Is it right to shape people’s behaviour to help them make better financial decisions? In this guest post, Professor Liam Delaney explores the pros and cons of ‘Nudge’…
A debate’s raging about the implications of behavioural economics and psychology for the regulation of consumer markets. There’s lots of evidence that people find financial contracts confusing and are influenced by many surface features, such as headline cashback offers, often to the detriment of their long-term finances.
Firms are readily exploiting these biases, and because the markets are so confusing the normal competitive pressures don’t apply. So what can be done to help consumers make better decisions?
Nudged into better decisions
A relatively recent arrival to this long-standing debate has been the extremely influential book Nudge by Thaler and Sunstein.
They argued that a form of regulation should evolve whereby regulators actively attempt to shape people’s behaviour to help them make better decisions but, where possible, not force them to make decisions in these directions. They called this idea Libertarian Paternalism, with the idea being that the state and regulator have a role in guiding decisions (paternalism) but that freedom of choice and consumer sovereignty should ultimately not be trampled on (libertarianism).
Nudge in practice
Nudge was enthusiastically adopted in the UK, including the development of a dedicated Behavioural Insights Team in the UK Cabinet Office. This team is currently conducting dozens of trials across all areas of government, examining how to use insights from behavioural science to improve aspects of policy in non-intrusive ways.
Nudge has also been extensively discussed in the consumer regulation literature. If people find financial contracts complex then perhaps behavioural science can inform what information should be given to consumers, how they should be educated about key financial quantities and so on.
There have been many pilot experiments to see how complex factors influence how consumers react to financial products. The resulting knowledge could then be used by regulators to produce guidelines for how products like credit cards and mortgages should be sold.
In the best scenario this will lead to larger markets with more active consumers and firms innovating to create better products, rather than simply employing various tactics to retain and charge higher fees to confused customers.
Not everyone’s pro-Nudge
As you might imagine from such a harmonious scenario, not everyone sees things in this way. On the one hand there has been wide criticism arguing that Nudge is leading to an overstepping of the role of the State and regulators. They argue that autonomy includes the autonomy to make bad decisions and we potentially undermine people’s freedom and integrity by attempting to preserve them from harm imposed by their own actions.
On the other hand some have argued that Nudge is the wrong response to understanding the power that arises from financial firms being able to exploit consumers in lightly regulated markets. Given the systemic importance of financial markets and the widespread potential for consumer exploitation, many have argued that regulators should intervene with hard policies to a far greater extent.
A recent article by Lauren Willis in the University of Chicago Law Review, for example, documents the extent to which large financial companies are able to quite easily side-step attempts to force them to make consumers more active choosers simply by employing some of the very tactics studied in the literature. Some have argued that confusing features of financial products should be banned, and that much stricter controls should be imposed on aspects of financial advice and selling.
The future of financial regulation
This debate is vitally important to the welfare of British consumers. It will have dramatic effects over the next few years on key questions such as: how should products such as credit cards and mortgages be regulated? What responsibility do companies have to ensure that their customers understand their products and the range of alternatives? How should regulators intervene in cases where consumers are making predictable mistakes with damaging consequences to their finances?
The outcomes of these debates will shape what consumer financial markets look like and how they are regulated in the future.
Do you think regulators should use lessons from behavioural economics to nudge people into making better financial decisions?
This is a guest contribution by Liam Delaney, Professor of Economics at Stirling. All opinions expressed here are Liam’s own, not necessarily those of Which?