No nudging, please

Despite what politicians and senior bureaucrats may let on, governments are highly susceptible to the allure of policy fads.

Federal Finance and Deregulation Minister Lindsay Tanner recently jumped on the behavioural economics, or "nudge theory", bandwagon, describing it as a way to ensure human behaviour was integrated into policy frameworks.  Developed by economists such as Nobel laureate Daniel Kahneman and Barack Obama's regulation tsar Cass Sunstein, nudge theory finds individuals often behave in ways that do not conform to the conventional view of the rational economic man.

Some prefer the status quo when making, say, consumption and labour market decisions, even though change would make them better off.  Others tend to follow the herd by mimicking the decisions of those around them.

For many of us, herders or status quo-ers alike, nudge theorists find our economic choices are often framed by the context in which they are presented.  As set out by the nudge theorists, people often display systemic errors of judgment compared with the neoclassical standard of economic behaviour.  Governments should steer individuals or businesses in preferred directions, but leave open the option for the regulated to choose their own course of action.

This peculiar stance for policy is known as libertarian paternalism and has already started drifting into the Australian policy discourse.

The discussion papers from the National Preventative Health Taskforce are replete with nudge references, advocating policies to stop people smoking, drinking and eating treats.

The insights of behavioural economics have infiltrated other areas of policy, ranging from gambling regulation right through to superannuation and financial market regulations.

Indeed, any issue affecting individual risks and actions seems to be fair game in the minds of nudge regulators.

Some commentators have seized on nudge theory to proclaim it as the death knell for neoliberal, free market economics.  However, the strongest case for free markets in fact rests on a world inhabited by fallible individuals.

Even with their cognitive and behavioural biases in tow, market competition gives economic actors incentives to learn from and correct any errors, thus improving on the assortment of goods and services on offer.  Because of this the freest economies in the world are also the most conducive to economic growth, social accord and personal happiness, even if they remain inhabited by imperfect humans.

The notion that the state should nudge individuals to make better decisions overlooks the fact politicians and government officials are also afflicted by behavioural biases.

For example, the raft of fiscal stimulus and regulation enacted by the Rudd government since late last year revealed an action bias by the government to do something about changing economic conditions.

In an effort to throw borrowed money at selected activities, such as pink batt insulation and school gymnasiums, the long-term costs of these policies appear to have been ignored.

These include the risks of overshot government spending driving up real interest rates and inflationary expectations, as noted in a recent report by the Bank for International Settlements.

That, and the stated reluctance of the government to withdraw its fiscal stimulus and financial sector guarantees, have almost certainly reduced the productive potential of the Australia economy in the long term.

Therefore, the behavioural biases possessed by public sector agents greatly weaken the notion that somehow they can instigate policies to rectify the biases existing elsewhere.

There is a risk that a new nudging rationale for government intervention would encourage politicians with a control bias, or a propensity to prefer greater public sector involvement in economic and social affairs, to meddle even more in our affairs.

Some of the more conventional problems of public policy remain unaffected by nudge economics.

Economist Friedrich Hayek pointed out that policies are affected by an inherent knowledge problem.  This means that a comprehension of individual preferences and circumstances by governments is extremely limited, increasing the risk of policy errors.

By not knowing what people really want, governments also remain susceptible to self-interested arguments by rent seekers delivering special benefits to the few at the expense of the many.

Despite the fanfare, the latest fad of nudge theory is nothing more than old-style paternalism in new clothing.  After all, nudge taxing, spending and regulating would have the same consequences of eroding our economic and social liberties as do the tired interventions of yesterday.

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