For years, the United Kingdom sent out letters to delinquent taxpayers urging them to pay their overdue tax bills. The letters cost the government tens of millions of pounds per year, but, unfortunately, most citizens ignored these pleas for payment.
In 2010, the UK launched the Behavioural Insights Team (BIT), which became the world’s first government organization dedicated to incorporating behavioral economics into policy. BIT saw the tax letter as an opportunity to test the value of behavioral interventions in a context that would affect the government’s bottom line. The organization sent out a new letter with an extra line, letting people know that their neighbors were ponying up, implying that they should, too: “We are writing to inform you that we have still not received your tax payment. By now, nine out of 10 people in your town have paid their taxes. It is imperative that you contact us.” The organization also sent the original letter without the additional line to a different set of delinquent taxpayers, allowing the government to measure the change.
The intervention proved to be valuable. More people began stepping up and paying their back taxes—to the tune of tens of millions of extra pounds in tax revenue collected.
"I’ve seen behavioral economics come into play in a variety of contexts, ranging from employee compensation and investment decisions to corporate strategy."
The letter is an example of how a small “nudge”—a well-thought-out tweak in the way choices are presented—can encourage people to change their behavior in pursuit of policy goals, says Michael Luca, the Lee J. Styslinger III Associate Professor of Business Administration at Harvard Business School. Luca has been bringing a group of students to London each year since 2014, partnering with BIT and applying behavioral insights to solve real world policy and managerial problems.
“One way to help people make better decisions is to change the choice environment—or the way in which decisions are presented,” Luca says. “There’s a growing body of research looking to develop a toolkit of low-cost, scalable interventions leveraging behavioral insights, and in many cases they’re being applied for the social good.”
The success of BIT’s tax letter helped the organization grow. Nicknamed the “nudge unit,” BIT started with eight people in 2010 and has since morphed into a “social purpose company” with employees in London, New York, Singapore, New Zealand, and Sydney, with a new office opening soon in Toronto.
Aside from generating big tax dollars for the UK, BIT has seen successes in areas ranging from reducing unemployment and increasing educational attainment to improving small business productivity. For instance, the acceptance rate of students from underrepresented schools to top universities in the UK rose 34 percent after a letter from a top-tier student with a similar background was sent to pupils. And patient referrals to overbooked hospitals dropped by 38 percent after installing a simple pop-up prompt in the referral system.
“Behavioral insights are increasingly being put into practice in the private sector as well. We’ve also worked with companies to use behavioral economics for the social good,” says Luca. As many as 200 cities, countries, nonprofits, and businesses reportedly use behavioral economics strategies to guide their decision-making.
In his Immersive Field Course at HBS, called "Behavioral Insights," Luca brings students to London to partner on projects with BIT and learn about the landscape of behavioral economics as applied to policy and managerial questions. The students work with clients, applying behavioral economics to propose solutions to problems that require some nudging of citizens, consumers, and employees to promote better decisions.
Dina Gerdeman: What important lessons do you hope students take away from this course?
Michael Luca: A deeper appreciation of the ways in which small—and sometimes subtle—changes in the way a process or product is structured can make a difference. Our intuition about these effects can also be off, which is why experimental testing is important as well.
It’s been fun to watch former students bring these ideas into their careers in various industries ranging from tech to consulting to finance. We’ve also had students go on to work at BIT and other organizations focused on bringing behavioral economics directly into policy. For example, one former student was involved in helping to set up a new behavioral team in the Australian government and coauthored a practitioner-oriented guide to behavioral insights in policy.
Gerdeman: Why is behavioral economics important in today’s business world?
Luca: It’s helpful to first define behavioral economics. Definitions vary, but here’s one that David Laibson and John List use in a recent article: “Behavioral economics uses variants of traditional economic assumptions (often with a psychological motivation) to explain and predict behavior, and to provide policy prescriptions.”
Principles of economics have long played a central role in a variety of corporate settings ranging from strategy and marketing to finance and human resources. Behavioral economics provides frameworks for knowing where and how to augment standard economic analyses with more realistic assumptions about human behavior.
In the business ecosystem, this is relevant in many contexts. For example, suppose that you noticed that most of your employees weren’t enrolling in your company’s 401k plan. One interpretation would be that the employees have thought carefully about the decision and aren’t enrolled because they don’t value the benefit that much. In this interpretation, it shouldn’t really matter whether the default is for employees to be automatically enrolled or not; in both cases, employees would think about their options and make a wise decision. After all, retirement savings is a big decision, and 401ks are a large part of the puzzle.
But the literature on behavioral economics suggests an alternative interpretation, which is that people might simply be sticking with the default [option] and not taking the time to enroll. In this case, the default matters a lot. A paper by Brigitte Madrian and Dennis Shea finds that this is exactly what the evidence suggests. Looking at a Fortune 500 company, the researchers saw a surge in employees staying enrolled in the plan after the company switched to automatic enrollment, so employees needed to opt out, rather than opt in. This highlights an important managerial decision not just about which plans to offer, but about how to set the default.
A growing body of literature has now explored the ways in which people respond to default settings and what this means for managers. This is just one example of how behavioral economics can influence managerial decisions. More broadly, a background in behavioral economics can help managers have an appreciation of where the standard economic analysis suffices, and where they should think more about how to structure the environment in which people are making decisions. I’ve seen behavioral economics come into play in a variety of contexts, ranging from employee compensation and investment decisions to corporate strategy.
Gerdeman: Small “nudges” can help people make better decisions by changing the way choices are presented. How popular is this approach with businesses today?
Luca: The course I teach is focused primarily on the concept of choice architecture, which is a piece of the behavioral puzzle. The idea is that you can help people to make better decisions by understanding systematic biases in judgment and decision-making and changing the environment in which decisions are made—hopefully for the better. As mentioned, setting good defaults is an example of this. But there are a lot of others as well, such as simplifying the choice environment and eliminating unnecessary complexity.
"As a field, we need to learn more about where and when behavioral economics is most effective, and what are the limitations and unintended consequences..."
The approach has really taken hold in policy settings, and there are now many teams in governments focused on bringing behavioral insights and randomized controlled trials into the policy domain. While this is far from a panacea, it has been a positive development in policymaking.
Companies have long used behavioral economics but have more recently begun to create these types of teams to be more systematic about it. Banks around the world, including Fidelity, Lloyds in the UK, Commonwealth Bank in Australia, and BPI in France, all have teams of behavioral economists working to solve problems. Retailers such as Walmart are also putting together behavioral teams.
New frameworks are continuing to develop, and the broader use of behavioral economics has continued to scale at an impressive pace. It has been exciting to be part of this movement, but there is still a lot more to do.
Gerdeman: Where does the research go from here?
Luca: As a field, we need to learn more about where and when behavioral economics is most effective, and what are the limitations and unintended consequences of behavioral interventions. It’s important not to lose perspective; nudges and behavioral economics aren’t going to fix everything and need to be part of a broader approach to problem solving within organizations.
About the Author
Dina Gerdeman is a senior writer for Harvard Business School Working Knowledge.
[Image: Easyturn]
Related Reading:
The Business of Behavioral Economics
Why Government 'Nudges' Motivate Good Citizen Behavior
Sharpening Your Skills: Motivation