp. 396-401
Published by: American Economic Association

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American Economic Review: Papers & Proceedings 2015, 105(5): 396^401
http://dx.doi.org/10.1257/aer.p20151049

Behavioral Economics and Public Policy 102: Beyond Nudgingf

By Saurabh Bhargava and George Loewenstein*

The United States, despite its affluence, faces Behavioral Economics (BE) as an alternative
a number of daunting policy challenges. We rank framework. While traditional economics offers
last among 16 wealthy peers in life expectancy, regulatory and price-based solutions to deal
infant mortality, and obesity, and have taken with market failures, such as those stemming
very little action on climate change, despite from the presence of externalities (e.g., pollu-
the extremity of the threat it poses not only to tion or education), BE prescribes strategies, and
future generations but even those alive today.1 rationales, for the use of policy to address the
Complicating matters is that the causes of these "internalities" (or "within-person externalities")
policy problems are multi-determined and can that stem from the failure of individuals to suc-
be engaged at different levels of policy analysis. cessfully pursue their own interests.2
For example, while obesity is proximally due In this essay, aimed broadly at students of
to the (persistent) intake of excessive calories,
policy and their instructors, we comment criti-
it can also be attributed to more intermediate cally on the past, present, and future role of BE
causes such as innovations in food production in public policy. We first describe the notable
and delivery which have lowered the cost successes
of of early applications of BE which
consuming (largely unhealthy) foods, to policy have typically involved proximal interventions
decisions such as the subsidization of corn (and designed to improve behavior. We then argue
hence corn syrup), or even to more deeply struc- that BE can and should now aspire to influence
tural factors, such as the sociocultural forces that
the design of policies aimed at the deeper causes
have promoted the availability of "super-sized" of policy problems. Through a set of guiding
portions and physical inactivity. To combat
principles, and case-studies, we seek to pro-
obesity, a policymaker must decide whether voke to students of public policy to think about
intervene proximally (e.g., mandating caloric how to leverage the teachings of BE more fully
displays), or more distally (e.g., reducing access
to deliver policy solutions whose scope is com-
to low-nutrient foods). mensurable with the magnitude of contempo-
Economics offers a useful framework for rary challenges.
thinking about policy. However, the traditional
approach in economics, by assuming fully ratio- I. The Birth and Early Successes of Nudge
nal and perfectly informed individuals, assumes
away many potentially problematic behaviors. The intellectual basis for applying BE to pol-
Recognizing human limitations and their con- icy was formally articulated in two papers pub-
lished in 2003. Titled "Libertarian Paternalism"
sequences, many policymakers have embraced
(Thaler and Sunstein 2003) and "Regulation for
Conservatives: Behavioral Economics and the
* Bhargava: Social and Decision Sciences, Carnegie
Case
Mellon University, 5000 Forbes Avenue, Pittsburgh, PA for 'Asymmetric Paternalism'" (Camerer
et al. 2003), both papers advocated an approach
15213 (e-mail: sbhar@andrew.cmu.edu); Loewenstein:
Social and Decision Sciences, Carnegie Mellon University,
to policymaking intended to benefit individuals
5000 Forbes Avenue, Pittsburgh, PA 15213 (e-mail: gl20@
not acting in their own self-interest, but which
andrew.cmu.edu). We thank Lynn Conell-Price, Ania
Jaroszewicz, Brigitte Madrian, Nachům Sicherman, imposed
Cass minimal burdens on those already
acting
Sunstein, and Richard Thaler for comments and feedback. rationally. This approach, as the titles
fGo to http://dx.doi.org/10.1257/aer.p20151049 to visit
the article page for additional materials and author disclo-
sure statement(s).
1 Relative rankings on health outcomes are taken from2 Coined
a by Herrnstein et al. (1993), an "internality,, is
2013 report published by the Institute of Medicine and The
produced when an individual fails to consider the full impact
National Research Council. of a behavior on her present/future utility.

