THE BEHAVIORAL ECONOMICS GUIDE 2016

There’s an ongoing and important debate about the ethics of nudging in marketing. In a recent
New York Times article, The Power of Nudges, for Good and Bad, Richard Thaler (2015) argued that
the use of nudges should be guided by three principles. Firstly, nudging should be transparent
and not misleading. Secondly, it should be easy to opt out of the nudge. Thirdly, there should be
“good reason to believe that the behavior being encouraged will improve the welfare of those
being nudged.” Thaler used examples from online newspaper subscriptions and airline bookings
to illustrate cases that fall short of meeting those guidelines. George Akerlof and Robert Shiller’s
new (2015) book Phishing for Phools provides a heap of examples about manipulation and
deception in the economic system. (A review by The Economist [2015] calls the book “thoughtprovoking”
but laments its inability to answer certain interesting questions, such as why phishing
occurs in some domains but not in others, or what could be done to prevent it.)
Finance, Regulation and the Limits of Nudging
Akerlof and Shiller’s book offers a wider look at phenomena related to the now popular
expression ‘irrational exuberance’ in financial markets. Financial markets are at the nexus of
multiple strands of applied behavioral science in both the public and the private sector. As a
result, finance is concerned with a range of stakeholders, from corporate actors to private
investors. According to Noah Smith (2015) at Bloomberg, finance seems to have embraced the
behavioral turn more than macroeconomics. He argues that researchers in finance are
pragmatic and interested mainly in approaches that work. Another reason mentioned by Smith
relates to the meaning of ‘behavioral’ in finance. While BE represents the use of psychology to
alter models of economic behavior, behavioral finance covers “anything that doesn’t conform to
the Efficient Markets Hypothesis (which says that you can only earn market-beating returns by
taking on extra risk).” Behavioral finance has embraced psychology to some extent, Smith
surmises, but it’s easier to show that standard finance theory fails than to provide evidence of
the psychological mechanisms that produce the failure.
Finance is a world full of complexity and uncertainty. Banks need to manage risk that arises both
internally (inside their organization) and externally (e.g. in natural, economic, and political
environments). The latter includes pressure surrounding compliance and uncertainty over the
direction and application of government regulations. Behavioral regulators are now heading in
the direction of bias correction, although the practical (and intuitive) objections to implementing
this policy remain unanswered (Miles, 2014). Internally, bias correction can help financial
institutions increase staff performance. With respect to external factors, bias correction also
includes banks’ relationships with customers and regulators.
In 2013, the then-CEO of the UK’s new Financial Conduct Authority (FCA), Martin Wheatley, gave
a talk at the London School of Economics, explaining the new direction that financial regulation
is taking in terms of the relationship between firms and consumers. Wheatley noted that,
historically, regulation was all about robotic compliance—reliance on rules, processes, and
disclosure. Today, the FCA assigns an important role to behavioral considerations throughout its
process of regulatory analysis (Iscenko et al., 2016). A core domain covered by the FCA’s
framework is consumer behavior 4 . For the purpose of understanding poor market performance,
4 A new book by Fred van Raaij (2016) aimed at scholars and policy makers provides a comprehensive review of
consumer financial behavior in terms of both different domains (saving, credit, insurance, tax, etc.) and psychological
Behavioral Economics Guide 2016 16