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Too good to be true?

As behavioral economics becomes the hottest economic theory for firms and policymakers promising easy and cheap fixes, it becomes crucial to remember that it also has its dark side.

Over the past decade, behavioral economics has become the whiz kid of economic research. Suddenly, traditional models which relied on unrealistic assumptions were criticized and modernized. Researchers reached out across disciplines (such as psychology and neuroscience) to decipher human behaviour in economic scenarios. The average homo oeconomicus no longer was rational and profit-maximizing; instead he became riddled with biases, averse to loss, pliable under peer pressure. Small-scale experiments to improve public health, enforce tax collection and boost recycling multiplied, and their positive outcomes encouraged more research in this new field (see previous “Nudge of the Month” articles for examples). Yet, as with everything new and exciting, this field has been building hype that might not be entirely justified.

For all its many advantages, behavioral economics cannot fully replace more traditional methods. In itself it is a useful tool; but it should still be subject to criticism about its obvious pitfalls. One of the most glaring one is that whilst nudges can help solve problems, they can rarely identify the its causes. In other words, it helps with the what, not with the why. Behavioral economics have shown time and time again that individuals fall prey to confirmation bias – to favor information confirming pre-existing beliefs. However, BE alone cannot explain why we have this bias in the first place. Searchers need to dabble with biology, evolutionary psychology and neuroscience to gather the full explanation. Most of the time BE is only a piece of the puzzle and cannot fully explain a phenomenon.

Another major criticism is that nudges don’t always offer the most efficient solutions. Take energy waste management. An experiment in the Bay area showed that when households received not only their energy consumption on their bill but also their neighbor’s, their consumption decreased by 1.5%. Policymakers had hoped to use social pressure to make them self-conscious. To an extent it worked, but only by a very small margin. To put it simply, nudges probably aren’t going to be enough to save the planet. They provide useful baby steps. However, to make a real change, traditional tools such as carbon taxation have been proved to have a substantial impact on energy consumption. But such traditional economic theories are a hard sell for politicians who find nudges much sexier than taxes or extra regulations, regardless of their effectiveness.

Nudging households to consume less by comparing them to their neighbour’s didn’t work out very well. Credit: Coding Horror

Moreover, understanding how the mind works and the different biases it relies on doesn’t mean policymakers can come up with the right nudges. There is always a trial-and-error dimension when creating an experiment, and BE is not immune to this particular fallacy. Nudges can be too weak, as seen when comparing household’s energy consumption to their peers’. But worse is when nudges are too overt and people refuse to be “manipulated” into changing their behaviour. In the same experiment, some politically conservative households rebelled against the comparison of energy consumption and elected to consume more. Backlash is possible if the experiment isn’t well constructed. A famous experiment proves this: an Israeli daycare decided to implement small fees for tardy parents. However, instead of incentivizing them to arrive on time to pick up their children, parents often went the other way. They viewed the small fine as a compensation for the moral violation of tardiness and tended to arrive even later. Getting the right choice architecture is crucial to come up with the correct nudge.

 Some nudges also fail with time. As behavioral economics becomes more popular and widespread, consumers realize how they are influenced and become insensitive to nudges. Many people now know that firms release an outrageously expensive product only to make the rest of their products seem relatively more affordable. They change their habits to not fall into this consumer trap.

Consumers are nudged into choosing the middle options, as the extremes are tailored to seem either too small or too large. This is a common sales trick that many consumers are aware of and tend to fight back. Image credit: Pinterest

Because of this, some changes brought on by nudges also have the undesirable feature of being temporary. After the initial change in behaviour, individuals tend to adapt and eliminate the effects of the change. In Singapore, individual text messages were sent to remind people to stay in state-funded literacy programs. It worked for a while before fizzling out as the texts were ignored. Nudges aren’t shoves; they aren’t always powerful enough to change deep-rooted habits.

So nudges aren’t the jack-of-all-trades of economics; they cannot solve all the problems of economic theory and policymaking. Their usefulness remains limited by their small scale and the lack of a complete understanding of the brain. They could be improved perhaps by daring to establish big-scale, expensive and potentially risky experiments that go beyond slightly changing an electricity bill. For the moment, few governments are willing to invest in such a risky endeavor. But as the hype for BE continues to build, scientists could harness it to push for more complete experiments to remedy some of its ills.

Carolina Leroy

Source materials

Credit for featured image: Taplytics

2 replies on “Too good to be true?”

True! BE remains very useful for small, costless changes. The danger is believing nudges can solve all problems, abandoning more traditional tools (like regulation and taxation) and in some cases observing a decrease in efficiency.

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