In crafting economic policies do our governments consider the ‘mind’ of the ‘human’ for whom the policies are meant? For example, will healthcare policies tackling malnutrition consider the fact that children may not like healthy food choices or that parents may not want to shift from traditional food choices to healthier options? The answer to these questions lie in looking at the Behavioural school of thought, whose progenitor, the Nobel laureate Daniel Kahneman, passed away on March 27, 2024. Kahneman, an experimental psychologist, won the Noble Prize for Economics in 2002.

Why behavioural economics? While philosophers who wrote about economics (think Adam Smith) from the earliest times considered human biases and follies, the formalisation of economics with the neoclassical school led to the creation of the ‘rational human’ as the basic economic entity. The ‘rational economic agent’ can shift through hordes of information, ‘maximizing’ her utility subject to budget constraints.

However, are humans ‘rational’? The last time you were in a supermarket purchasing groceries, were you enticed to buy candies at the billing counter? Purchased items on ‘offer’ you really did not need? We are indeed subject to biases that impact our economic decision-making.

Much like the atoms of physical sciences, the economic agents in economics are building blocks: and wrong assumptions about them render the entire edifice shaky. It took psychologists Kahneman and Amos Tversky to drive home this point, leading to the birth of behavioural economics.

Key insights

Kahneman and Tversky’s path-breaking work in the 1974 showed how humans are subject to ‘predictable’ biases. The duo’s work on Prospect theory (1979) introduced concepts like loss aversion which tells us why, for example, we are ‘more pained’ at losses, than we are ‘happy’ about equivalent gains. While behavioural economics has expanded in myriad direction in the last 50-odd years, one of the most pertinent is public policy.

If human beings fail to take rational decisions, from the choice of a meal in a cafeteria to savings preferences, should the ‘state’ step in to ‘nudge’ them in the ‘right’ direction? Behavioural public economics, following on the work of Kahneman (with Tversky) and extended upon by Nobel Laureate Richard Thaler, shows how public policy-making can be modulated keeping in view humans are prone to biases. Nudge theory talks of ‘libertarian paternalism’ — where public and private institutions can design effective policies for humans with limited rationality and willpower. The Nudge theory thus offers a scope for policymakers to ‘correct’ inherent cognitive biases in citizens.

A good example are policies during the Covid-19 pandemic, which showed how difficult interventions that target regular behaviour can be. Changing habits through improved information was not always effective. Nudge-based interventions, like ‘guiding’ people in public places to a ‘hand-washing’ section and so on, worked better. Moreover, nudging need not be limited to individuals. Policies like ‘green nudges’ can help in addressing environmental concerns.

However, ‘nudge theory’ is not without criticisms. If the government takes up ‘paternalism’, can we rely on it to be ‘libertarian’ always? Who decides what is the ‘right’ choice and how? How do we prevent the use of ‘paternalism’ based on say religious or moral notions? However, this does not mean a step back from behavioural public economics or ‘Nudges’: it means we need more discussion on ‘how’ to do it right. Acknowledging the departure from rationality is not only crucial for policymakers. Going forward, these are areas which will require extension of the insights developed by Kahneman, the psychologist who gate-crashed into economics.

The writer is Associate Professor at National Institute of Bank Management, Pune. Views are personal