Why Narendra Modi Needs To Understand Richard Thaler

Behavioural economist Richard Thaler has deservedly won the Nobel Prize in Economics. It is important that his splendid work is taken seriously by the Indian government.

Thaler is one among a bunch of pioneers who have used insights from psychology to craft a more realistic picture of how human beings interact in an economy. It is a powerful challenge to the dominant view till recently that human beings are perfectly rational calculating machines. Thaler has shown in his work that our economic behaviour is marked by limited rationality, strong perceptions about fairness, the inability to stick to goals and what is called hyperbolic discounting.

Human behaviour is central to economics, and became even more so after a new generation of economists after the mid-1970s began to weave assumptions about individual human behaviour into their models of the macro-economy. The role of expectations was also underlined. These concepts have a tinge of psychology to them, and even though rational expectations were the dominant assumption, it should not be forgotten that Herbert Simon won the Nobel Prize in Economics way back in 1978 for his work on bounded rationality, an idea that repeatedly crops up when one is reading Thaler as well.

Thaler is not a pure man of theory. His work has important applications in public policy. Thaler and his co-author Cass Sunstein have given us the idea of a nudge, or the design of rules in such a way that people make choices that a government thinks is better for them.

The paradoxical name they give their idea is libertarian paternalism – where people are not denied choice, yet nudged in a particular direction. One popular example has to do with compulsory savings. A new employee has to choose whether to sign up for a pension plan or not. Behavioural economists have shown that most people choose the lazy way out by sticking to the default option. So a government can nudge people towards saving more for old age by making the pension plan the default option, while employees continue to have the choice to opt out.

Several governments have set up nudge units, with behavioural economists working to create new types of choice architecture. The Narendra Modi government needs to follow suit, especially as it is keen on changing citizen behaviour in areas as diverse as cleanliness to use of digital money to the education of the girl child.

Here is one example. Should the communication about a programme such as Swachh Bharat Abhiyan focus on the gains from clean neighbourhoods or on the risks from garbage on the streets? Behavioural economists have shown that people prefer avoiding losses compared with making gains – or loss aversion. So the government would be better served if the Swachh Bharat messaging is focused on the risks rather than the gains.

This is a trivial example, but the broader point is important: The Titanic of public policy often crashes into the icebergs of our behavioural quirks. Thaler and his peers need to be studied in New Delhi and India’s state capitals.

(MINT)