At a glance
The average interest rate on credit card debt in Australia is about 17 per cent, so logic would dictate that households should direct any spare cash to paying it off.
Yet although almost half of households have at least A$10,000 in savings (according to figures from ME Bank), the credit card debt clock run by the Australian Securities and Investments Commission reveals the average Australian still owes about A$4250 on their plastic. Many households willingly carry high-interest debt despite having the means to pay it off.
This sort of habit is one of the puzzles that intrigues Richard Thaler, professor of behavioural science and economics at the University of Chicago Booth School of Business. Thaler is seen as one of the founders of behavioural economics, and in 2017 he was awarded the Nobel Prize in Economics for his work challenging conventional economic wisdom about how people behave.
Traditionally, economists constructing economic theories have treated people as well-informed, self-interested and driven to make choices solely according to what delivers them the greatest possible material benefit. (Of course, even the most hardline economists realise this is not how most people do things in real life, but some still say such gross characterisations are necessary to help understand how markets work.)
Thaler, however, has for decades drawn on insights from psychology to show how people act in ways that are rational to them – just not in the ways assumed by economists.
His work on mental accounting, for instance, shows how people think of purchases in relative terms rather than the absolute terms that many economic theories assume.
Timo Henckel, from the Australian National University’s Research School of Economics, says you can see this sort of behaviour when people go to considerable effort shopping around to get A$10 off the price of a A$50 jumper or pair of jeans (saving 20 per cent on the original price), but don’t even contemplate going to a car yard in a more distant suburb to save A$400 on the cost of a runabout priced at A$12,000 (a 3.3 per cent saving). Since, relatively speaking, the A$10 discount outweighs the A$400 saving, it’s seen as being worth the effort of shopping around.
However, Henckel believes Thaler’s biggest contribution has been in using insights from behavioural economics to improve the effectiveness of public policy.
In his famous 2008 book Nudge, Thaler and co-author Cass Sunstein set out how people can be steered in their choices by the way decisions are framed. For instance, in the US there was concern that not enough workers had retirement savings plans, and those who were in a plan were not putting enough away.
Thaler’s solution was to make workers’ enrolment in a retirement plan automatic, and to index contributions to salary increases – he and his collaborator Shlomo Benartzi trademarked it as the Save More Tomorrow plan. When this method was trialled at several companies in the US, starting in 1998, retirement savings rates among employees more than trebled in three years.
Applying the same principle, Thaler suggests countries can dramatically increase organ donation rates by automatically registering people as donors unless they explicitly opt out.
Real-world results bear this out. Spain has had an opt-out organ donation system since 1979, and now has the world’s highest deceased organ donation rate. In 2016, it recorded 43.4 individual donors per million people, much higher than the EU average of 19.6 donors per million people, or the US average of 26.6 per million, according to statistics from Spain’s health ministry.
The nudge movement
Several governments have established behavioural economic units within departments to apply such insights and improve the effectiveness of their policies, including the UK Government’s Cabinet Office, the Singaporean Government and the New South Wales Government’s Department of Premier and Cabinet.
Since the early 2000s, David Halpern, global chief executive of the Behavioural Insights Team (BIT) – a company that grew out of the British Cabinet Office’s “nudge unit” – has been at the centre of efforts by governments to draw on knowledge about human psychology to improve public policy.
Although governments have long been in the business of trying to shape people’s behaviour, from using the threat of imprisonment to discourage criminality, to heavily taxing cigarettes to deter smoking, Halpern says many such interventions are based on little more than gut feel, and can be incredibly costly and ineffective.
He is bemused that so many governments and companies readily embark on multimillion-dollar policies and projects without first trialling how their ideas might work.
Some tax subsidies and other incentives to boost retirement incomes barely boost savings rates by a cent for every dollar outlaid, Halpern says, while a simple change such as automatically enrolling employees in retirement savings schemes can achieve far better outcomes at a fraction of the cost.
“The key question is, ‘What would most people want to do?’ Most people intend to get around to saving, and the idea is to reduce the barriers and friction that stop them from doing so,” Halpern says.
“You are going with the grain of what people want to do.”
