Economics and Politics as Choice Architecture

Posted April 28, 2008

Some years back, I passed through Schiphol in Amsterdam and realized why some designers consider it the world’s finest airport. Its layout is logical and efficient, public internet terminals are numerous and free, and the stores, including a full 24/7 supermarket, are so attractive that locals come to the airport to shop.

But it was the urinals that made the biggest impression. At my first pit stop, I looked down and noticed that an insect had unfortunately chosen to land directly in the target zone. I took aim and was secretly pleased when I scored a direct hit. When the bug did not flinch, I realized that the joke was on me.

The purpose of the ceramic fly was instantly clear – to minimize needless mopping by reminding men to focus their efforts. Baking an insect onto a urinal reportedly reduces the amount of janitorial work required at the airport. Years later, JFK airport awarded the company that designed Schipol the contract to build the new international terminal in New York – so you no longer have to fly to Holland to witness this miracle of sensible design.

I recalled my visit when Richard Thaler and Cass Sunstein cited the strategic placement of ceramic insects as an example of a “nudge” – a low cost incentive to make the right choice. The two men have just published an important, educational, and fun book titled Nudge. If you read Jam Side Down, you are very likely to read this book, not just because I will recommend it so highly but because everyone who reads it will recommend it so highly.

It is rare for a book to really change the way I see things. I have been exposed to enough bad ideas that I am a slightly jaded intellectual grouch. Too few ideas
strike me as genuinely new and fewer still are presented in a provocative enough manner to make you care whether they are new or not.

So when a book re-frames the way I look at, well, almost everything – I
want to scramble to high ground and alert the village. When the authors are scholars who have been to the wilderness and questioned the sacred tenets of their
respective disciplines, the impact is even more revelatory. If you
liked Freakonomics, Predictably Irrational, or The Logic of Life, you
will like Nudge even better – it packs about 50% more insight per page
and the insights matter more. If you follow the blogs or columns of
Tyler Cowen, Thomas Sowell, or Robert Samuelson, you are in for a treat.

The book is full of both ideas and of examples like the ceramic fly
that leave you thinking “why don’t we always do it this way?” The book
is like a naughty dessert – you start it eagerly, savor each bite, and
feel annoyed that it ends sooner than expected since the
good professors were exceedingly generous with their endnotes.

The authors are faculty of the University of Chicago and both distinguished,
long ball scholars. Thaler is world famous for pioneering “behavioral economics” which
studies the influence of social, cognitive, and emotional biases on
economic decisions. The idea that homo econimus makes choices that are
affected by society, emotions, or consistent errors is heresy among
heirs to Milton Friedman and other rational choice stalwarts at the
University of Chicago (although in most respects, Thaler refines
Friedman instead of refuting him). When Daniel Kahneman received the 2002 Nobel Prize in Economics for his work in Prospect Theory, a cousin of Behavioral Economics, he immediately credited Thaler’s fundamental influence on his thinking.

Cass Sunstein is a highly
influential legal scholar with broad interests . Sunstein has written about roughly every legal topic there is,
including the use and misuse of cost/benefit analysis in public policy
decisions, animal rights, gay rights, methods for aggregating
information such as prediction markets and wikis, FDR’s second bill of
rights (which proposed a right to an education, a right to a home, a
right to health care, a right to protection against monopolies, and
more), presidential impeachment (he actively opposed the impeachment of
Clinton), and constitutional law. Sunstein writes for the New Republic
and frequently blogs at the (Eugene) Volokh Conspiracy and at the
(Lawrence) Lessig blog. He is comically prolific. His CV lists
twenty-eight books and more than three hundred articles (and cautions
that it displays only “a very partial listing”).

The authors have intriguing connections to the Obama campaign. Austin
Goolsby is Obama’s lead economic advisor and Thaler’s colleague and
soulmate. Sunstein was on the law faculty when Obama taught there and,
if you believe the Internet, is dating Harvard’s Samantha Powers who
was (wrongly, wrongly, wrongly) fired by Obama for calling Hillary a
“monster”. (Hillary is not a monster. She is a vampire who will not die
– and Powers should have articulated the distinction). The romance could
also be the nudge behind Sunstein’s decision to leave Chicago to become the director of Harvard’s Program on Risk Regulation.

Both men embrace a political philosophy that they term “libertarian
paternalism”. They deeply respect the right of individuals to make
their own (even palpably stupid) choices and would far prefer to see
government guide choices than ban activities.

The philosophy at first appears oxymoronic – “libertarian” being
conservative to the extent that it is laissez faire and “paternalism”
being liberal to the extent that it favors state intervention or protection.
Squaring the tension between these ideas is the task and the beauty of
the book. The central thesis of Nudge is that like it or not, the way
we structure choices creates incentives. Structuring smarter choices
provides people with a nudge (like judge – not noodge, like stooge. A
nudge is a shove in the right direction. A noodge is a wonderful
Yiddish term for someone who nudges too much and becomes a pain the
ass).

