The end of the beginning

Behavioural economics (BE) has become a very familiar term and you're more than likely to find a copy of ‘Nudge’ on someone’s coffee table these days. I’m sure you’ve come across Kahneman, Knetsch and Thaler's mug study[1] about the concept of endowment bias or Ariely, Loewenstein and Prelec’s social security number study[2] looking at the subconscious effects of anchors and while these and many other studies have been essential in the development of the behavioural sciences, research is now moving on and becoming more applied with real life field trials; we are in a new era of real world application. This is an important development, since it will mean even more accurate insights into behaviour, and more precise application to different industry sectors, contexts, environments and demographics.

In a talk at the London Business School recently, Shlomo Benartzi, Professor of Behavioural Decision-making at UCLA, highlighted how initially behavioural economics was used simply “to criticise the behaviour of others and make fun of the dumb things people do”, something he calls BE 1.0. Now though, he says the field has advanced to BE 2.0 and “designing behavioural solutions” in the real world. Another noted behavioural economist, Dean Karlan who is Professor of Economics at Yale defines BE 2.0 similarly: “Behavioral economics as a field was very much focused on laboratory evidence. Now we are seeing a new wave that one may call behavioural economics 2.0, that takes these ideas and tests them in the real world as ways of improving public or business policy.”

This shift has been driven by two factors: one, a growing dissatisfaction among many in both business and government with how behaviour has traditionally been understood or explained - the standard model of economic behaviour which assumed that people made rational choices and decisions was revealed to be a false premise and time and again it failed to explain why we were really doing what we were doing. This realisation, combined with a second factor, the growth in ground-breaking research, showed that the behavioural sciences did seem to be able to understand and explain behaviour far more convincingly.

This new era of real world application has three main features:

• Firstly, it is now moving beyond the lab and the university professor. Initially research was mainly lab-based, conducted by academics, testing different behavioural economic concepts such as anchoring, loss aversion or the hot-cold empathy gap with simulated scenarios, often on a computer, or in simplistic tasks. For example, a well-known study on priming, asked participants to read from a text peppered with words which prompted associations with old age and then timed how quickly they walked along a corridor. Its remit now is real life application, interrogating the multitude of problems which beset our daily lives with well-designed trials and field experiments based on the concepts identified by the behavioural sciences. It is being adopted enthusiastically by businesses, governments, regulatory bodies, charities and intergovernmental organisations alike.

• Secondly, its impact is now being examined against a much wider demographic. Previously, with predominantly university based lab studies, concepts were usually tested only on students – a relatively young and narrow cohort of society.  Research by academics like Ellen Peters, Professor of Psychology at Ohio State University, suggests that different age groups or those with different skill sets (such as numeracy) can be more or less sensitive to cognitive biases, anchors and heuristics. So field studies are now able to test and check this. In the future we may be able to understand the subtleties in how different heuristics and biases affect a broad spectrum of people.

• Thirdly, the field is becoming more intricate and cleverer as we understand how to hone and perfect the tools of BE. For example, the subject of how to alter behavioural outcomes through the strategic use of defaults has moved several steps forward in its understanding of what is effective and where and when. The application of defaults is now far more subtle - no longer is it a simple dichotomy of whether to set the default to opt-in or opt-out. In a recent talk at the British Academy for the humanities and social sciences in London, Cass Sunstein, Professor at Harvard Law School and former regulator within the Obama administration discussed the many different types of defaults – from mass defaults to active choosing and personalised defaults - and how to apply them, showing that we've moved far beyond a straightforward one-size-fits-all default. With careful design, and clever use of technology, defaults can be tailored specifically to individuals or removed and replaced with what is called ‘active choice’ when a preference is requested.

BE applications in this new era

BE embraced by governments

Governments in the US, UK and Australia are really getting into the granular detail of what does and does not work, using robust experiments in the form of Randomised Controlled Trials and thinking pretty creatively. David Halpern, head of the UK government's Behavioural Insights Team explains how they test beyond the lab results in the real life trials they run: “We are very experimental in our approach. [We run trials] in order to find out what works in an American lab and [check that it also] works in the real world with British consumers.”[3]

They have had noted success in several areas of government, including tax and debt collection, energy savings, pensions enrolment, charitable giving and encouraging job seekers back to work. For example, applying the behavioural economic concept of social norms to letters demanding tax payment by including a statement like ‘9 out of 10 people in your town pay their tax on time’, raised the letter success rate by 15 percentage points to 83%, a move which has the potential to generate an extra £30 million annually for the Exchequer. The UK government as a whole appear pretty enthusiastic about the application of behavioural economics too. At a recent talk in London from Dan Ariely, one of the leading academics working on behavioural economics, the majority of the audience were from a diverse selection of government departments, and some are currently running their own trials to see how different applications of behavioural economics could improve policy outcomes.

The new Financial Conduct Authority (FCA) has also redesigned its approach to consumers with a view to more effective regulation and with behavioural economics in mind. At a recent FCA talk, CEO Martin Wheatley stated that behavioural economics was “very much part of our toolkit” and affirmed the FCA's intention to empathise with and try to understand the consumer better.  

