MINISTRY OF ECONOMIC DEVELOPMENT
Behavioural analysis for policy
New lessons from economics, philosophy,
psychology, cognitive science, and sociology
OCTOBER 2006
i
Acknowledgements
The contributions of Geoffrey Leveritt,
Alison Cossar, Mark Jones and
Louise Hull in preparing this paper are
gratefully acknowledged.
Thanks also to the many people who
offered comments, suggestions and
encouragement.
Policy Development Toolkit
This paper is available on the Policy
Development Toolkit (PDToolkit).
https://psi.govt.nz/pdtoolkit/default.
aspx
ISBN 978-0-478-30400-8 (paperback)
ISBN 978-0-478-30451-0 (PDF)
ISBN 978-0-478-30452-0 (HTML)
Ministry of Economic Development
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MINISTRY OF ECONOMIC DEVELOPMENT BEHAVIOURAL ANALYSIS FOR POLICY
Executive Summary
Assumptions about behaviour are an important part of the policy process. A policy analyst’s
assumptions can colour the way problems are defined, objectives set and options designed and
implemented. It is important to ensure that the assumptions relied on reflect the way people
actually behave.
The neoclassical economic theory approach to policy tends to assume that people will behave
by making rational decisions, acting in self-interest and making decisions with complete
information.
Other disciplines, including behavioural economics, psychology and sociology, can help provide
a broader understanding of the range of factors that influence people’s behaviour.
Understanding our assumptions about the way people behave is important in designing effective
policy. It is also important to get assumptions about behaviour right, or to at least consider the
range of behavioural responses, so as to minimise potential unintended consequences.
Policy analysts should ask two fundamental questions:
• Does this policy involve an issue driven by people’s behaviour or decision-making – does
the intervention adequately tackle the reasons for behaviour or adequately guide people to
preferred behaviour?
• Would people respond to this policy with behaviour which would be undesirable or defeat
the purpose of the intervention – what assumptions does the policy make about the intrinsic
motivations of any affected parties? Does this policy assume that affected parties have a
particular way of understanding the world?
Behaviour and decision-making
• There are two different approaches to understanding the processes of decision-making, which
are called normative, and descriptive. They are not incompatible, but they have different
goals and different methods. The difference between the two approaches means the policy
analyst needs to decide which approach is appropriate for the study or analysis of issues when
defining a policy.
• Most decisions in the world are made under uncertainty (including policy decisions). Making
decisions under uncertainty means they are not made with perfect information, and so things
irrelevant to decision-making in traditional economics (because they are not needed once
you assume perfect information and perfect rationality) become important: beliefs, the actual
information people possess, culture, peers, learning, and the many other things studied within
behavioural economics, psychology and other relevant fields.
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• Beliefs play a role in behaviour but should play a limited role in policy analysis. There are real
issues with trying to use beliefs as an explanation for, a cause of, or a predictive tool for, the
behaviour of other people – the public in general, or possible targets of the policy. The issue
lies in predicting what someone else’s behaviour will be, given their beliefs; and deciphering
what someone else’s beliefs are, given their behaviour.
• In explanations of other people’s behaviour, we tend to overlook relevant details of the
situation the person was in and the way the person was interpreting the situation. The policy
analyst should ask if they can scaffold (guide or direct) people’s choice to that preferred by
policy by adjusting any environmental or institutional structures.
• A policy analyst needs to take care when assessing a decision. That a decision has a bad
outcome does not entail it was a bad decision or irrational; and a decision may seem irrational
but in fact it’s a good idea given the person’s actual goals or current environment. That some
people make mistakes, and that some decisions will be wrong, must be accepted.
Motivations and aspirations
• Choice is a satisficing activity – policy interventions should not be based on the assumption
that people will engage in a detailed or exhaustive search for optimisation; rather, people aim
for threshold standards beyond which they don’t keep searching.
• People are generally motivated by fairness, status, social norms and personal identity – policy
should incorporate these factors, rather than focus solely on cost-benefit analysis or financial
incentives, in order to achieve desired behavioural changes.
• Changing social norms are difficult but using people with certain influences can help – don’t
underestimate peer pressure.
• People make better choices when they feel in control – policies should encourage greater
personal involvement, rather than focusing solely on the provision of (often complex)
information.
The way people understand the world
• Emotions play a large part in people’s perceptions of the likelihood of positive or negative
events, especially if the events are linked to particularly frightening, happy or exciting
outcomes or to things that a person has previously experienced.
• People are generally loss averse – loss of a given amount of money or resource will have
greater value than gaining the same thing. People will take fewer risks that might result in
losses than they would in order to achieve gains. This has important policy implications, for
example when assets are redistributed from one group to another.
• Unconscious and ingrained habits can cause people to think that established ways of doing
things are the most efficient, even where this is not the case. These perceptions can be
challenged by bringing habits into people’s conscious attention and through designing policy
so that individuals can see greater incentives to adopt more efficient practices, instead of
continuing with less efficient habits.
• How information is presented or framed can influence the way people use that information to
make choices.
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Contents
Executive summary
iii
Behaviour and decision-making ......................................................................................................... iii
Motivations and aspirations ................................................................................................................iv
The way people understand the world ................................................................................................iv
Introduction
1
Part 1: Behaviour and the policy development process
3
The policy development process ......................................................................................................... 3
The neoclassical economic model ....................................................................................................... 4
Alternative approaches to understanding behaviour .......................................................................... 5
Part 2: Behaviour and decision-making
7
Understanding decision-making ......................................................................................................... 7
Beliefs, behaviour, and their use in policy analysis ............................................................................10
Situations and structured decisions. ..................................................................................................12
Assessing decisions ...........................................................................................................................14
Key points ..........�
15
Part 3: Motivations and aspirations
17
Preferences ........�
17
Optimisation ......�
17
Fairness .............�
18
Peer pressure and social norms .........................................................................................................18
Identity .............�
20
Status ...............�
20
Personal involvement ........................................................................................................................ 20
Key points ..........�
21
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Contents/continued
Part 4: The way people understand the world
23
Perceptions and probabilities ........................................................................................................... 23
Framing effects .�
24
Habits ...............�
25
Loss aversion ....�
26
Key points .........�
27
Further reading
28
Policy development generally ........................................................................................................... 28
Decision-making and behaviour ........................................................................................................ 28
Behavioural economics and other behavioural theories ................................................................... 29
Case studies
Case Study 1: Regulatory capture ....................................................................................................... 4
Case Study 2: Consumer response to marketing information ............................................................. 9
Case Study 3: Information disclosure for managed funds ..................................................................10
Case Study 4: A fine is a price ............................................................................................................13
Case Study 5: Unintended impacts of performance bonuses for nurses ............................................19
Case Study 6: Workplace safety levy discount for small businesses in six high risk industries ......... 24
Case Study 7: Rate of organ donation............................................................................................... 25
Case Study 8: Encouraging saving .................................................................................................... 26
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Introduction
1.
Many aspects (but by no means all) of current public policy analysis and design have
their roots in neoclassical economic theory. This means that many policies are based on
assumptions about rational decisions, self-interest and complete information. This paper
adds to the standard neoclassical understanding by leading the policy analyst into a careful
scrutiny of the assumptions which underlie public policy choices.
2.
Part 1 of the paper looks at the policy development process and behavioural responses
to policy initiatives. This part also describes the assumptions underpinning the standard
neoclassical economic model. Part 2 of the paper describes some of the current theory
of decision-making from cognitive science, adaptive behaviour research, behavioural
economics and philosophy. Parts 3 and 4 then place this decision-making theory within
the context of people’s motivations, aspirations and understanding of the world. These
sections will help policy analysts challenge their assumptions so as to develop effective
policy interventions.
3.
This paper is intended as an introductory guide to encourage policy analysts into a deeper
understanding of people’s behaviour, the factors that influence behaviour, and how to
incorporate this into the policy development process. It doesn’t provide all the answers, nor
is it a step-by-step guide to lead you through behavioural analysis. Hopefully this paper
will whet your appetite for the subject and enable you to make better policy decisions.
