Thaler and Sunstein have tapped into a timeless idea that has been often overlooked: consumer choices are frequently driven by irrationality.
Summary Notes
Thaler and Sunstein have tapped into a timeless idea that has been often overlooked: consumer choices are often irrational.
According to one of Thaler’s most cited research article, ‘economic theory’ is based on ‘rational maximizing models’1Thaler, Richard., 1980. But, if people’s choices are irrational even in certain well-defined situations, economic theories will be incontinent with reality. This is where behavioral economics or psychological economics has huge advantages in terms of predicting economic aspects of real life. Behavioral economics can be a tool to ‘direct’ people towards better outcomes. In other words, people’s choices can be ‘nudged‘.
But, obviously, there is an ethical dilemma.
We don’t know people’s personal financial circumstances. So how could we guarantee that it’ll benefit an average person by ‘nudging’ them into some financial decision, based on a general statistical foundation? Does the concept of ‘nudging’ still preserve freedom of choice?
To put it somewhat crudely, we only have so much freedom of choice when it comes to both macro and microeconomics. Even though we have the right to choose, evidence suggests that we often miss out on making the ideal choices for our own interests.
The first third of the book is centered around the idea that people do not consistently select the best paths for themselves when faced with multiple choices. The authors examine the ‘Two systems’ model, which has been the focus of significant research by the prominent economist Daniel Kahneman, a Nobel Prize winner in the field of economics. In short, these two systems correlate to two types of thinking, (1) automatic and (2) rational. Most of our choices are influenced by the first system, that is, they are intuitive and not reflective, therefore there are a lot of margins for error. Even if we make choices with the influence of system 2, which is rational, they are sometimes with flaws.
‘If you have personally experienced a serious earthquake, you’re more likely to believe that an earthquake is likely than if you read about it in a weekly magazine’
And it will likely increase the number of unnecessary insurance purchases. Also, people are, most of the time, unrealistically optimistic even when the stakes are high. One key idea that stands out in the book is ‘loss aversion,’ which posits that the unhappiness from losing an item is double the happiness gained from obtaining it. The bottom line of all these examples is that people are ‘nudge-able’
‘The more choices you give people, the more help with decision-making you need to provide.’
‘A nudge, as we will use the term in 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.
This notion gives life to the new concept that the authors introduce as ‘Libertarian paternalism‘. Libertarian paternalism is an approach that seeks to influence people’s behavior in a way that benefits them, while still respecting their freedom of choice.
The next few chapters of the book are dedicated to solving this issue of bad decision-making (especially in the domain of microeconomics) by ‘nudging’. One of the best ways to overcome making bad decisions, according to the authors is by acknowledging ‘peer pressure’
‘The bottom line is that people are easily nudged by other humans. Why? One reason is that we like to conform.’
But, ‘peer pressure’ can go both ways. It could be a positive influence on someone to make better decisions but at the same time, consistent and unwavering people can move groups and practices in their preferred direction. This could potentially lead to ‘collective conservatism’ which is the tendency of groups to stick together to established patterns even as new needs arise. This is a good example of ‘bad’ nudges. However, the authors argue that statistically speaking, ‘peer pressure’ is one of the most successful ways to implement a ‘good’ nudge.
The authors’ exploration of how nudges could be relevant to marriage was both captivating and somewhat contentious. They propose that marriage should fall under the purview of private entities, with the state responsible for establishing default regulations that apply in the absence of alternative agreements. In the event a couple separates, how much support should be provided to a partner who has limited career prospects due to their time spent caring for children? Suitable default regulations would offer protection, as they are likely to remain in place (especially since most individuals do not anticipate divorce), and if they are modified, a clear agreement must be reached between the parties involved. This nudge could safeguard the more vulnerable partner and help remove the government from the institution of marriage.
“Marriage might be seen, in part, as a solution to a self-control problem, in which people take steps to increase the likelihood that their relationship will endure. If divorce is difficult, then marriages are more likely to be stable. Marital stability is usually good for children (though children can also benefit from the end of a bad marriage).”
Overall, the authors have made two major claims. (1) Seemingly small features of social situations can have a massive impact on people’s behaviors — nudges. and (2) Libertarian paternalism is not an oxymoron! — the idea is coherent and it works. And the authors propose that these claims can potentially offer ‘a real third way’, or can break through some of the least tractable debates in contemporary democracies. Especially, in a democratic society, specificity is somewhat challenged by the notion of ‘one size may fit all’.
But is that true, for everybody, at all times? Probably not…
Abiding by this idea is the collective sacrifice people have to make in the name of democracy. But the authors suggest a ‘third way’ where people do not have to be oppressed by the collective pressure imposed by democracy and break through it to be able to make selective choices that will make their lives better.
How to do so?
Government officials can use ‘gentle nudges’ to direct people to their subjectively better outcomes.
‘Choosing the right plan, rather than a random plan, has the potential to save both seniors and the government a lot of money’
“No less than those in the private sector, the public can nudge people in directions that will make their lives go better while also insisting that the ultimate choice is for individuals, not for the state.”
(Featured image was created with amazon book cover image)
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