The Dark Side of Nudges

Maria Alejandra Madi

• Publisher: Routledge
• Year: 2019
• ISBN:
  9780429806452
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

The concept of "nudging" has hit news headlines in recent years following the implementation of nudge policies in many parts of the world, the establishment of behavioural policy units in some countries, and the award of the Nobel Prize in Economics to the behavioural economist Richard Thaler in 2017. However, questions remain about whether nudging is an optimal approach to policy-making.

This book presents a critical approach to the study of nudging to highlight the foundations, rationale and effects of current policy-making trends in the neoliberal age of behavioural economics.

In this provocative book, the author presents a re-examination of the methodological foundations of behavioural economics and its consequences for addressing the deep social and economic policy challenges of our times. It is argued that, although the concept of nudge proposed by Richard Thaler and Cass Sunstein rejects the theorization of economic behaviour under models of strict rationality, nudge policies focuson methodological individualism in economic thinking and economic policy.

The complexity of social and economic policy problems of the twenty-first century calls for a revision of our conceptual outlooks, and to increase recognition of the failure of methodological individualism in economics to address the unprecedented social, political, and environmental challenges of globalization. Offering a new take on the epistemological assumptions underlying behaviourally-informed policies, this book will prompt the general public to consider new ideas about the darker side of behavioural economics.

1 Setting the scene

The concept of nudge

Introduction

Behavioural economics aims at deconstructing the “standard” rational choice approach to decision-making based on utility-maximizing principles given constraints determined by prices, income, and available information.

The behavioural economics approach argues that human behaviour is characterized by cognitive biases, lack of willpower, and selfishness, which prevent making rational choices. Optimal (rational) economic behaviour can also be affected by:

1) the way in which information is processed to make choices;

2) how choices are framed and attended to; and

3) how unobservable mental states take part in the decision-making.

Therefore, behavioural economics turns out to be in close affinity with cognitive psychology, which has been developed in direct opposition to “classical” behaviourism (Lambert 2006, 52).

The concern about the challenges to rational behaviour is not new. Classical behaviourism – a leading school of twentieth century psychology associated with the name of J. Watson – assumed that only actually observed or objectively measurable behaviour can serve as the subject matter for psychology (Angner and Loewenstein 2007). However, the predecessors to behavioural economics are mainly associated with the ideas of Herbert Simon who was awarded the Nobel Prize in 1978. Simon (1987) put into question the rational choice assumptions and coined the term “bounded rationality”. His conceptualization of rationality refers to the entire spectrum of constraints on human knowledge and capabilities that prevent people from behaving as predicted by neoclassical theory.¹ Bounded rationality refers to human decisions bounded by limitations in both knowledge and computational capacity.

The recent behavioural turn in economic theory is considered to have been triggered by papers published by Tversky and Kahneman (1973; 1974). After criticizing the orthodox expected utility theory, the authors offered an alternative concept for decision making under uncertainty that was called “prospect theory”. Thaler’s (1980; 1985) relevant contributions appeared at the same time and provided a great deal of empirical evidence on the “suboptimality” of decisions made by economic agents, such as underestimating opportunity costs, the inability to abstract from sunk costs, and insufficient self-control. Thaler, like Kahneman and Tversky, aimed to develop an empirically adequate theory of choice that would be able to describe actually observed decision-making processes.²

All things considered, Thaler and Sunstein’s research on nudges refers to a variety of simple changes in the choice environment. Nudging is supposed to work by appealing to individual cognitive biases in decision-making.

What is wrong with the conventional model of rational choice?

The neoclassical approach to economic theory presupposes perfect rationality of the economic agents. Economists mean several things when referring to “perfect rationality” Camerer et al. (2003, 1214–1215). First, individuals have well-ordered preferences (objectives) and aim at fully satisfying them when making decisions. Second, they do not make mistakes (at least systematically) when calculating the benefits and costs associated with multiple choices. Third, in uncertain situations they can make probabilistic estimates of potential outcomes using all available information and revise those estimates as soon as new data arrives. Obviously, the first point is the most important.

This concept of rationality is purely formal and rationality turns out to be a synonym for a consistency of preferences that are manifested in the actual choices made by an individual. According to Arrow (1996, xiii), “the major meaning of rationality is a condition of consistency among choices made from different sets of alternatives”. In this approach, given a certain order of preferences and a certain set of constraints (physical, institutional, informational) individuals choose the best options of those available to them. As a result, it is expected that whatever choice they make, they will have no reasons to regret them or take them back (Saint-Paul 2011).

The homo economicus has only one utility function, that is to say, a single set of preferences. This principle is the starting point for the neoclassical normative approach to welfare economics that interprets the welfare of a society as an aggregate of individual preferences (Sugden 2008).

Tversky and Kahneman (1986) analysed the formal requirements to be met by choices. Among the axioms of the rational choice theory, two appear to be the most significant: transitivity and context-independence.

