Experimental & Behavioral Economics Defaults, paternalism, and 2019-05-29¢  Experimental & Behavioral

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  • Experimental & Behavioral Economics

    Defaults, paternalism, and nudges

    Prof. Dr. Dorothea Kübler Taught by Dr. Hande Erkut Summer term 2019

  • Memos Nudging: Pros


  • 3

    Nudging targets behavior rather than beliefs

  • 4

    Nudging: Robustness?

  • 5

    Nudging: Egalitarian?

  • 6

    Nudging: Egalitarian?

  • • Economics deals with choices that people make, how the choices of decision makers interact etc.

    • Revealed preference theory (Samuelson, 1948) shows how to construct utility functions (that are not observable) from (observable) choices.

    • Experiments investigate real choices in contrast to surveys with attitudinal questions, measurement of physiological reactions etc.


  • Revealed preferences (Positive):

    – The choices that people make

    Normative preferences: – The choices that they should make


  • Positive (revealed) preferences

    • Positive preferences are preferences that predict my choices

    • Economists usually assume that revealed preferences are normative preferences (policy recommendation are often based upon revealed preferences, thus implicitly assuming revealed preferences = normative preferences)

    • Example: choosing dark chocolate over milk chocolate reveals preference for one kind of chocolate over another…


  • Normative preferences

    • Normative preferences are preferences that society (or you) should optimize

    • Normative preferences are philosophical constructs • Normative debates are settled with empirical evidence and

    philosophical (ethical) arguments


  • The limits to “revealed preferences”

    Behavioral economists are particularly skeptical of the claim that positive and normative preferences are identical. Why? Cognitive mistakes

    – Complexity of choice (e.g., financial products) -> delay or avoid decision

    – Limited personal experience -> some decisions are made only once in a lifetime (…)

    – Passive choice, i.e., people often accept default options (made by others) -> preferences may be unstable because variation in defaults can generate variation in outcomes

    – Self control problems


  • Choosing Today Eating Next Week Time

    If you were deciding today, would you choose fruit or chocolate for next week? Read and van Leeuwen (1998)


    Self-control problem

  • Choosing Today Eating Next Week Time

    Today subjects typically choose fruit for next week. -> 74 % choose fruit


  • Time

    If you were deciding today, would you choose fruit or chocolate for today?

    Choosing and eating simultaneously


  • Time Choosing and eating simultaneously

    70% choose chocolate


  •  Desire for instant gratification (Read, Loewenstein & Kalyanaraman, 1999) Choose among 24 movie videos • Some are “low brow”: Four Weddings and a Funeral • Some are “high brow”: Schindler’s List

    • Picking for tonight: 56% of subjects choose “low brow.” • Picking for night two weeks away: 29% choose “low brow.”

    ->Tonight I want to have fun…, next week I want things that are good

    for me.


  • Present-Bias and Consumption

    Generally, intertemporal decisions can be classified according to when costs and benefits of a decision occur. Simple theoretical framework: • Consumption activity A with benefits u(x1) in t=1 and u(x2) in t=2 • Activity A can be

    – An investment good: immediate costs, long-run benefits (e.g., exercising, doing homework, “high brow” movie): u(x1)0

    – A leisure good: immediate benefit, long-run costs (e.g., spend on credit card, smoke cigarette): u(x1)>0 , u(x2)

  • How is consumption decision impacted by present-bias? • Desired consumption at t=0:

    ex ante agent wants to consume at t=1 if

    • Actual consumption at t=1:

    agent consumes if

    • Self-control problem (if β u(x2)>0 – Agent over-consumes leisure goods -> u(x2)

  • Naiveté and consumption How is consumption decision impacted by naiveté? • Forecasted consumption: at t=0 agent expects to consume A if with estimate of β in future periods (from t=0‘s perspective) • At t=1 agent consumes A if

    • Naiveté (if ): – Agent over-estimates consumption of investment goods -> u(x2)>0 – Agent under-estimates consumption of leisure goods -> u(x2)

  • Self-control & 401(k) savings plans

    • Voluntary, private retirement saving plan & one of the most important pillars of the US retirement system

    • “Employer-sponsored” plan, i.e., employer offers the plan to employees • Employees are free to choose

    – whether or not to enroll – contribution level (saving rate) – portfolio composition

    • Penalty for early withdrawal of funds • Strong incentives for employees to participate in 401(k) plans

    – tax deferral (defined contribution framework) – often: contributions up to certain threshold matched by employer

     nevertheless, people seem to save “too little” for retirement


  • Madrian and Shea (QJE,2001)

    • Study the impact of change in default rule on 401(k) savings behavior at a large US firm.

    – Health Care company – Paper-and-pencil 401(k) choice

    Default rule:

    employees have to enroll actively if they want to participate in the plan

     “Opt In”

    Default rule:

    employees have to notify employer if they do not want to participate

     “Opt Out”

    April 1, 1998


  • Active Enrollment

    Before April 1, 1998: Opt in regime

    – Only employees with at least one year of employment are eligible to participate.

    – Choose contribution rate between 1% and 15%, with 50% employer match for first 6%.

    – In order to participate, employees have to • authorize payroll to deduce contribution • choose contribution rate • choose investment allocation.


  • Automatic Enrollment

    After April 1, 1998: Opt out regime

    – All employees can participate immediately. – Employer match only for employees with at least one

    year of employment. – New employees are automatically enrolled in 401(k)

    plan with possibility to opt out. – Default contribution rate = 3%. – Default allocation = 100% money market fund. – Possibility to change contribution rate and allocation at

    any time • identical constraints as before April 1 23

  • Measuring the Effects of Automatic Enrollment

    How to exploit the discontinuity in 401(k) design? Compare three groups of employees:

    – OLD (hired before 03/31/97)*: employed, eligible before 04/01/98, no automatic enrollment

    – WINDOW (hired between 04/01/97 and 03/31/98): employed, not eligible before 04/01/98, no automatic enrollment

    – NEW (hired after 04/01/98): eligible, automatic enrollment with less than 2 years of tenure

    – 3+, three and more years of tenure

    Compare participation, contribution, and asset allocation Data from June 1997 – June 1999


  • Participation on June 30, 1999

    • Tenure matters • WINDOW has higher average tenure on June 30, 99 than NEW  Compare group behavior for similar level of tenure.

    Madrian/Shea (2000)

    Participation rates


  • Contribution rates, conditional on participating (default = 3%)

    • Difference remains when controlling for employer-match eligibility, tenure and individual differences.


    Contribution rates

  • Explaining the default effect

    • Status quo bias (driven by procrastination) Why procrastinate? -> procrastination happens if cost exceeds short run benefits

    – Direct transaction costs: implementing a decision – Indirect transaction costs: making a decision

    • Complexity (contribution rate, allocation of portfolio)

    – Self-control problem


  • In general, defaults can influence outcomes without restricting choices of decision makers -> makes it interesting for policy makers • Caveat:

    – The very inertia that increases 401(k) participation also lowers employees’ contribution rate.

    – Overall, this may lead to lower total savings in the long run compared to alternative plans that require active savings decisions.

    • Alternatives: – Choose higher contribution rate as default (might not

    be possible for all employees) -> SMarT (Thaler, Benarzi, JPE 2004)

    – Implement active decisions


  • Active decision mechanisms require employees to make an active choice about 401(k) participation.

    – Welcome to the company