In standard economics, which assumes that people always make rational choices, free choices and trades essentially maximize the level of social welfare whenever resources are limited. For efficient resource allocation, the right of individuals to choose freely should thus be guaranteed. As explained in Chap.1, the idea that we should regulate the choices people make and intervene in order to improve their welfare is called paternalism. In traditional economics, paternalistic policies are essentially considered undesirable.
However, as we have seen thus far, people’s decision-making is affected by difficult selection biases such as hyperbolic discounting; instead of maximizing long-term interests, people actually fall for self-destructive choices. What can we do to address such problems while continuing to offer people the freedom of choice?
In the field of behavioral economics, an idea has been proposed to intervene in people’s choices in order to improve the welfare of society by merely changing the choice framework without forcing them to make certain choices. This idea is called libertarian paternalism (Thaler and Sunstein 2003, 2009) or benign paternalism (Benjamin and Laibson 2003). Here, I will use the term libertarian paternalism.
A good example is the introduction of automatic registration. Even if there were systems such as national and corporate pensions that you know from a long-term perspective you should enroll in, if you had to indicate your will to participate and take necessary steps to enroll, many people would end up choosing not to enroll because of the related hassle. One of the proposals of libertarian paternalism is to change systems in which people cannot enroll unless they indicate their intention to an automatic registration system in which people are automatically enrolled when they become eligible, unless they indicate their will to reject enrollment.
A system in which you are required to indicate your will when choosing to enroll or participate is called an opt-in system, while a system that mandates you to indicate your intention when choosing to cancel or not to participate is called an opt-out system. In short, introducing an automatic registration system means shifting from the opt-in system to the opt-out system.
Such a change is a paternalistic intervention in the sense that it intentionally influences people’s enrollment choices; however, it 100 % guarantees freedom of choice because members always have the right to opt out (choose to cancel). This is libertarian paternalism, which intervenes while guaranteeing freedom of choice.
As you can see from this example, libertarian paternalism proposes to design the choice framework so that people will voluntarily (in a broad sense) choose what is desirable for them. So, how can you make people choose a certain option, as a magician does? You can actually use people’s selection bias to your advantage and pave the way so that they are least resistant to choosing the option that you want them to choose. Richard Thaler and colleagues call this type of slight encourage- ment a “nudge” (Thaler and Sunstein 2003, 2008). It is the same idea as that behind a magician who takes advantage of the habits of the audience to make him or her choose an intended card. Let me explain this more specifically.
6.3.2 “Nudging” Decision-Makers by Changing the Default
The initial setting that is applied when one indicates no intention or will is called the
“default.” Changing the default choice is one of the most effective techniques in nudging decision-makers.
People often have a selection bias that tries to maintain the current condition because they have to incur a psychological burden when choosing an option that alters the current condition. This is the status quo bias, which I explained in the previous chapter. Because of this bias, people have a strong tendency to get “hung up” on and choose the default. When this “default bias” interferes with their desirable choice, we can use the same bias to actually nudge the behavior of the decision-makers toward a better option by setting the desirable option as the default. The introduction of an automatic registration system, as mentioned in the previous section, intends to nudge individuals with a strong status quo bias toward enrolling by switching from the opt-in system (with the default being “not enroll”)
to the automatic registration system or opt-out system (with the default being
“enroll”).
It should be noted that changing the default like this would have no effect if all decision-makers were rational because they would always choose the best option, regardless of the way in which choices are presented. Intervention methods that use a default bias is something not found in traditional economics.
There are numerous reports of attempts to improve choices by changing the default. For example, initiatives to actually introduce the automatic registration system that I just discussed are seen in various pension systems. Introduction of the automatic registration system is under way, especially overseas, where enrollment in a public retirement pension is not mandated as in Japan (Thaler and Sunstein 2008). Some examples are Pension Legislation enacted in 2006 in the United Kingdom, the Pension Protection Act of 2006 in the United States, and the KiwiSaver Act that came into effect in New Zealand in 2007 (Carroll et al. 2009).
The introduction has also been successful in the defined contribution corporate pension plan, or 401(k), in the United States. According to a study conducted by Brigitte Madrian and Dennis Shea, the enrollment rate had actually improved from 49 to 86 % just by changing the 401(k) enrollment system from standard opt-in to automatic registration (Madrian and Shea 2001).
The change in the prescription format that Japan implemented in 2008 to promote the use of generic drugs and curb healthcare costs is also an intervention that changed the default (Iwamoto 2010). In the past, the doctor signed (or wrote the name or placed the seal) on the line of the prescription slip that said “can be filled with a generic drug” whenever the drug specified by the doctor could be switched to a generic one. However, the format was changed so that the doctor signed (or wrote the name or placed the seal) on the specified line only when the prescription could notbe filled with a generic drug (Promotion of the Use of Generic Drugs in: Main Revisions in the FY 2008 Revision of the Medical Payment System, the Ministry of Health, Labour and Welfare). This can be considered a libertarian paternalistic measure that tries to promote the use of generic drugs by changing the default to
“can be filled with a generic drug.” According to a study conducted by the National Federation of Health Insurance Societies (Kenporen), the percentage of individuals who have used generic drugs has dramatically increased following this default change, from 17.6 % in 2008 to 47.4 % in 2011 (National Federationof Health Insurance Societies 2008, 2011).
