Wednesday, August 20, 2014

Behavioural Science and Public Policy

Below is cross-posted from and is my attempt to summarise behavioural science and public policy for Irish policymakers (but clearly similar issues in other countries): 

I have posted here on a number of occasions about the relevance of the growing literature on behavioural economics and public policy for the Irish context. This post updates this with some new material and I hope people don’t mind if I draw on some from previous posts.

Increasingly, behavioural science is being used as a term to encapsulate the integration of psychological factors into understanding economic decision-making. This is basically an attempt to preserve the phrase “behavioural economics” to refer to explanations with explicit utility-theoretic foundations and also to avoid a lot of work from psychology simply being repackaged as “behavioural economics”. It is not a wholly satisfactory compromise as the phrase “behavioural science” means different things to different people but it is certainly helping to form a shared set of ideas and methodologies and looks likely to continue as the main way of describing this work.

There are a number of reasons for the explosion of interest in this area including the award of the Nobel prize to Daniel Kahneman in 2002 and the adoption of the book “Nudge” by the Obama and Cameron administrations. I think also the sense of purely neo-classical microeconomics being bound up with the regulatory failures surrounding the financial crisis is also fueling an appetite for more realistic accounts of decision-making. It is likely that a lot of what is now called economics will increasingly move towards a disciplinary more blurry field in particular in areas like financial regulation.

Some recent very useful overviews of this area include: Shafir’sBehavioural Foundations of Public Policy is excellent; Sunstein’s lengthy “Empirically-Informed Regulation” provides a strong overview; Nudge is obviously important; a recent paper by Brigitte Madrian outlines the behavioural approach to policy; this excellent short paper by Beshears et al makes the case for the limitation of revealed preferences and the need for other mechanisms; one of the researchers in our group has put together a data-base of studies employing what can loosely be called “Nudges” in various areas of policy; Publications of the Behavioural Insights Team in the Cabinet Office are available here; I have also put together a fairly detailed reading list on behavioural economics and public policy, including legal and ethical issues; The Brookings Institute publication “Policy and Choice: Public Finance through the lense of behavioural economics” is one of the best available introductions to this area.

In terms of why Irish policy-makers should care about this area, below is not intended to be exhaustive but is an attempt to summarise the main areas.

1. The use of “nudges” to encourage saving is the most developed behavioural policy literature. This has reached national policy significance in the roll-out of pension auto-enrolment in the UK. The Irish pension framework was to see the entire private sector begin to be auto-enrolled in 2014 but subject to an economic recovery that has not yet materialised sufficiently. The psychology behind how people react to default settings in pensions is very interesting with a lot of opportunities and threats, among the latter the possibility that people will anchor too much to the default contribution and under-save as well as the possibility that naive consumers will simply be ripped off by providers who can charge higher fees with this less savvy group.

2. The role of behavioural science in financial regulation is a key question. The Financial Conduct Authority has been exploring this area actively. This excellent FCA occasional paper examines the potential implications of behavioural economics for financial regulation. In the US context, this very interesting report by Barr, Mullainathan and Shafir from 2008 outlines a new approach to consumer regulation based partly on the notion of “sticky defaults” whereby firms would be required to default people into the most desirable option based on their characteristics and only move them if they make choices following being provided with clear information. Such models are discussed in relation to two markets fraught with behavioural bias and consumer exploitation, namely credit cards and mortgages. The document also sets out proposals for changing the incentives of brokers.

As noted in another post, this literature is leading to a lot of very interesting questions for financial regulation that are hard to ask in a neo-classical setting. Below are some examples but obviously a small subset.

Should credit card variable and teaser rates be banned or at least taken out of the regular offers made to consumers?

Should mortgage providers be forced to disclose better deals available to their customers?

Should pay-day lenders be granted full access to the Irish market? If so, how do you regulate them?

Should auto-enrolment proceed in Ireland, what provisions should be put in place so that companies do not exploit naïve consumers by charging fees well in excess of regular rates?

Do behavioural biases prevent annuities markets from functioning optimally?

3. The implications of behavioural science for the design of welfare and taxation policies is another active area with applications across the Irish policy sphere in everything from structuring environmental taxes to design of incentive systems to encourage employment. Cass Sunstein, who is one of the main figures in this area, recently released a new book called “Simpler: The Future of Government“. It outlines an approach to government that emphasises making regulations, laws and taxes less confusing and more robust.

4. The search for alternative measures of welfare and social progress is a big concern of the emerging literature (see summary and readingsfrom recent conference on this). The Stiglitz-Sen commission is becoming a standard reference on this topic and it is pretty comprehensive. Understanding how we go from the empirical literature in this area into meaningful indicators is an important direction for this literature. As well as interest in measuring well-being, there is growing interest in the bidirectionality of well-being and economic activity with a lot of recent work looking at impact of mental health in particular on economic functioning. (See Layard: Mental Health: The Frontier of Labour Economics). Related to this, an increasing literature has been examining the economic importance of ensuring good child mental health. This literature is helping us to understand better the interplay between poor child mental health and later economic outcomes. A recent PNAS paperby Goodman, Joyce and Smith gives a good indication of the type of research being conducted in this area. This is an extremely important area of research at the interface of psychology and economics.

5. A lot of recent research has begun to examine more closely the mechanics of what happens during job search from a more psychological perspective. Some of this research is explained in accessible form in this Brookings Institute publication. There is no question that traditional labour supply models are not a complete guide for understanding the behaviour of people who have been laid off and the literature on job activation needs badly more cross-disciplinary work to understand what is shaping behaviour and what environmental changes people might respond to.

6. James Heckman and colleagues have been working on a large programme to integrate personality psychology and a theory of human development into economics. This is extremely important in terms of providing a theoretical and empirical basis for allocation of spending in health and education. Many of these papers are available on Heckman’s IDEAS webpage. Colleagues in Geary are involved in a collaboration looking at early childhood development. Some of these ideas are presented in accessible form on this website.

There are clearly several empirical, ethical and legal issues with the development of this agenda across all of these areas. The enthusiasm for randomised controlled trials in this area clearly has to be tempered with an awareness of their limitations (e.g. here). Furthermore, the extent to which interest-groups constrain the types of policies that emerge will be interesting to observe.

Along with colleagues, I have organised an annual workshop on economics/psychology in Ireland and it will take place again on October 31st in the Geary Institute (sign-up page here). Anyone interested in this area is welcome to attend.

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