The Concept of Choice Architecture - Essay Example

Written Assignment Critically evaluate the concept of choice architecture and the ‘Save More Tomorrow’ schemes adopted in the US and the UK. Thaler and Sunstein (2009) define a ‘choice architect’ as an individual who has the responsibility of shaping the context in which decision making takes place. The main idea behind choice architecture is that decision making occurs in a dynamic environment which is shaped by various elements that influence decisions (Thaler, Sunstein & Balz, 2010). A choice architect creates the context or the environment in which decisions are taken. Under this definition, a person who designs a particular contribution plan for employees to enroll in is also a choice architect. And so is a doctor who prescribes alternative methods of treatment. In many of the publications concerning choice architecture, the idea of using choice architecture to make better choices has been emphasized (Thaler & Sunstein, 2009; Thaler, Sunstein & Balz, 2010). This is called libertarian paternalism which advocates freedom of choice (Thaler & Sunstein, 2009; Thaler, Sunstein & Balz, 2010; Blumenthal-Barby, 2013). As such, people should be free to make choices and to opt out of programs as they wish. In 2012 a Committee of MPs suggested relaxation of the NEST pension scheme in order to make it more attractive (BBC News, 2012). This would involve elimination of the limit on how much can be paid in and the transfer of existing pension pots into the pension scheme. Currently, the workplace pension policy implemented by the UK government allows employees to opt out of the plan (Department for Work & Pensions, 2014). Hence, the ability to opt out of the plan reflects libertarian paternalism. The resulting impact is that the employers as well as the government – as choice architects – have pointed the employees to a direction where they can attain a greater benefit. Meaning, the choice architects have enabled employees to make better choices that benefit them. The involvement of choice architects in libertarian paternalism is of vital importance. Choice architects enable better choices by nudging people (Thaler & Sunstein, 2009). Nudge is an action used figuratively to suggest enablement or encouragement of people so that better choices can be made. So a choice architect points the individual to the decision which is beneficial but without restricting one’s freedom of choice or attempting to influence their choices or forcing the outcome on them (Coons and Weber, 2013). In the end choice architecture is an approach to make better decisions by focusing on intricacies and directing the decision maker through a relevant context (Widger and Crosby, 2014). Two important choices that are faced by a household involve savings and investments. Thaler and Benartzi (2004) explain that many households may fail to optimize their money management and one reason for this imbalance is the lack of self-control (Thaler & Shefrin, 1981). Traditional benefit plans or as the authors call it, defined-benefit plans, do not require any form of self-control thereby explaining the lack of self-restraint and control. However with the emergence of “defined-contribution” plans, employees now have a greater responsibility in the sense that they have the say on whether to join the plan or not, and employees get to choose their own savings rate (Thaler & Benartzi, 2004). This provides an incentive for self-control and a better behavior resulting in beneficial choices (O’Donoghue & Rabin, 2007). According to Thaler and Benartzi (2004), those individuals who had an option to join the defined-contributions plan but chose not to had a lower savings sufficiency. This shows that when given the responsibility and flexibility to handle their own savings, most of the employees do not contribute to the plans or do it sparingly (Thaler, 2002). That is, on average, the people cannot manage their money very well (Hauser, 2004). Hence, the Save More Tomorrow plan was proposed by Thaler and Benartzi (2004). The Save More Tomorrow plan also known as the SMarT plan allows low-saving employees to literally save more. The plan uses the theoretical framework of ‘choice architecture’ describing their low-saving behavior as a “mistake” and subsequently creating an environment that fosters better decision making and choices that improve their saving rates (Thaler and Benartzi, 2004). The approach of decision making based on choice architecture encourages employees to save more and thus increase their retirement funds by directing their choices through the SMarT plan. The plan follows libertarian paternalism in that the employees can opt out from the plan at anytime thereby allowing them the freedom to choose for themselves. The Save More Tomorrow plan allows employees to commit a specific amount of their salary increases now and the amount will be added towards their retirement savings (Thaler and Benartzi, 2004). The plan has been implemented at many workplaces and about 60 percent of the American companies offering defined-contribution plans now use the Save More Tomorrow model (Grene, 2012).Since the adoption of the SMarT plan by employers, the results have shown the promising scope of the plan. In the various companies it has been adopted, the saving rates have shot up markedly (Thaler & Benartzi, 2004; Benartzi & Thaler, 2013). The Save More Tomorrow plan greatly derives from behavioral economics. A common principle of economics is that people are rational beings. That said they are able to do a cost-benefit analysis and respond to incentives that maximizes their self-interest (Mankiw, 1998). Hence, people are driven by their self-interest and tend to respond to marginal changes when given incentives. The Save More Tomorrow uses behavioral economics to direct people to make choices that work in their interest and maximize their benefit (Hauser, 2004). This is the essence of the choice architecture which works to optimize the benefit by directing an individual to make better choices. For the employees, it is in their interest to save for the future and the Save More Tomorrow allows this by providing an incentive to save. Because people normally find it difficult to reduce their consumption due to lack of self-control, they suffer from low savings and hence fail to optimize their money management (Thaler & SHefrin, 1981). However, the SMarT plan solves this by taking a portion of the future salary increases so that they can be saved for the future. Initial