Harvard economist Sendhil Mullainathan is one of a new generation of economists of Indian origin who have made a mark in global economics. Mullainathan and others such as Abhijit Banerjee, Raghuram Rajan and Viral Acharya are following in the footsteps of an earlier generation of giants such as Jagdish Bhagwati, Amartya Sen, T.N. Srinivasan, Avinash Dixit and Partha Dasgupta.
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Mullainathan is a behavioural economist, part of a growing band of economists that studies how humans are wired to make economic choices not always in their best interests. We often save less than we should or follow unhealthy lifestyles. Neither banning an activity nor taxing it heavily nor providing more information to consumers can alter behaviour on its own. The problem lies with the way our brains are wired. We are fallible. Behavioural economists do not accept the standard assumption used by mainstream economists that people are rational cyborgs who always choose what is best for them. Their view of human thinking is more nuanced and gives due importance to the ability of our biases and cognitive limitations.
I was lucky to listen to a fascinating talk given by Mullainathan at the TED India conference held in Mysore in 2009. He spoke of how all of us make choices that ensure that problems such as poverty, corruption and discrimination are sticky despite good ideas on how to deal with them. For example, he asked why some 400,000 Indian children die of diarrhoea every year despite the easy availability of simple solutions such as oral rehydration salts. It’s worth watching this video on www.ted.com.
Last week, the US government appointed Mullainathan to a senior position in the Consumer Financial Protection Bureau, a new agency set up after the financial crisis to ensure that “markets for consumer financial products and services work for Americans”. The Barack Obama administration had earlier appointed Peter Orszag, an economist with a deep interest in behavioural economics, as its budget czar; he later resigned. UK Prime Minister David Cameron has set up a so-called nudge unit to use the insights of behavioural economics to make the right choices about, say health and savings, without a heavy dose of regulation.
These appointments are perhaps an indication that behavioural economics is gradually moving from the fringes to the heart of policy. The timing is apt. It comes around a decade after Daniel Kahneman won the Nobel Prize in economics for his integrating the results of psychology in his studies of human decision making under uncertainty. Though the circumstances were different, it took a similar span of time for the insights of two other radical thinkers to make their way into economic policy. Keynesian economic policy became the ruling ideology 10 years after the publication of The General Theory of Employment, Interest and Money in 1936. Western governments embraced monetarism almost 10 years after Milton Friedman published his landmark paper, “The Role of Monetary Policy”, in the American Economic Review.
Libertarians have good reason to ask why governments should believe they are capable of directing people towards better choices. But behavioural economists say in their defence that the goal of a nudge policy is not to impose decisions on citizens, but to create an environment where better choices are more likely to be made. The metaphor of nudging is borrowed from Nudge: Improving Decisions About Health, Wealth and Happiness, by Richard Thaler and Cass Sunstein.
The question of whether policy based on behavioural economics is just another name for state paternalism—where governments pretend to know more than citizens—will continue to dog us. The larger criticism about whether behavioural economics has anything useful to tell policymakers has still not been adequately addressed. Can it be used to change behaviour in more important areas than the prevention of smoking or avoiding binge eating?
One critical policy question where the insights of behavioural economics can be applied relates to the current Indian debate on whether the government should provide cheap food or free cash to the poor. Those who argue in favour of food fear that the poor may misuse cash to buy alcohol or gamble it away. Banerjee and Esther Duflo have showed in their careful analysis of the economic lives of the poor that even families with very low incomes spend a disproportionate amount of money on items such as entertainment.
The Indian government would do well to invite behavioural economists to understand why the poor behave as they do, and whether it is possible to tweak conditional cash transfer schemes so that people are nudged into using their cash received from the government to buy food or healthcare rather than more immediate attractions. The policy debate would hopefully be enriched if some of this empirical research were put on the table. And some light would hopefully replace some of the excess heat in the ongoing battles about how to help the poor.
Niranjan Rajadhyaksha is executive editor of Mint. Your comments are welcome at firstname.lastname@example.org