Behavioural Economics and Public Policy

How much do you think you'd be able to save if a portion of your check went automatically to your savings account unless stated differently? How would your response be to an email that asked you to book a date to take the coronavirus vaccine? What do you think of an economy when a political party says that nominal GDP has grown by 15%?

This is what public policy looks like when we use behavioural economics. This explanation will help you learn everything you need to know about behavioural economics and public policy. After reading it, you will have answers to the questions above.

Theory of behavioural economics and public policy

You might already know that classical economic theory argues that humans make decisions perfectly rationally and that whatever decision they make provides them with the best possible outcome.

In contrast, behavioural economics suggests that human beings don't always make rational choices and external factors often influence them. Those external factors could be the general circumstances under which a person lives or external factors that stimulate them to make certain decisions.

Behavioural economics is a branch of economics that analyses and extracts conclusions from these factors.

Government policy on behavioural economics

The insights provided by behavioural economics have been increasingly appealing to governments worldwide in the last decade. The reason for that is that many believe that those insights could help governments come up with more efficient public policies. As the insights provide a broader explanation of human behaviour, governments could use the insights from this research to develop specific policies with a more efficient economic impact.

An important part of behavioural economics is a tool that governments use: nudges. These are indirect suggestions aiming at altering the behaviour and choices of an individual. Think of the impact of the government putting a reminder on every sink in the country about water waste. Surely, this would at least cause a fraction of people to use water more carefully.

The UK government has already established a team that is dedicated to behavioural economics and public policy. The team is called Behavioural Insights Team (BIT), and it aims to consult the government of the UK on improving their public policies. The team is now advising governments worldwide using insights analysed and gathered using behavioural economics tools.

Why is behavioural economics important for public policy?

At the core of behavioural economics lies the idea that human behaviours are affected by external factors and that they are prone to change. The main contribution that a combination of psychology and economics has brought to public policy is that human beings are not always rational, and their behaviours can be changed.

This has provided a great opportunity for governments in terms of making public policy more efficient. The reason for that is that they can use various tools and techniques of behavioural economics to ensure that people make the right choices that benefit the entire society.

In addition to having behavioural economics tools at hand that make the implementation of public policies more efficient, governments also have the chance to use these behavioural insights to design policies that coincide with the needs and wants of citizens. This enables the government to design more realistic policies that address a broader range of people, which in turn makes public policies much more efficient.

Behavioural economics techniques and public policy

There are numerous ways in which the government uses behavioural economics to develop new policies that encourage people to make certain choices. It is important to note that the government uses behavioural insights to encourage people to make choices that benefit them and society.

Here are some behavioural economics techniques used in public policy:

Applied behavioural economics: default choice

To better understand default choices consider the case of automatic pension enrollment.

Fig. 1 - Default choice and automatic pension enrollment

Applied behavioural economics: framing

Individuals choose to convey certain aspects of an event, which enables them to tell parts of the story according to their interests. As well as in real life, this is also very common in marketing where companies choose to talk about some aspects of a product to frame it in a way that helps them generate sales.

Politicians often do this, especially when they talk about the health of the economy. This includes choosing specific sentences or certain ratios. For example, when they talk about GDP, many politicians choose to talk about nominal GDP, which also includes the price levels, and not talk about the real GDP, which points to the growth in goods and services alone. A significant increase in GDP is not always good, as it could be just because the price levels rose, not necessarily the overall production.

Applied behavioural economics: mandated choice

Under a mandated choice, an individual must choose one of the alternatives provided.

Fig. 2 - Mandated choice and COVID-19

Applied behavioural economics: restricted choice

This is done to ease individuals’ process of decision-making. Often people don't have the time to evaluate all the possible options out there. The government applies the restricted choice technique when it forces energy companies to provide a limited number of alternatives to consumers. This way, the consumers have it easier to choose which price to pay.

Nudges and public policy

Nudges aim to alter human behaviours by indirectly offering suggestions to individuals in a way that they don't change economic incentives to engage in a particular choice. That is to say that government suggestions aim to alter your choices, but they don't provide an economic gain or loss to push you to make a choice.

In contrast to nudges, you have shoves.

The government provides financial gains or losses to ensure that individuals adhere to certain behaviour.

Of governments' many behavioural economics tools, nudges are the most common and successful ones. Nudges may be successful because individuals are affected by stimuli that are apparent and novel. As a result, tiny changes in behaviour can, at least in principle, result in more significant changes in behaviour.

Evidence from many studies shows that simply asking (nudging) someone to participate in a health care plan has significantly increased the number of people interested in and enrolling in health care programs.

Governments use varying degrees of nudging in almost all public policies. Nudges are especially used to make the implementation of a public policy more efficient. That is because nudges serve as a reminder to individuals to change their behaviour and act in their and society’s best interest.