Nudge

By Richard Thaler & Cass Sunstein

Nudge is a concept in behavioral science, political theory and behavioral economics which proposes positive reinforcementand indirect suggestions as ways to influence the behavior and decision making of groups or individuals.

Nudges provide the key to predictably altering peoples’ behavior without forbidding any course of action outright or significantly changing their incentive structures. Nudges are low-cost tools that alert, remind, or mildly warn people by exploiting human psychology, thereby molding behavior in powerful ways. Whereas classical economics conceptualizes man as perfectly rational (“homo economicus”), nudges are crafted in light of evidence from behavioral psychology suggesting that, in the real world, human beings are flawed in myriad ways. Examples abound, but among the most important is the status quo bias, which leads people to follow default options.

The book starts with the example of the director of food services for a large city school system. The director hatches a plan to change the way that food is displayed and see how it affects the choices made by kids.

The director is what Thaler calls a “choice architect”. A choice architect has the responsibility for organising the context in which people make decisions. “Many people turn out to be choice architects, most without realising it…if you design the ballot voters use to choose candidates, you are a choice architect”.

There are many parallels between choice architecture and more traditional forms of architecture. A crucial parallel is that there is no such thing as a ‘neutral’ design.

Libertarian Paternalism

Thaler encourages all choice architects to follow the idea of Libertarian Paternalism. The libertarian aspect of the strategy lies in its belief that people should be free to do what they like. The paternalistic aspect lies in the claim that it is legitimate for choice architects to try to influence people’s behaviour in order to make their lives longer, healthier and better — as judged by themselves.

Human Error

Thaler asks whether the two tables are the same or identical. The average human would say that they are different when in fact the two images are the same with one simply being rotated vs the other.

This is used to explain the idea that human’s have systematic bias’s in there decision making that can be recognised and used to a certain end.

Two Systems

Thaler goes on to describe how the human mind is made up of two systems. System 1 which is involved in intuitive and automatic action and System 2 which is associated with thinking.

When life asks us difficult questions we tend to use rules of thumb or heuristics to help. These can be helpful but can also lead to systematic biases.

Amos Tversky and Danial Kahneman identified three heuristsics and the biases associated with them in their original work.

Anchoring — Anchoring or focalism is a cognitive bias for an individual to rely too heavily on an initial piece of information offered when making decisions. If a person is asked what the population of Chicago is then they will tend to start with a number (an anchor) and adjust upwards or downward from this. The bias occurs due to the choice of the Anchor. When asked the Chicago question, those who start with a small city as an anchor underestimate Chicago and vice versa. The anchoring effect is even seen in the order that questions are asked in.

Students were asked a.) How happy are you? b.) How often are you dating?. When asked in this order the correlation between the two questions was low (0.11), however, when asked the other way around the correlation jumped to 0.62…When prompted by the dating question, the students use what might be called ‘the dating heuristic’ to answer the question about how happy they are.

In the context of the book, Anchors server as nudges.

Availability

The availability bias is the human tendency to think that examples of things that come readily to mind are more representative than is actually the case. The psychological phenomenon is just one of a number of cognitive biases that hamper critical thinking and, as a result, the validity of our decisions.

When asked how much should one worry about terrorism or avian flu? People use the availability heuristic to answer these questions by assessing the likelihood of risks by asking how readily examples come to mind. This heuristic explains why in the aftermath of an earthquake, purchases of new earthquake insurance policies rise.

When ‘availability bias’ is at work, both private and public decisions may be improved if judgements can be nudged back in the direction of true probability.

Representativeness

Think of this as the similarity heuristic. The idea is that when asked to judge how likely it is that A belongs to category B, people answer by asking themselves how similar A is to their image or stereotype of B.

Consider the phenomenon of cancer clusters. These can cause a great deal of private and public concern. Suppose that in a particular neighbourhood we find an apparent elevated cancer rate. The problem is that in a population of 300 Million it is inevitable that certain neighbourhoods will see unusually high cancer rates within a one-year period.

Gains & Losses

Thaler describes how People hate losses more than they like gains with this being known as ‘loss aversion’. He describes how people were asked Heads you win $X, tails you lose $100. How much does X have to be for you to take the bet? The average answer was around $200 implying that the prospect of winning $200 offsets the prospect of losing $100.

Loss aversion helps product inertia, meaning a strong desire to stick with your current holdings. In another experiment, half the students in a class received coffee mugs and half got large chocolate bars. The mugs and chocolate bars cost about the same and in pretests students were as likely to prefer a mug to a candy bar or vice verse, Yet, when offered the opportunity to switch from a mug to a candy bar or vice versa, only 1 in 10 switched (the endowment effect).