For Halpern, one of the most important tools in the behavioural economist kitbag is the randomised control trial, a study in which subjects are randomly assigned to two groups, one to test a theory or intervention, and the other a control group with no intervention. The BIT group makes heavy use of the technique, designed to reduce bias, having conducted more than 500 trials.
“It makes for a more complicated model of the economy, but a more accurate description and better policies,” Halpern says. “Yes, it is more complicated, and ideas have to be tested, but businesses that are not doing it will be outfoxed.”
Clocking on, clocking off: breaking the 9-to-5 habit
On occasion, people need a slightly firmer nudge – even a shove – to do what they truly want to. For example, while many organisations have flexible-hour policies in the workplace, staff may be reluctant to take full advantage of them.
That may be because they’re worried managers would look dimly on them working flexible hours, or because of ingrained habits and obligations, such as getting their children to and from school, or activities like going to the gym.
As a result, they are still enduring the pressures of peak-hour commutes, and their workplaces miss out on the extended productivity that comes from combining early starters and late leavers.
When the Behavioural Insights Unit within the NSW Department of Premier and Cabinet was tasked with getting people out of stubborn 9-to-5 work practices at eight Sydney-based organisations, they devised three interventions.
First, they changed the default settings in Microsoft Outlook to narrow the range of hours in which people would be available, discouraging the scheduling of early and late meetings.
Second, they used building entry card data to show managers that their teams were mimicking the boss’s start and leave times. They encouraged managers to act as role models for more flexible working hours, and to have open conversations with their staff about the possibilities.
Finally, they organised a nine-week competition between teams in each workplace. Those who adopted the most flexible working practices accumulated the most points.
The first two interventions saw a 3.3 per cent lift in the number of staff starting and finishing work in off-peak times. The workplace competition, however, resulted in a 6.4 per cent jump in the number of off-peak arrivals and a 4.9 per cent rise in off-peak departures.
Two months after the intervention concluded, the number of off-peak arrivals was up 7.1 per cent, and departures were up 3.8 per cent.
The limits of behavioural economics
Useful as behavioural economics can be, Henckel is concerned that the benefits it can offer are in danger of being over-egged.
“[Behavioural economics] is a bit fashionable at the moment. A number of governments worldwide have set up behavioural economic units within various departments, and there’s a desire to ‘behaviouralise’ policy,” he says.
While he acknowledges that the work of such units and the randomised control trials they run are useful, Henckel says their work cannot give the whole answer.
“Economics is an area where there is never just one approach that delivers all the answers that you want,” he warns.
“It’s not just experimental economics, it’s not just randomised control trials; theory alone won’t do it, empirical work alone won’t do it. It’s got to be a whole mosaic of different approaches and lines of attack that ultimately together paint a reasonably coherent picture.”
Changing our tax habits
The Australian Taxation Office (ATO) is using insights from behavioural economics to encourage people to lodge paperwork on time, accurately report income and deductions, pay tax debts and move to paperless tax transactions.
“We ask how we can make it as easy as possible for people to do the thing we want them to do, or that they need to do, and harder for them not to,” an ATO spokesperson says.
The ATO’s in-house Behavioural Insights Unit has, so far, applied its techniques to more than 180 activities. Many of them are implemented on the ATO’s myTax website, including pre-filling income, salary, dividend and private health insurance details in online tax return forms, providing pop-up messages to let taxpayers know when their work-related expense claims appear out of step with their peers, and using emails and text messages to inform on progress in processing tax returns.
To prompt people to pay tax debts on time, the ATO last financial year sent out 560,000 pre-emptive SMS reminders, a move it says netted A$800 million in payments at a cost of just A$0.09 per SMS, compared with A$1 for a formal letter.
The idea is to make it easier for taxpayers to meet their obligations, give them certainty about ATO processes, provide targeted and personalised messages, emphasise the cost of not taking action, and use social norms to encourage the right behaviour.
“This ethos now permeates the way the ATO thinks about design – of processes, systems, communications and engagement activities,” the ATO spokesperson says.
“By looking at things through this lens, it increases the likelihood of getting better outcomes for the client and for the organisation.”
