The pioneer of behavioural economics and “nudge” theory has added a welcome dose of realism to the fieldby Paul Wallace / October 10, 2017 / Leave a comment
Nearly nine million workers are now saving into a workplace pension as a result of automatic enrolment, an initiative which started five years ago. The policy was introduced because Britain’s private pension system was collapsing as employers withdrew their support for traditional schemes. But it is also a rare example of a breakthrough in economics translated into an effective policy, first in New Zealand and then in Britain.
That breakthrough came from behavioural economics and this week one of its pioneers, Richard Thaler of Chicago University, won the Nobel prize for his work in this area. So apart from the fact that behavioural economics is a strand of the discipline that actually works in practice, what exactly is it? And how does it differ from mainstream economics, whose practitioners are routinely (and often unfairly) chided for their shortcomings, including macroeconomists’ notorious failure to spot the looming financial crisis before it struck?
Conventional economics is built on a necessary fiction: that people are wholly rational in the way they behave as economic agents, seeking to optimise outcomes for themselves. The assumption is essential because irrational conduct, however common, is impossible to model. However, it does not acknowledge routine departures from rational behaviour such as harmful procrastination and biases in our thinking. This is the gap that behavioural economics fills in ways that are helpful to policymakers.
One such gap is in our approach to retirement saving. People know they should save in order to provide for themselves when they stop working. But the natural temptation is to put off any decision to save for the long-term—before it is too late and the long-term is upon us. One solution is compulsion, but that is unpopular. Behavioural economics has a more attractive answer: enrolling workers automatically into voluntary pension plans. They can still opt out but most stay in (the opt-out rate in Britain has been around 10 per cent). Simply switching the default decision from opting in to opting out makes a huge difference.
Apart from increasing access to pensions, well-designed schemes can increase the amounts that people save by putting that on automatic pilot, too. Plans can provide for a portion of future pay increases to be diverted into higher saving. By making this commitment in advance, people are more likely to save the extra amount than…