Loss aversion is only one of the factors that contributes to the ‘Status Quo Bias’ — the general tendency to stick with your current situation. In one study conducted on people’s pensions the average number of asset allocation changes over a lifetime was 0!

Framing

Choices can be presented in a way that highlights the positive or negative aspects of the same decision, leading to changes in their relative attractiveness. This technique was part of Tversky and Kahneman’s development of prospect theory, which framed gambles in terms of losses or gains.

Different types of framing approaches have been identified, including risky choice framing (e.g. the risk of losing 10 out of 100 lives vs the opportunity to save 90 out of 100 lives), attribute framing (e.g. beef that is 95% lean vs 5% fat), and goal framing (e.g. motivating people by offering a $5 reward vs imposing a $5 penalty).

Energy conservation is now receiving a lot of attention, so consider the following information campaigns: a.) If you use energy conservation methods, you will save $350 per year. b.) If you do not use energy conservation methods, you will lose $350 per year. It turns out that campaign b is far more effective than a. This is due to people tending to make choices using System 1 and not System 2 which was rephrase the question to see if it would produce a different answer.

Following The Herd

Conformity bias refers to our tendency to take cues for proper behavior in most contexts from the actions of others rather than exercise our own independent judgment.

In the 1950s Solomon Asch, a brilliant social psychologist, conducted a series of experiments on social conformity. He asked participants a series of very simple questions. When people were asked on their own, participants got all of the questions right. When asked in a room with others, in which everyone else gave an incorrect answer, people erred more than 1/3rd of the time!

Social influence is one of the most effective ways to nudge behaviour.

Examples: The academic achievements of American students correlate closely with their roommates.

-Teenage girls who see other girls becoming pregnant are more likely to become pregnant themselves.

-Obesity is contagious (Those who eat regularly with another person eat 35% more — if four people, then we eat up to 75% more).

Example: Students invited into a room with five others. They are asked to match a line against one of three other choices (A, B or C). When the five others (all collaborators in the test) speak out the wrong answer, it makes the real respondent doubt his/her own answers. In numerous tests, the respondents conformed with the others and gave the wrong answer between 20–40% of the time.

Example: In Minnesota, four different messages were tested to see which led to greater tax compliance. The idea that won was ‘Over 90% of Minnesotans paid their full taxes’. The same principle was applied to reduce college drinking and teen smoking.

Example: San Marcos California energy bills graphically demonstrated if the household was using more or less energy than their neighbours by using a J or L. This led to a dramatic reduction in energy usage.

Default Nudges

Default nudges are set up in a way that if you do nothing, you’ll still do the right thing by sticking to the preset standard.

At scale, companies can use this by automatically enrolling their employees in their matching-retirement plan programs, unless they explicitly object to participating. This helps a lot of lazy people save for retirement, because they would never have enrolled if they’d had to actively do it themselves.

Save More Tomorrow

Classical economics suggests that people calculate how much they will earn over the course of their careers and how much they will need after they stop working. Then, they save up just enough to enjoy a comfortable retirement without sacrificing too much while they are still working. While this provides excellent advice for how people should think about saving, it utterly fails to accurately describe how people do think and behave when it comes to financial planning.

This account fails to capture two crucial constraints. First, people have bounded rationality with respect to understanding and solving the mathematical problems involved in figuring out what to do. Second, people have bounded willpower with respect to implementing these plans. How can choice architects address the first part of saving for retirement, i.e. joining a plan and deciding how much to invest?

Most public social security systems provide defined-benefit plans that entitle participants to a benefit based on their salary and time worked under the plan. These are well designed in that they are forgiving of mindless human mistakes, requiring participants to decide only when to retire and when to start claiming benefits. The authors identify this as an ideal domain for nudging: because people have to make only one decision per lifetime, choice architecture can help them do a better job of weighing the relevant factors. They endorse automatic enrollment in savings plans unless and until participants decide to opt out. This can be augmented by a Save More Tomorrow program, which provides for automatic increases in contribution rates over time.

Some More Examples of Nudges

-Save money tomorrow — An automatic enrollment system, where the money is invested at source. Since pay rises are often mentally accounted for differently, the scheme ensures there is a commensurate increase taken into savings.

-Give money tomorrow — Works on a similar principle to the above where people make a future commitment to give money to a charity based on future pay rises.

-CARES — A stop smoking campaign where patients deposit the amount they would have spent on cigarettes in an account. If clean from nicotine after 6 months they get the money back — otherwise it goes to charity. Evidence has shown this approach increases likelihood to quit by 53%.

-Healthcare plans — where premium is reduced if go to the gym etc to earn ‘vitality’ points.

-Civility check/24 hour delays on emails to ensure people do not over-react in the heat of the moment.