6.3.3 Nudging Hyperbolic People
Since many self-destructive choices, including undersaving and obesity, seem to be related to hyperbolic discounting, as seen in the previous chapter, it would be very useful if we could actually use the same hyperbolic discounting to nudge people toward choosing future-oriented options.
One way to use hyperbolic discounting is to set up a choice framework in a way that the options that undermine the long-term interests will have a large and immediate cost, while the desirable option can be chosen without any hassle.
This intervention should nudge hyperbolic individuals who take the immediate effort serious toward the option that is desirable in the long run.
A sandwich experiment conducted at a fast food restaurant by Julie Downs, George Loewenstein, and Jessica Wisdom, a research group around Carnegie Mellon University, is an interesting field experiment that demonstrates the effec- tiveness of such an intervention (Downs et al. 2009). They first prepared three versions of menus—A, B, and C—with the items listed in a different order. Menu A featured low-calorie products on the front page, while Menu B listed equal numbers of low- and high-calorie products on the front page, and Menu C featured high- calorie products on the front page. Since the same products could be found on all the menus if the customer looked at all the pages, the menus did not actually impose any restriction.
The key here is that the psychological cost (the hassle) of choosing a product with the same calories differs by menu. For example, when choosing a low-calorie item, while you can choose one from the items listed on the front page if Menu A is presented, you cannot choose the same item from Menu C without going through the trouble of turning the pages.
Based on this field experiment, Downs and others showed that the probability of customers choosing a low-calorie item—and the actual number of calories cus- tomers consumed there—was heavily influenced by which menu was presented;
customers chose low-calorie items when presented with the low-calorie menu (A) and high-calorie items when presented with the high-calorie menu (C). For example, customers who were presented with the low-calorie Menu A were 48 per- centage points more likely to choose low-calorie items than the customers who were presented with the mixed Menu B. The results also showed that the customers who were presented with the high-calorie Menu C chose low-calorie items only at a probability that is 47 percentage points lower than in the case of being presented with the mixed Menu B. This indicates the possibility of improving people’s meal choices just by adding a slight default change that actually harnesses the status quo bias that stems from hyperbolic discounting.
Similar intervention experiments that change the level of hassle related to food choices are also under way at cafeterias in junior high schools, high schools, and universities in the United States. For example, some cases have been reported where making changes such as placing a salad bar where the line for the cashier will pass and moving the fruit display to the front of the cashier drastically increases the consumption of these healthy foods (Schwartz 2007; Just and Wansink 2009).
These days, similar arrangements have also been found at university co-op cafete- rias in Japan; these are probably based on the same thinking.
For that matter, placing products that appeal to impulsiveness, e.g., potato chips and chocolates on sale, just before getting to the checkout in a supermarket is also the same type of attempt to nudge hyperbolic consumers (although they have the opposite effect on health).
A project called “Smarter Lunchrooms,” which aims to improve diets in schools by applying behavioral economics insights, is spreading through the work of a Cornell University research group led by David Just and Brian Wansink. There, creative designs similar to those explained in the sandwich experiment are proposed in various forms to make it easier for individuals to choose healthy foods while selectively placing a slight psychological burden on unhealthy foods and making them more difficult to choose (Just et al. 2008; Lee 2012).
6.3.4 Making People Commit to Future Savings
Another way of using hyperbolic discounting is to create a mechanism by which people can commit now to a patient choice in the future. Although hyperbolic individuals apply a high discount rate when making a choice that relates to immediate gratifications, they are patient when making a choice that related to distant future gratifications. For example, although they might not be able to save money now, even when recommended to do so, they would probably be willing to participate in a savings plan in the future. Therefore, presenting an option that allows them to commit now to such a future savings plan would be a way of harnessing hyperbolic discounting.
The best example is a social experiment of the SMarT program that Richard Thaler and Shlomo Benartzi conducted by using a real 401(k) (Benartzi and Thaler 2004). SMarT, which stands for Save More Tomorrow, is a program devised in an effort to use 401(k) to increase the amount of savings among employees. This program offers a plan that automatically increases the 401(k) contribution rate whenever the employee gets a raise and encourages employees who have been reluctant to increase the contribution rate despite recommendations to enroll in the plan. Employees are free to cancel the plan after enrollment. In that sense, this program meets a requirement of libertarian paternalism.
Unlike the automatic registration mentioned in the previous section, this pro- gram requires employees to express their intention to enroll; therefore, it is not a program that intends to increase the enrollment rate by working on the status quo bias. In fact, the automatic registration system actually has a problem, in which many individuals exhibit status quo bias once they are automatically enrolled and stay with the plan’s default—set at a low contribution rate (about 3 %)—so that the savings rate ultimately never increases. The SMarT plan was devised to overcome that problem.