Like the Behavioural Insights Team (BIT) they intend to carry out randomised controlled trials in the field and have already run a successful trial looking into how to improve consumer redress for mis-sold products. Companies often notify their customers that they might be eligible for compensation, but many fail to respond, perhaps too short of time to read and digest the notification letter, or discarding it in the belief that it is junk mail. The FCA worked with a firm which was voluntarily writing to almost 200,000 of its customers about a failing in its sales process. Using insights from behavioural sciences it designed several different versions of the letter with the aim of increasing customer response rates. They assessed the impact of incorporating the FCA logo, the identity of the signatory, simplification of the letter text or putting the key information in bullet point format at the top of the letter. The inclusion of salient bullets had the greatest individual impact, raising response rates by 3.8 percentage points over the control, whilst combining all of the positive interventions together into one letter led to response rates seven times better than the control.[4]

The FCA also intend to apply behavioural insights in the way that they regulate and supervise companies. For example, by ensuring that defaults don't exploit consumers, or in the framing or sequencing of information. In the motor insurance industry for example, 80% of consumers buy an add-on to their policy because they are automatically “opted-in” by default. However, when given the opportunity to choose to purchase the same product, only two out of five customers go on to do so.[5]

In the US, the Obama administration has been working with insights from the behavioural sciences to determine the most effective way to provide a tax rebate, implement an effective pensions system, create a good environment for daily decision-making in government, as well as ways in which to ensure good voter turnout for the presidential election. In fact Obama draws on a consortium of behavioural scientists, who feed useful and relevant insights to him and his advisors.

When tackling the problem of how to get more people to vote, Obama’s team recognised the inherent behavioural challenges behind voting – for instance, even though we all know we have the right to vote, many of us don’t, not necessarily because we don’t believe in it, but more because we ‘just don’t have time’ or assume that other people won’t get around to voting either. Obama's team's behavioural analysis uncovered a series of triggers and barriers to voting which allowed them to harness the power of a range of behavioural economic insights to ‘dial down’ the barriers and ‘dial up’ the triggers. For example, they used commitment bias to encourage people to make a definitive plan to vote well before voting day based on the insight that once people have committed to do something they are much more likely to follow through. They also created a detailed picture of how their potential voters lived – knowing their target voters’ TV viewing habits enabled very precise and effective targeting of campaign communications. This undoubtedly made a significant contribution to voter turnout and the eventual success of each of Obama's presidential campaigns.

These approaches by various governments across the political spectrum are extremely attractive due in part to their unarguable success, speed of application, impressive results and relatively low cost. In a recent talk at the Institute for Government, BIT's David Halpern noted that “We have reached the point where any political party could use these techniques. They are cheap, easy to implement and effective." At the same talk Cass Sunstein also highlighted how, in these times of economic recession, behavioural economics is a huge asset to have at one’s fingertips, "If you can find a way to promote safety and health and protect the environment that doesn't cost a lot of public and private resources, that's good in a tough economic time."

BE business application

Application of the behavioural sciences has not been limited to policymakers. Businesses and public bodies are also applying insights across a wide range of areas, including retail finance, savings and pensions, financial regulation, energy and power, as well as consumer goods. Implementers include Opower, NEST, Allianz, Barclays, Unilever, Diageo, ebay, PNC Bank and Simple Bank. 

Unilever has been drawing on insights from the behavioural sciences to develop more effective ways to research consumer behaviour, especially important health behaviours such as tooth brushing, hand washing, or how to make showering more environmentally sustainable. By investigating these everyday routines using theories of habit formation, looking at the triggers which prompt us to carry out these behaviours and developing technological aids to track behaviour more accurately, they are managing to create a much more precise blueprint of actual consumer behaviour to work from. For example, technological aids such as ‘spy toothbrush’ or soap bars containing an accelerometer are much better at tracking what consumers are actually doing than asking them. Similarly, sound sensors in showers are able to track how long people take in the shower - 8 minutes is the average. Ask someone how long they shower for and they'll usually underestimate the time.

In the energy sector we are also seeing imaginative applications of behavioural economics. The energy software company Opower has been working with utility companies across the US to help consumers use less energy and use it more efficiently with the help of behavioural economics. We all know we should try to reduce our energy consumption, but we often struggle with this; we don't know where to start, we find the prospect somehow overwhelming, or we simply forget to turn lights off or to switch TVs and PCs off standby etc. To tackle this problem Opower sent out carefully designed, consumer-friendly Home Energy Reports, using what behavioural scientists call descriptive social norms (what everyone else is doing) to tell households how much energy their (more efficient) neighbours are using in an effort to encourage them to reduce their own electricity consumption. The reports also include little energy saving tips, small steps which, over time, can make a difference. Figures from 14 different randomised controlled trials for 600,000 households across the US show that the average program reduces energy consumption by 2% and for the heaviest energy users, by as much as 6.3%. Opower have also been linking up with energy companies in the UK (First Utility) and Australia (Energy Australia) to initiate similar interventions.

