‘Nudge’, the landmark book by Richard Thaler and Cass Sunstein, turned ten this year. Shortly after its publication, public sector experiments started to prove the concept at scale: adding social norms to tax letters and using defaults to get more people saving for retirement, for example. These first generation nudges were, and remain, highly effective. On the back of their success, behavioural science has gone from a radical, fringe idea to being embedded in government departments and ministries worldwide.
A decade on, nudging is coming of age. Increasingly sophisticated behavioural insights, beyond ‘simple’ nudges, are being applied to more diverse policy challenges than ever before. Further, nudges are being woven into the design of markets to shift the behaviour of both companies and consumers to drive better, fairer outcomes. Three policy changes in the UK this week demonstrate the power these second generation nudges.
Price caps to fix ‘broken markets’
Behavioural science is beginning to influence the design of ‘harder’ policy levers like taxes, mandates and price caps. While at first glance these levers might be dismissed as moving beyond the realms of nudging, in fact they can be designed to make behaviour change easier for consumers, and to influence the behaviour of companies.
Take the UK sugar levy, which turns a year old this week. It effectively nudged companies to reformulate their products with lower sugar content so they are either no longer subject to the tax, or fall within a lower tax bracket. From a behavioural perspective, reformulation is particularly appealing as it doesn’t require individuals to change their habits to improve their health.
The price caps on fixed odds betting and rent to buy products, both coming into effect this week, work on a similar logic. These are markets with problematic equilibria and business models that rely in part on exploiting behavioural biases and mispredictions.
The design of fixed odds betting terminals (FOBTs) is synonymous with a state of detachment from reality which increases the financial vulnerability of players. With individual stakes being reduced from £100 to £2, rather than spending up to £1,000 in ten minutes, people can spend up to £20, for example. While the reduction came into force this week, gambling operators were already working on ways to subvert the ruling, offering new (similar) games to customers. The Gambling Commission took early action to warn the operators that they risk further regulatory enforcement, which the operators heeded and have withdrawn.
There is a huge industry in high-cost credit, and it comes in many guises. StepChange research found that around one in seven people borrowed money to meet a household need last year, with around 3 million resorting to high-cost credit. 400,000 of those were borrowing in the rent-to-buy sector where people can pay over £1,500 for a fridge that would cost £300 outright. Following on from the successful payday lending cap, the Financial Conduct Authority (FCA) is now capping the rent-to-buy market. These caps work by both changing the behaviour of suppliers – FCA analysis of the payday lending cap found that firms are now much less likely to lend to customers who cannot afford to pay – and helping consumers to get better deals without needing to actively shop around (analysis of the payday lending cap found that 760,000 borrowers are saving a total of £150m per year). Despite the success of these caps, more thought needs to go into a more holistic financial offer that helps people to transition out of debt and start saving.
Smarter defaults to help people save
In pensions, nudges are evolving beyond binary opt-in/opt-out models and into more sophisticated choice architecture – from the auto-escalation of pension contributions, to savings accounts that help employees save into their pension while setting aside money for a rainy day.
The change in pensions defaults, from an opt-in to an opt-out system, has led to 10 million people in the UK newly saving for retirement. Perhaps less celebrated is the ‘auto-escalation’ built into the default. On Saturday, the minimum contribution levels will automatically increase from 5% to 8% (3% from employers and 5% from employees), which is expected to impact a quarter of the workforce (it will not affect the self-employed, those who are already contributing more than the minimum and those who have opted out). Defaults are sticky and once in place, very few people choose to opt out, making these smarter defaults a highly effective way to encourage people to save more: the previous increase to 5% had “little to no impact on cessation and opt-out rates” in the National Employment Savings Trust (NEST).
Of course, the defaults can be made smarter still. Richard Thaler and Shlomo Benartzi proposed a form of auto-escalation where contributions would increase at the same time as pay rises. This allows people to save more without ever seeing a drop in their take home pay, harnessing loss aversion to the saver’s advantage. There are practical constraints to building this into national-level policy, but innovative pension providers can offer this to employers to differentiate their workplace pension products.
Saving for a comfortable retirement is important, but so too is having access to savings during your working life. In fact, having even a small rainy day savings buffer is hugely consequential. Research on scarcity shows that being worried about money has broader impacts on the way we think and make decisions in the rest of our lives. It leads to a tunnelling effect where people tend to make very short term decisions – like taking out a payday loan – that aren’t in line with their long term goals. Harvard Professor Brigitte Madrian has proposed a ‘sidecar’ account: a savings account that would sit alongside your workplace pension to help you build and maintain a rainy day pot during your working life. This is currently being tested by NEST Insights, and if effective should form part of the wider pensions default.
The next generation of nudges
Here at BIT we are enthusiastic about the potential for second generation nudges to tackle a range of policy challenges. Stay tuned next week, as we release a new paper that considers how first and second generation nudges can be used online, to shape digital markets and platforms that work for everybody.