Saturday, March 17, 2007

The New Default

There's a good article in the New York Times by Teresa Tritch called "Helping People Help Themselves," about the influence of behavioral economics on public policy. (It's TimesSelect, but if you've got an .edu address, that's no longer a problem.) In particular, Tritch looks at the 2006 pension reform bill:

A key provision of the 2006 pension reform law allows an employer to automatically enroll employees in the company’s 401(k) retirement plan, rather than requiring them to sign up.

The idea for “auto-enrollment” came from research in behavioral economics showing that status quo bias is prominent among the factors that keep non-savers from participating fully in 401(k)s. The tendency to continue doing what one has always done — such as spending one’s paycheck rather than saving a portion of it — is often stronger than the rational arguments in favor of joining the 401(k). Procrastination only magnifies status quo bias.

Automatically enrolling all employees circumvents status quo bias — but not, it’s important to note, by usurping choice. Employees are free to opt out if they don’t want to participate. Once enrolled, however, status quo bias works for — not against — the goal of bigger nest eggs, because saving a part of each paycheck becomes the new norm, helping to ensure that workers stick with the savings program.

Tritch also describes “loss aversion” (where people feel perceived loss more acutely than gain) and "endowment effect" (a kind of fetishization of our own money because we have it). Both of these, along with "decision paralysis" (where we avoid decision in favor of the default), typically hinder us from making the calculation that 401(k) contributions are a good idea. Instead, we hold onto our money like it's, well, money.

But if our default position is to opt-in rather than opt-out, we're much more likely to do it. It's less work, for one thing; and it's easier for us to rationalize pension contributions as one more thing that's taken out of our check, whether we do anything or not. It becomes the new default -- we could choose to opt out and do something else with our money, but in the absence of strong economic pressure or an usually market-minded mindset, we probably won't.

Tritch generally avoids coming down firmly on any policy prescriptions apart from the pension law, opting for open-ended rhetorical questions instead. But she does approvingly quote the following general principle, from economists Richard Thaler and Cass Sunstein:

Mr. Thaler and Mr. Sunstein point out that in situations where it seems that no one is making a controlling decision, it is usually because “the starting point appears so natural and obvious,” it is taken as a given. Automatic enrollment, however, is a different choice that establishes a different default position. Is steering the employee in the direction of participating objectionable? No, especially since the employee is free to opt out.

Which leads to their second point in the search for a middle way between hands-off government and the nanny state. If no coercion is involved, there is no justification for rejecting government interventions out of hand.

There are two policy areas that I immediately thought of when I read this, each of which would push the status quo in opposite directions.

The first is health care. Most employer-based health care begins with a default position, the plan chosen by your employer; however, you can choose to opt out, getting a lump sum that you can put towards shopping another plan (or if you already have coverage through a spouse, pocketing the difference).

Why wouldn't this work for government-paid health insurance as well? The default plan would enroll everyone in one (or perhaps a mercifully small selection) of national health care plans; if you don't like any of those plans, or don't want to have health insurance, you could petition to get your money back. It wouldn't kill the private health insurance industry, but would definitely transform it; you could easily imagine higher-priced boutique insurance (the equivalent of private prep school) and cut-rate catastrophic care plans (the equivalent of just-legal liability-only car insurance). It would be much closer to a genuine free market than what we have now -- and by default, everyone would be covered.

The other policy area is K-12 education, where the default position is (rightly, in my opinion) automatic enrollment, but which is currently by Thaler and Sunstein's standards a tad on the coercive side. In most cases, you're required to enroll in the neighborhood public school, or, if you opt for private school, you get nothing back to offset the increased tuition. The auto-enroll + anti-coercion position pushes you towards a real school-of-choice program plus private school tuition rebates/vouchers. Which is, conveniently, the position I find myself supporting most of the time.

I'm not sure how I would feel about allowing children/parents to go off the grid entirely, for either home-schooling or non-education altogether. Again, my typical position is that mandatory education exists in part to protect children from the choices of their parents, and get them to the point where they can make economic, political, educational, and personal decisions for themselves. You have to remember, for every parent who wants to home-school their child so they can teach them about Jesus, there's a drug-addicted or alcoholic parent who would be more than happy to have their kids drop out if it meant a few extra thousand dollars in income.

This is the other point, which is that economic choice requires some basic level of government regulation. You can't have a fly-by-night insurance company making off with people's health insurance money and either refusing to pay out or making off with it altogether. Likewise, if the money is being routed through the federal government for the purpose of education, schools receiving this money should submit to some regulation to meet standards for their educational mission. If private schools weren't willing to submit to any regulation, they could continue to operate the way they do now, totally subsisting off tuition, donations, and endowment. No federal education money.

To me, this seems like a much saner approach to both health care and education than either the current status quo or the utopian dreams of either a totally-market-based or totally-socialized approach. But surely, even with my refined intellect, there's something here I'm missing. Any thoughts?


PoN said...

The setting of a default with a solid opt-out option is something that warms even my libertarian heart.

Regarding the alcholic parent who wants to force their kid out of school - I definitely think vouchers are the way to go (not bags of cash).

"schools receiving this money should submit to some regulation to meet standards for their educational mission"
I also agree. But I think it should be pretty broad, like at least 75% of graduates can perform at or above state level. We continue to fund public monopoly education that does much worse.

PoN said...

Oh something I forgot:

“The presumption that individual choices should be free from interference is usually based on the assumption that people do a good job of making choices, or at least that they do a far better job than third parties could do,” wrote Richard H. Thaler — another presumptive candidate for the Nobel Prize — and Cass R. Sunstein, both of the University of Chicago, in a recent essay. “As far as we can tell, there is little empirical support for this claim."

There is a huge caveat left out from this statement: which is that the decision-maker's goal in both cases is to maximize the welfare of the subject. There's also a wealth of research on agency conflicts. From CEO stock scandals to our president leading us after Iraq's "WMD", those we have making decisions for us often do not have our best interests in mind.

That's why I much more comfortable with the sorts of programs that rely on status quo bias, or combating impulse.

Also, I don't know where to put this, but the kinds of programs where you make a decision that gets locked in always reminds me of the Odyssey. Odysseus bound himself to the mast of his ship so he could hear the call of the Sirens, but not swim off to his death. Predictably, I'm cool with that.