29th September, 2008

Book review by Paschal as Published in the Irish Times, 29 September, 2008.

Paschal Donohoe is a member of Seanad Eireann. He was formerly the Commercial Director for Procter & Gamble Ireland.

In the crowded world of new business theories and gurus a snappy catchphrase is essential. Chaos Theory, Tipping Points and many other ideas, some old and some new, have been taken a long way by a catchy slogan. The latest of these theories is ‘Nudge’ by Richard Thaler and Cass Sunstein of the University of Chicago.

The authors recognise that personal decisions made by individuals, in their business and personal lives, can led to outcomes that are bad in the long run for either the individual, a business or society at large. The breadth of choice itself can contribute to these bad decisions. This is because of the confusion of evaluating different options or the lack of information to understand what is on offer. Even worse, no decision may by made at all. The product may remain on the shelf, the pension ignored or the environmentally friendly car may remain in the car show room. The authors refreshingly reject the idea that each of us are proud members of that wonderful breed called “homo economicus” or economic man, they deny that “each of us thinks and chooses unfailingly well”.

This rejection is taken in an original and enjoyable direction as the writers suggest what policy makers and business leaders can do about this. The “invisible hand” much loved by Adam Smith and the University of Chicago, where both authors teach, must by complimented by “nudges”. The way in which choices are presented can be changed, or nudged, to create better long run decisions. They examine choice architecture or the way in which choices are presented and the effect this has on the decisions we make.

Many nudges are reviewed. Some of the strongest examples are defaults, or what happens when a decision is not made. They examine the American pension system, where a worker not doing anything about their pension means not having a pension at all. All efforts at pension reform should be concentrated at changing this default setting, from non enrolment to enrolment.
The setting of social norms by peer pressure is another example of a nudge. They showcase the ‘Don’t Mess with Texas’ litter campaign which reduced state littering by 29%. A nudge is also how governments and businesses can play a role in helping consumers understand the choices they need to make. This can be done through providing a RECAP service or Record, Evaluate and Compare Alternative Prices. Governments should insist on bills that make it easier for customers to compare pricing regimes and tariffs across different companies. The recurring theme is that little interventions can have a big effect on making the right decision for the long run.

As these interventions are, by their nature, so small it is difficult to argue with the good intentions behind them. It is ironic that the authors hail from the University of Chicago, the institution famous for advocating the economics of big changes or ‘shock therapy’ which has had such a decisive effect on Western economic and social policy. However in going from the role of big to small changes the book emphasises well how the presentation of choices can have such a major effect on the decisions actually made.

It is difficult to accept the big claims that are made for these small steps when the writers claim they have created a new creed called “libertarian paternalism”. Freedom to choose must be preserved at all costs, but individuals should be helped by their governments and companies to make the right choices. You can be free, but preferably free to do certain things. I suspect the author’s intrinsically free market instincts are twitching furiously as they confront business and social dilemmas which are not open to easy solutions because, as the authors acknowledge, few of us have access to perfect and complete information all of the time. What we have is a fudge, rather than a nudge.

However in focusing on how people make choices in the real world Nudge is an example of one of the more exciting areas of social research called “behavioural economics”. This is researching carefully how people buy and sell in the real world as opposed to the idealised assumptions of the class room. They are questioning whether we really act rationally all of the time in every purchase we make? Do we always weigh up the benefits of the future with the instant gratification of now? This is already leading to some practical steps. Last year the Office of Fair Trading in the UK established a behavioural economics unit.
So maybe quibbling about the theoretical purity of “Nudging” is missing the point. If this thinking leads to steps that practically improve our ability to make decisions well it should be welcomed. Barnet Council in London will be handing out free energy metres to allow homes to measure their energy use. Any insight that easily swoops from how long household bulbs are switched on to pension provision must be appreciated. The authors through wit and a wide variety of examples make this easy to do.