References to further reading are provided at the back for those readers who wish to take
their knowledge further.
1
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PART 1:
Behaviour and the policy development process
New Zealand’s economy and society are becoming more complex over time, and as a result policy
makers need to keep up to date and ensure that government policies reflect the dynamics of the
modern New Zealand economy and society.
Government policy interventions are fundamentally about inducing a desired response from a target
population. It is therefore important to understand our assumptions about how people behave to
ensure that policies can work most effectively. It is also important to get assumptions about behaviour
right so as to minimise potential unintended consequences.
The policy development process
4.
The Policy Development Toolkit sets out the steps in the policy development process,
including defining the problem, setting objectives, designing options, getting decisions,
implementation, monitoring and evaluation. The assumptions which the policy analyst
brings to each of these steps can have a large role in the ability of the policy to achieve its
intended effects.
5.
Problem definition, setting objectives and designing options are particularly amenable to a
behavioural analysis. Whereas the traditional economic approach would see any deviation
from rational behaviour as a problem, a behavioural approach accepts that people are
influenced by factors such as peers, culture and social networks. Policies which are based
on the assumption that it is necessary to correct these “problems” may therefore be out of
step with general public views.
6.
The types of policy instrument available to the analyst include: new (or amending existing)
legislation, increasing enforcement, information and education campaigns, economic
instruments (taxes, subsidies and tradable property rights), voluntary standards/codes of
practice, and self-regulation/co-regulation. The different types of policy instruments are
intended to achieve different behavioural responses and so must be designed based on the
analyst’s assumptions about behaviour. The choice of policy instrument adopted requires
consideration of the context in which it will be implemented to ensure that it achieves the
right behavioural response.
7.
A behavioural approach is also vital at the implementation stage. For example, the way a
policy is presented or framed can have a large influence on the way the policy is interpreted
and responded to by the people targeted by the policy.
8.
It should also be noted that the success of a policy intervention depends not just on the
response by the target population – whether businesses or consumers – but also on the
behaviour of regulators. This is particularly important in deciding how to implement a
policy to achieve best effect.
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case study 1: Regulatory capture
It is important to consider behaviours and incentives of people responsible for implementing a given
policy/regulation in addition to those who are regulated.
In the UK, large publicly owned companies were privatised during the 1980s including the monopoly
telecommunications provider (British Telecom), the monopoly gas supplier and provider (British Gas)
and the monopoly electricity provider (The National Grid). These privatisations were complemented
by prescriptive regulation of maximum prices and quality standards that were enforced by regulatory
bodies that the UK government set up. Most of these privatisations, combined with subsequent
opening of the markets to some competition from other players, have been considered successes
and are widely recognised to have reduced prices and improved services.
However, many critics of this privatisation have pointed out that rates of return on capital (a measure
of profit) of these privatised companies have often noticeably exceeded rates of return on capital
in other industries that are subject to more market competition. Excess profits have been seen as
detrimental for society as a whole since this usually means that companies are keeping prices higher
than the minimum level needed to be in business. Some critics of this privatisation process argue
that the agencies set up by the government to regulate the industries have sometimes been captured
by interest groups (regulatory capture). For example, the regulatory agencies may at times have not
placed sufficient pressure on regulated companies to reduce prices, due to the regulatory bodies
themselves being over-influenced by political considerations and also by groups of shareholders who
hold company assets and who seek to obtain a large return (value of shares increase when company
profits increase). However, evidence that regulatory capture has ever occurred in the UK is limited,
although regulatory capture is always a risk where companies with limited market competition are
regulated. The important role of implementation is to consider the likely behaviour of regulators who
will implement the policy, as well as the likely response from targets of the policy.
Source: Alain Anderton, Economics, third edition, Causeway Press, 2000
The neoclassical economic model
9.
Many aspects (but by no means all) of current public policy analysis and design have
their roots in neoclassical economic theory. This theory also underpins much of the
content of university economics degrees. Although neoclassical economic theory and its
assumptions have progressed significantly since it was first developed in the 19th century,
at its core are a number of simplifying assumptions (that are still sometimes used in policy
analysis) about how those impacted by a policy would behave. These big assumptions or
simplifications have often been made because of knowledge gaps of actual behaviour or
reactions to policy in a complex world, particularly when trying to predict the behaviour
of a large number of firms. Behavioural theory (or behavioural economics) is intended to
complement neoclassical economics by filling in some of these gaps and challenging some
of these assumptions.
10.
The traditional (core) neoclassical assumptions include:
• All individuals have complete information about goods, services or states of the world.
This implies that people will always be able to make the decisions which most satisfy
them.
• All individuals act completely rationally and logically in a consistent manner. For
example, people will not be unduly influenced by advertising or do things on impulse.
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• All individuals act in complete self-interest to maximise their own welfare and their
decisions are not influenced by the welfare of others.
• People (who include workers), goods, capital and money are totally mobile in that they
can quickly move to where they’re needed. For example, if a person was unemployed
in Auckland (and couldn’t get a job locally) and suddenly lots of new jobs became
available in Christchurch, the person would automatically relocate to Christchurch to get
a job, regardless of family or social ties in Auckland.
• Quantifiable variables, such as money, are often given greater weight in neoclassical
economics in terms of motivating behaviour than other less easily quantifiable aspects
that may do more to influence quality of life, such as the satisfaction derived from doing
a good job, clean air or green countryside.
11.
Traditional economics models behaviour as occurring as a result of perfectly rational
choices made with perfect information. Government intervention is therefore only needed
when markets fail, which would be rare, given that people would have the ability to make
excellent, profitable choices ensuring all possible opportunities would be fully realised.
12.
Neoclassical economics and how it is modelled to formulate policy and understand
behaviour has progressed significantly and variations of the neoclassical model used for
some policies often relax some of the above assumptions and incorporate sophisticated
real world data. Alternative aspects for policy design explored in this paper are designed to
complement the wealth of currently applied theoretical models.
Alternative approaches to understanding behaviour
13.
Alternative theories, from diverse disciplines such as behavioural economics, psychology,
cognitive science, philosophy and sociology, provide alternative approaches to understanding
behaviour. For example, behavioural economics asserts that people systematically misjudge
the costs and benefits of their actions, as a result of cognitive ability, emotional responses
or moral judgements in individual decision-making. Policies which blindly assume
rational behaviour may not be effective. Interpersonal behavioural theories emphasise the
importance of other people on an individual’s behaviour which could support government
intervention towards correcting “bad” influences.
14.
This paper discusses alternative theories of behaviour, contrasting them with the traditional
economic approach. These disciplines allow us to take alternative perspectives which
complement traditional neoclassical economics. In particular, behavioural theories can
provide insights into people’s motivations, inter-personal relationships, understandings
and choices that allow a richer analysis of human behaviour than one constrained by the
assumptions of neoclassical economics.
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PART 2:
Behaviour and decision-making
This chapter introduces some of the current theory of decision-making from cognitive science, adaptive
behaviour research, behavioural economics and philosophy. It begins with things a policy analyst needs
to understand about decision-making, before it turns to questions about the assumptions underlying a
policy which involves decision-making by the public.
Understanding decision-making
15.
Nearly all behaviour involves choice, and the processes by which choices are made range
from the semi-automatic (such as for the operant responses of animals to a signal), to the
thoughtful reasoning among options, characteristic of people. The process of thoughtful
reasoning in order to make a choice we call decision-making, and the study of decisionmaking is the study of the process of choosing a preferred option, or course of action, from
among a set of options.
16.
There are two different approaches to understanding the processes of decision-making,
which are called normative, and descriptive. They are not incompatible, but they have
different goals and different methods.
17.
The normative approach is not a study of how people actually make decisions, and why
they make the decisions they do, it is a technique for modelling the aggregate outcomes
of the decisions of interest, enabling the study of the consequences of the outcomes. For
modelling purposes all people are assumed to make the same sorts of decisions in the
same sorts of situations, and the types of decisions they make are assumed to be perfectly
rational. This is the approach of traditional economics. Traditional economics assumes
people are perfectly rational decision makers who always follow certain rules of behaviour
and preference, and have complete information.
