Which way to nudge? Uncovering preferences in the behavioral age.

Author:Goldin, Jacob

ESSAY CONTENTS INTRODUCTION I. THE PROBLEM OF BEHAVIORAL PREFERENCE IDENTIFICATION A. Setup: Nudges and Frames B. The Optimal Choice of Frame C. Limitations of the Traditional Approach II. EXISTING METHODS FOR CHOOSING WHICH DIRECTION TO NUDGE A. Minimizing Opt-Outs B. Following Majority Choices C. Revelatory Frames D. Preferences and Consistency III. OVERCOMING THE PROBLEM OF BEHAVIORAL PREFERENCE IDENTIFICATION A. The Augmented Revelatory Frame Approach B. The Demographic Extrapolation Approach CONCLUSION INTRODUCTION

Governments face frequent and inescapable decisions about choice architecture--the features of legal and institutional design that affect people's voluntary choices. (1) For example:

* Should a bank be allowed to automatically enroll new account holders into "overdraft protection" (2) unless they opt out, or should customers have to opt in to receive this type of service?

* In what order should a government website list the prescription drug plans that are available for Medicare Part D beneficiaries to enroll in? (3)

* Should the packaging for a medical drug disclose the product's effectiveness in terms of its success rate or its failure rate? (4)

* Should the government compel companies like Facebook and Google to adopt default privacy settings that prohibit advertisers from using customers' personal data to predict which advertisements the customer will enjoy? (5)

Historically, law and economics scholars would answer each of these questions the same way: it doesn't matter. Legal rules shape behavior by changing people's incentives; policies that don't affect incentives don't affect behavior.

But the old view is strikingly out of date. Research conducted in behavioral law and economics over the past few decades has found that even features of a decision that don't affect the chooser's incentives--such as which option is the default or what order the choices are presented in-may nonetheless shape what people choose, and often in substantial ways. (6) A growing chorus of academics has called on governments to utilize these findings when designing choice architecture to "nudge" people's choices in directions that will improve the chooser's own welfare. (7) And policymakers have listened, placing advocates of this approach in powerful administrative positions and even creating entire "nudge squads" within government devoted to the idea. (8)

In this Essay, I argue that efforts to design choice architecture to improve people's welfare clash head-on against a tension rooted in the foundations of behavioral law and economics itself. The tension is this: using nudges to make people better off requires knowing people's preferences, (9) but the very fact that people respond to nudges means that one can't learn their preferences simply by observing their choices. Previous theories for designing nudges have overlooked the magnitude of this problem by focusing on the wrong piece of information-the majority preferences of all decision makers-when what really matters for designing nudges are the preferences of the subgroup of decision makers whose choices are affected by the nudge. And it is the decision makers in this subgroup for whom the preference identification problem is most extreme. One cannot learn which option a person prefers by looking to see which option she chooses when what she chooses varies according to preference-irrelevant factors-i.e., which way she is nudged. Because of this dilemma, the case for nudging often founders because it cannot answer a basic question: which option should people be nudged toward? The goal of this Essay is to clarify the nature of the challenge and to propose some concrete ways of overcoming it.

To illustrate a situation in which the problem of behavioral preference identification (as I label the tension described above) is likely to arise, consider the choice people face when deciding what type of car insurance to buy. (10) Suppose a state requires auto insurers to offer both limited- and full-liability insurance to customers, and the state must decide which type of insurance should be the default. (11) That is, the state could either require auto insurers to present limited insurance as the default and give consumers the option of upgrading to full insurance for an added fee, or instead present full insurance as the default and give consumers the option of downgrading to limited insurance in exchange for a price discount. Which insurance is the default is likely to affect which insurance some of the customers decide to purchase, (12) so the state's choice matters. Moreover, customers are likely to differ in which type of insurance they prefer--some will value the affordability of limited insurance while others will care more about the reduced risk associated with the full insurance option. But because customers' insurance choices vary based on a preference-irrelevant feature of the decision (the default), policymakers cannot look to their choices to learn which option they actually prefer. (13) As a result, the state lacks the information it needs to determine whether a default of limited or full insurance will make people better off.

To be sure, there are two cases in which determining the best direction to nudge will not be so difficult. The first is when policymakers have strong (possibly paternalistic) views of their own about which of the available options would make decision makers better off. For instance, many experts believe that people should save more for retirement than they currently do. (14) If that view is correct, the best way to design the choice architecture that governs retirement savings decisions is to adopt whichever nudge moves saving rates closest to the level that the experts believe is optimal, such as by implementing automatic enrollment into savings plans with a high default contribution rate. (15) Similarly, if policymakers are confident that people would be better off eating healthier foods or smoking fewer cigarettes, they can design nudges to promote these objectives, such as by requiring calorie labeling at fast food restaurants (16) or eye-catching health warnings on cigarette packages. (17)

Second, the problem of behavioral preference identification is lessened when the decision under consideration involves substantial externalities to other members of society. (18) For example, nudges are frequently advocated for in the context of organ donation, where the strong positive externalities associated with there being additional organ donors provide grounds for implementing an opt-out organ donation default rule, quite apart from the preferences of the affected decision makers. (19) Similar arguments might inform the design of nudges to promote environmental goals (20) or the collection of tax revenue (21)--areas where one person's decisions have an effect on others in society. (22)

Although policymakers can circumvent the problem of behavioral preference identification when one of these conditions is met, settings like these represent the exception rather than the norm. Absent knowledge of people's choices, policymakers will typically lack reliable beliefs about which option will best promote people's welfare. (23) Consider the auto insurance example discussed above--is there any reason to predict that most drivers would be better off with full as opposed to limited insurance, or vice-versa? (24) And in most cases, the externalities associated with a decision will be secondary in importance to the effect of the decision on the decision maker herself. Indeed, it seems likely that one of the reasons the retirement savings and organ donation examples have received so much attention in the literature on nudges is that they represent two of the rare major policy issues in which determining the right direction to nudge is relatively uncontroversial. (25)

The problem of behavioral preference identification thus creates a practical dilemma for nudging enthusiasts. Although behavioral law and economics has shown that important policy questions about choice architecture are ubiquitous, it has so far failed to provide any satisfactory tools for answering those questions when they arise. As a result, even policymakers who would like to implement welfare-enhancing nudges often lack the information needed to do so. (26) Without a principled method for choosing the best direction in which to nudge, policymakers are left to make decisions about choice architecture in an ad hoc manner or based on their own intuitions about what people prefer. Neither of those options is appealing; poorly designed choice architecture results in nudges that make people worse off.

Part I of the Essay sets out the problem of behavioral preference identification. I begin by identifying what information policymakers need to determine the optimal direction in which to nudge. To keep things simple I assume that people are choosing between two options and that the government's goal is to maximize the number of individuals who end up with the option they most prefer. (27) Those who have considered this question in prior work have concluded that the optimal nudge is majoritarian, in that it is best to nudge toward whichever option more people prefer. (28) In contrast, I argue that the optimal nudge is subgroup majoritarian: the best direction to nudge depends on the preferences of those individuals who are inconsistent, i.e., whose choices vary according to the direction of the nudge. Intuitively, it is the preferences of this subgroup--rather than the full population-that matter for determining the optimal nudge, precisely because only inconsistent people's choices are affected by the nudge's design. The consistent people don't enter into the equation because they end up choosing the same option regardless of the nudge's direction. (29)

After identifying what information matters for determining which way to nudge, the next question to ask is how that information can be obtained....

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