396

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VOL. 105 NO. 5 BEHAVIORAL ECONOMICS AND PUBLIC POLICY 102: BEYOND NUDGING 397

of the papers suggest, was meantnotto appeal

limit toproposing nano-size interven-
itself to
both conservatives and progressives by may
tions that prom-not significantly address the more
ising to improve welfare while basicpreserving
causes, or the magnitude, of contemporary
freedom of choice. The specific policy
type problems.
of policy Returning to the earlier exam-
ple of
espoused by this framework was obesity, while interventions intended
popularized
as a "nudge" by a later best-selling to nudge
bookindividuals
of that into healthier eating may
title. Nudges, such as the strategic modestly placement
improve diet (e.g., the caloric displays
of fruits in the school lunch line, were defined
mandated by the Affordable Care Act (ACA)),
as "any aspect of the choice architecture that
such policies are not likely to address the struc-
alters people's behavior in a predictable tural supply-side way
dynamics or socio-cultural fac-
without forbidding any options or tors significantly
that have contributed to the recent rise in
changing their economic incentives" (Thaler
obesity. While nudges should remain an import-
and Sunstein 2008, p. 6). These ant interventions,
part of the policy toolkit, insights from BE
according to Nobel Laureate Daniel haveKahneman,
the potential to expand this toolkit and
yield "medium-sized gains by nano-sized more aggressively address the underlying causes
investments."3 of problems. Because these fundamental causes
The intellectual foundation laid by these writ- generally involve market failures due to exter-
ings sparked a remarkable rise in the influence nalities, imperfect information and competition,
of BE on public policy, the most celebrated and and widely recognized limits to consumer deci-
widely adopted of which was the use of auto- sion making, the policies emerging from such
matic defaults to sharply increase employee insights need not be more controversial than the
savings for retirement. In addition, a series of policies espoused a decade ago by the initial set
"informational nudges" applied simplification, of papers.
social comparison, informational salience,
and the reduction of "hassle" costs to improve II. Expanding the (BE) Policy Toolkit
medical adherence, parental school choice,
efficiency of home energy use, and take-up of We outline three principles to help guide
social benefits (see Madrian 2014). Regulators policymakers in expanding the role of BE in
further applied BE to simplify disclosures asso- public policy. The complexities of contemporary
ciated with, for example, credit cards, insurance financial and health decisions, and the inability
choice, and fuel economy, and even replaced the of individuals to navigate them, motivates a first
infamous food pyramid with a simpler "food principle: policymakers ought to move beyond
plate." Beyond the specific policies it inspired, the simplification of choice environments toward
the influence of BE is manifest in the estab- the simplification of the products and incentives
lishment, growth, and global influence of the that underlie such choices.
United Kingdom's Behavioural Insights Team In recent years there has been an explosion
(BIT), which was charged with channeling evi- in the complexity of decisions confronting con-
dence-based insights from BE to improvesumers.
the One study which examined the com-
design and implementation of policies. The plexity
suc- of 55,000 retail financial products (e.g.,
cesses of the unit led other nations, including for
the savings and investment) offered to European
United States, to install similar institutions.4consumers from 2002 to 2010 found that such
While applauding these successes, and their products became increasingly complicated, and
role in cultivating interest in evidence-basedthat
and this complexity was correlated with higher
BE-inspired policy, we believe that BE should firm profitability, lower product yield, and was
often concentrated in markets populated with
less sophisticated consumers (Celerier and
3 "Daniel Kahneman's Gripe with Behavioral Vallee 2014). Consumers also face an expanded
Economics." The Daily Beast. http://www.thedailybeast. set of insurance options and credit instru-
com/articles/20 1 3/04/26/daniel-kahneman-s-gripe-with- ments, including payday loans and complex
behavioral-economics.html.
mortgages - a large fraction of which include
4 As a point of disclosure, Loewenstein has had numerous
teaser
interactions with the BIT, and is on its advisory board, and
rates. Doing little to allay the problem,
Bhargava has had a number of interactions with the Socialand, in fact, likely exacerbating it, has been a
and Behavioral Sciences Team in the United States. parallel surge of lengthy, and for a majority of