Ebay have also been getting wise to the huge potential of behavioural economics. If you've browsed their UK website recently you may have noticed little messages popping up on the screen for different products, alerting you to how many people have viewed an item that day, how many bought, or how many people are ‘watching’ that item. These pop-up messages help to create a sense of urgency in the consumer and can often make them more inclined to buy now as they don’t want to miss out and lose an opportunity to purchase - “I'd better buy it now before it sells out!”. It also enables social norm and ‘copying’ effects since we often use the purchasing decisions of others as a shortcut to help us to decide to buy a particular product -“Lots of other people have bought one so maybe I should too.”.

Medical and healthcare adherence is a huge problem globally, leading to further health complications and high, unnecessary costs, so many healthcare companies and institutions across the world have been looking into ways in which to apply behavioural science tools to problems such as adherence to prescription medication, poor attendance at GP surgeries and other health appointments and commitment to anti-smoking campaigns. For example, the Medicaid Leadership Institute and a team from Oklahoma Healthcare Authority, SoonerCare worked with the behavioural research think tank ideas42 and conducted a field trial on diabetes patients to test the impact of different behavioural interventions and had remarkable success.

Letters were sent out to 2,500 patients diagnosed with type 2 diabetes who had not yet begun statins medication, despite their condition. Patients received one of four interventions:

• One group received the basic letter encouraging them to call their doctor to arrange a cholesterol check and discuss a statins prescription
• A second group received a $5 gift card with their letter which could be activated after attending an appointment
• A third group received a letter which had been redesigned to include a suite of ‘behavioural nudges’ such as making the consequences of remaining untreated more salient or including post-it note reminders
• A fourth group received both the nudge letter and the $5 incentive

The results were astounding. Those who had received the behavioural nudge letter (the third group) saw a 78% increase in response compared to the control group. The team are now looking into how to develop this initiative further.[6]

Behavioural economics is also being applied in many areas of behavioural finance, including pensions and retirement savings. With the demise of defined benefit, employer-based pensions, governments and firms recognise that individuals must now set up their own pension to be ready for retirement. But this can be a daunting and confusing task for people and many put off signing up. In response, financial institutions have applied insights from behavioural economics by ‘changing the default’ so that people are automatically enrolled. In the US, auto-enrolment schemes into pensions and retirement savings schemes have shown that they can raise enrolment rates from a lowish 40% - when people must actively opt-in to the scheme - to a far more satisfactory 85-90% when people are automatically enrolled. In fact, such was the success of these schemes, that auto-enrolment became law in 2006 through the Pension Protections Act. The UK has now followed suit and has implemented auto-enrolment and the new national pensions institution NEST is also achieving initial enrolment rates of 90%.[7]

Once we are enrolled, however, it may still be the case that we are not saving enough. We tend to stick to the default rate suggested even though this is typically low – saving just 2% or 3% of income and not sufficient to provide a good standard of living in retirement. So financial institutions like Allianz have been implementing what is known as the Save More Tomorrow scheme - a retirement savings plan designed by behavioural economists Richard Thaler and Shlomo Benartzi which recognises how people’s aversion to loss of take home income when starting or increasing savings contributions can make them reluctant to save. Auto-escalation solves this problem by asking people to commit to save more after their next pay rise and pension increases made to coincide with a pay rise means money 'lost' to pension contribution is not missed. These schemes have increased contribution rates to as much as 13%. Such is its success, the model is becoming increasingly widely adopted with over 50% of employers in the US offering auto-escalation. 

Allianz have also devised a toolkit for the design of workplace retirement plans based on insights from behavioural economics. Called the Behavioural Audit, it assesses how effective their clients' employer pension schemes are from a behavioural finance perspective. For example, do they use auto-enrolment to opt-in employees, is the default contribution rate high enough, how is the fund choice constructed and presented to employees? From this assessment, Allianz can then go on to make recommendations to the employer on how to redesign their pensions schemes using behavioural economics insights.[8]

More fascinating tools are being built by other finance specialists too. Barclays Wealth has created a behavioural finance team[9] to help its clients manage their wealth more effectively by addressing the plethora of heuristics and cognitive biases which can affect us. They offer a Financial Personality Assessment which measures six different factors to determine how clients’ emotions and attitudes with regard to investing might affect their investment decisions.[10]

Conclusion

Behavioural economics has moved from the lab into the real world and its real life applications demonstrate how it can provide both the strategic framework and constructs to understand and change the behaviour of entire cohorts of our societies, global businesses and multitudes of consumers over the long term.

In the future, being able to understand the subtleties of defaults, licensing effects[11], how heuristics and biases impact differently on a range of age groups or IQ levels, or how long a single ‘nudge’ lasts in the long term will also be important. While we cannot yet assume that we might one day fully understand every part of our behaviour, we've certainly taken a big step towards this.

Read more from Crawford Hollingworth, Founder of The Behavioural Architects.