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Should you be nudged away from making financial mistakes?

A man looking very confused

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?

Comments
Member

When nudging entered the world of finance, it became a different situation entirely. Subtle undertones used to feather financial institutions nests with down instead of coir, can weaken and undermine trust when things go drastically wrong as we witnessed during the economic crash in 2007/8. Regulators who work alongside such practices, often do so in order to ally apprehension and fear among members of the general public. We saw this happening with the energy companies when they were engaged in and were obviously operating a very lucrative cartel system which was conveniently `nudged` and interpreted into tacit cooperation by the regulator.

I am not opposed to nudging when used in other directions. In fact I unwittingly used it just last week when a neighbour parked her car immediately behind mine, entirely blocking my exit. I popped a little thank you card on her windscreen, adding the words “For not parking behind my car as you are blocking my exit.” She has so far not repeated her unneighbourly deed.

I note the concept of nudging has its routes in Chicago. I remember visiting there a few years ago and left there with not too happy memories as, having travelled extensively throughout the world, it was the only place where, on departing, I was followed out of the hotel by a member of staff who promptly accused me of not settling my bill. Fortunately I was able to produce a receipt to prove my guiltlessness but the expected apology never arrived. Not altogether surprising given that it was home to one of American societies most infamous gangsters whose motto paradoxically was “Be careful who you call your friends. I’d rather have four quarters than a hundred pennies.” I will not be returning to Chicago any time soon.

Member

Apologies routes should read roots and ally allay:-)

Member

When one takes out a financial product, in order to nudge, the nudger needs to know who you are; what your financial circumstances are; what reasoning there is behind the decision and how much sugar you take in your coffee. The nudger also has to be someone or some body who doesn’t have a vested interest in you, your money or the product you are choosing. The nudger also has to be philanthropic, since the friendly warnings and advice are given to help the investor out of kindness. I would have thought that anyone investing or putting money away somewhere, would need to have a clear idea of what he/she was doing, before signing the documents and making the transfer. Prior to doing this, the individual might need to seek advice and do some research. If the product is not understood then the investor should seek advice. Anyone rushing into a risky deal “blind” really deserves all he/she gets. School education is vital to prepare children for the raw financial world they have to negotiate. Legal legislation is also vital to regulate this complex world so that it is less easy to exploit those of us (and I include myself) who find the small print very threatening and clouded in mystery. It ought to be easy for anyone to get clarity on any investment and, perhaps, a nudging service should work that way round rather than tapping people on the shoulder at the time of finalising the transaction. I would have thought that financial advisors would have a thing or two to say if this service was free!

Member

Remember the conversation on “midata”? “midata could allow companies to develop insightful services………”
If midata (your data) was collated then these regulators (and others) would be in a much better position to help you with your decision making.
Perhaps this is taking the scenario too far, but the point well made is that each individual has particular circumstances that can generally best be addressed by understanding them. So, logically, detailed information about them would be necessary to make the best nudge.
Do we want that sort of a future? Some might benefit, but I would still rather have understandable financial products that allow, and encourage, me to make my own decisions.

Member

Quite agree. “Nudge” is the language of fruit machines and we all know how on our side they are.

Member

Thank for many interesting comments.

I have a reading list (linked below) for those who are interested in reading more about this issue including the applications, critiques and wider aspects of the debate – suggestions welcome if people feel I am leaving out anything obvious. As an economist, I find the move from a model where we assumed everyone was rational to a model where institutional context matters a lot more, due partly to the fact that people find financial products confusing, very welcome. It has improved substantially the realism of the debate at least in Economics and provided much more overlap between economics, psychology and law. But it undoubtedly opens up a plethora of complex ethical questions about personal responsibility, autonomy and the role of the state as witnessed by the comments above and the literature.

http://economicspsychologypolicy.blogspot.co.uk/2012/04/behavioural-policy-readings.html

Member

Thanks for your feedback Liam highlighting the broad spectrum and ethical aspect associated with the psychology of economics. There are always going to be more questions than answers in such a complex subject but it is good to be given the opportunity to debate at least some of them.

You will appreciate with the added experience and lessons learned that comes with maturity, much has been gained that is not always found in modern text. Nevertheless it is good to be given an opportunity to debate some of the issues relating, in particular to the subtleties and tactics used at an economic and commercial level, often disguised as advice and how consumers can differentiate between the two without becoming too compartmentalized in the process.

Member
Gordon Lawrence says: