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Nobel Prize Winner’s Ideas ‘Nudge’ Public Policy

By John Soroushian, Kenneth Megan

Thursday, October 19, 2017

This year’s Nobel Prize-winning economist Richard Thaler is a titan in the field of behavioral economics. Thaler has provided valuable insights into the limits of human rationality, suggesting that default choices and the presentation of various options can subtly “nudge” individuals towards making decisions that are in their best interest.

What sets his work apart from many theoretical researchers is that the nudge concept can be broadly applied to public policy. Behavioral economics has been especially influential in the field of personal savings and informed the work of BPC’s Commission on Retirement Security and Personal Savings.

Richard Thaler not only challenged the status-quo, but he has contributed to solutions for America’s retirement security challenges in a groundbreaking way.

Traditional economic theory assumes that people quickly gather all available information and make decisions that optimize their welfare. Thaler’s research has shown that human behavior often deviates from this model. For example:

  • People often lack the self-control to stick with their own long-term plans. A new college graduate might want to save to buy a condo, but then spends too much going out with friends.
  • People have a bias towards the status quo and hesitate to change things. An entry-level worker might forego setting up a 401(k) workplace retirement savings account even though their employer offers matching contributions.
  • People often make decisions based on rules of thumb rather than a comprehensive analysis of all available facts. A mid-career worker might choose to save 10 percent of their salary based on a rule of thumb from a friend without analyzing their own specific retirement needs.

To counteract these common shortfalls in human rationality, Thaler helped conceptualize “nudge theory,” which calls on subtle policy interventions to help individuals make decisions that are in their long-term economic interest. For example, automatically enrolling workers into a 401(k) – requiring them to opt out if they do not wish to participate – can increase plan participation by countering peoples’ bias towards the status quo.

Several of the proposals in the BPC commission’s 2016 report leveraged Thaler’s research and insight. Not only did the commission encourage auto-enrollment and auto-escalation – whereby contributions gradually increase each year automatically – for employer-sponsored retirement plans, it also proposed that employers be allowed to auto-enroll their workers into a short-term savings account for emergencies. The theory behind such an account is that it may prevent employees from cashing out their retirement savings when they hit a rough financial patch.  

Other proposals from the commission were designed to protect individuals from making decisions based on rules of thumb. For example, the Social Security retirement ages could be renamed to provide more information about the advantages and drawbacks to claiming benefits later vs. earlier. Social Security recipients who claim at the “early eligibility age” (currently age 62) receive a much lower monthly benefit than those who claim at the “full retirement age” (soon to be age 67). Similarly, those who delay claiming Social Security until age 70 receive a higher benefit relative to those who claim at full retirement age. A new name for the “early eligibility age” could be the “reduced benefit age,” and what is currently age 70 could be the “maximum benefit age.” These simple adjustments would help prospective claimants make a better-informed judgment on when to claim.

Similarly, the commission recommended redesigning the Social Security benefit statement, which is periodically mailed to workers and displays their benefit projections based on various ages of claiming. The statement should ideally emphasize the higher monthly benefits that come from both continuing to work and waiting to claim benefits. Creatively highlighting these attractive gains could leverage behavioral insights and better communicate the advantages of claiming later.

These practical applications show that Thaler’s research has implications far outside the realm of academia. His work has both recognized the limits of human rationality and helped to identify policy interventions that nudge individuals into making better-informed choices. Thaler not only challenged the status-quo, but he has contributed to solutions for America’s retirement security challenges in a groundbreaking way.

KEYWORDS: COMMISSION ON RETIREMENT SECURITY AND PERSONAL SAVINGS, NOBEL PRIZE, RICHARD THALER