Government Forgets about the Market When Trying to Change Behavior

Making good long-term decisions is important, yet few of us seem to be on top of it.

Investing in a retirement plan while you are young can save you considerable hardship when you are older. However, some estimates show that more than half of Americans are not saving enough for retirement.

Most people understand the importance of a healthy diet, yet over two-thirds of Americans are either overweight or obese, which may lead to host of major health problems.

Similarly, chronic patients who are prescribed a lengthy course of treatment often fail to take their medication, which leads to an estimated $100 billion to $300 billion in additional medical expenditures each year through hospitalization and more expensive treatments.

What all these problems have in common is that they stem from consumers' inability to take the most beneficial course of action due to behavioral biases. Scholars refer to these biased decisions as behavioral failures.

As the examples above demonstrate, the impact of these decisions can be substantial.

Faced with these concerns, policymakers have increasingly sought to counter behavioral biases through regulations and taxes.

In 2015, the city of Berkeley, California, passed the first tax on sugary drinks in an effort to curb consumption of soda and ultimately reduce obesity. On a federal level, the Department of Energy issued a series of regulations over the last decade that imposed a higher energy efficiency standard on appliance manufacturers. The agency justified the efficiency standards primarily on the grounds of saving consumers money in the long term.

Other prominent examples include regulation in the areas of consumer finance and food labeling.

What often escapes the notice of policymakers is the crucial role that markets play in generating products and services that would help consumers overcome their biases.

For example, financial advisers and personal finance apps help consumers stay on track with their finances. Similarly, numerous diets and wearable technology tools help consumers reduce the negative impacts of excess weight.

Similar to policy prescriptions, these tools increasingly incorporate behavioral insights to become more effective in helping consumers overcome their biased decision-making.

My recently published edited book, "Nudge Theory in Action," examines the challenges and successes of both government and market nudges.

The analysis shows that neither approach is without downside.

While markets excel in experimentation and innovation in their search for effective solutions, there are real concerns with companies exploiting consumers' biases for their own benefit.

In contrast, regulatory approaches often lack the flexibility to innovate or incentives to continuously improve upon their solutions.

For example, while the Department of Energy's energy-efficiency standards have reduced consumer spending on energy, these savings often came at a considerable upfront cost to consumers. Given the considerable differences among consumers and their ability to finance new appliance purchases, the standard left some consumers worse off.

Importantly, the standard limited the appliance choices available to consumers.

In contrast, an energy analytics company Opower used behavioral insights to help consumers reduce their energy usage. The company did so by showing consumers how their energy usage compares to their neighbors.

While completely voluntary, the service resulted in significant reduction in energy expenditures.

Government efforts to correct consumers' mistakes through regulations or programs will likely become more prominent in the future.

In 2015, President Obama issued an executive order that encouraged federal agencies to employ behavioral insights to design more effective government policies and programs. Further, the order directed all agencies to develop strategies for greater use of behavioral sciences.

However, the limited success of behavioral regulations and taxes to date indicates that the rush to nudge consumers may be premature.