Behavioral Economics #5: Seeing the world in nudges

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Here we are at Part 5 of the Behavioral Economics series. So far, we’ve talked about the foundations of traditional economics, the flaws that some prominent psychologists and economists found and exposed in these foundations, the multi-pronged attack that these academics launched on traditional economics, the slow process of change as behavioral economics was born but had to become respected by the world of academia, and the many brave individuals that led the movement of this revolutionary new way of practicing economics.

It took a long time to get here, but in this article we will finally talk about the fun stuff with behavioral economics, namely its real-world applications. Yes, we get to talk about behavioral economics in action! In this article we’ll also see how it’s changing (and has the potential to fundamentally change) the world we live in.

But before I begin, I have to present and define three important terms: choice architecture, libertarian paternalism, and a nudge. Knowing what these terms mean is crucially important and necessary for you to understand both the applications of behavioral economics and why many of them are so important and innovative.

If this is the first time you’re tuning in to the Behavioral Economics series, please click the button below to read Parts 1-4 before reading this article. Also, much of the research and definitions cited in this article comes from Richard Thaler and Cass Sunstein’s bestselling book ‘Nudge: Improving Decisions About Health, Wealth, And Happiness.

Choice Architecture

Imagine that you have to design the cafeteria of a local high school (note: we’re only talking about the design of the cafeteria here. Assume that you have no authority over which items are placed on the menu). You have to decide how the food is displayed, in what order the food and drinks are placed, which foods and drinks will be displayed on eye, ankle, or stretching height, whether everything will be displayed in one aisle or in various aisles, and so on.

Congratulations! You are now officially what Thaler and Sunstein call “a choice architect”, which means that you have “the responsibility for organizing the context in which people make decisions.” Thaler and Sunstein give various examples of what it means to be a choice architect, such as:

If you design the ballot voters use to choose candidates, you are a choice architect. If you are a doctor and must describe the alternative treatments available to a patient, you are a choice architect. If you design the form that new employees fill out to enroll in the company health care plan, you are a choice architect. If you are a parent, describing possible educational options to your son or daughter, you are a choice architect. If you are a salesperson, you are a choice architect (but you already knew that).
— Page 3 of 'Nudge: Improving Decisions About Health, Wealth, And Happiness'

If a choice architect is responsible for “organizing the context in which people make decisions”, then choice architecture is simply “the design of different ways in which choices can be presented to consumers, and the impact of that presentation on consumer decision-making.” It is the landscape — the environment — in which we make decisions about everything in our lives, from buying food in a supermarket to who to swipe right on in a dating app. Arguably every single application of behavioral economics involves tinkering with people’s choice architecture.

Think of it like this. Whenever and wherever you have to make a choice, you will always find yourself in a choice architecture designed by a choice architect. Who knew there were so many architects in the world?

(Source: pages 1-4 of Nudge)

Libertarian Paternalism

Behavioral economics, and all the policy recommendations that come from it, is firmly rooted in the principle of libertarian paternalism. I know what you’re thinking: “Libertarian paternalism? I didn’t open this article to read about yet another political lecture and high-minded political philosophy. I’m tired of politics!

Calm down, this term is not political at all.

And before you close this tab and call me a liar, hear me out because Thaler and Sunstein are very aware of your concerns. “We are keenly aware that this term is not one that readers will find immediately endearing. Both words are somewhat off-putting, weighted down by stereotypes from popular culture and politics that make them unappealing to many."

In fact, the authors argue that “if the terms are properly understood, both concepts reflect common sense — and they are far more attractive together than alone. The problem with the terms is that they have been captured by dogmatists. (Page 5)

The “libertarian” part of the term simply means that “people should be free to do what they like — and to opt out of undesirable arrangements if they want to do so.” It means that policies that are inspired by behavioral economics should maintain or increase freedom of choice and not burden those who want to exercise their freedom. (Page 5)

Even though I strongly believe in it, I recognize that the “paternalism” part of the term is perhaps slightly more controversial and more likely to divide opinion. Thaler and Sunstein again:

