Behavioural Economics in the Domain of Public Policy

In an ideal world, people always make optimal decisions that provide them with the most significant benefit and satisfaction. The rational choice theory in the domain of economics says that when presented with various options under the conditions of scarcity humans will choose the option that maximizes their satisfaction. This theory expects that individuals, given their preferences and constraints, can go with judicious decisions by successfully focusing on the costs and benefits of every choice accessible to them. An ultimate decision taken will be the best decision for the person. The rational individual has self-control and is unaffected by feelings and outside factors and, thus, realizes what is best for himself. Behavioral economics states that humans are irrational and are incapable of making good decisions.
Behavioural economics relates psychology and economics to explore why people sometimes make irrational decisions and why and how their behaviour does not follow the estimates of economic models. Decisions like choosing how much to pay for a trip, whether to go to a graduate school, whether to pursue a healthy lifestyle, how much to contribute towards investing, etc., are the sorts of decisions that people make at some point in their lives.

Behavioural Economics and Public Policy

Policy design rules are based on insights from psychology and economics and could have a major impact on the effectiveness of policy implementation in areas such as under-saving, contract design, the measurement of vulnerability, and political support for redistributive policies. Behavioral Economics has gained relevance in the economic literature, and various policy concepts are discussed within the same. It may therefore be enticing to build a link between developments in theory and practice—but whether or not such a connection exists, and if it does, how strong it is, certainly deserves a closer look since paradigm shifts in the theoretical literature do not, neither by necessity nor immediately, automatically translate into respective turns in economic policy. In general, if a connection is observed, it is still an interesting question to research which aspects this includes, how far-reaching it is, where it started, etc.
Behavioural economics hence has become increasingly significant in helping to shape a range of economic policies. Perhaps its strongest point is that the ideas and insights gained from research can be applied in many contexts where policymakers might mediate.
Below are the main ideas as to how this relates in the terms of policy making:

Choice building

The choice-building relates to the symbols and signals that are present at the time that individuals make choices. For example, when deciding to purchase a financial product, an individual is likely inclined by outside surroundings, posters, and what the ‘choice architect’ says. It may be that the situation in which economic decisions are taken or economic choices are made is weighted heavily in favour of the seller, who may lead the buyer towards the decision that is most favourable to them. In that case, interventions can be made to prevent this decision-making bias.
For example, policymakers may pass legislation to insist that there is a time delay between being able to sign the contract or discussing the product with the salesperson and or having a ‘cooling-off period after the signing of the agreement.
Decision edging
Decision edging is structuring an environment so that individuals arrive at a decision that yields the seller of the policymaker the best result. For example, Netflix’s subscription package typically has three prices reflecting different levels of streaming provision. The first option is usually ‘basic’ with fewer options but is the cheapest; last option is the highest level of service, with, often, an excessively high price (which few will choose), and option two is the mid-range and mid-priced option, which seems ‘good value’ compared with the very high price.
Decisions are being framed so that option two is the favoured option, and – crucially – more people are likely to buy when they feel that they have a choice. Therefore, offering just a single price, that is, option two would lead to fewer sales overall.

POLICY APPLICATIONS

Nudges

Behavioural economists suggest that policymakers can adapt some of the theories developed to nudge individuals towards making rational choices. A nudge is a slight push towards creating a ‘wanted’ choice or avoiding an ‘unwanted’ option and often involves manipulating the choice structure and environment. For example, by forcing retailers to hide cigarettes behind screens, someone who must have never smoked may be nudged away from doing the same.
Nudges are unlikely to work on their own. They are more likely to be successful in combination with other, perhaps more traditional measures, such as putting a tax on unwanted behaviour or subsidising wanted behaviour.

Mandates choices and restricted choice

These suggestions have been incorporated into legislation, especially regarding monetary amenities and complex financial products.
In terms of the restricted choices and government policy, options may be limited so that, along with other approaches, individuals might be stimulated to choose the most suitable option for their settings. For example, if an urban road pricing scheme is operational, drivers may only be allowed to travel into the city on Saturday or Sunday, but not during the week. They must enter their license number into a website and state on which day they travel. There is a choice, but since it is restricted, they can also choose not to travel.

The basic step for behavioural economics to intrude more into policy making is to strive to achieve behaviourally-motivated impacts at a greater scale since most of the current programmes in developing countries have been implemented as small-scale experiments.

 

Liza Khurana

Research Intern at CPRG