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398 AEA PAPERS AND PROCEEDINGS MAY 20 15

consumers, incomprehensible, infor

example, the importance of fairness perceptions,
disclosures from firms. emotion, and limited attention, implies that the
In the midst of this growth in complexity, behavioral response to a new tax may depend
surveys of financial literacy indicate that most not only on the underlying demand elasticity,
Americans do not understand financial concepts but on the salience, complexity, nominal inci-
such as interest, inflation, expense ratios or dence, and framing of the tax. Likewise, if wage
diversification, and are unaware of the terms that expectations are subject to loss aversion, tiered
govern their borrowing or the incentives facing unemployment benefits may be more effective
those who provide them with products and ser- than standard unemployment insurance in short-
vices. Not surprisingly, these deficits predict a ening unemployment spells (DellaVigna et al.
range of suboptimal financial behaviors with 2014).
respect to investments, savings, credit card debt, Beyond improving the design of policies,
choice of insurance, and mortgage delinquency insights from BE could be used to help mobi-
(Hastings, Madrian, and Skimmyhorn 2013). lize citizens, through education and persuasion,
Of particular policy concern is that the burdens rather than simple nudging, in support of poli-
of complexity may be greatest for the econom- cies aimed at ambitious issues such as economic
ically disadvantaged (Mullainathan and Shafir inequality or climate change.
2013). Simpler and more standardized products
and incentives hold the promise of easing such III. Three Case Examples
burdens and reducing inequities.
A second principle is that policymakers should Examples of policies that are poorly designed
aggressively protect consumers from behavioral for real humans, or that fail to address the deep
exploitation by firms. The traditional economic causes of unwanted outcomes, abound. We dis-
rationale for intervening in competitive markets cuss three, intentionally disparate, examples of
to protect consumers is the existence of informa- policy domains in which nudges alone provide
tional asymmetries. However, recent theoretical inadequate remedies but BE, broadly conceived,
work (e.g., Heidhues and KEszegi 2014) sug- could help to deliver more meaningful solutions.
gests that the presence of unsophisticated con-
sumers may lead to a steady- state in which firms A. Health Insurance
exploit consumer biases and inattention through,
for example, the strategic use of product com- While BE is already an active and construc-
plexity or marketing. tive participant in the domain of health, the
We contend that the possible exploitation of insurance side of the market is a setting in which
consumer biases should broaden the conven- poor decision-making may require a bolder
tional rationale for consumer protection.approach.
While In recent years, there has been a trend
economists generally favor disclosurestoward
as an expanding the number of health plan
choices available to consumers, often through
efficient means of instituting such protections,
public or employee-sponsored exchanges. The
given the practical limits of even well designed
disclosures (c.f., Loewenstein, Sunstein, and for greater choice is to better enable
rationale
Golman 2014), more aggressive measures consumers
may to choose appropriate plans and to
be required - for example, taxation, or the
improve prices and quality via provider com-
explicit regulation of choice. Policies of this Neither goal is likely to be fulfilled if
petition.
type should not be particularly controversial consumers make uninformed plan choices.
when, in their absence, firms would be moti- In our own recent research, we analyzed the
vated to exploit consumers' weaknesses. insurance choices of over 50,000 employees of
A third principle is that BE should be lever-
a large US firm which offered its employees an
aged to improve the design and implementa- expansive, standardized, health plan menu in
which nearly all low-deductible plan options
tion of policies based on traditional economics.
Given that an individual's behavior is deter- were financially dominated by otherwise
equivalent high-deductible plans (Bhargava,
mined not by actual, but perceived, incentives,
Loewenstein, and Sydnor 2015). A majority of
BE points to a range of tactics that could enhance
employees, and especially low-income employ-
the efficacy of conventional economic incentives
(Congdon, Kling, and Mullainathan 201 1). ees,For selected dominated plans, which resulted in