The paternalistic aspect lies in the claim that it is legitimate for choice architects to try to influence people’s behavior in order to make their lives, longer, healthier, and better... In our understanding, a policy is “paternalistic” if it tries to influence choices in a way that will make choosers better off, as judged by themselves [the choosers].
— Page 5 of 'Nudge: Improving Decisions About Health, Wealth, And Happiness'

Let’s be honest. People don’t always know what’s best for them, save enough money for retirement, have perfect self-control, or eat the type of food that will help them prevent chronic diseases in the future. People do not consistently make choices that are in their best interests although, in fairness, the world is a difficult place. As Richard Thaler once said, “we don’t think people are dumb. We think the world is hard.” Hence, we need to help people.

The paternalistic part of libertarian paternalism recognizes this and strives to design choice architectures in which it’s not only easier and clearer for people to make choices that improve their “health, wealth, and happiness”, but also such that they are encouraged (not forced!) to make better choices.

A Nudge

A nudge, as we will use the term, is any aspect of the choice architecture that alters people’s behavior in a predictable way without forbidding any options or significantly changing their economic incentives. To count as a mere nudge, the intervention must be easy and cheap to avoid. Nudges are not mandates. Putting the fruit at eye level counts as a nudge. Banning junk food does not.
— Page 6 of 'Nudge: Improving Decisions About Health, Wealth, And Happiness'

Nudges are the essence of the real-life applications of behavioral economics. Remember the discussion about the difference between Humans and Econs in Part 1 of the series? This distinction is particularly important because of what Thaler and Sunstein state about nudges:

In accordance with our definition, a nudge is any factor that significantly alters the behavior of Humans, even though it would be ignored by Econs. Econs respond primarily to incentives. If the government taxes candy, they will buy less candy, but they are not influenced by such “irrelevant” factors as the order in which options are displayed. Humans respond to incentives too, but they are also influenced by nudges.
— Page 8 of 'Nudge: Improving Decisions About Health, Wealth, And Happiness'

Now that we have all of that out of the way, let’s look at some examples of how behavioral economics is being used to change my life, your life, and the world at large.

Real-life applications

1. Tax compliance: In Minnesota, officials conducted an experiment with the goal of increasing tax compliance through a nudge. They gave four groups of taxpayers the following information. Group 1 was told/reminded that their taxes went to good works like education, police protection, and fire protection. Group 2 was threatened with the risks of punishment for not paying taxes. Group 3 was given information about how they can get help if they’re confused about how to fill out the tax forms. Finally, Group 4 was told that more than 90% of Minnesotans already complied with their obligations under the tax law. Which intervention worked? Group 4. By leaning on the fact that humans, as social animals, care very much about what their peers think and do, this intervention was successful in significantly improving tax compliance. A similar experiment, with similar results, was done in the UK.

2. Smoking and binge drinking. Similar to the previous example, public officials in Montana tried to affect social norms, this time around the problems of binge drinking and smoking. They adopted a large-scale educational campaign that stressed that strong majorities of Montana’s citizens do not drink and, on college campuses, that 81% of Montana college students have four or fewer alcoholic drinks per week. In the case of smoking, they emphasized that 70% of Montana teens are tobacco free. These initiatives significantly decreased smoking and binge drinking because, just like in the previous example, they emphasize social norms and the behavior of peers to discourage the aforementioned behaviors.

3. Energy consumption. Three hundred households in San Marcos, California were part of a clever experiment regarding energy consumption in the home. In their monthly energy reports, they were informed about not only their own consumption, but also the neighborhood average energy consumption. In the next few weeks, those who consumed more than the neighborhood average significantly reduced their use while, through what psychologists call the boomerang effect, those who consumed less than average increased their energy use. “If you want to nudge people into socially desirable behavior”, write Thaler and Sunstein on page 69, “do not, by any means let them know that their current actions are better than the social norm.