The SMarT plan, which increases the contribution rate whenever a worker receives a raise, has two characteristics that are perfect for hyperbolic individuals with a low propensity to save, so that they can increase their savings rate. First, hyperbolic individuals whose discount rate is lower for the future are more recep- tive to saving money in the future than to saving money today. A plan that allows them to commit to future savings is just what they need.
Second, hyperbolic individuals tend to stay in the same plan because they are strongly affected by status quo bias. Meanwhile, their savings rate would continue to increase because the contribution rate increases each time they get a raise.
Whereas the automatic registration system uses status quo bias to increase the enrollment rate, the SMarT plan uses status quo bias to increase the savings rate.
Furthermore, the SMarT plan has an advantage that allows one to avoid the negative effect of loss aversion. Assuming that people are concerned about the amount of monthly take-home pay after the pension contribution is withheld, individuals with a strong tendency of loss aversion would shun a plan that increases the contribution rate, even when there was no raise, because the amount of take- home pay would decrease each time and thus engender a strong sense of loss. The SMarT plan, which increases the contribution rate only when there is a raise, can preclude such a loss aversion effect.
As a result, the SMarT plan has indeed helped increase the rate of employee enrollment in the 401(k) and the amount of their installment savings. Thaler and others report that, in the case of a medium-sized American manufacturer who became the first company to implement the SMarT program, 78 % of eligible employees enrolled in the SMarT plan at the time of program introduction in 1988 and a whopping 80 % of them continued to participate through to the end of the implementation period (40 months), which spanned four salary-review cycles.
The savings rate, which was 3.5 % on average, increased to 13.6 % during that time.
Based on these results, more than one-third of large employers in the United States have, as of 2007, introduced the SMarT method or a similar method that automat- ically increases the rate of contribution to their 401(k) (Thaler and Sunstein 2008).
6.3.5 Reverse Thinking: Asymmetric Paternalism
As we can see from these real-life examples, the idea of libertarian paternalism is a form of reverse thinking that attempts to improve choices by actually using selection biases such as hyperbolic discounting and status quo bias, which tend to lead to self-destructive choices. Specifically, it addresses the situation by setting
“enroll” as the default—a condition that allows them to enroll by doing nothing—
when there are many individuals who would otherwise do nothing and not enroll in the pension due to status quo bias. Alternatively, when people cannot save money today because they are hyperbolic, libertarian paternalism establishes a mechanism through which hyperbolic individuals are more likely to want to save by creating an option that allows them to commit to a future savings plan.
As a result, libertarian paternalistic interventions are often characterized by a particular property: although they affect decision-makers who exhibit selection bias, they do not affect rational decision-makers who do not exhibit such bias. In a way, it intervenes by “marking the option buttons” with paint that only decision- makers with a specific selection bias can see, to selectively target only those
individuals. Such a characteristic is called asymmetric paternalism (Loewenstein et al. 2007).
Asymmetric paternalism becomes very useful when external parties (and even the decision-makers themselves) cannot tell which decision-makers have selection bias. This stands in contrast with how conventional paternalism, which intervenes through taxation and trade regulation, results in a problem in which the regulation traps everyone, including rational decision-makers with no such problem, in the same manner.
6.3.6 Putting It into Practice
When actually designing a social system based on libertarian paternalism under consumers’ heterogeneity, it is necessary to take some practical caution. For example, when considering some sort of new pension system, what do we need to watch out for to actually design the enrollment mechanism? Here, we should keep two major principles in mind.
First, the default needs to be consistent with the rational judgment of society at large. For example, when mandating the individual to choose one of the options, it is important that the default be set to the one that the majority of decision-makers with rational judgment would choose. That is, whether the enrollment in some sort of a new system should be done using an automatic registration or a standard opt-in method should be determined based on the criterion of whether or not the majority of eligible, rational individuals would choose to enroll. Richard Thaler and Cass Sunstein call this principle the “market-mimicking approach” (Thaler and Sunstein 2003).
As a way of retrofitting this market-mimicking approach, we could revise the default after introducing a system so as to minimize the number of those who cancel the default. This is a method in which we can go ahead and launch a system with one default and then revise it if many individuals opt out from that default. A good example is a 401(k) in the United States that switched to an automatic registration system with “enroll” as the default because many individuals opted out from the
“do not enroll” default (i.e., they enrolled) under the standard opt-in enrollment system.
However, there is a problem with this method. First, although this method requires predicting the rational choices of decision-makers, making such a predic- tion is sometimes simply impossible. There is no doubt that predicting choice is difficult, but even when testing a default and collecting data, you will never know if the observed data comprise selection results that are completely free of the influ- ence of status quo bias. Second, although this is more of a question of having a default itself, setting one default when there are a variety of decision-makers poses the risk of diverting many people from their own unique optimal choices.
The second principle is a method that mandates all decision-makers to clearly indicate their choice in order to avoid these problems. A group of researchers