18.
The descriptive approach seeks to understand how people make decisions. It is based on
empirical observation and experimental studies of decision-making. It investigates the
psychological factors that guide behaviour in decision-making situations and attempts
to understand how humans make decisions, and especially how they make good, useful
decisions. This is the approach of cognitive science, psychology, and some work within
behavioural economics.
19.
The difference between the two approaches means the policy analyst needs to decide which
approach is appropriate for the study or analysis of issues when defining a policy. To
inform the choice for analysts, this section of the paper will focus on the findings from the
descriptive approach to decision-making.
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20.
First, the descriptive approach does not assume individuals have complete information. It
breaks types of information people have at their disposal into three, and this leads to it
discussing three different types of decisions: decisions which are certain, decisions under
risk, and decisions under uncertainty.
• When people know all the options and know the outcome for each, that is, they know
they will get what they choose, such as when choosing from among dishes on a menu,
or groceries from a shop, their decision is certain.
• When the options for choice are known, but people can only know the chances (the
probability) for each outcome, such as betting on a horse at a race, or making a bet at
poker, people make decisions under risk.
• When all the options to choose among aren’t known, and the probability of each possible
outcome isn’t known, people are making decisions under uncertainty.
21.
Most decisions in the world are made under uncertainty (including policy decisions). This
is because, for one, it’s not possible for a person to gather, and to think through, all the
information they would need to turn most decisions people face into certain decisions. For
example, deciding for certain what export market a firm ought to move into, entails that
the firm knows a great many things about a market, its own abilities, and capacity, and
what will happen to the market and the world economy over time. One person could never
gather every piece of information on all this, work out how it all fits together and so know
exactly (not probably) what the impact will be on their business.
22.
The most important thing that follows from understanding that people make decisions
under uncertainty (and so not with perfect information) is that things irrelevant to decisionmaking in traditional economics (because they are not needed once you assume perfect
information and perfect rationality) become important: beliefs, the actual information
people possess, culture, peers, family, learning, and the many other things studied within
behavioural economics, psychology and other relevant fields.
23.
If all people had perfect information, and perfect rationality, it is the information and the
rules of rational decision-making which would form decisions. That being the same for
all people, all people faced with the same choice would make the same decisions. If we
discard the assumption of perfect information and perfect rationality, we see there will be
variations across people in what information they have, what beliefs they have, because
there are variations in what people have learnt and what they have experienced, what
they think and believe; faced with the same choice there will be variations in the decisions
people will make.
24.
Given that people do not gather or use every piece of information that bears on a decision
and its outcomes, what information do people use for deciding on a course of action?
People gather facts and beliefs about the world as they experience it. People also learn from
other people about the world and how they should behave in it, either from their peers or
from previous generations.
25.
Questions to ask or to study when considering the information people use when making
decisions (especially where they are making difficult decisions, such as whether to launch a
product offshore, or whether to trust a financial provider, or whether to take on large debt
now, or wait and save for a few more years) are:
a) What is the likelihood a person could intuitively know the best choice to make to reach
their goals? That is, faced with a new choice or situation could they easily think about
it and reason it through themselves so they make the choice that means they reach their
goals? The term ‘goals’ is used broadly to include any action, undertaken with a purpose,
from buying a coffee or crossing a street through to solving a mathematical problem, or
choosing a mortgage, or successfully taking a company offshore.
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b) Is the situation complicated enough a person couldn’t figure it out beforehand, but
would need to have a few tries, and so learn from experience what their best choice in
a situation is?
c) If so, is the situation so complicated that simply giving it a try is likely to mean a
number of people will not reach their goals with their first choice and will suffer as a
result? Is government intervention needed to guide people to the right choice?
d) How could people get the information needed to make their best choice – is the
information required quite commonly known to people in their circles so a person might
learn it from them? What information is commonly available in the media, for example,
or on the web, that might be directing decisions in a certain way?
26.
The ways in which people obtain and process information are discussed further in Parts 3
and 4 below.
case study 2: Consumer response to marketing information
A bank in South Africa wanted to make more loans. Instead of just lowering its interest rate, it
wanted to investigate some contextual factors. It sent out 60,000 letters to existing clients saying
“Congratulations! You’re eligible for a special interest rate on a new loan.” Like a drug trial, the
interest rate was randomised – some were offered low rates, others high rates. In line with traditional
economics, the people who received the high interest rate were less likely to take up the offer.
But the bank also randomised other aspects of the letter. For some letters, a photo of a bank employee,
varied by gender and race, was placed in one corner. In other letters there were a variety of tables,
some complex and others simple illustrating the structure of the loan. Some had deadlines. Some
had the chance to win prizes.
The results were stunning. Even though the repayments represented nearly 10% of a persons annual
income, people appeared to be influenced by factors other than the actual interest rate. The letter
with just one example of a loan size and term with its monthly repayments was more successful than
the letter with four examples. A photo of a female employee increased demand for a loan among male
clients as much as by dropping the interest rate five points. Any of the other initiatives had an effect
equal to one to five percentage points of interest.
The impact of some of the small, non-financial cues raises questions about what really drives
decisions, particularly the effect on big decisions. It can indicate that people respond to the feeling
of social inclusion, cultural norms and status rather than financial facts and has implications for the
provision of information to consumers.
Source:
Marianne Bertrand, Dean Karlan, Sendhil Mullainathan, Eldar Shafir and Jonathan Zinman, What’s Psychology Worth?
A Field Experiment in the Consumer Credit Market, Working Papers from Economic Growth Center, Yale University (2005)
http://econpapers.repec.org/paper/egcwpaper/918.htm
27.
In order to make a good decision it is not always necessary to have as much information as
one can get and understand. Sometimes applying a rule of thumb to make a decision, even
on very limited information, means one can still make the right decision. Rules of thumb
are called heuristics. They are not infallible, of course, but a good heuristic should work
well most of the time.
28.
For example, the recognition heuristic is a heuristic whereby if people have heard of
something, they think it must be for a reason, and so ‘having heard of something’ is a
simple rule for making a decision. For example, where one is asked ‘which city is bigger,
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New York, or Iasi, Romania? Most people think ‘I have never heard of Iasi, so it cannot
be very important, and therefore big, so I will choose New York.’ They have applied the
recognition heuristic to very limited information and based on one reason – having heard
of it – they have made the right decision: New York is bigger than Iasi (Iasi has around
800,000 people).
29.
So the policy analyst should be careful about assuming people who are not ‘fully informed’
with a great deal of information are not making good decisions. They may be using limited
cues and applying good decision rules to them. Equally, developing an understanding of
which decision rule works and teaching the use of it may help people as much as giving
them lots of information. Both of these cases would be something careful study would
discover.
case study 3: Information disclosure for managed funds
Traditional economic approaches have required information provision as a means of overcoming
asymmetry and correcting market failures. However, the implementation of such policies can
sometimes be problematic, particularly in cases of complex or specialised information.
For example, research has shown that 43% of New Zealanders believe that managed funds are so
complicated that they are suitable only for the expert investor. This is despite the requirement under
the Securities Act that an issuer of a managed fund must give prospective investors an investment
statement. The investment statement answers a series of questions, such as: What sort of investment
is this? How much do I pay? What returns will I get? What are my risks? Can the investment be altered?
How do I cash in my investment?
A 1999 Securities Commission study found that, where a prospective investor used an investment
statement to help make an investment decision, the investment statements were generally
understandable and useful. However, specific comments from respondents also focused on problems
of length and complexity of the investment statement.
Notwithstanding the general understandability and usefulness of investment statements, the
prevailing view of complexity of managed funds can act as a barrier to people accessing the
information in the first place.
Source: Michael Wydeveld, Investors’ Opinions of Managed Funds Investment Statements, Securities Commission, July 1999,
www.sec-com.govt.nz
Beliefs, behaviour, and their use in policy analysis
10
30.
Beliefs play a role in behaviour, of course – no one would deny this – but what role should
they play in policy analysis? Policy analysis is focused on solving problems, and so looks
to explanations of, or predictions of, behaviour, as a way to help it understand and solve
issues.
