The Economics and Politics of Choice Architecture

Some years back, I passed through Schiphol in Amsterdam and realized why some designers consider it the world’s finest airport. Its layout is logical and efficient, public internet terminals are numerous and free, and the stores, including a full 24/7 supermarket, are so attractive that locals come to the airport to shop.

But it was the urinals that made the biggest impression. At my first pit stop, I looked down and noticed that an insect had unfortunately chosen to land directly in the target zone. I took aim and was secretly pleased when I scored a direct hit. When the bug did not flinch, I realized that the joke was on me.

The purpose of the ceramic fly was instantly clear – to minimize needless mopping by reminding men to focus their efforts. Baking an insect onto a urinal reportedly reduces the amount of janitorial work required at the airport. Years later, JFK airport awarded the company that designed Schipol the contract to build the new international terminal in New York – so you no longer have to fly to Holland to witness this miracle of sensible design.

I recalled my visit when Richard Thaler and Cass Sunstein cited the strategic placement of ceramic insects as an example of a “nudge” – a low cost incentive to make the right choice. The two men have just published an important, educational, and fun book titled Nudge. If you read Jam Side Down, you are very likely to read this book, not just because I will recommend it so highly but because everyone who reads it will recommend it so highly.
It is rare for a book to really change the way I see things. I have been exposed to enough bad ideas that I am a slightly jaded intellectual grouch. Too few ideas strike me as genuinely new and fewer still are presented in a provocative enough manner to make you care whether they are new or not.

So when a book re-frames the way I look at, well, almost everything – I want to scramble to high ground and alert the village. When the authors are scholars who have been to the wilderness and questioned the sacred tenets of their respective disciplines, the impact is even more revelatory. If you liked Freakonomics, Predictably Irrational, or The Logic of Life, you will like Nudge even better – it packs about 50% more insight per page and the insights matter more. If you follow the blogs or columns of Tyler Cowen, Thomas Sowell, or Robert Samuelson, you are in for a treat.

The book is full of both ideas and of examples like the ceramic fly that leave you thinking “why don’t we always do it this way?” The book is like a naughty dessert – you start it eagerly, savor each bite, and feel annoyed that it ends sooner than expected since the good professors were exceedingly generous with their endnotes.

The authors are faculty of the University of Chicago and both distinguished, long ball scholars. Thaler is world famous for pioneering “behavioral economics” which studies the influence of social, cognitive, and emotional biases on economic decisions. The idea that homo economus makes choices that are affected by society, emotions, or consistent errors is heresy among heirs to Milton Friedman and other rational choice stalwarts at the University of Chicago (although in most respects, Thaler refines Friedman instead of refuting him). When Daniel Kahneman received the 2002 Nobel Prize in Economics for his work in Prospect Theory, a cousin of Behavioral Economics, he immediately credited Thaler’s fundamental influence on his thinking.

Cass Sunstein is a highly influential legal scholar with broad interests . Sunstein has written about roughly every legal topic there is, including the use and misuse of cost/benefit analysis in public policy decisions, animal rights, gay rights, methods for aggregating information such as prediction markets and wikis, FDR’s second bill of rights (which proposed a right to an education, a right to a home, a right to health care, a right to protection against monopolies, and more), presidential impeachment (he actively opposed the impeachment of Clinton), and constitutional law. Sunstein is comically prolific. His CV lists twenty-eight books and more than three hundred articles (and cautions that it displays only “a very partial listing”).

The authors have intriguing connections to the Obama campaign. Austin Goolsby is Obama’s lead economic advisor and Thaler’s colleague and soulmate. Sunstein was on the law faculty when Obama taught there and, if you believe the Internet, is dating Harvard’s Samantha Powers who was (wrongly, wrongly, wrongly) fired by Obama for calling Hillary a “monster”. The romance could also be the nudge behind Sunstein’s decision to leave Chicago to become the director of Harvard’s Program on Risk Regulation.

Both men embrace a political philosophy that they term “libertarian paternalism”. They deeply respect the right of individuals to make their own (even palpably stupid) choices and would far prefer to see government guide choices than ban activities. The philosophy at first appears oxymoronic – “libertarian” being conservative to the extent that it is laissez faire and “paternalism” being liberal to the extent that it favors state intervention or protection.

Squaring the tension between these ideas is the task and the beauty of the book. The central thesis of Nudge is that like it or not, the way we structure choices creates incentives. Structuring smarter choices provides people with a nudge (like judge – not noodge, like stooge. A nudge is a shove in the right direction. A noodge is a wonderful Yiddish term for someone who nudges too much and becomes a pain the ass).