The authors argue that whether we want to or not, we architect choices all the
time. They open with a fine example of a school cafeteria that
discovers that it can nudge kids towards better diets by putting
healthy foods at eye level and in front. They assert further that we can use the
emerging science of choice architecture to nudge people to make choices
that are healthy, pro-education, financially intelligent, and
environmentally sound. You don’t ban stupid choices – but you create
non-punitive incentives for good ones (for example, you make organ
donation an opt-out, not an opt-in program. You save tens of thousands
of lives every year and nobody is any worse off for having structured the choice more intelligently). The notion of choice architecture is
the great idea at the heart of the book.

But why do we need to nudge? Well, because we often make choices that
are not in our self interest – especially if the decisions are complex,
infrequent, or make a difference someday instead of now. In these cases, markets fail
because choice fails. Humans (as opposed to the fictional “Econs” that
the authors mock throughout the book) appear to be well-designed to
make simple decisions with immediate consequences such as stepping off
of the curb – although the authors point out that in the more touristed
precincts of London, even that decision benefits from the “Look Right”
nudge on the sidewalk.

Humans (think Homer Simpson, not Econs like Star Trek’s Mr. Spock) think
poorly when the choices are overly complex or can be delayed without
immediate cost (or worst, both). Signing up for a complex
mortgage or not joining a 401k plan is painless today — and who can
really figure out the implication of all of those choices? And don’t even start on
Medicare Part D. In the face of choices like this, even the Finance faculty
turn out to be more Simpson than Spock. Many of us just go on
auto-pilot. The authors argue that a nudge will at least stack the deck
in our favor and reduce the frequency and severity of bad choices.

The authors look at the architecture of a variety of important choices
from savings and investment decisions to the structure of utility
bills. They look at incentives around marriage and issue an eloquent
call for privatizing the institution, in a chapter that could easily
reframe the same sex marriage debate.

A good example of smart choice architecture is the Save More Tomorrow
Plan which Thaler developed in the mid nineties. Instead of asking
employees to save more and reduce their take home pay, a Save More
Tomorrow Plan asks employees to check a box to increase their savings
rate each time they get a raise. Over time, the result is a dramatic
increase in savings as employees commit to save instead of spending
future income. With a nudge, Thaler has turned the human tendency to
procrastinate and defer pain from a vice to a virtue in a manner that
preserves choice (employees can opt-out, although in practice few do)
and has little if any additional administrative cost.

Transparency figures prominently in many of the nudges that the authors
recommend. They urge that credit card companies be required to annually
disclose how much we’ve spent on late fees and interest payments and to
do it online using standardized definitions that permit consumers to
compare the cost of alternative cards (something that is gruesomely
difficult today). They would surely approve of the stickers on major
home appliances that estimate the cost of energy over a five year
period and would favor a similar sticker for cars showing likely fuel
costs. The authors do not explore nudges that involve reduced transparency like the suggestion that making all political contributions anonymous would immediately reduce the ability of contributors to purchase self-interested legislation.

Unfortunately the book stops short of applying
“libertarian paternalism” to more controversial nudges – perhaps
because the authors do not agree on what to do. For example, many
libertarians regard paid sex between freely consenting adults as
harmless. Others believe that prostitution is always degrading and
should be outlawed. Since the authors resist banning much of anything,
this seems like fertile ground for a nudge.

It would be
easy to ask men to voluntarily forswear paying for sex and post their
names on a public website. Men, in their more upstanding moments, would
enroll knowing that un-enrolling takes 15 days (and the tension between
what the authors call the Automatic Mind and the Reflective Mind –
between our inner Homer Simpson and our inner Spock – underlies a great deal of choice
architecture). The local cat house would be legal and regulated, but
prevented under serious penalty from serving any man on the “do not
call” list. Add the ability of anyone (reporters and wives come to mind) to request an email notification in the event that someone asks that their name be removed and a lot of the controversy and hypocrisy that surrounds paid sex would disappear (and yes, the market for fake IDs would explode).

You could imagine a similar nudge for recreational
drugs, which in almost all cases represent poor choices but for which
the cost of prohibition vastly exceeds the social benefits.
The authors are surely aware that libertarian paternalism can
contribute to a better choice architecture in these controversial cases. Since tenure
is a valuable nudge given to ensure that faculty enjoy complete freedom to
explore society’s most challenging and controversial problems, their reluctance to do so suggests either caution bordering on cowardice or, dare we say it, a
failed nudge.