31.
The role of beliefs in policy analysis turns on whether we need to rely on beliefs as the
cause and explanation of behaviour, or whether we can side-step beliefs for another cause,
and another explanation, such as the situation the individual was in, or their previous
behaviour.
32.
Why might we want to side-step beliefs? If they are involved in behaviour, as they are, why
aren’t they a neat package of explanation and prediction for the policy analyst worrying
about the reasons for a particular behaviour?
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MINISTRY OF ECONOMIC DEVELOPMENT BEHAVIOURAL ANALYSIS FOR POLICY
33.
The problem is that there are real issues with trying to use beliefs as an explanation for, a
cause of, or a predictive tool for, the behaviour of other people – the public in general, or
possible targets of the policy. The issue lies in predicting what someone else’s behaviour
will be, given their beliefs; and deciphering what someone else’s beliefs are, given their
behaviour.
34.
Contrary to the usual, ordinary, understanding of beliefs and behaviour, it turns out that
using beliefs in this way is rather unreliable. This section explains this further. The next
section explains how to do the side-step – looking to the origins of the behaviour not
via the beliefs themselves but to whatever might have caused the beliefs, causes such as
environment and situations in which people operate.
35.
Usual, ordinary, understandings of the world are called folk theories. They are often bundles
of beliefs that turn out not to be true, because they are based on observing the world and
these perceptions were misleading. The most famous example, perhaps, is from folk physics
– and is the belief that the sun rises and sets. It looks like it rises and sets, so, reasonably,
people believed it did. The belief was useful, because days turn to night and knowing this
and the signal for it – the sun rising and setting – is useful for operating in the world, but
it was not true. Beliefs do not need to be true to be useful.
36.
The theory that we can explain or predict a person’s behaviour from their beliefs (or
attitudes) is folk psychology. Folk psychology takes the following as true: if a person desires
goal g and believes action a is the best way of attaining g, then all things being equal, the
person will do action a.
37.
In other words, folk psychology holds that there is a clear relationship between beliefs
and desires (called expectations and preferences in economics) and behaviour, where one
reliably follows the other. It is the notion of the type of relationship between belief and
behaviour which forms folk psychology, not the notion that beliefs matter for behaviour
(this paper is not advocating the doctrine of behaviourism). Folk psychology holds that if
you specify the belief, then you can know what the behaviour will be, and vice versa. This
is an important assumption in traditional microeconomics. However, it is not true, for two
reasons.
38.
The first reason is the move back from behaviour to belief (or to attitudes, or values, or
character). Beliefs are not empirically observable, we cannot read minds, we cannot see
a belief; we only see their effects – behaviour. We only see what someone says, or does.
When we say: ‘given Mary did behaviour w, she believed x’, we must infer the existence of
x from w. We have no other way of knowing what the belief was. How then do we know
that it was belief x, and not belief y or z? If y or z could explain the behaviour, how can
we tell which it really was? How do we choose which is the correct explanation for Mary’s
behaviour? The answer is we can’t. We can only speculate which belief best fits behaviour,
but we do not know for sure, as we can not independently establish their influence or
content (there is no test to perform other than watching the result).
39.
The second problem comes from saying: ‘Mary’s belief x and goal g will result in behaviour
w.’ This entails that there is some regularity between them, or a causal connection, which
ensures the belief will result in the behaviour. Yet there is no rule or law or constant
relationship connecting beliefs and behaviour, so that having a belief makes someone do
certain behaviour, or that entails a certain belief guarantees having a certain behaviour. For
example, I can believe it is lunchtime, believe I am very hungry, believe I have money and
that there is a café next door with food I like, and believe I have time, and yet not go to
lunch. My beliefs do not make me go to lunch, and having the beliefs does not necessarily
mean I will go to lunch. Hence, knowing my beliefs about lunch would not have helped
you predict my lunchtime behaviour, and knowing Mary’s beliefs would not let us predict
her behaviour – we can guess, but not predict.
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40.
So note the distinction that is being made here. While your beliefs matter for your behaviour,
what I can say about your behaviour given your beliefs is unclear. Equally, what I say
about your beliefs given your behaviour, is unclear. Thus what a policy analyst can say
about the actual causes of behaviour of groups of people is unclear. Yes, the behaviour was
caused by belief – but which one? What was it? How can we tell whether that belief would
result in the behaviour again?
41.
If a policy analyst speculates or guesses what a belief must have been, chances are they will
get it wrong, and targeting that belief will not deal with the problem in future – the future
performance of the behaviour in question. This is where the side-step becomes important.
Can we look to the origins of the beliefs – to any outside causes such as environment and
situations? It turns out, environment and situation are better tools for explanations and
predictors of behaviour than beliefs.
Situations and structured decisions.
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42.
In explanations of other people’s behaviour, we tend to overlook relevant details of the
situation the person was in and the way the person was interpreting the situation. In fact,
making the assumption that a person must have acted as they did because they hold the
value so-and-so or have the character such-and-such, and not because of the situation
they were in, is called the fundamental attribution error – the error of attributing behaviour
to a person’s values or character, and not to a person’s situation or circumstances.
43.
The ‘situation’ includes events, and other social factors such as rules, peer behaviour, time
limits, social roles (behaviour ‘expected’ of a person because of their role – as parent,
manager or teacher, for example). ‘Person factors’ include personality traits, character
traits, perceptions, emotions, moods, beliefs.
44.
The distinction between the person and the situation is not between thinking or reasoning or
other such internal cognitive abilities which all people have, and the situation; but between
individual ‘difference factors’ such as traits or attitudes, character and so forth, which can
be distinctive to a person. Thus the distinction, in explaining behaviour, is between using
person factors distinctive to a person to give an account of their past behaviour and make
predictions about their future behaviour; and using the situation the person was in or had
experienced to give an account of their past behaviour and make predictions about their
future behaviour. Using person factors, the explanations or predictions do not vary with
the situation a person is in, but with their ‘character’.
45.
The distinction between the person and the situation remains a controversy in personality
research and social psychology. However, what has been found in lab and field experiments
is that manipulations of the immediate social situation overwhelms in importance individual
differences in character or dispositions. It has been found that in novel situations, personality
traits, values or beliefs will not predict with any real accuracy how someone will respond.
46.
The classic study in this area involved students of the Princeton Theological Seminary
(so presumably all possessors of high virtue, or at least, of certain virtues). The study is
famous for making a case for considering the situation as more important than character,
personality, virtues or attitudes.
47.
The students were asked to prepare a brief talk on the parable of the Good Samaritan,
which they were to give in a nearby building. One by one, the experimenter gave the
students directions to the building, and then told the students either that they were early, or
late, for the talk. On the way to the building, one by one, all students passed a man slumped
in a doorway, coughing and groaning (a confederate of the experiment). The study’s main
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question was whether the students would spontaneously stop to help the man. The results
reflected the manipulated situation factor: whether the students thought they were early or
late for the talk (and not the students’ presumed character). 63% of those who thought they
were early stopped to help, and only 10% of those who thought they were late stopped. In
other words, while one might think the beliefs and character of all the students were very
similar, the situation varied their response: 90% passed the man by when they thought they
were late, nearly 40% passed him by when they thought they were early.
48.
So a very important approach for the policy analyst is to determine what situation or
circumstances would and does drive the behaviour of interest, and how and whether the
situation could be altered. The analyst can investigate the frequency of the behaviour,
the situation in which it occurred, or which people experienced before it occurred, and
investigate how altering environment can alter the behaviour.
49.
For example, one way to adjust peoples’ situation in order to encourage certain purchasing
choices, such as of New Zealand produce, can be done by arranging the aisles in supermarkets
to force people to walk past New Zealand goods first.
50.