The authors argue that whether we want to or not, we architect choices all the time. They open with a fine example of a school cafeteria that discovers that it can nudge kids towards better diets by putting healthy foods at eye level and in front. They assert further that we can use the emerging science of choice architecture to nudge people to make choices that are healthy, pro-education, financially intelligent, and environmentally sound. You don’t ban stupid choices – but you create non-punitive incentives for good ones (for example, you make organ donation an opt-out, not an opt-in program. You save tens of thousands of lives every year and nobody is any worse off for having structured the choice more intelligently). The notion of choice architecture is the great idea at the heart of the book.

But why do we need to nudge? Well, because we often make choices that are not in our self interest – especially if the decisions are complex, infrequent, or make a difference someday instead of now. In these cases, markets fail because choice fails. Humans (as opposed to the fictional “Econs” that the authors mock throughout the book) appear to be well-designed to make simple decisions with immediate consequences such as stepping off of the curb – although the authors point out that in the more touristed precincts of London, even that decision benefits from the “Look Right” nudge on the sidewalk.

Humans (think Homer Simpson, not Econs like Star Trek’s Mr. Spock) think poorly when the choices are overly complex or can be delayed without immediate cost (or worst, both). Signing up for a complex mortgage or not joining a 401k plan is painless today — and who can really figure out the implication of all of those choices? And don’t even start on Medicare Part D. In the face of choices like this, even the Finance faculty turn out to be more Simpson than Spock. Many of us just go on auto-pilot. The authors argue that a nudge will at least stack the deck in our favor and reduce the frequency and severity of bad choices.

The authors look at the architecture of a variety of important choices from savings and investment decisions to the structure of utility bills. They look at incentives around marriage and issue an eloquent call for privatizing the institution, in a chapter that could easily reframe the same sex marriage debate.

A good example of smart choice architecture is the Save More Tomorrow Plan which Thaler developed in the mid nineties. Instead of asking employees to save more and reduce their take home pay, a Save More Tomorrow Plan asks employees to check a box to increase their savings rate each time they get a raise. Over time, the result is a dramatic increase in savings as employees commit to save instead of spending future income. With a nudge, Thaler has turned the human tendency to procrastinate and defer pain from a vice to a virtue in a manner that preserves choice (employees can opt-out, although in practice few do) and has little if any additional administrative cost.

SpockTransparency figures prominently in many of the nudges that the authors recommend. They urge that credit card companies be required to annually disclose how much we’ve spent on late fees and interest payments and to do it online using standardized definitions that permit consumers to compare the cost of alternative cards (something that is gruesomely difficult today). They would surely approve of the stickers on major home appliances that estimate the cost of energy over a five year period and would favor a similar sticker for cars showing likely fuel costs. The authors do not explore nudges that involve reduced transparency like the suggestion that making all political contributions anonymous would immediately reduce the ability of contributors to purchase self-interested legislation.

Unfortunately the book stops short of applying “libertarian paternalism” to more controversial nudges – perhaps because the authors do not agree on what to do. For example, many libertarians regard paid sex between freely consenting adults as harmless. Others believe that prostitution is always degrading and should be outlawed. Since the authors resist banning much of anything, this seems like fertile ground for a nudge.
It would be easy to ask men to voluntarily forswear paying for sex and post their names on a public website. Men, in their more upstanding moments, would enroll knowing that un-enrolling takes 15 days (and the tension between what the authors call the Automatic Mind and the Reflective Mind – between our inner Homer Simpson and our inner Spock – underlies a great deal of choice architecture). The local cat house would be legal and regulated, but prevented under serious penalty from serving any man on the “do not call” list. Add the ability of anyone (reporters and wives come to mind) to request an email notification in the event that someone asks that their name be removed and a lot of the controversy and hypocrisy that surrounds paid sex would disappear (and yes, the market for fake IDs would explode).

You could imagine a similar nudge for recreational drugs, which in almost all cases represent poor choices but for which the cost of prohibition vastly exceeds the social benefits. The authors are surely aware that libertarian paternalism can contribute to a better choice architecture in these controversial cases. Since tenure is a valuable nudge given to ensure that faculty enjoy complete freedom to explore society’s most challenging and controversial problems, their reluctance to do so suggests either caution bordering on cowardice or, dare we say it, a failed nudge.