Monday, February 27, 2006

Behavioral Economics 101

You know that watching television is useless and yet when you sit in front of a dumb serial, you feel powerless to switch it off and get onto more important tasks! Why? Read The Market Place of Perceptions for it. If conventional economics made you think that man is an optimising-machine, behavioral economics lays bare all those rudimentary assumptions and makes them more realistic.

Lessons for policy analysis? How would savings accounts function in a world where people need not partake part of their income for the future and option to invest in savings was completely voluntary? I have my doubts and hence the need to tinker the market design with lessons from behavioral economics! You can read Steven Venti's Choice, Behaviour and Retirement Saving for a more elaborate account. Here is the gist.
The lessons of behavioral research for plan design are perhaps most relevant for voluntary employer-based pension arrangements and personal saving decisions. Here the research suggests that certain key features of plan design can have significant effects on saving by addressing self-control problems, the tendency to procrastinate, and the cognitive difficulties associated with planning. In the U.S., employers and other private sector plan providers have, in recent years, greatly increased the information and planning aids available to participants. Whereas in the past most 401(k)-type plans were "take-it-or leave-it" offers to employees, most firms now recognize that leaving the retirement saving decision completely in the hands of the employee has resulted in poor financial choices by some employees, most notably low participation by low-income and less educated employees. Firms have begun to promote their saving plans among employees, and many firms now also use default options for participation, contributionlevels, asset allocation, and cashing out to help their employees make prudent choices.
Pssst. This is one of those things that you should hold me accountable only if it happens and not otherwise :-) I think Sendhil Mullainathan's work is one of the most relevant for policy-making in developing countries and will not be surprised if he wins a Nobel Prize. And for the patriotic, yes he is from India!

HT: Marginal Revolution

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