Monday, August 31, 2009

On Becoming a Libertarian Paternalist: Designing Better Policies for the Society (Part 2)

In my post dated 26 August 2009, we have discussed the basic concepts of Libertarian Paternalism, introduction to better policy making, and examples of human errors with respect to daily economic activities. Today, we will discuss some useful guidelines in making better policies and how to implement such guidelines in actual life.

The Six Guidelines of Better Policy Making

According to Thaler and Sunstein, there are 6 basic guidelines for better policy making:
  • Expect Error;
  • Defaults;
  • Understand Mappings;
  • Give Feedback;
  • Structure Complex Choices; and
  • Incentives.
Each will be further discussed below:


1. Expect Error

I guess this is the first guideline to be considered by policy makers. Since most men make mistakes, a good policy will consider such fact and will ensure that the mistakes can be fixed in the easiest way.

What is the actual implication of this guideline? While governments or private institutions can try their best to design a good policy, they must be aware on the possible failures due to human errors and must ensure that the system will be able to sustain and fix such problem. There are many examples for this problem, but let me show a very interesting case as provided by Thaler and Sunstein, that is the case of birth control pills. Some of you might be aware that in one month, most women will take birth control pills for about three consecutive weeks and then stop for one week (due to the menstruation period). Many women have difficulties to adopt to this system and some of them may forget to take their pills in accordance with the required schedule. So what the companies do with this condition? They provide 28 pills in 28 containers, each having a specific number from 1 to 28. However, pills in containers no. 22 till 28 are only placebos made for the sake of compliance by human users, and thus they don't have any effect whatsoever. Interesting isn't it?

2. Default
The "Default" guideline is made due to the fact that most people will take the options which require the least effort, or in other word, people would instinctively take the easiest route in doing something (seems familiar?). In our daily life, the "Default" option represents an option that, if the chooser does not do anything, will cause most people to end with such option, whether the option itself is good or bad. The case will be stronger if there is any suggestion (explicit or implicit) on such "Default" option, i.e. people will most likely take such option without much hesitation.

In reality, we can't avoid this "Default" problem. Governments and private options in many cases need to provide "Default" option, such as the default choice of menu in a fine-dining restaurant or the default choice for investment policies in your pension funds. Now, since the "Default" option is very powerful, it would be best to ensure that any "Default" option is made for the benefit of the people. How can we do this?

There are two possible ways. First, we can design that each "Default" option requires an active approval from the relevant user. This means that a "Default" option will only be applied once it has been approved by the user. However, in several cases, some people ended up with having no benefit simply because they are too lazy to activate their own "Default" option.

The other way is to design the best possible policy that can be made by the government or private institutions and then such policy will be made as the default option, whereas any people who don't agree with such option will always be free to opt out. Take as an example your computer's download system. All major software company requires the user to actively choose whether they want to download a file or not for each downloading session as a default option, instead of the automatic downloading system. Why? Simply because downloading a file automatically might be dangerous (e.g. causing computer virus attack) and you'll need to properly asses such risk whenever you are trying to download a file. Simple, but important. And in each case, you can always change the setting (of course, if your administrator permits you to do that).

3. Understand Mapping
The third guideline deals with the fact that most people will have some difficulties when they are facing complex choices. A good policy will provide some mapping mechanism to its users, enable them to review the possible options in an easier manner and will allow them to choose the best option for them. In other words, we're talking about better disclosure to the public.

Now, let me ask you some simple questions, do you really understand the actual costs for using your credit card ? Or how to calculate your telephone bills? I bet that most of us wouldn't even know.

That's why we need a regulation which would require companies to have better disclosure system. The implementation of the "Understand Mapping" guideline should be cheap and will maintain the basic freedom of choice for consumers. It would also be good for the business because it can increase fair competition without having to use excessive litigation method (such as the use of Anti Monopoly and Unfair Competition Commission) or forced price control.

As an example, let us see the telecommunication industry. Imagine that the Government now requires each telecommunication provider to provide all relevant information related to the costs of their services and to provide a simple costs comparison with other providers. The information should also be easy to be obtained by all consumer. With this kind of policy, we would have a better understanding on the actual costs for using telecommunication services and can easily spot the best provider which would satisfy our needs. Each telecommunication company will also have better incentives to increase their business efficiency and to optimize their services due to this information disclosure system. Wouldn't that be nice?

4. Give Feedback
It goes without saying that a good policy will be able to provide a feedback to the user, whether they have done well, or were actually making mistakes. A nice example provided by Thaler and Sunstein is our internal computer system that warns us before our computer battery completely runs out.

Based on this guideline, I also have an idea where there is an integrated system to supervise the use of credit cards by each person. We know that each credit card has its own limit. However, in many cases, rather than acting as a limiter for people in using credit cards, such limit encourages people to spend their credit cards up to its maximum limit, and in some other cases, people tend to obtain many credit cards to increase their total credit cards limit. All of these are totally wrong.

Now, by using this integrated system, the banks would know how many credit cards are owned by a person, including each of their limits. Whenever certain amount of the combination of the limits have been reached (which should be in accordance with the credit worthiness of the user), all of the credit cards wouldn't be available for use. We have this supervision system for banking loan and credits application, why not for credit cards? We can help many people by using this kind of system. Remember, having many credit cards doesn't mean that you're becoming richer.

5. Structure Complex Choices
Actually, this guideline is deeply related to Guideline no. 3. When people are facing complex choices, they tend to simplify the choice. That's why a good policy maker will structure its policies to be easily understood and choosed by the user. One of the most useful methods that is being widely used is the "Collaborative Filtering."

Don't be afraid with the name, since it's basically a public review system and the internet really helps the development of this method. As an example, when you want to buy a law textbook and you have many choices but don't have enough time to read all of the available books, what would you do? You'll ask other people's opinion right? In the world wide web, you can simply search the title using Goggle or Yahoo and then you can see whether any people have made a review on such book. It is easy, cheap, and in most cases would be helpful for us in making an efficient decision.

6. Incentives
This is my favorite guideline and has been discussed various times in my other posts. It's very simple, people respond to incentives, they actually calculate the costs and benefits of everything, though maybe not as complex as a professional would be. Therefore, a good policy should always calculate the best incentive to be used in order to make such policy can be effectively applied.

Some legal scholars claim that currently most regulations are no longer effective to bind the people and therefore they are questioning the efficacy of the law itself. If only these people understand the basic nature of men, they would not say such a thing. You can't expect people to follow the law if you don't provide a suitable incentives for them. If you think that people will act according to a law only because of morality or religious reasons, I suggest that you need to reevaluate again your idea, or I'm afraid you will be frustrated.

I wouldn't provide any examples for this guideline as I believe you have seen many in my previous posts and I assure you that you will see more in my future posts.
Concluding Remarks

I hope this article can enlighten you on how the government and private institutions should design a policy which would maximize the benefit for the people without minimum cost to the people's freedom of choice. I personally agree with most of this Libertarian Paternalism movement, but I need to put some qualification here. What matter most to me is finding the most effective policy in improving people's live, so when the circumstances show that preserving free choice would not be efficient, some other methods would be needed. This is especially relevant when we're dealing with major criminal acts, such as terrorism, money laundering, and corruption. Of course it would be really nice to reduce these criminal acts by using positive incentives, but don't put too much faith on that.

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