The interesting part, however, came later. Half of the households were given a non-verbal signal that told them if their consumption was above or below average. This signal came in the form of an emoticon (yes, really). Those that consumed “too much” received an unhappy emoticon on their report and those that consumed below average got a happy emoticon. “Unsurprisingly, but significantly, the big energy users showed an even larger decrease when they received the unhappy emoticon. The more important finding was that when below-average energy users received the happy emoticon, the boomerang effect completely disappeared!” (Page 70) That is, the latter group that was below-average did not increase their energy use after seeing the happy emoticon. I never expected those things to be useful beyond social media…

4. Energy consumption… with traffic lights. In 2007, researcher Clive Thompson investigated an innovative idea by Southern California Edison to get its customers to conserve energy at home: the Ambient Orb. The Orb is a lovely little ball that glows red when a household is using a lot of energy (i.e. incurring high energy costs) and green when they’re using little energy. This clever little nudge made people more aware of their choices and resulted in a 40% reduction, during peak periods, of energy consumption.

5. Save More Tomorrow (SMT). Arguably one of the most successful applications of behavioral economics comes, quite remarkably, in the field of saving for retirement. A huge problem in America is that people do not save enough for retirement at all. SMT combats this by allowing employees to commit themselves, in advance, to a series of increases in their retirement contributions timed to coincide with pay raises. For example, when you get a 3% wage increase, you’ll automatically increase your retirement contribution by a similar percentage (less than 3% though, of course). This is also combined with automatic enrollment; that is, employees are automatically enrolled in a retirement savings plan and have to choose to opt out if they don’t want to be in it.

By synchronizing pay raises and savings increases,” write Thaler and Sunstein on page 115, participants never see their take-home amounts go down, and they don’t view their increased retirement contributions as losses.” Thus far, SMT has been fantastically successful in increasing retirement savings. I highly recommend you check out this TED Talk by one of its pioneers, Shlomo Benartzi, to learn more about it.

6. Give More Tomorrow. In a clever spinoff of the previous application, Anna Breman (2006) conducted an experiment with a large charity in which donors were asked to increase their donations either immediately or starting in two months. The second group increased their donations by 32%.

7. Organ donation. On page 180-181, Thaler and Sunstein report that in Germany, 12% of citizens gave their consent to be organ donors while in Austria 99% of citizens did. The difference is that Germany (at the time that Nudge was written) uses an opt-in system for organ donation, which means that you have to explicitly state that you want to become an organ donor in order to become one. Austria, on the other hand, uses an opt-out system: you have to explicitly state that you do not want to be an organ donor, otherwise you will be listed as one by default. Clearly, default options (and choice architecture) matter.

8. Going to college. On page 207-208, Thaler and Sunstein discuss a very simple nudge at San Marcos High School in the city of San Marcos, Texas. In order to graduate, students have to complete an application to nearby Austin Community College (note: technically, it doesn’t say that the students have to go attend the college if they are accepted). Furthermore, counselors at the high school emphasized how much more money college graduates earn compared with high school graduates by explaining it as the difference between a Mercedes and a KIA car.

From 2004-2005, the percentage of students at the high school who went to Texas colleges rose 11 percentage points (to 45%) and more than 45 Texas high schools have similar programs. “Schools in Florida and California have created programs modeled after San Marcos’s. In Maine a state legislator is proposing a law requiring high school seniors to submit at least one college application before they graduate.

9. Automatic tax returns. Countries like Denmark, Australia, Norway, Sweden, Belgium, Chile, Portugal, Spain, the Netherlands, and France use varying degrees of what is called a pre-filled tax return form (proposed by economist Austan Goolsbee in 2006). Anyone who doesn’t itemize deductions and has no income that is not reported to the IRS (e.g. tips) receives a tax return that is already filled out. The person would only need to verify the information, sign it, and send it back. This would replace the current system where the default is that the person has to complete the form from scratch. “Denmark pioneered the pre-filled tax return idea [in] the early 1980s, and the other Nordic countries soon followed. Finland Prime Minister Matti Vanhanen awarded his Tax Administration an award in 2006 for its automatic tax return program." (Page 232-233).

