I’ve missed the zeitgeist with this one – this book was apparently very popular with Barack Obama’s policy team well before he won the election. And Sunstein is now head of the White House’s Office of Information and Regulatory Affairs. Nevertheless, it is still a great read, even two years late.
This book does a superb job of translating the themes of behavioural economics:
- Heuristics: People often make decisions based on approximate rules of thumb, not strictly rational analysis. See also cognitive biases and bounded rationality.
- Framing: The way a problem or decision is presented to the decision maker will affect their action.
- Market inefficiencies: There are explanations for observed market outcomes that are contrary to rational expectations and market efficiency. These include mis-pricings, non-rational decision making, and return anomalies. Richard Thaler, in particular, has described specific market anomalies from a behavioral perspective.
into policy choices – mainly for governments, but also for anyone who is trying to help people towards good decisions, without taking away their choices.
So the authors talk about various ways in which public policy can be improved by understanding the real behaviour of real people, rather than always assuming that they behave “rationally” (or in ways that would see them make economically rational decisions, at least).
The key chapter of the book, for me, was the chapter about Choice Architecture. As part of their introductory section explaining that humans do not always behave as “homo economicus”, Thaler and Cass describe what they call “Choice Architecture”. Choice architecture consists of all the different ways in which people’s choices are influenced within a given decision making framework:
- Defaults – depending on the significance of the decision to the person making it, many people will take the option that involves the least effort. So, for example, when installing new software, most people will take the default option. So the person who decides the default has huge power in that decision. In many cases, doing nothing is the default option. But that doesn’t always have to be the case. Organ donation is a good example where different cultures have different defaults – in some cases the default assumption is that organs will be donated. And in other cases that they won’t. And organ donation rates are mammothly different as a consequence.
- Expect error – many people make errors. A good choice architecture is forgiving of that. Good examples come from medicine – where drug regimes are designed to help patients remember to take them (for example, there are rarely pills that need to be taken every second day, because they are most likely to be forgotten).
- Give Feedback – people make better choices when there is immediate feedback about what they have chosen – for this reason many digital cameras make better photographers. So the more frequently people make choices, with feedback, the better their subsequent choices will be
- Understanding mappings from choice to welfare – how do people figure out which choice is going to work for them? In medicine, where the choice is often between different types of undesirable side effects with different probabilities – this can be very difficult. So helping someone going through this choice do the translation between the choices and what the outcome will be like is an important part of setting up a good choice architecture. For example, for big medical decisions, talking to someone else who has made one of the choices can be extremely helpful – particularly if they have worked out how to live with a particular side effect.
- Structuring complex choices into simpler ones – If you are offered a flat choice between 30 different options – for example for ice cream – it’s quite hard to decide quickly. But if similar choices are grouped together (fruit sorbets with each other, various chocolate options together, and then the weird and wacky bubble gum flavours in a third spot) – you will probably choose one group, and then choose within the group, and be able to come up with a good choice. But the choice could be changed by the groupings you are given.
- Incentives – (most often price) – this is the part of choice architecture which always gets a mention in economics textbooks. But it is often not that important, particularly in situations where the price paid isn’t particularly obvious (situations that many companies try hard to engineer – for example exactly how different credit card charges work isn’t all that obvious until well after the payment decision has been made) There are many situations where price is a long way from being the main consideration – an just calling those situations “price inelastic” doesn’t necessarily capture the right policy information about what incentive might work. And of course, incentives are not just about the consumer price. They are also about understanding the incentives for all the suppliers in the chain – the home builder who has no incentive to put insulation into a house before it is sold, to the hairdresser, who gets a commission if she can convince me to start colouring my hair to hide the grey.
Fundamentally, offering a choice to someone (with or without a price signal), and especially offering a default choice (which is often unavoidable) will be making decisions on behalf of the chooser. It is important to be aware of that – so that the default or the framing is as constructive as possible. And it can be stronger than that. By being aware of the choice architecture of many aspects of our society, public policy decisions can be improved. It’s not an example in the book, but I think Sydney’s experience with water policy shows that. This paper from IPART shows that “if price increases were used to replicate the demand reduction achieved by level 3 water restrictions, residential water (usage) prices would need to rise by between 62 per cent and 143 per cent. If the water (usage) price increase applied to both residential and non-residential consumption, prices would need to rise by between 57 per cent and 121 per cent. ” Sometimes price isn’t the most effective way for a government to achieve a given outcome – it can be achieved with nudges in other ways that may have smaller negative effects than the price alternatives. One chapter of the book (grandly titled Saving the Planet) suggests that making an effort to provide feedback to people about the environmental consequences of their decisions would significantly improve behaviour.
The book is less successful in extending the analysis to the case for privatizing marriage – or, less radically, making the “default” partnership (currently marriage) a more logical structure. Although they make some good points, here they start to tread into the area many micro-economists find themselves in – pontificating on a subject that has been written about extensively without making the effort to read the the previous literature more than superficially. A minor cavil, though, for what is an excellent and thought provoking book. It should be read by policy wonks everywhere.
Adding it to my list… (given that I was, and may be again one day, a policy wonk).