Behavioral Economics – How to make better choices and policies

  11-Sep-2020 13:04:06

Behavioral economics Economics India Policy making research


What is Behavioral Economics?

Imagine yourself in the following situation, you are in a supermarket and you are shopping for biscuits. There are about fifty varieties of biscuits in front of you varying in flavors, prices, nutritional value, packaging, etc. Now, suppose you want to put one in your cart, which one would you go for? The obvious answer will be whichever is your favorite brand or your favorite flavor or a new variety that looks delicious from the packaging of it. Do you know that according to rational economic theory, you might be considered as an “irrational consumer”? You might think, “But hey, how do you shop for biscuits like a rational consumer? What is that even supposed to mean!? Well, a rational consumer or an ‘Econ’ as they say in Behavioral Economics would compare the prices of all fifty varieties, compare their nutritional value, compute the differences in utilities that he would derive from them, make complex mathematical calculations and then choose a pack of biscuits. Sounds insane right? You might argue that a person like this would resemble a computer more than a human. That is exactly the problem with traditional economic theory, which is based on the premise that human beings are rational and know how to maximize their welfare. Human beings are not perfectly rational all the time. We are emotional, we have limited cognitive abilities, we go out of the way to please our loved ones even if it does not give us any utility, we are impulsive and we sometimes make choices that we regret.

Behavioral economics provides a framework that considers human psychology. It understands our limitations and aims at helping consumers to make better choices to improve their personal and financial well-being, firms and industries to market their products better & make profits, and Governments to formulate more coherent policies. Behavioral Economics uses ‘Nudging’ as a tool for the above. According to Richard Thaler and Cass Sunstein, the authors of the book ‘Nudge’ which is a pioneering book in the field of behavioral economics and behavioral science, “anudgeis any aspect of the choice architecture that predictably alters people's behavior without forbidding any options or significantly changing their economicincentives. To count as a merenudge, the intervention must be easy and cheap to avoid.” Coming back to our supermarket scenario, a shopping bot, an assisting app or a shopping assistant that helps you choose a better variety according to your taste is a behavioral intervention that might be useful where choices are slightly more confusing than choosing a pack of biscuits.

How can you make better use of behavioral insights?

As human beings, we intend to do so many things, we set goals for ourselves and have a desire to achieve them. All those new year resolutions or statements like “I will exercise and eat clean from tomorrow”, “I will not shop unnecessarily and save more money” or “I will dedicate an hour for my hobbies every day.” are familiar thoughts that cross our minds but rarely do we act upon them. This is known as the action-intention gap. The cause of this gap is that we fall prey to short term rewards even if we know it is not the right choice for our long term wellbeing. Our desire overcomes our willpower. So how do we avoid falling into such a lapse zone? Here are a few strategies that might help you achieve those long term personal and financial goals.

  • When it comes to personal finances, save or invest your money having a specific goal in mind. For example, if you want to travel more, create a travel fund and let the money get deducted from your salary account automatically every month. Invest your money keeping in mind the things you would like to spend it on. Let's say the countryside farmhouse you would like to buy, or renovate your home or get that home-theatre you always wanted. When you create a mental account for a specific cause, you are less likely to spend that money elsewhere in haste.

  • Warren Buffet says, “Do notsavewhat is left after spending; instead spend what is left aftersaving.” For saving more money daily, make cash envelopes for different categories like food, entertainment, shopping, necessities, etc. Once you have spent all the money from an envelope, you will pause and think before you make that additional expenditure. According to research, most of the time you won't make one. If you are someone who uses digital wallets, put a fixed amount of money in your wallet on a daily or weekly basis, so that you spend more mindfully and are aware of the excess expenditure. Basically, learn from your mom and create your budget!

  • While shopping for any product or service, you need to know, that human beings when faced with too many choices or a ‘choice overload’ might make unfavorable decisions for themselves. To avoid being in that sort of a frenzy, streamline your choices. Think about the attributes that truly add value and shortlist products accordingly. The more limited the choice set, the more efficient the choice.

  • For your health and fitness goals, try pre-committing to your goal in front of your friends. Social pressure will push you harder to achieve it. Pay for your gym class every month instead of one time yearly payment. Paying monthly, will remind you of your goal and help you stick to it. We all know how many times we ended up hitting the gym after paying for the gym membership last year!

  • Put cute little reminders on your fridge, so that every time you want to indulge in those additional calories, you are made to pause and reflect on your decision.


