BUSINESS

The Limits Of Obama’s Favorite Economic Theory

Sometimes a nudge isn't enough.
President Barack Obama believes in subtly helping steer people away from predatory financial products. But sometimes a firmer
President Barack Obama believes in subtly helping steer people away from predatory financial products. But sometimes a firmer hand may be needed.

Economic theories don't usually get their own executive orders. But last summer, President Barack Obama changed that.

In September, the president issued an order, titled “Using Behavioral Science Insights to Better Serve the American People,” that essentially requires the federal government to use what Cass Sunstein, a Harvard Law professor, and Richard Thaler, a University of Chicago economics professor, call “nudges.” What's a nudge? Basically, it's a decision you make about the way choices are presented. In what order do you list someone's options? How do you describe each one? If you are asking someone to fill out a form, how long is it? How easy is it to understand? Where do you get it and where do you turn it in? And, crucially, what do you make the default option? Is it "click here to subscribe," or "click here to unsubscribe"? Opt-in or opt-out?

Some policymakers are strongly pro-nudge because they can be a cheap, simple and effective way to steer people in a particular direction, and help them make better choices -- or, anyway, what the policymakers believe to be better choices. Other people are uncomfortable with nudges, objecting to the whole idea of officials trying to exert a subtle influence in the name of advancing a policy agenda. But there's no such thing as no nudges: As soon as you try to present someone with options, you have to communicate those options somehow. And every possible method carries a nudge of some kind.

Obama has faith in the power of nudges. But how far do they actually get you? In a new paper, John Campbell, a professor of economics at Harvard, argues that sometimes a nudge is not enough. In many cases, strong, explicit regulation -- especially when it comes to consumer finance -- makes more sense.

Among economists, the general presumption is that "people know what they are doing, they’re consenting adults, leave them alone,” Campbell told The Huffington Post. But in some cases, like when it comes to consumer finance, this is almost certainly incorrect: A lot of us don't fully understand the financial services available to us, and some businesses are happy to take advantage of that. Campbell says his work shows that there are scientific reasons lawmakers should feel “comfortable intervening in markets to protect people from themselves.”

Intervention is necessary, he says, because disclosure and financial education aren’t enough to protect consumers. Lawmakers can legally require businesses to make certain information public, but it's easy to camouflage that information with colorful fonts and lots of extraneous words. Meanwhile, it's great to educate people about financial products, but businesses can always make those products more and more deliberately confusing.

Thaler told HuffPost in an email that he doesn't think he and Campbell really disagree.

Sunstein and I have never argued that nudges can solve all problems," Thaler wrote. "We need regulation to prevent and punish fraud, for example.”

Thaler said he thinks Campbell “underestimates the power and flexibility of [automatically pre-selected choices] as policy instruments.” But he agreed with Campbell’s core point.

"People have great difficulty with financial decisions and we need to help them out," Thaler wrote. "Moreover, neither education nor disclosure are sufficient. I have been saying similar things for years, just not as well!”

Campbell acknowledges that Sunstein and Thaler's nudges sometimes work. And when they do, they can have a major positive effect.

“It’s almost like a free lunch: We’ve made some people better off, we’ve hurt nobody," he said. "Libertarians can be happy, and paternalists can be happy. My point in this paper is to say, 'Yeah, that’s great when you can do it, but you may need to go further."

Regulators, particularly the Consumer Financial Protection Bureau (Campbell and Thaler both sit on the agency's academic research council), are moving beyond nudges.

Campbell says this is happening in the regulation of short-term credit, such as payday and car-title loans. You can nudge people away from using overdraft protection -- which allows bank customers to run a negative balance, but only if they repay the loan at a high interest rate -- by giving people the choice to sign up if they want it, instead of being automatically enrolled. But nudging people away from payday loans -- short-term, high-interest loans, secured by the borrower’s next paycheck, that often send people into a tailspin of debt -- is not as easy.

In that sense, Campbell's work formalizes the limit that's implicit in the name of Sunstein and Thaler's concept. Sometimes people need more than a nudge.

CONVERSATIONS