Changing the situation or environment in this way in order to change behaviour is called
scaffolding the behaviour, or choice. It is a stronger concept than that of offering a carrot,
it is altering the situation or environment in order to try and force a certain choice. Thus
the policy analyst should ask if they can scaffold (guide or direct) people’s choice to that
preferred by policy by adjusting any environmental or institutional structures.
case study 4: A fine is a price
A study of parents’ reaction to the introduction of a fine for the late collection of children from a day
care centre demonstrates the actual impact of a rule which was designed to change behaviour. The
study observed 10 day-care centres over a period of 20 weeks. In 6 of the 10 day-care centres a fine
was imposed on parents who arrived more than 10 minutes late. The remaining 4 day-care centres
served as a control group and no fine was introduced.
Surprisingly they found that after the introduction of the fine there was a steady increase in the number
of parents coming late which ended being almost twice that in the non-fine situation. Moreover, after
the removal of the fine the number of parents coming late remained at the same high level.
This was a counter-intuitive result from the traditional economic viewpoint, which holds that the
introduction of a monetary penalty should have changed the balance of the costs and benefits
associated with being late, therefore leading to a reduction in that behaviour.
The authors of the study speculated that the fine changed the rules governing the behaviour in the
situation, and conveyed the message that being late had a price, and that the teachers’ activity of
guarding the children after-hours is a simple market activity which could now be bought. Any personal
beliefs or notions of appropriate behaviour which one might say come from ‘character’ were overridden by the new rule for the day care centre.
Source: Gneezy and Rustichini, “A Fine is a Price” Journal of Legal Studies Vol 24, January 2000
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Assessing decisions
51.
Decisions in traditional economics are assessed by whether they are rational, where
‘rationality’ is relative to rules of logic and probability, and it is assumed that the agent
has perfect information. The ‘best’ action is the one which maximises utility, typically in
terms of financial gain. Given the issues facing decision-making under uncertainty, a more
realistic definition is practical rationality, which is rationality relative to a person’s goals
and beliefs; so it is defined as acting consistently with one’s goals and one’s beliefs about
the world. So utility is personal or subjective. One person’s utility may not be another’s,
and what forms utility should not be assumed but studied.
52.
Another way a decision may be rational is if it matches the environment, by being a good
strategy given the environment. This sort of rationality requires that the decisions be
successful given the environment, even if it is inconsistent with a person’s own goals or
desires. As the environment changes, what is rational will change.
53.
It is also important to note that making decisions under uncertainty entails there will
always be a certain amount of error in decisions – in large groups there will always be
some people who will make mistakes, and for those who must make similar decisions
over and over, some decisions will always be mistaken. The question is what percentage
of error is acceptable, not how to ensure there are no mistakes. In decision-making under
uncertainty there will always be a failure rate.
54.
Thus a policy analyst needs to take care when assessing a decision. That a decision has
a bad outcome does not entail it was a bad decision or irrational; and a decision may
seem irrational but in fact it’s a good idea given the person’s actual goals or current
environment. That some people make mistakes, and that some decisions will be wrong,
must be accepted.
55.
Thus questions to ask when designing policy around a situation involving people making
decisions are:
a) Is the decision consistent with the person’s expected utility, and is that consistent with
the desired outcomes of the policy? If the answer is yes it may be that policy should not
intervene, unless for example the expected utility is to cause harm to others.
b) Is the decision a good decision, or strategy, given the current environment? If yes, then
one cannot tackle the decision without first changing the environment.
c) What error rate can be expected (and tolerated) given the situation or decision? This
informs decisions on screening tools, information load, and the success rate that can be
reasonably expected of policy (or agencies delivering policy).
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Key points
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There are two different approaches to understanding the processes of decision-making,
which are called normative and descriptive. They are not incompatible, but they have
different goals and different methods. The difference between the two approaches means
the policy analyst needs to decide which approach is appropriate for the study or analysis
of issues when designing a policy.
Most decisions in the world are made under uncertainty (including policy decisions).
Making decisions under uncertainty means they are not made with perfect information,
and so things irrelevant to decision-making in traditional economics (because they are not
needed once you assume perfect information and perfect rationality) become important:
beliefs, the actual information people possess, culture, peers, learning, and the many other
things studied within behavioural economics, psychology and other relevant fields.
Beliefs play a role in behaviour but should play a limited role in policy analysis. There are
real issues with trying to use beliefs as an explanation for, a cause of, or a predictive tool
for, the behaviour of other people – the public in general, or possible targets of the policy.
The issue lies in predicting what someone else’s behaviour will be, given their beliefs; and
deciphering what someone else’s beliefs are, given their behaviour.
In explanations of other people’s behaviour, we tend to overlook relevant details of the
situation the person was in and the way the person was interpreting the situation. The
policy analyst should ask if they can scaffold (guide or direct) people’s choice to that
preferred by policy by adjusting any environmental or institutional structures.
A policy analyst needs to take care when assessing a decision. That a decision has a
bad outcome does not entail it was a bad decision or irrational; and a decision may
seem irrational but in fact it is a good idea given the person’s actual goals or current
environment. That some people make mistakes, and that some decisions will be wrong,
must be accepted.
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PART 3:
Motivations and aspirations
The previous section has used cognitive science, adaptive behaviour research, behavioural economics
and philosophy to introduce the types of decisions people make and the role of beliefs and situations
in behaviour and decision-making.
This section examines economic assumptions about motivations and aspirations – what people want
to achieve out of life – and how this impacts on behaviour, decision-making and the effectiveness of
policy interventions. It brings together the main insights from current behavioural economic thinking
on how people form preferences and the motivations and aspirations that underlie those preferences.
Preferences
56.
The role of preferences in shaping behaviour is a key difference between behavioural
economics and mainstream neoclassical economics. Neoclassical economics starts from an
assumption that people seek to maximise their individual utility. It does not seek to analyse
preferences, as these are assumed to be revealed by a person’s actions, and that the person’s
actions are inevitably directed towards the goal of maximising the person’s welfare.
57.
In contrast, behavioural economics looks at the preferences underlying behaviour, in
particular how those preferences are determined. It is useful to understand preferences as
it provides some insight into likely behaviour. This paper provides a simplified guide and
it must be remembered that preferences may not be consistent between individuals. Also,
individuals’ preferences may change over the course of their lifetime.
Optimisation
58.
One major difference between neoclassical economics and behavioural economics, in terms
of motivations and aspirations, is the degree to which a person is assumed to seek an
‘optimal’ outcome. Neoclassical economics models choice as an optimising activity. That is,
people keep searching for something better until the additional costs of searching outweigh
the additional benefits of finding something better. This model has obvious drawbacks
– how can a person know that there is something better out there to keep searching for,
how does a person trade off the risk that they will make a mistake because they are unable
to process the additional information they have gathered?
59.
Behavioural economics rejects the notion of optimisation, and suggests that people aim
for threshold standards beyond which they don’t keep searching. This avoids the infinite
regress problem of continually searching for the optimal choice when you don’t know what
is out there, or even how to decide on the best search rule to find it.
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Fairness
60.
Neoclassical economics says that people take an individualist approach to assessing their
own welfare. On the other hand, behavioural theories recognise that we live in a society,
and people’s behaviour is influenced by those around them. These influences come through
consideration of factors like fairness, the preferences of others, and personal identity.
61.
Neoclassical economics says that people conduct a rational cost-benefit analysis when
deciding what do. Under this assumption, financial incentives would be expected to
encourage people to act in a particular way. However, this approach ignores the many
situations where people do things for others without thinking of the rewards. In these
cases, people are often motivated to behave in particular ways because it is the ‘right thing
to do’ – that is, they have become conditioned to accepting that behaviour as a social
norm.
62.
Related to the concept of ‘doing the right thing’ is the role of fairness in market transactions.
Neoclassical economics assumes that supply and demand functions are independent. That
is, consumers do not consider the supplier’s behaviour, rather they make an objective
choice based on the goods or services offered. Behavioural economics says that people
may pay a premium to buy goods made in certain conditions. They may walk away from
materially advantageous transactions if they believe they are being treated unfairly.
63.
The classic example of this type of behavioural bias is demonstrated by experiments
involving an ultimatum game where one participant is required to divide a sum of money
between themselves and another participant. The second participant can then accept
the proposal, or walk away so that neither participant receives anything. Neoclassical
economics would suggest that the first participant should offer, and the second participant
should accept, any positive but small amount. However, research has shown that first
participants tend to offer larger amounts than necessary, and that second participants often
reject offers which are positive but which they consider too small to be fair.
