In an interview on Human Traits Essential to Capitalism

Your last three picks are all very recent books. Tell me about Nudge.

We’re now coming up to 2008, when Richard Thaler and Cass Sunstein published this book. It looks quite a bit different from the first two in that it reflects much more modern psychology. I admired Adam Smith for his personal observations, but there was no experimentation, there was no real modern psychology in it. What Sunstein and Thaler emphasise is a lot of principles of psychology that can only be understood with regard to actual experiments. So they talk about things like anchoring, availability, representativeness, heuristic optimism, overconfidence, asymmetry of appreciation of gains versus losses, status quo bias, framing, self-control mechanisms – all the things that we’ve learned about.

We’re way ahead of Adam Smith now in our understanding of people, and that suggests a different model for our economy. Nudge doesn’t present itself in a grandiose way at all, but it’s a very important book. It really is a different model of our economy, and how government should be involved.

How should we be organising our economy post-crisis?

The book points out that the free enterprise system emphasises choice. The classic theory of capitalism is that information is decentralised – it can’t be centralised – and so the important thing is that people should be, as Milton and Rose Friedman put it in their 1980 book of that name, ‘free to choose’. If people are free to choose, that will allow the economic system – and this is Adam Smith again – to adjust its activities to take account of all of their diverse information.

But what Thaler and Sunstein point out is that individual people are not experts in making any of these choices. They succumb to these psychological errors. As a result, they say that what our society should be doing is providing what they call "choice architecture". The government, which in their model is benevolent, sets up rules that encourage people to make the right choices, that nudge people to make the right decisions. But in cases where people have specific information that makes them want to do otherwise, they can.

Can you give an example?

I could give you the first example in their book, which is the Save More Tomorrow scheme. The problem they identify is that most people – at least in the United States, but I’m sure in other countries as well – don’t save enough for their retirement (or whatever) and that that failure to save is acknowledged. A survey of people in the United States asking, "Do you think you are saving enough?" found that most people said, "No, I’m not." So it’s like dieting, in that most people wish they were slimmer than they are, but they can’t quite do it. Similarly, they wish or think they should be saving more, and they can’t quite do it. That means we ought to offer policies or programmes that nudge them, that help them.

In the case of dieting, you don’t leave bowls of candy out all around the house if you know you’ll be tempted by them. Our society has to try to nudge people towards other virtues, like saving. The Save More Tomorrow plan is thus a very ingenious idea: You offer people the option of signing up for a programme that will withhold from their pay cheque any future pay increases. So you sign up today and you’ll be saving more tomorrow. And experiments with this show that it does indeed raise the saving rate. So this is the kind of thing the government needs to think more about doing. Abject acceptance of Adam Smith’s principles suggests that we should provide people with the most elaborate choices. The naive assumption has been that people can handle those choices, which isn’t right. But, instead, the government has a different role. It’s still a free enterprise system, but it’s one that has nudges in various places.

But it involves politicians being sensible, rather than just trying to get re-elected.

Cass Sunstein, one of the two authors, is now in a high position in the Obama administration, and some of their proposals have made it into legislation. I’m not a political scientist – government is imperfect, and it reflects special interests. But sometimes it triumphs, sometimes it does work. You bring in experts and they point out that we need to put chlorine in the water supply, and we do it! It does work. Sunstein and Thaler’s proposals will probably be somewhat adopted.

But in the savings example, isn’t there something cultural going on as well? The more capitalist a country is, the worse it seems to be at saving. I lived in China, where people might be earning RMB 1,000 a month, and yet somehow they managed to have RMB 30,000 in their savings account.

It’s an interesting phenomenon, and it may not be permanent. I think it may reflect the stage that China is going through. It used to be that the Japanese had a higher saving rate. In China, they have a sense of epic transformation right now. It’s a kind of patriotic feeling, as well as a sense of uncertainty, that encourages saving. It’s not the capitalist difference, I don’t think. You’re suggesting that China saves more because of some cultural values that are at odds with capitalism?

I think culture plays a big role in our attitude to money. I’m originally from Holland, where we like being thrifty.

That’s a stereotype of the Dutch, isn’t it? That they’re stingy?

It’s true. You may have a million dollars in the bank, but you’ll still take a bus rather than a taxi.

I bet it’s not true. Because if the Dutch had been conspicuous savers for centuries, they would be vastly richer than any of us. It would accumulate over centuries. I like to use another example from Holland, which is that home prices in Amsterdam, according to Piet Eichholtz at Maastricht University, haven’t gone up – they’re no higher in real terms today than they were 300 years ago. So, I’m sorry, but you can’t be right.

The amazing thing about saving is that if you really save a lot and you do it for a hundred years, reinvesting interest, you will get awfully rich, and that’s a fact. The best example of that is not Holland, it’s Singapore, which has had a government imposed saving plan. In Singapore, they have a mandatory saving plan that has propelled that nation up rapidly. It’s just arithmetic. If you save and invest, it adds up, because of the power of compound interest.

So in this context, Nudge is advocating a libertarian style of paternalism – a free-choice version of what Singapore is doing.

Yes, that’s right – by nudging people, rather than caning them.

In an interview on Behavioural Economics

Tell me about your next book, Nudge.

Nudge is also a very important book. One of the reasons Nudge is so important is because it’s taking these ideas and applying them to the policy domain. Here are the mistakes we make. Here are the ways marketers are trying to influence us. Here’s the way we might be able to fight back. If policymakers understood these principles, what could they do? The other important thing about the book is that it describes, in detail, small interventions. It’s basically a book about cheap persuasion.

What’s your favourite example in there?

My favourite example is the little fly when men pee [a painted fly in urinals which reduces spillage]. It’s not a big example, it’s not a hugely important social innovation. But it’s significant because it shows that in many cases – such as peeing – we are just not that thoughtful about what we’re doing. And because of that, we could take those cases and think about small ways to change the environment to get people to behave better.

The other interesting thing about Nudge, which goes beyond its application to policy, is that it brings up the philosophically difficult debate about behavioural economics: How much do you really want to push people? What level of pushing is OK, and what level of pushing is not OK? That’s a very difficult discussion. Imagine I taught you some tricks that allow you to persuade people to do what you want them to do. Up to what level is this OK, and up to what level is it not? Sunstein and Thaler take a very strong position on that. They call it “libertarian paternalism” [nudging behaviour without eliminating free choice]. At the end of the day, I don’t really agree with their position. But that doesn’t take away from the fact that they are the first ones to bring the discussion to the forefront.

Is there, in your view, a better way of doing it?

I don’t have a complete philosophical position on this. I actually don’t think there is going to be one answer, because it all depends on the cost, and how much danger people can get themselves into. For example, I don’t think that nudges are relevant to the domain of drinking or texting while driving. Sunstein and Thaler think nudges are enough to make people save for retirement. I don’t think so. I think we need to mandate saving for retirement. With the concept of nudges you’re basically saying, “People know what the right thing to do is, and as long as we push them a little bit it will be OK.” It’s a nice philosophical position. Because as a policymaker it’s hard to say, “People are really stupid, we need to protect them from killing and hurting themselves.” But often nudging may not be enough. It’s an empirical question. There are some cases where nudging might be sufficient. Sadly, in other cases where it’s not sufficient, we basically need to think about how to force people to do the right thing.

So straightforward paternalism, rather than the libertarian variety.

That’s right. And if I were a politician, it would be a tough sell. I don’t want to say to my constituents, “Look guys, I think you’re idiots. You’re incapable of making decisions, so I’m going to make them for you.” But I think there are many cases where this is the right thing to do. Maybe we could force people but allow them to appeal, so that not everybody is forced 100%.