My AFR oped today is on behavioural economics and ‘nudging’. Full text below.

Give reform a bit of a nudge, Australian Financial Review, 3 November 2009

It turns out that lemmings don’t actually follow one another off the edge of a cliff. Thanks to some investigative journalists, we now know that a 1958 Disney documentary depicting the event was made by the filmmakers throwing large numbers of lemmings to their deaths.

Nonetheless, the lemming myth has stuck in the popular consciousness – perhaps because it’s such an accurate metaphor for the way many of us make our daily decisions. At a café, we tend to eat the daily special. Our mobile ringtone is probably the default factory setting. We are more likely to vote for the candidate at the top of the ballot paper.

In Nudge: Improving Decisions About Health, Wealth and Happiness, Chicago University academics Richard Thaler and Cass Sunstein argue that economists and politicians have overestimated the attention that citizens devote to decision-making. Rather than assuming that people have the time of a monk and the skills of an actuary, it might be better to craft policies for busy lives. Or to put it another way, the representative citizen is closer to Homer Simpson than to HAL.

One set of Nudge reforms aim to improve default options. In the political arena, wars have been waged over optional versus compulsory systems. Yet in many choice regimes, people simply stick with the default option. Getting defaults right can make a big difference to people’s lives.

The best known application of this kind of ‘behavioural economics’ research is in the area of savings. Recognising that the typical person under-saves for retirement, Australia introduced compulsory superannuation in 1992, and steadily increased the compulsory contribution. But for all the talk of superannuation choice, the vast majority of us are in the default fund chosen by our employer and the default plan chosen by that fund.

A series of nudges would improve retiree wellbeing. We should raise the default contribution rate from 9% to 12%, but allow people to opt down to 9% if they choose. The default superannuation fund should be a low-fee index-tracking fund, with people free to pick a boutique fund if they so desire. And the default investment strategy ought to rebalance over the lifecycle (high growth for young people, more cautious investments for those approaching retirement).

Other nudges help people make better choices by putting the right information in front of them. Despite punitive interest rates on credit cards, many do not pay their full bill each month. So Thaler and Sunstein suggest that credit card companies should be required to send everyone an annual breakdown of the fees they have incurred.

Similar information reforms could help in other domains. When renting a car, the cost of fuel can exceed the cost of hiring the car. So why not mandate that all rental car companies list fuel efficiency on their selection sheets? And in the bewildering mobile phone market, we could require all phone companies to also offer a standardised product (e.g. 300 minutes per month). Neither reform would constrain choice, but people would now choose guzzling cars and complex phone plans because they wanted them, not because they didn’t know any better.

Nudges could also improve the way in which government agencies currently operate. The Australian Taxation Office automatically knows most taxpayers’ incomes. So why doesn’t it simply post out letters in August, telling each of us the amounts it has on file? Anyone with complex affairs or who wished to claim deductions would still be welcome to lodge a tax return. Otherwise, taxpayers would merely be required to make a quick phone call to confirm that the letter was accurate.

Another nudgeable policy area is helping welfare recipients manage their money. Centrelink has recently developed a system of ‘voluntary income management’, which lets income support recipients choose to have part of their payments quarantined for use only on essentials such as groceries and rent. For anyone with an addiction problem or an overbearing partner, this kind of scheme can make life a little easier. It should be available to any welfare recipient who wants to sign up.

Or take organ donation. At present, driving licence renewals include a box that can be ticked by anyone who wants to donate their organs. Although three-quarters of Australians do not tick the box, some are surely just sidestepping the issue; preferring not to think about an issue with morbid undertones. We could raise organ donation rates by requiring everyone to either tick ‘Yes – I will donate’ or ‘No – I will not donate’.

Changing defaults, improving information, and making government more effective are all part of what Thaler and Sunstein have tagged ‘libertarian paternalism’. Unlike most government programs, these reforms aim to improve wellbeing without constraining choice. Perhaps our cash-constrained governments could be nudged into checking them out?

Andrew Leigh is an economist in the Research School of Social Sciences at the Australian National University.

With more space, I would also have mentioned Joshua Gans’ proposal for bank account number portability – another of my favourite nudge-type reforms.

Incidentally, if you have a few spare minutes, the video that’s hyperlinked from the first paragraph is pretty extraordinary (lemmings at the 14 minute mark).