Peer pressure and social norms
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64.
An individual’s behaviour is not decided in isolation. Social norms, sanctions and institutions
(not just organisations but systems of rules, such as the public service) influence decisions.
Habits, rules of thumb, communal loyalties and religious/spiritual values play a significant
part in the decision-making process. Other people can be seen to facilitate, deflect or
constrain individuals actions in the market.
65.
As such, peer pressure can have a profound effect on the decisions of an individual.
Teenagers feel it especially keenly. Whatever the social norm is for teenagers at the time,
an individual can be rejected from the group if they do not conform. For example, a person
brought up in a high crime neighbourhood may face a choice between a career of crime
or a regular job. The resulting decision will probably be less than a matter of comparing
the advantages of one over the other, than the structure of peer groups and gangs in the
neighbourhood.
66.
Within cultures, conventions can be followed long after the reason for the convention has
become lost. Therefore, it can be difficult to facilitate a change in behaviour, even when it
seems good sense, if it goes against a cultural norm. The decision-making of individuals
from some cultures can be seen by others to be irritatingly slow and indecisive, but their
culture probably considers that decisions must be made collectively by members of the
family, church or community. Culture plays a role in business decision-making also – even
if a business brings in new people, they are often quickly assimilated into the business’
culture.
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67.
Behaviour which has become common and accepted as normal will take time to change.
However the processes by which it became accepted and became a social norm – by people
seeing that others approve of it, or that others they admire are doing it – are also the
processes by which it can be changed. 30 years ago it was common for workplaces to
be filled with cigarette smoke, but anyone lighting up today in a workplace would be
considered rude, even without considering the illegality of doing so.
68.
Policies which attempt to change social norms could usefully draw on influential
individuals or groups in society. For example, in his book The Tipping Point, Malcolm
Gladwell identified these influential groups as follows: Mavens, who are people with such
expert knowledge that you would take their advice if given it; Connectors, who are people
with great connections so that if they have information it can be disseminated to a large
number of people; and Salesmen, who are people with the power to persuade us to change
our behaviour.
69.
The use of experts to influence decisions can, however, backfire, as people can respond
negatively to a ‘know-it-all’ who assumes they know what is best for you. Conversely, the
use of heroes to inform and influence is a tried and true marketing technique.
70.
Changing social norms can also be achieved through targeting people affected by problem
behaviour, rather than directly targeting the perpetrator. For example, some public health
campaigns have found that it is more effective to be directed at the target’s spouse and get
them to exert pressure on the target to change their behaviour.
case study 5: Unintended impacts of performance bonuses for nurses
The UK Government in the 1990s, as part of its drive to improve public sector efficiency, decided to
award a modest (compared to wages) monetary performance bonus to nurses for exceeding targets
specified in their job description. Neoclassical economics predicts that this policy would increase
overall performance due to the financial rewards. However, this policy was subsequently found to
have a negative effect on overall performance.
This can be explained as the nurses who were previously performing well in their role being more
motivated by feeling good about delivering a worthwhile service (or doing the right thing) than by
how much they were getting paid. Placing a monetary value on good performance may have reduced
this feel-good factor among high performing nurses, due to them perceiving themselves as being
‘bribed’ to perform well and not being ‘trusted’ by their employer. The policy failed to account for
these motivational effects.
That said, there are two opposing effects involved in these type of bonuses of (i) the diminished ‘feel
good’ factor of providing a good job and (ii) the monetary incentive to perform. At low levels, the
monetary effect (ii) will be outweighed by the feel good factor in (i), but at very high bonus levels
relative to wage rates, the monetary effect of a very high bonus may outweigh this ‘feel good’ factor.
The relevance for policy design is to judge at what bonus level the monetary factor will outweigh the
feel good factor and whether this can be afforded.
Source: Richard Layard, Happiness: lessons from a new science, New York: Penguin Press, 2005.
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Identity
71.
Personal identity is an important component of preferences and people’s objectives in life.
In the same way as neoclassical economics takes preferences as given, it also discounts the
role of identity in framing decisions and objectives. The behavioural perspective incorporates
the idea of identity in analysing people’s behaviour. People derive their identity from the
social groups to which they belong. The identity adopted by a person conjures up a set of
values and ideals which influence behaviour. A person may alternate between different
identities, so that a policy which evokes a particular identity may activate concepts and
priorities that are associated with particular tastes and values and hence will have a better
chance of achieving the desired behavioural response.
72.
Almost all individuals identify with a group within society, be it age, income, religion,
gender, and so on. Even within these groups, individuals have different motivations for
making decisions. Psychological experiments have identified three major reference groups
within groups: aspirational, associative and dissociative. Aspirational groups are those
with whom an individual would like to compare. Associative groups are those people who
hold similar ideas and values to the individual. Dissociative groups are those people whom
an individual would not like to be like.
Status
73.
In its focus on individual welfare, neoclassical economics ignores the impact of social
status. Behavioural economics recognises that people tend to judge their well-being not
by how much they have in isolation, but by their positions relative to other people whom
they use as reference points. This suggests that policy initiatives should be aware of the
differential impacts they may have on status.
74.
People place value on the groups they identify with, and this may affect their decisionmaking. Careful research would reveal that a Skoda Octavia (a modestly priced car) is
essentially the same vehicle under the skin as an Audi A3. However, despite being more
expensive, a person may prefer to purchase the Audi because of the status it signifies.
75.
Reputation is a status symbol, but careful consideration should be given to using this
as a way of modifying behaviour. A policy example is the Confiscated Car Club, where
fine defaulters find their vehicles are impounded until they pay their fines. This targets
the status symbol of the individual, in this case their car. However, it is possible that the
defaulters may regard confiscation as a badge of honour amongst their peers, thereby
diminishing the impact of the policy.
Personal involvement
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76.
In contrast to the neoclassical assumption that people are always motivated by rational selfinterest, people tend to make better choices when they feel in control. This has important
implications for policy interventions involving the provision of information. Neoclassical
theory says that more information and choice is always good. Therefore, policy interventions
should aim to ensure consumers have the information necessary to make the best choice,
along with many things from which to choose. In contrast, behavioural economics says
that more information and more choice may be overwhelming.
77.
A participatory approach to policy making can lead to more effective changes in people’s
behaviour, as well as increased well-being. Interestingly, increases in well-being can be
attributed as much to participation in the process as to the improvement in policy as a
result of the participation.
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78.
Conflicting interests, where a recommended practice may benefit the wider community but
has costs for the individual having to make that decision, can be emotional. An example
is the sacrifices that were required during rationing. Although the costs to the individuals
were relatively high, the ‘greater good’ feeling prevailed. However, when an individual
cannot see the wider benefit, then the individual preference can become more important.
79.
Trust is a major factor in making decisions. Studies have shown that when making a
significant decision, many people will seek advice from family and/or friends rather
than experts in the field. This is because people feel they can trust family members to be
honest, rather than a salesperson who may have other motives than the best interests of
the customer. Also, the bond between the family member/friend lasts longer than that with
the salesman.
Key points
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Choice is a satisficing activity – policy interventions should not be based on the assumption
that people will engage in a detailed or exhaustive search for optimisation; rather, people
aim for threshold standards beyond which they don’t keep searching.
People are generally motivated by fairness, status, social norms and personal identity –
policy should incorporate these factors, rather than focus solely on cost-benefit analysis or
financial incentives, in order to achieve desired behavioural changes.
Changing social norms are difficult but using people with certain influences can help
– don’t underestimate peer pressure.
People make better choices when they feel in control – policies should encourage greater
personal involvement, rather than focusing solely on the provision of (often complex)
information.
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PART 4:
The way people understand the world
Following the discussion of what motivates people to act, this section examines economic assumptions
about the way people understand the world. As discussed in Part 2, a person’s situation has a big
influence on behaviour, but situation is not objective – it is constructed around the way in which the
person understands the world.