commitments to the plan are measly which seems attractive to the employees. In addition, the contributions are taken from salary increases. Psychologically this instills a sense of loss aversion among the employees because instead of having their present salaries cut, the plan takes a portion of the salary increase. Hence, employees do not have to cut back their consumption to contribute to their SMarT plan and save more (Grene, 2012). It can therefore be noticed that the SMarT plan overcomes many psychological and behavioral hurdles that prevent employees from saving. By providing incentives to the employees, the SMarT plan enables employees to increase their savings for future use. The role of choice architecture plays an important role as it provides the employees with the liberty to make their own choices. It further enables them to sustain their current rate of spending without having to lose out a portion of their salary just to make a contribution to their pension plans. Therefore the SMarT plan encourages greater savings by eliminating psychological barriers and promoting savings by making employees responsible for their own savings. In a way, the SMarT plan allows employees to make better decisions about their future retirement funds. It also allows employees the freedom to opt out of the program thereby eliminating the restrictions on employees who may feel bounded in other plans. By using behavioral economics thus the program drives up savings among employees. Consequently it also enhances the saving sufficiency of the employees by committing the contributions from future salary increases. Therefore as one’s salary increases a contribution is made to the plan. Instead of cutting down their spending and consumption, the employees are able to increase their savings. The SMarT plan also has a strategy to overcome the barrier of enthusiasm among employees. However, the plan also allows the employees with the freedom to easily opt out. As such, many employees are emotional and responsive to short term losses at which point they may consider other options for which the plan provides the freedom to opt out (Grene, 2012). It has been realized that giving too many options ultimately reduces buying. Often employees may opt out because they may feel that this is not the right time to enroll in the program however it is suggested that those employees can be asked to propose a time frame by which they might be ready to enroll. Committing in advance helps to strengthen employee enthusiasm about the program. The SMarT plan therefore helps particularly those employees with low savings or those who lack the willpower. In the end, it enables high savings rate by ensuring pre-commitment of contributions. The choice architecture approach has therefore enabled the creation of a context in which low-saving employees make contributions to the plan and increase their retirement funds. Furthermore, there are no strings attached because employees can easily opt out of the program based on the philosophy of libertarian paternalism. Employees enjoy the freedom to be able to opt out of the program. Efforts are also made to make it easy for employees to re-enroll even after they opt out. Such strategies include pre-commitment and pre-defined date by which the employee may enroll into the program. The recent shift to defined-contribution plans has shifted the responsibility of saving to the employees and in this regard, SMarT plans enable employees to save more by mitigating the psychological barriers and providing an incentive to as contributions have to be made from salary raises. In closing, while pension plans feed the self-interest of employees, seldom are employees willing to save because of inaccurate savings calculations or due to lack of self-control. This behavioral flaw is addressed by the Save More Tomorrow plan because it applies behavioral economics to provide an incentive to employees for saving. Employees are able to avert losses by committing a share of their salary increases rather than a portion of their current salary. That way, employees psychologically feel better because their spending does not have to be reduced. The employer plays an important role in shaping the environment for the whole plan. The employer acts as a choice architect thereby enabling employees to enroll in the program. By doing so the employer is able to help the employee raise his or her savings rate which is beneficial for the employee. The employee can also opt out anytime but doing so only reduces their own benefit but pre-commitment strategies enable employees to enroll again. References BBC News, (2012). Improve pension scheme, MPs say. [online] Available at: http://www.bbc.com/news/business-17367644 [Accessed 5 Jan. 2015]. Benartzi, S. and Thaler, R. (2013). Behavioral Economics and the Retirement Savings Crisis. Science, 339(6124), pp.1152-1153. Blumenthal-Barby, J. (2013). Choice Architecture. In: C. Coons and M. Weber, ed., Paternalism: Theory and Practice, 1st ed. Cambridge: Cambridge University Press. Gov.uk, (2015). Workplace Pensions - We're all in. [online] Available at: https://www.gov.uk/workplacepensions [Accessed 5 Jan. 2015]. Grene, S. (2012). ‘Save more tomorrow’ gives pensions a boost. [online] Financial Times. Available at: http://www.ft.com/intl/cms/s/0/7cbd3ef8-36f7-11e1-96bf-00144feabdc0.html#axzz3NxUJ8G3z [Accessed 5 Jan. 2015]. Hauser, S. (2004). Save More Tomorrow. Rochester Review, 66(2). Mankiw, N. (1998). Principles of microeconomics. Mason, Ohio: Thomson/South-Western. O'Donoghue, E. and Rabin, M. (2007). Incentives and self control. In: R. Blundell, W. Newey and T. Persson, ed., Advances in Economics and Econometrics: Volume 2: Theory and Applications (Ninth World Congress), 1st ed. Cambridge: Cambridge University Press, pp.215-245. Thaler, R. (2002). Save More Tommorow A Simple Plan to Increase Retirement Saving. Capital Ideas, 4(1). Thaler, R. and Benartzi, S. (2004). Save More Tomorrow™: Using Behavioral Economics to Increase Employee Saving. Journal of Political Economy, 112(S1), pp.S164-S187. Thaler, R. and Shefrin, H. (1981). An economic theory of self-control. Journal of Political Economy, 89(2), pp.392-406. Thaler, R. and Sunstein, C. (2009). Nudge. New Haven, Conn.: Yale University Press. Thaler, R., Sunstein, C. and Balz, J. (2010). Choice Architecture. Social Science Research Network. [online] Available at: http://ssrn.com/abstract=1583509 [Accessed 5 Jan. 2015]. Widger, C. and Crosby, D. (2014). Personal benchmark. Hoboken, NJ: Wiley. Read More