What is behavioural economics?

Posted on August 16, 2019

As a relatively new approach to economic theory, behavioural economics has quickly caused a major shift in the way economists think about the world. Given the close relationship between economic theory and the work of the public sector, this new approach is also changing government service delivery.

What is behavioural economics?

Behavioural economics uses human psychology to understand how individuals and organisations make economic decisions. By integrating psychology into economic theory, it aims to provide a more realistic study of human decision making, which reflects the fact that we are rarely rational, impartial and flawless agents of change.

Behavioural economics emerged in the late 1970s, but only became a dedicated discipline of economics in the last three decades. In 2017, it went mainstream following the decision to award Richard Thaler the Nobel Prize in Economics for his work in creating the nudge agenda.

The nudge agenda

The concept of using behavioural insights to improve public service delivery is known as the nudge agenda, as it ‘nudges’ people to make small changes to their behaviour that results in large-scale, positive consequences. Governments use the nudge agenda to improve people’s lives and communities, by using behavioural insights to improve engagement and use of public services.

In Australia and the UK, the Behavioural Team of the Australian Government (BETA) and the Behavioural Insights Team (BIT) both sit within the Department of Prime Minister and Cabinet, and the UK Cabinet Office respectively. These positions reflect the potential influence of behavioural economics on public policy and exist around the world, extending to the European Commission.

Characteristics of a nudge agenda

In his text, A Course in Behavioural Economics (2nd Edition), Erik Angner provides a useful list of characteristics typically exhibited in nudge interventions:

  • they aim to help people make better decisions themselves, rather than making decisions for them
  • they impose little to no cost on those who are exposed to the intervention
  • they have little to no effect on the choices of those who are already well-informed.

The term nudge indicates the level of actual change these interventions are designed to have on public policy. The idea is that by making small, incremental changes to the way things are presented or function, you can make significant changes to how people interact with government services and benefit from them.

One of the earliest examples of nudge theory – even though wasn’t call that then – was the painting of lines down the centre of the road to encourage drivers of the first automobiles to stay on their side of the road. This modest intervention the two were reduction in the number of head-on crashes around corners. As with this example, small, incremental changes to the way things are presented or function can yield significant public benefits. M

Examples of nudge interventions

Examining a few different examples of how behavioural economics is being applied, helps us understand the scope of its application.

In 2017, BETA wanted to improve the financial wellbeing of consumers making minimum contributions to their credit card debt. By sending these consumers a reminder SMS about their upcoming repayment, BETA witnessed a 28% increase in the following month’s repayments compared to those who received no message.

In 2018, the NSW Behavioural Insights Unit (BIU) wanted to increase the number of student applications for rural teacher placements. By improving the information available on placements and sending a reminder SMS near the closing date, BIU tripled the number of rural placement applications from approximately 4% to 12%.

In 2019, the Victorian Behavioural Insights (VBI) team wanted to improve the number of Victorians paying their land taxes electronically via BPAY View. By simply advertising the BPAY details of the Victorian State Revenue Office, VBI was able to increase the number of BPAY View registrations by 34%.

Challenges with behavioural economics

While governments are excited to integrate behavioural economics into policy making, some experts are cautious about applying it to a broad range of policies, due to the inherent challenges associated with its use.

For example, the London School of Economics argues that the ability to nudge individuals effectively requires an immense amount of information about what influences their behaviour. Without this understanding, we may inadvertently nudge people in a direction that is inconsistent with long-term government objectives.

The authors say this issue is particularly relevant for complex policy areas that are more sophisticated than a ‘donate or don’t donate’ decision. Andrew Frain and Randal Tame give us an example of this in their discussion of a BETA study, which found that blind recruitment in the public sector made things worse for women and people of colour.

Aside from the potential pitfalls of applying behavioural economics where they are ill suited, we also need to consider who has the right to redesign public policy. Nudge interventions that encourage people to make ‘correct’ or ‘better’ decisions are filled with people who are intrinsically no better at making decisions than the people whose choices they are trying to improve.

Vox’s Henry Farrell makes the case that appointing nudge units as the architects of public policy amounts to a form of technocracy, arguing that while many outcomes of the nudge agenda are beneficial, there are still ‘no good opportunities for those ordinary people to voice their preferences.’ He certainly presents a healthy scepticism about the proposed benefits of behavioural economics.

For more information about whether behavioural economics should be incorporated into policy design in your organisation, feel free to get in touch.