The ways in which people understand the world and take in information have important implications
for policy making. A person’s understanding influences how they respond to policies and targeted
information and ultimately influences how policy can most effectively target information to the public
to achieve behavioural change.
Perceptions and probabilities
80.
Neoclassical economic theory assumes that people perceive the world in a rational and
objective way, given the information available. However, behavioural economics provides
some explanation of how factors such as emotions and habits can detract from the objectivity
of people’s understanding, albeit in differing degrees across different individuals. Policy
making would be made more effective by considering how different factors impact on
people’s understanding from the outset.
81.
Whilst neoclassical economic theory assumes that people rationally process probabilities
of events occurring before making decisions, behavioural economics research argues that
people are naturally poor at appreciating probability and think in terms of frequency of
events.
82.
General research also suggests that people broadly underestimate the likelihood of events
that are unfamiliar to them and overestimate the likelihood of events that they can relate to,
either when they have previously experienced similar events or where they are particularly
frightened of or excited about certain events occurring.
83.
Emotional influences play a greater role in the way humans perceive the world than one
might think. For example, after a severe local bus crash, local people (particularly those
involved firsthand) may believe that bus travel is less safe than it actually is. They may as a
result decide to only travel by car (the travel mode where they haven’t personally experienced
any crashes), even though the injury and fatality rate of car travel is significantly greater
than for bus travel. Under such circumstances, local publicity informing people of this fact
might be needed to stem reductions in public transport use.
84.
Another example of people over-estimating risks due to painful experience is that many
people were more reluctant to go to beaches in the regions around Indonesia and India in
the months following the December 2004 tsunami.
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85.
In another example, the gambler’s fallacy describes an erroneous belief that a series of
losses indicate that a win is imminent. If a gaming machine hasn’t paid out for a while, it
must be due for a big win, so if I play just one more round…
86.
People often underestimate gains that will accrue in the future, especially when compared
with immediate gains. For example, because many people under 50 find it difficult to
relate to life after retirement, they may consequently under-save relative to the level of
pension savings required to benefit them most over their entire lifetime. In addition, noone knows for certain how long they will live for and this uncertainty may cause people to
significantly underestimate their life expectation compared to what might be a reasonable
estimate based on how long other people with similar characteristics/health normally
live.
case study 6: Workplace safety levy discount for small businesses in six high risk
industries
This recent policy aimed to address the impact of some small firms in high risk industries not
implementing enough health and safety measures because they often believe it’s unlikely that any of
their employees will have an accident. This perception arises from the firms never previously having
experienced an accident among their employees, partly because they employ very few people. The
lower the number of employees, the lower the probability of an accident among all employees.
However, small firms tend to have a higher accident probability per single employee or per 100 workers,
due to having lower health and safety provisions compared to large companies in the same industry
who have previously experienced accidents (due to the sheer numbers of people they employ).
The policy decision was to award a discount on the workplace safety levy for small firms in some
high risk industries. This discount applies only after eligible firms have demonstrated that they have
sufficient health and safety measures in place to reduce the likelihood and severity of accidents. The
cost of improving health and safety is likely to be significantly outweighed by increased economic
growth after losing fewer productive workers, in addition to other social benefits.
Source: ACC &DOL Workplace Safety Levy Discount legislation, April 2006. See weblink:http://www.osh.dol.govt.nz/publications/
research/acc-levy0603/
Framing effects
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87.
Knowledge that different ways of presenting the same information will be perceived
differently due to the influence of emotions is useful to encourage positive outcomes
through behaviour or compliance with a given policy. For example, in advice provided to
people starting up their own business, ‘30% of all new businesses become very profitable
in the long term’ sounds better than ‘70% of all new businesses will fail within their first
5 years’ and ‘ensure that you complete filling in all necessary paper work quickly’ may
sound more positive and motivational than ‘don’t delay or miss filling in any necessary
paperwork’.
88.
Information should also be presented in a way that doesn’t overload people and doesn’t
create new bias. For example, if information on all pensions saving products were given to
people at the same time, this would look more overwhelming and may delay people making
appropriate decisions than if the same information were distinctly ordered by grouping
products into main features e.g. low or high risk/return, high or low total product turnover.
People could then quickly choose just to read about the products that would suit them and
this may lead to faster decision-making.
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MINISTRY OF ECONOMIC DEVELOPMENT BEHAVIOURAL ANALYSIS FOR POLICY
89.
This information would also need to be presented objectively so as not to bias choices
between providers. For example, by indicating that higher forecast returns also carry higher
risk or that total turnover is not indicative of a provider’s competence.
90.
The way default options are framed under a policy may also have a significant impact
on people’s responses to the policy. For example, if the government presents a particular
option as the default, people may perceive that option to be the ‘best’ or ‘approved’ option,
so will adopt that choice, rather than carefully evaluating all options available.
case study 7: Rate of organ donation
What drives the decision to become an organ donor? While the majority of people believe organ
donation is good, rates of donation are variable in different countries. Germany has a low rate of
donation while Austria has a very high rate. New Zealand has a low donation rate.
A difference between countries is their default position on organ donation. Some, such as Austria,
employ presumed consent (a person is a donor unless they register not to be) while others, such
as Germany, have explicit consent (a person is not a donor unless they register to be). Countries
with presumed consent have significantly higher levels of registered donors than those with explicit
consent.
If personal preferences play a vital role, it could be that public education campaigns would have
an effect. It would also predict that defaults can influence choices. People may think a default is a
suggestion by the policy-maker and therefore regard it as a recommended action (and react either
positively or negatively). Making decisions involves effort, while a default is effortless. It also enables
a person to defer making an emotional and painful decision. If defaults represent the status quo,
opting out of the default may involve a trade-off.
To confirm these real world observations, Johnson and Goldstein conducted an on-line experiment that
removed the factor of effort in the decision-making process. Their ‘virtual organ donation decisionmaking’ results matched the real world – rates were lower for those people who had to opt-in.
These results raise another question. Do increased agreement rates mean increased rates of donation?
There are many reasons preventing registered donors from donating, including family objections to
a person’s consent; doctor’s hesitancy to use the default option; mismatch with potential recipients;
or religious and cultural objections.
The evidence is that high rates of consent also lead to a high rate of actual donation, even when the
same reasons preventing donation are present.
Reference: Johnson J and Goldstein D. Do Defaults Save Lives? Science 21 Nov 2003, pp 1338-1339
Habits
91.
In contrast to information overload, habits (past behaviour influencing present behaviour)
have been found by psychologists to significantly narrow the choices which people believe
are available to them. For example, certain work activities are carried out in less efficient
ways than they could otherwise be, due to the present ways of carrying them out being
habitual or ingrained into the sub-conscious.
92.
Effective targeting of information can bring sub-conscious habits (current ways of doing
things) into consciousness, so that they can then be changed to increase efficiency.
Targeting information would be particularly effective in changing previously inefficient
habits if accompanied by making old habits less convenient.
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93.
An example of policy increasing efficiency by changing habits is building low bridges
over congested sections of road to ensure that certain large vehicles use faster motorways
instead. Congestion on these road sections and also journey times for all vehicles using
these roads would then be reduced.
case study 8: Encouraging saving
Responding to concerns that New Zealanders don’t save sufficiently for their retirement, the
government is establishing the Kiwisaver pension scheme.
Traditional approaches to encouraging saving have used incentives that focus on people’s rational
analysis of the situation. For example, they assume that barriers to saving result from a rational
concern that the rate of return to savings is too low. Policy responses have attempted to increase that
rate of return, for example through a tax subsidy.
The Kiwisaver scheme uses some of the principles of behavioural economics. In particular, Kiwisaver
relies on behavioural insights on myopia, status quo bias and social norms to encourage saving.
Participation in Kiwisaver is voluntary, however, workers are automatically enrolled when they start
a new job and have six weeks to opt out. Those who don’t choose a provider are randomly allocated
to a default provider. This ensures that those who do not consciously think of saving become started
in a savings programme.
By exposing more people to savings, this is also expected to create a culture of saving. In this way,
saving for retirement will become the norm.