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VOL. 105 NO. 5 BEHAVIORAL ECONOMICS AND PUBLIC POLICY 102: BEYOND NUDGING 399

protections
unnecessary spending equivalent, (Acquisti, Brandimarte, and
on average,
to 42 percent of annual premiums. Loewenstein
Experiments 2015).
reported in the paper suggest thatTo the extent
these adverse that privacy disclosures are
choices were associated with a lack of basic mandated, the "informational nudge" approach
health plan literacy, that targeted education would
had express them in a simple, vivid, and
only moderate success in improving choice standardized fashion to heighten attention and
understanding. However, given that even sim-
quality. In recognition of the difficulty of choos-
ing between plans, the insurance exchanges of information may be ignored or misinter-
plified
the ACA adopted a standardized online interface preted, simplified disclosures are unlikely to be
and organized plans into metal tiers that sufficient.
were Rather, the optimal strategy to protect
linked to actuarial value. However, in another, consumers in these settings with asymmetric
ongoing project, we find that the metal labels, interests may entail regulations that explicitly
rather than facilitating more efficient choices, restrict firm use of information to purposes
slightly worsened them. judged to be in the consumer's interest and con-
A superior solution to attempts to simplify sistent
the with reasonable expectations - a strategy
choice interface, but not fitting the definition recently
of adopted by the European Union.
a nudge, would be to mandate the provision of
dramatically simplified and standardized insur- C. Climate Change
ance policies or to even restrict plan menus to
include only reasonable options. A recent paper BE has in recent years played a positive role
(Loewenstein et al. 2013) demonstrated notin addressing climate change - for example, by
only
that a simplified product of this sort could be
providing input in the design of new fuel effi-
understood by consumers, but indicated its ciency
fea- labels or the use of social comparisons
sibility; the simplified product was actually tomar-
reduce home energy use. This role can and
keted by the insurance company that funded should
the be enlarged. Despite the severity of the
research. The company's copay-only plan threat listed posed by climate change, international
different prices for different services butand domestic efforts toward concerted action on
elimi-
nated the deductibles and coinsurance that are a climate change policy have largely failed.
major source of confusion. Requiring the provi-Standard economic theory offers clues as
sion of such a simplified product, and dictating to the causes of this paralysis. The notion of a
its characteristics, would improve plan choice free-rider problem helps to explain the failure
and increase the likelihood that firms compete of individuals and states to unilaterally change
on price and product quality. their behavior. Economic theory also provides
regulatory and market-based solutions for deal-
B. Privacy and Information Disclosure ing with externalities, such as a carbon tax, or a
system of cap-and-trade.
The Internet age, despite its many dividends, Although the path forward is clear, the pau-
poses a grave challenge to individual privacy city of actual progress may be due, in large part,
and, with that, critical questions for policymak- to psychological factors, such as motivated
ers. Activities in which many of us routinely disbelief, the ostrich effect, confirmation bias,
engage - e.g., e-mailing, texting, social media, present-bias, adaptation, and intangibility. In
Internet searches, cell phone and E-ZPassa brilliant book titled Don't Even Think About
use - leave digital traces which make us vul-
It: Why our Brains are Wired to Ignore Climate
nerable to commercial exploitation, discrim-Change , George Marshall (2014) draws heavily
ination, and unwanted monitoring. While theon BE to explain why individuals and nations
are failing to act on, and in some instances
disclosure requirements favored by traditional
economics should, in theory, enable individu-even denying the existence of, climate change.
Marshall then draws on the same research to
als to safely navigate the increasingly complex
privacy landscape, limited attention, motivated
identify strategies to capture the attention of the
reasoning, and biased assessments of probabil-
population and mobilize individuals and nations
to take action.
ity lead most to simply ignore such disclosures
or, more worrisomely, to infer that the presenceResearch on collective action shows how con-
of privacy disclosures implies non-existent centrated interests, such as energy firms, may

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400 AEA PAPERS AND PROCEEDINGS MAY 2015

yield a strong political advantage

most reliable source over
of financial security in later
life.
tic individuals. However, concentrated
ests, such as tobacco companies, have
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