The Economics of Decision Making: 'Nudge: Improving Decisions About Health, Wealth, and Happiness,' by Richard H. Thaler and Cass R. Sunstein

by: John M. Mason

The underlying premise of the book, Nudge: Improving Decisions About Health, Wealth, and Happiness, by Richard H. Thaler and Cass R. Sunstein, (Yale University Press, 2008), is that people, in general, are not as perfectly rational as economists assume they are in many of the most fundamental models used in economics and financial economics. Thaler and Sunstein approach the problem-solving of human beings from the standpoint of the behavioral economist and see people as fallible decisionmakers. (See other reviews on behavioral economics here and here.)

This book is important for a very basic reason: the journal Foreign Policy has listed the pair of Thaler and Sunstein seventh on their recently released list of the top 100 global thinkers. Their work has “earned them an ear in the Obama White House” and Sunstein has gone to work there as the new head of the White House's Office of Information and Regulatory Affairs, which deals with everything from avian flu to student loans.

Thaler and Sunstein contend that humans are conflicted because they approach decision-making by having to deal with two competing tendencies: the tendency to act in an intuitive and automatic way and the tendency to be reflective and rational. This conflict arises out of the evolutionary successes of the species starting from being primarily an Automatic System that reacts quickly and responsively to stimuli and later becoming a more Reflective System in which the human works out, rationally, solutions to the problems that need resolving. Survival of the human species has been dependent upon the development of both kinds of decision making.

However, the authors find it convenient to divide humans into two categories: Econs, who are perfectly rational in all that they do, and Humans, who are imperfectly rational, deal with incomplete information and are fallible. The division is between real people, who are part Automatic System and part Reflective System, and hypothetical people, who are just Reflective System.

Thus, humans are inconsistent, react to biases, rules-of-thumb and prejudices, have hang-ups and other psychological shortcomings, are myopic, engage in mindlessness and are perpetual imitators. And, they tend to be adapters and not innovators (“never underestimate the power of inertia”). People, because they are a bundle of inconsistencies and tend to move incrementally, cannot be expected to immediately change their behavior because some policy maker or, in the words of the authors, some “choice architects," make major changes in the incentives that impact them.

When choice architects change incentives they are attempting to achieve specific “outcomes.” These incentives can be looked upon as a form of coercion. “Nudges,” on the other hand, relate to changes in any factor that significantly alters the behavior of humans. “Nudges” do not rely on coercion: individuals still have their freedom to chose. The “nudge” is an attempt to encourage people to make better decisions.

Econs respond primarily to changes in incentives, but are not influenced to any degree by “nudges.” Humans, however, respond to incentives, but they are also influenced by “nudges.” But, “nudges,” according to the authors, attempt to preserve the freedom of choice of the person being nudged. That is, “nudges” do not require that individuals make the desired decision. Changes in incentives are aimed at getting everyone to change their behavior, because it is the rational thing to do.

This leads Thaler and Sunstein to label their approach as “libertarian paternalism.” Yes, they argue, choice architects are attempting to change behavior and in that sense they are paternalistic. But, the authors continue, people should be free to do what they like and so they still have their liberty when it comes to making a decision. They claim that it is “legitimate for choice architects to try to influence people’s behavior in order to make their lives longer, healthier, and better.”

Thaler and Sunstein argue that it is impossible to avoid influencing people’s choices and that, because of this, a choice architect, in making policy, should be intentional in choosing “nudges” to help people make better decisions. They further argue that paternalism does not always involve coercion. People don’t have to make the decisions that would help them to better health, wealth, or happiness.

How does this change how the government does business?

The authors say that some people object to “paternalism” because they “strenuously object to government efforts to influence choice with the goal of improving people’s lives.” These people “worry that governments cannot be trusted to be competent or benign.”

Thaler and Sunstein respond that: “We share these concerns. In particular, we emphatically agree that for government, the risks of mistake, bias and overreaching are real and sometimes serious. We favor nudges over commands, requirements and prohibitions in part for that reason. But governments have to provide starting points of one kind or another. This is not avoidable.” Governments do this every day through the rules they set, the laws they pass, and the programs they develop.

This leads to further questions like: “Has this approach been applied in the Obama administration and, if so, what have been the consequences of adopting this approach?” “Has adopting this approach confused people and helped to account for misunderstandings about how the Obama administration is attempting to solve problems, like health care, job creation, energy and so on?”

One problem with “nudges” is that they are not totally obvious to the public and are not connected with any splashy “kick-off.” The public is used to “big plans” and “high profile” events to introduce them, but this does not happen with “nudges.” "Nudges” tend to be introduced quietly and incrementally.

Nudges change the process of how things get done and do not emphasize the outcomes that are to be achieved. Maybe this is a reason why the approaches to various problems that Obama has taken are being challenged by his more liberal supporters.

If Thaler and Sunstein are becoming as influential as their placement in the Foreign Policy list of the top 100 global thinkers implies, then we should all be aware of their ideas. Obviously, if they are getting the ears of important people, it is necessary to know where they are coming from in order to attempt to interpret what these important people are doing.