Source: Savings Incentive Proposal, Treasury Report to Minister of Finance, 14 March 2003, http://www.treasury.govt.nz/release/
securingyourfuture/5jul05/tr03-368.pdf
Loss aversion
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94.
Another emotional impact on how people perceive the world is evident through many
people perceiving a given loss as having greater value than gaining the same thing. For
example, many people would resent losing $1,000 of money that they already possess more
than they would enjoy gaining $1,000.
95.
Research also indicates that this same principle applies to belongings and communal
resources. For example, building a road over existing local parkland to improve the road
network is likely to result in a feeling of loss to society, even if the same amount of
parkland is relocated elsewhere.
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Key points
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Emotions play a large part in people’s perceptions of the likelihood of positive or negative
events, especially if the events are linked to particularly frightening, happy or exciting
outcomes or to things that a person has previously experienced.
People are generally loss averse – loss of a given amount of money or resource will have
greater value than gaining the same thing. People will take fewer risks that might result in
losses than they would in order to achieve gains. This has important policy implications,
for example when assets are redistributed from one group to another.
Unconscious and ingrained habits can cause people to think that established ways of doing
things are the most efficient, even where this is not the case. These perceptions can be
challenged by bringing habits into people’s conscious attention and through designing
policy so that individuals can see greater incentives to adopt more efficient practices,
instead of continuing with less efficient habits.
How information is presented or framed can influence the way people use that information
to make choices.
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Further Reading
The following references provide a guide to further reading on the topics covered in this paper. Note
that this list is merely a snapshot of selected works, and much more material is out there to help in
producing good policy analysis incorporating behavioural analysis.
Policy development generally
Ministry of Economic Development, A Guide to Preparing Regulatory Impact Statements (RISs),
March 1999, www.med.govt.nz
• This guide takes individuals through all the steps of preparing RIS/BCCSs that are
required for any policy proposals with legislative implications. This guide also outlines
criteria that the Regulatory Impact Analysis Unit looks for before agreeing that a RIS/
BCCS is of a suitable standard for submission to a Cabinet Committee with the Cabinet
Paper.
Policy Development Toolkit, https://psi.govt.nz/pdtoolkit/default.aspx
• PDToolkit is an online resource that provides access to policy development guidance
documents and websites produced by New Zealand government departments, including
guidance on policy processes.
UK Home Office, Understanding policy options, Home Office Online Report 06/06, March 2006,
http://www.homeoffice.gov.uk/rds/pdfs06/rdsolr0606.pdf
• This report summarises the evidence base on the use of policy instruments to address
market failures in different contexts. The paper discusses alternate theories of behaviour
– rational choice model, individual level theories, interpersonal behavioural theories and
community theories of behaviour – and the implications for policy design.
Decision-making and behaviour
Any good university library will have books entirely on decision-making, within the Cognitive Science
sections or Psychology sections.
The Stanford encyclopaedia on the web is another good place to start: http://plato.stanford.edu/
contents.html, look at ‘beliefs’, ‘behaviourism’, ‘folk psychology’
as is EpistemeLinks: http://www.epistemelinks.com/Main/MainEncy.aspx
For authors working within the areas discussed in this paper, look for Baruch Fischoff (on attribution
and values), Ross and Nisbett (on the person and the situation), Alexander Rosenberg (on
folk psychology, behavioural economics and micro-economics), Eldir Shafir (decisionmaking, economics and cognitive science), Gilbert Harman (attribution and character), Gerd
Geigerenzer (on heuristics and rationality), Dan Dennett (on rationality).
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Behavioural economics and other behavioural theories
New Economics Foundation, Behavioural economics: seven principles for policy-makers, http://
www.neweconomics.org, 2005
• This paper distils many concepts from behavioural economics and psychology down to
seven key principles which highlight the main shortfalls in the neoclassical model of
human behaviour: other people’s behaviour matters; habits are important; people are
motivated to ‘do the right thing’; people’s self-expectations influence how they behave;
people are loss-averse; people are bad at computation; people need to feel involved and
effective to make a change.
Earl, Peter E, “How Mainstream Economists Model Choice, versus How We Behave, and Why It
Matters”, in Edward Fullbrook (ed), A Guide to What’s Wrong with Economics, Anthem Press:
London, 2004
• Contrasts the approaches of mainstream economics and behavioural economics in
studying the microeconomics of choice. Focuses on four major areas of difference:
trade-offs and the shopping trolley; choice between competing products; how well do
people choose; what determines overall happiness.
OECD, Roundtable on Demand-side Economics for Consumer Policy: Summary Report, 28 April
2006, http://www.oecd.org/department/0,2688,en_2649_34267_1_1_1_1_1,00.html
• This paper argues that policy makers have tended to focus on the structure of markets
rather than on the ways in which consumers’ behaviour shapes market outcomes. Drawing
on insights of conventional and behavioural economics, the Roundtable explored the
extent to which economists’ studies of the demand side of markets might be able to
contribute further to consumer policy.
Epstein, Richard A, Behavioural Economics, lecture to New Zealand Business Roundtable, 3 August
2004, http://www.nzbr.org.nz/documents/publications/publications-2005/behavioural_
economics_epstein.pdf
• This paper challenges widely held neoclassical economic assumptions such as rationality
and self interest, summarises the developmental history of behavioural economics and
uses behavioural economics to bring fresh insight into ways of looking at organisational
design of businesses and the market place.
Lakomaa, Erik, Can behavioural economics improve the understanding of politics, 1 January 2006,
http://pubchoicesoc.org/papers_2006/lakomaa.pdf
• This paper argues that the classic public choice theory has been very important in explaining
various political phenomena. Incorporating insights from behavioural economics, such as
self serving biases, loss aversion, encompassing sentiment coordination, status quo bias,
endowment effect and framing, could improve the analysis of the shape and function of
political institutions.
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Bernheim, B Douglas, and Rangel, Antonio, Behavioural Public Economics: Welfare and Policy
Analysis with Non-standard Decision Makers, NBER Working Paper, July 2005, http://www.
nber.org/papers/w11518
• The paper discusses several emerging approaches to applied welfare analysis under
non-standard (“behavioral”) assumptions concerning consumer choice. This provides a
foundation for Behavioral Public Economics. It illustrates application of these approaches
by surveying behavioral studies of policy problems involving saving, addiction, and
public goods.
Earl, Peter E, ”Economics and Psychology in the Twenty-First Century”, Cambridge Journal of
Economics (2005) vol 29, issue 6, pages 909-926
• Discusses the relationship between economics and psychology, and the institutional
and psychological barriers to the success of a research programme in psychological
economics.
Smelser, Neil J, and Swedberg, Richard, (eds), The Sociological Perspective on the Economy,
Handbook of Economic Sociology, Princeton: Princeton University Press, 1994
• This Handbook provides articles on economic sociology. The basic tenet of the book is
that people are influenced by other people to make decisions based on social norms,
rather than making decisions independently as an individual. Traditional economics
assumes economic actions are rational, while sociology sees rationality as variable.
Gittins, Ross, “No woman (or man) is an island in the economy”, Sydney Morning Herald, April 16
2005
• An article by the SMH’s economic columnist, which describes the use of sociology with
economics and summarises the philosophy of Smelser and Swedberg (above). Short and
informative.
Layard, Richard, Happiness: lessons from a new science, New York: Penguin Press, 2005
• This book looks specifically at the factors that maximise happiness, using a mixture
of empirical observation, psychology and economics literature. The book argues that
different levels of happiness can be recognised by observing different neural impulses
during brain scans and that these broadly correlate with people’s ranked preferences as
to what make them most happy. The book also argues that certain key factors contribute
to increasing most people’s happiness and challenges many currently held psychology
and economic-related beliefs.
Gladwell, Malcolm. The Tipping Point: How little things can make a big difference, Little, Brown and
Company, London, 2000
• This book discusses the reasons behind the ability of certain ideas and behaviours to
reach ‘tipping point’ and spread their influence like epidemics. It demonstrates that
small changes can result in large-scale behavioural changes and that what seems like an
obvious change may not produce the desired effect.
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