Nudge Theory

A little push in the right direction...

By Nicky Sullivan

Reading our website, blogs and social media posts, you’ll come across a small, mild-sounding phrase that keeps popping up in all kinds of places; nudge theory.

Nudge is such a little word; it sounds so soft and bland, timid even, that it can come as a surprise to find it defines one of the most interesting and potentially powerful ideas to come out of modern economics. It is also at the heart of how we at iamMoney strive to serve our clients’ best interests.

For most of its history, the basic assumption behind economic thought is that human beings are rational creatures who make decisions that “maximise their utility”, i.e. create the most personally advantageous outcomes, and anyone who questioned this idea was dismissed as, well, irrational.

But over the last few decades, behavioural economists like Richard Thaler have been developing an alternative idea: Humans do not make rational decisions at all but they can be encouraged to do so by mitigating the essential weakness in our brains that leads to bad decision-making. Two years ago, he received the Nobel Prize in Economics for his work.

It is known as Shephard’s Tabletop and comes from the book, ‘Nudge’, that

Thaler and law professor Cass Sunstein published in 2008. In it, they ask you

to look at the tables and have a think about which one would work better as a

coffee table in your living room, based on its dimensions. If you’re like most

people, the authors say, you think the table on the left is much longer and

narrower than the one on the right. And you would be wrong.

In fact, both tables are identical, although at different angles. You can

measure them if you like. It’s puzzling and infuriating because even when you

know the tables are the same, they still look different. That is because the

angles and the way the legs are arranged play with our brain’s habit of making

assumptions.

If that sounds strange, take a look at the picture below:

Because thinking and decision-making requires the use of expensive energy

(our brains use around 20% of the energy our bodies burn every day) our

brains developed short-cuts to make the process more rapid and economical. This gave rise to two different systems: One that’s intuitive and automatic (cheap!) and another that’s rational and reflective (time and energy consuming).

In Thaler and Sunstein’s analysis, the two levels are operated by, respectively, Homer Simpson and Mr Spock. And despite the terrifying thought that we all have a Homer Simpson running loose in our heads, for the most part, this split-level system works in our favour. If we had to stop to think about it every time we need to duck to dodge a ball, the global population would be

substantially lower.

Unfortunately, those shortcuts can create short circuits, leading to bad decisions and bad choices based on bad understandings. The ‘short circuits’ include things like stereotyping and making judgements based on known or familiar, but irrelevant, information. They can even influence your own judgement of how happy you think you are.

In one experiment, college students were asked two questions: (a) How happy are you? and (b) How often are you dating? When the questions were asked in this order, there was little connection between the answers given, so people gave an unbiased answer to the first question. But when the order was reversed, more people reached the conclusion that they must be unhappy because they’d been prompted to think about the last time they’d had a date. “Gee, I can’t remember the last time I had a date! I must be miserable.”

But the conditions under which we make bad judgement calls, or choices, can be much more serious than this. These include situations that test our capacity for self-control and there is a large gap between the costs and the benefits involved.

It’s the same whether the cost-benefit gap comes between the immediate pleasure of, say, a cigarette now, and the risk of lung cancer down the line; or having to drag a tired body to the gym in the hope that maybe, perhaps, some day those five-year-old jeans will fit again - or saving for retirement.

But we also falter when it comes to decisions that are difficult, or at which we don’t have a lot of practice (like a mortgage), or on which we don’t get a lot of feedback - and we never get feedback on the decisions we don’t take.

Traps lie all around us in things like language codes, so that we may understand what all the words contained in the phrases “capital appreciation fund” and “dynamic dividend fund” mean, but that doesn’t mean we would have any idea what they are describing in this context, or be able to compare them.

Thaler and Sunstein proposed that changing the way in which information is given can change the way in which people make decisions about it, and that they could be imperceptibly “nudged” towards decisions that are more in line with their best interests.

Governments have already enthusiastically adopted the strategy in order to encourage people to change their behaviour (for example, pay their taxes) through nudges, rather than by taxes or laws. This can be as subtle as the Singaporean government printing tax bills on pink paper (the colour typically used for debt collection), which led to an improvement in prompt payment rates, or as blunt as trials in the UK which showed that letters sent to non- payers of vehicle tax that had been changed to use plainer English, essentially “pay your tax or lose your car” doubled the number of people paying the tax. Letters using the up front language and a photograph of the car in question led to that number being tripled.

And it’s not just about taxes. ‘The Economist’ magazine describes another British programme, which encouraged students who had received good grades at schools with a poor record of progressing pupils to university, much less to good ones to which good students could aspire, to apply.

These students all received a letter from a University of Bristol student named Ben who explained that employers care about the reputation of the university a job applicant had attended and pointed out that top universities can be a cheaper option for poorer pupils because they give more financial aid. He added that he had not known this when he was their age.

The letters worked. “The students who received the letter, and another similar one some months later, were more likely to be at a prestigious university than those who received just one of the letters, and more likely again than those who received none,” said the magazine.

Unfortunately, the way our economy is organised means many companies are given strong incentives to profit from our personal Homer Simpsons and the poor decisions he makes; rather rather to try to eradicate or minimise them (think extended warranties, which Thaler and Sunstein counsel strongly against).

This is where iamMoney is different.