In Nudge: Improving Decisions About Health, Wealth, and Happiness, Professors Richard H. Thaler and Cass R. Sunstein propose a dramatic alteration of the way public policy is approached.
They start with the basic theory that the way options are presented has a tremendous effect on the likelihood of different choices being made. By deliberately altering this presentation, policymakers can “nudge” people into making better choices than they might make if left to their own devices.
Consider this. A friend of yours is a director of food services for a large school system, and he knows that by simply rearranging the order and layout of the cafeteria, the consumption of many items fluctuates by as much as 25%. Given his options as the choice architect, wouldn’t his best option be arranging the food to make the students best off and healthiest?
This example highlights what Thaler calls “libertarian paternalism.” The paternalism comes from the belief that it is appropriate to influence people’s behavior in a way that makes them better off. It’s libertarian, however, in that choices aren’t taken away — they don’t propose mandates or bans — they are merely reframed.
Classical economic theory assumes that humans are rational decision makers who, when faced with a set of options, will calculate which choice maximizes their utility. This textbook view of human behavior may be appropriate in economic models, but is not an accurate portrayal of how humans behave in real life. People are not Homo economicus; they are Homo sapiens. We are subject to a myriad of fallacies, biases, and misconceptions that lead to sub-optimal choices in many areas of life.
Much of what causes humans to stray from purely rational decision making stems from the fact that we have two modes of thinking. This is covered in great detail in Daniel Kahneman’s Thinking, Fast and Slow, in which he proposes that the mind consists of System 1, which operates automatically and with little effort, and System 2, which requires effortful attention and can make more complex calculations. Thaler and Sunstein call them the Automatic System and the Reflective System, but the idea is the same. We make bad choices when our Automatic System hijacks the decision making process, preventing us from thinking it through rationally and completely.
“First, never underestimate the power of inertia. Second, that power can be harnessed.”
- Richard Thaler
This is manifested in a series of universal cognitive biases, some more well-known than others. One common example is the availability heuristic — we are more likely to overestimate the probability of an event if there are readily available examples of it occurring. Media coverage of plane crashes, for example, make us think they are more common than they actually are. Another bias is overconfidence — people are unreasonably optimistic about their own circumstances, even in the face of statistics to the contrary. Unfortunately, we rarely believe that the 50% divorce rate will apply to our nuptials. Finally, a couple that are particularly accessible to being fixed through nudges are framing and temptation. Framing refers to the way information is presented — think “90 of 100 survive” vs. “10 of 100 die” — that affects the way our Automatic System perceives a fact. Temptation is the result of conflicts between the Automatic and Reflective systems in the moment vs. in the future, or more intuitively conflicts between the Planner and the Doer. It’s easy for the Planner to decide to go on a diet, but when given a cookie, the Doer can’t help but give in.
Nudges are meant to give the Planner a fighting chance. A particularly useful example is with retirement planning. Currently, 30% of employees with employer-matched 401(k) benefits fail to enroll. If employees are automatically enrolled in a 401(k) plan — but importantly, given the ability to opt out — they are more likely to save. They are “nudged” into doing what should be rational, but what our irrational sides prevent. Another example is organ donation. When people have to opt in to becoming an organ donor, they usually don’t — even if they profess a more abstract belief in organ donation in general. By switching to an “opt-out” program, people keep their freedom of choice, but are nudged toward the one that saves more lives.
The proposals in Nudge seem reasonable and worthwhile, but are not without downsides. No matter how well-thought out a policy is, there are always unintended consequences. The idea of even well-meaning government bureaucrats tampering with people’s behavior may strike some as Orwellian, and it is in fact true that over the course of history, attempts to engineer a “perfect” society of citizens have led to tragic ends. The libertarian half of “libertarian paternalism” seems to mitigate this concern, but lines can be blurry about when nudges have gone too far. Another concern is that nudges remove peoples’ agency and personal responsibility for their own decisions, and in the process de-emphasize traditional notions of morality. If a person’s decisions are so easily manipulated, how can anyone be held accountable for their actions?
Despite these concerns, Nudge remains an insightful look into how we as humans make decisions and provides a framework for setting up institutions in such a way that can help maximize our long-term well-being. If implemented responsibly, Thaler and Sunstein’s proposals can go a long way in improving the lot of our amazing, if somewhat irrational, species.
This classic brief was originally written by Nick Bezner.
A link to the full book can be found here. The views expressed are, unless expressly stated, the views of the author or the brief writer, not Titans Of Investing as an organization.
Want to learn more about Titans of Investing? Click here.