10. Smoking cessation. Committed Action to Reduce and End Smoking, or CARES, is a savings program of the Green Bank of Caraga in Mindanao, Philippines. Someone trying to stop smoking opens a savings account with a minimum balance of $1. For six months, he deposits the amount of money that he would have spent on cigarettes into the account. Once the six months are over, he takes a urine test to confirm that he hasn’t smoked during this time. If it comes out clean, the person gets all the money deposited over the six months back. Otherwise, the money is donated to charity. Evaluation of the program found that participants were 53% more likely to quit smoking.

11. Flies in the urinal. At Schiphol Airport in the Netherlands, authorities had a fantastically simple idea to make men’s restrooms cleaner. They placed the image of a black housefly in each urinal in order to help men improve the, ehm, “aim” of their urine by giving them something to “shoot for” when they’re relieving themselves. The flies reduced spillage by 80%.

12. The Civility Check. People often write nasty messages on social media and/or send insulting emails to people in the heat of the moment. To fix this, Thaler and Sunstein propose the Civility Check. This piece of software would detect when you’re about to send a nasty (or uncivil) message and flash the following message on your screen: “WARNING: THIS APPEARS TO BE AN UNCIVIL EMAIL. DO YOU REALLY AND TRULY WANT TO SEND IT?” In an age in which cyber-bullying is such a serious problem, I think this idea is worth a try.

13. The UK Behavioral Insights Team. One of the most formalized adoptions of behavioral economics. The Behavioral Insights (aka The Nudge Unit) exists to “generate and apply behavioural insights to inform policy, improve public services and deliver results for citizens and society”, mostly in the United Kingdom though their work spans dozens of countries around the world. The Nudge Unit really excites me because this is behavioral economics adopted within the framework of government and used to inform government policy. Their work spans a wide variety of areas, so if you’re curious about what they do make sure to check out their website or the fantastic Freakonomics podcast episode that they were featured in.

Former U.S. President Barack Obama tried to replicate this initiative after signing an executive order in September 2015 that created the Social and Behavioral Sciences Team. This was intended to be the American version of the Nudge Unit but was, unfortunately, disbanded in January 2017. This was, coincidentally, also when current President Donald Trump was inaugurated (though correlation is not causation).

14. Recycling. Research of a Norwegian recycling program found that people were more likely to recycle if they were made aware of how many people in their community also recycled. Social norms matter.

15. Trayless cafeterias. When Alfred University in New York stopped offering trays at their cafeteria, food and beverage waste decreased between 30% and 50%, which amounts to roughly 1,000 lbs (453.6 kg) of solid waste and 112 gallons (424 liters) of liquid waste saved on a weekly basis, according to the college.

16. Carbon labels. To combat climate change, Japan is labeling consumer goods to show their carbon footprints. “Ministry research shows one example of a carbon footprint using potato chips”, Thaler and Sunstein write on page 261. “A bag of chips emits 75 grams of carbon dioxide, 44 percent of which comes from growing potatoes and another 30 percent from the production process. The rest comes from packaging, delivery, and bag disposal.” Similar programs exist in places like Britain and France.

17. Nudges in the field. A series of wonderfully simple nudges in various countries and areas of life (link). Click the pictures and then the directional buttons to cycle through all of them. I especially like the turtle-plastic bag one.

And many, many more nudges that I do not have the time or space to list. Believe me, this list barely scratches the surface of the various applications of behavioral economics.

Return on Investment

One quick note about nudges and behavioral economics in general. While the financial benefits from many of these initiatives aren’t life-changing, the point of them is that their return-on-investment is usually very high. Why? Because the costs of most of them are incredibly low (and are often only one-time costs while the benefits continue to accrue over the long-run). Changing default options, adding a message in a tax form, pre-filled tax forms, a fly in a urinal, automatic enrollment. Much of this isn’t life-changing stuff.

A few thousand in savings here, hundred thousand in savings there; it all adds up in the long-run, especially when the cost is only one-time.

Next Up: The Future of Behavioral Economics

In the next part, I will formally conclude the series with a discussion about what I think the future of behavioral economics is and what experts in the field are saying about it. Stay tuned!

See you, Space Cowboy.