• The condition of transitivity assumes that, if A is preferred over B, and B is preferred over C, then A is preferred over C. Rational agents can make choices when presented not only with isolated pairs of alternatives but also with multiple options.
• The context-independence condition assumes that a choice between two options is independent from the order in which they are offered. Adding a new option to the existing two should not influence the choice unless the third option is preferable to the previous two. To sum up, the results of rational choices do not depend on how the options are presented.

Against the neoclassical theory assumptions on human behaviour, where human beings are rational decision-makers that act towards self-interest, behavioural economists developed some critical ideas:

• First, as Tversky and Kahneman (1986, 252) state, empirical research showed that in real life “deviations of actual behavior from the normative model [of rational choice] are too widespread to be ignored, too systematic to be dismissed as random error, and too fundamental to be accommodated by relaxing the normative system”.
• Second, irrational behaviour undermines the belief of a single rational self. In fact, there are two selves, but only one makes rational decisions.
• Third, the normative prescriptions of the rational choice theory are undermined since:

i) people have a poor understanding of their own true interests and often act contrary to them; and

ii) the options actually chosen by individuals could not be the best for them out of all of those available.

Cognitive biases and choice heuristics

It is undeniable that how the human mind works is one of the greatest contemporary debates. Behavioral economics rejects the assumption of pure rationality in order to explain why real people suffer from a variety of cognitive biases that affect their decision-making and wellbeing, including lack of self-control, and excessive optimism, among others. Indeed, Thaler and Sunstein advocated the need to consider the assumption of bounded rationality in the attempt to understand human actions and to analyse the heurisitcs and biases that explain the gap between our good intentions and our actual behaviour.

Resting on the foundational scholarship of Kahneman and Tversky, Thaler and Sunstein address that people often operate under the influence of systematic cognitive biases that prevent them from making sound decisions. Indeed, the changing paradigm in understanding human behaviour started in the early 1970s, under the research of Kahneman. He believes that the distinction between “econs” and “humans” (while econs refer to the rational homo economicus, humans suffer from a variety of cognitive biases that prevent them from being fully rational) contrasts the traditional conception related to the neo-classical rational behaviour with many insights emerging from cognitive psychology.³ Since the late 1970s and throughout the 1980s, Kahneman developed his investigations and highlighted the cognitive biases. For instance, his research results criticized the neoclassical theory of consumer rationality, the relevance of loss aversion, and the life-cycle hypothesis. The research results put into question the neoclassical assumption of self-control and the application of the concept of opportunity cost in economic decisions that permeate the relationship between present goods and future goods. Kahneman stated that humans do not have self-control. In addition, he identified two types of human: planners, who think and care about the future, and doers, who do not.

In the book Misbehaving, Thaler (2015) explains that, between 1986 and 1994, the debate within the Chicago school of economics was marked by resistance towards the new ideas. However, the research and the training of researchers continued to be focused on the identification of financial market anomalies and criticism of the efficient markets hypothesis, the consumer sovereignty, and the transaction cost hypothesis of Ronald Coase. Since then, research on cognitive biases has been close to neuroscience and neuroeconomics.

Kahneman, Tversky, and different specialists on behavioural economics, built up a research programme that focuses on judgment under uncertainty. Among the fundamental outcomes, they recognized errors in probabilistic thinking. In Tversky and Kahneman’s (1973, 237) claim the following:

In making expectations and decisions under vulnerability, individuals don’t seem to pursue the analytics of possibility or the factual hypothesis of forecast. Rather, they depend on a predetermined number of heuristics which once in a while yield sensible decisions and at times lead to serious and efficient blunders.

Thaler and Sunstein’s research relies on the Dual Process Cognitive Theories (DPTs), especially as portrayed by Kahneman. The human brain functions in ways that invite a distinction between two kinds of thinking: automatic thinking and reflective (rational) thinking. Kahneman called these ways of thinking System 1 and System 2, respectively. Automatic thinking is characterized by being fast and intuitive. Reflective thinking refers to the processing of information in a deliberate and conscious way. Therefore, it is slow and demands effort and concentration.

System 1 plays a very important role in decision making, particularly in the case of making judgments under the circumstances of ambiguity, limitation of time, and thought processes. System 2 is under control, intentional, purposeful, and based on analysis. For instance, people make long-term plans for saving or dieting (utilising System 2), but then, when the time comes, reverse those plans and fail to resist to the desire for short-term gratification (employing System 1). Moreover, making different choices can reveal different emotional states, despite prices and levels of income. In summary, DPTs explain why human beings not only fall short of rational decision-making, but their behaviour may actually systematically deviate from its normative prescriptions.⁴

The empirical systematic errors in reasoning and judgment have been named “cognitive illusions”. Among the constraints on rational decision-making, the researchers highlight the limited ability of individuals:

1) to allocate their attention to more than a comparatively small number of relevant features in their environment; and

2) to assign probabilities and appropriate weights to a variety of threats an...