In Economics, there has been a long tradition of using market based incentives(regulations) to regulate market failure.
Laws on minimum age for buying cigarettes and alcohol.
Using corrective taxes to respond to externalities.
Maximum CO2 emissions for new vehicles, laws which restrict flight times at night.
Regulations for tax compliance and retirement savings.
However the cost of implementing these taxes and regulations can be high and might be accompanied by political limitations.Hence the requirement for an alternative or a complementary tool is justified.
With these intentions to make people better off,Thaler and Sunstein formulated the “nudge” theory.
This focuses on using cheap and simple nudges to achieve beneficial outcomes instead of regulations.That is,use behavioural economics in government policy making.
Let’s take the example of energy conservation. The most effective nudge involved sending households a letter comparing their energy consumption to that of their neighbours, which led to a reduction in energy utilisation of 27.3 kilowatt hours per dollar spent on the mailings. When judged against traditional interventions, such as offering utility customers a refund if they cut their energy usage, the nudge proved to be eight times more cost-effective.
Similarly,the Behavioural Insights Team in UK used nudge techniques to speed up the payment of £30 million a year in income tax by rewriting reminder letters to inform recipients that most of their neighbours had already paid.
It turns out that human beings are often busy, distracted, and socially motivated.
As a result, our “decisions” are often the result of subconscious, non-rational influences. Simply put ,If we know our neighbours are recycling, we are more likely to recycle.
Choice architecture is also considered a powerful tool in nudging. For instance, instead of placing strict regulations on retirement savings or using campaigns, governments can simply auto-enrol employees to the scheme, and those who do not wish to continue can use the opt-out option.This method showed noticeable effects in boosting annual savings in the US.
Behavioral studies tell us when faced with overly complex choices, people are more likely to take the option that requires the least effort.This also because of psychological inertia -the tendency to maintain the default option.
Other success stories include boosting police diversity, increase in uptake of organ donation, increase in efficiency in the fuel economy etc.
Thaler and Sunstein use the term ‘libertarian paternalism‘ as a name for the underpinning philosophy that they advocate when considering and applying Nudge theory.However,these tools are not without drawbacks. Conterversial questions include,
“But is nudging moral?”
”Where do nudges shade into manipulation?”
“Do nudges tamper with freedom of choice?”
“What will happen when dictators learn to manipulate choice architecture?”
While controversies are rich in the air regarding the extent to which nudges can be implemented,
Richard Thaler says that whenever he autographs a copy of his book, Nudge, he writes, “Nudge for good!” .Good nudges can help individuals overcome natural human limitations to make better choices.