Behavioral Economics in Public Policy

Now we come to the domain of policymaking. How can the government ensure that citizens are better off and maximize their welfare? India is a developing country. We still see a large technological and infrastructural gap between rural and urban areas. Many people fail to benefit from the very policies that were meant to enhance their welfare. Financial inclusion and access to technology are a must if we want to widen the reach of a policy or make sure that it benefits the targeted section. Using behavioral sciences in policymaking eliminates many such loopholes and can help us achieve both equity and efficiency.

For financial inclusion, opening accounts is definitely the first step but financial counseling is mandatory for every account holder owing to the severe lack of financial literacy in our country. The counseling should explain different ways of investing along with different types of accounts you can open. The counseling should take place over several sessions and not just one. Along with a compulsory daily expense or salary account, every citizen should have a mandatory savings account. If savings aren't in the banks, they are a leakage in the economy. The task of maintaining the savings account could be done proficiently by women of the family provided they are educated regarding the practices and equipped with Smartphones. While opening the savings account, there should be an option to name the account based on its purpose. For example, the ‘Children’s Education’ account. The minimum balance can vary according to income. Apart from that, a monthly reminder should be sent at the beginning of the month to deposit a fixed amount in 'children's education'. The amount could be as low as 50 rupees or 100 rupees. Every time you are tempted to withdraw from the savings account for some reason, the system will show a pop up with a question, “ are you sure you want to withdraw from children’s education?”. Imagine the kind of impact that question has.

Small reminders can alter such behaviors and thus avoid undesirable outcomes. 'Children's Education' is just an example. The account could be for investing in farm machinery, building your house, or any other relevant cause. The ‘Sukanya Samridhi’ scheme which aims at empowering the girl child, does have some of the above features. But for all other account holders, having a minimum balance requirement is not enough. Monthly reminder messages to deposit money, or questioning the user before he spends his minimum balance can make a lot of difference. So many accounts in rural areas are empty accounts or accounts with hardly any funds. A surveillance system should keep a track of all such accounts making sure they are serving the purpose. Investment in artificial intelligence is essential for the same. The contracts for such systems can be outsourced to private firms

Engagement with users develops a sense of answerability, thereby increasing compliance. Tax compliance can be improved by nudging. The UK reduced tax delinquency rates by using a simple mechanism. They informed people via email/text if they belonged to the small percentage of the population who were delinquents or to the majority who were sincere.

If our existing online banking and payment apps were updated with expense tracking features that allow users to plan and limit their spending, they could be tested to control impulsive over-consumption. These apps could send text messages to notify the user, motivate him/her to stick to their consumption goal, or set a small penalty for every time you spend over and above your budget for the day or week.

Saving and investing need to be portrayed as essential requirements because they indeed are. When everyone around you does it, you are likely to do it too! This is because human beings have a need for belonging. Indulging in socially acceptable behaviors is a way to fulfill this need. Nudging people to save, invest and even buy insurance, by leveraging social norms could benefit them on an individual level as well as generate large volumes of credit in the country’s financial system.

Here’s how Behavioral Economics and Behavioral Insights have helped policymakers worldwide

Countries like the UK, Singapore, Canada, Australia, Peru, USA, Netherlands already have specialized behavioral insights teams that work closely with policymakers and executives to incorporate nudging strategies that maximize social welfare as well as minimize costs. Here are a few examples.

  • The government of Singapore made Job Centers more easily navigable so that people desperately in need of jobs could reach them quicker. A combination of pre-committing strategy and financial incentives in the intervention increased the percentage of people who found employment through them from 32% to 49%. Along with this Singapore has used peer pressure and principles of social conformity and compliance to encourage cleanliness in the city.

  • Canada managed to see a surge in organ and tissue donors by 143% just by making the registration process simpler. In an experiment with recycling behavior, they simply tested the impact of different labels on garbage bins. Turns out, the label that performed the best, increased organics recycling by 82%.

  • MineduLab’ established by the Ministry Of Education in Peru, successfully reduced dropout rates & enhanced learning outcomes among students by showing them videos on the importance and benefits of higher education. They also improved teacher attendance by using behavioral science based messaging.

  • The ‘Save more tomorrow’ is a behavioral intervention implemented in the United States designed by Richard Thaler and Shlomo Benartzi to encourage people to save more for their retirement. The program requires you to pre-commit to increasing your saving rate every time you get a raise. The amount gets deducted from your account automatically. That way, your disposable income remains the same and you do not fall prey to loss aversion because you are not losing any money you have with you at the moment. Opting out of the scheme is possible anytime but because of inertia, people generally don’t.

It is high time we have a dedicated behavioral insights center in India established by the government that works closely with the government and also with firms or corporations to take on socio-economic projects. For a country as dynamic as ours we could find general as well as specialized solutions for problems ranging from poor tax compliance to climate change.

By: Yeishita Kelkar