PDF Summary:Nudge, by Richard H. Thaler and Cass R. Sunstein

Every day we face choices—what to order at a restaurant, what clothes to buy at a store, what show to stream after work. We make these choices without realizing how the way they’re presented affects us. If grocery stores didn’t stock candy at the register, would we eat less of it? If we had to “opt out” of being organ donors rather than “opt in,” would the organ donor pool grow?

In Nudge, Nobel Prize-winning economist Richard Thaler and legal scholar Cass Sunstein examine how the way choices are designed and structured can “nudge” us toward better decisions. In this guide, you’ll learn why people make bad investment choices and how Thaler and Sunstein propose to revitalize the institution of marriage (by abolishing it). You’ll also find commentary on the psychological research underlying Nudge’s concepts as well as more recent data that sheds new light on Thaler and Sunstein’s findings.

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(Shortform note: Nudges can also be used to take advantage of the layperson. For example, a financial firm might nudge a naive client toward an investment that benefits the firm itself more than the investor.)

How to Design Choices

Thaler and Sunstein name six primary techniques a choice designer can use to structure a set of options in order to nudge people toward the best decision: offer defaults, draw a map, narrow the field, offer incentives, anticipate error, and emphasize outcomes. Of these, the authors spend the most time examining the first four—offer defaults, draw a map, narrow the field, and offer incentives. We’ll look at each more closely below:

Offer Defaults

Thaler and Sunstein’s most versatile nudge is providing a default—a choice that’s automatically made if the chooser does nothing.

The theory underlying this style of nudge is people’s innate status quo bias, which says that when faced with a choice, many people will choose to either do nothing or stick with their initial choice, even if the new choices are superior to that initial choice.

(Shortform note: Status quo bias is related to two other biases: inertia and loss aversion. Inertia describes the human tendency toward inaction. Loss aversion describes the tendency to psychologically feel losses more strongly than gains—studies show that people overvalue losses to gains by approximately 2:1, causing them, on occasion, to make riskier decisions to avoid loss. Loss aversion also encourages inertia, as people tend to stick to their original decisions rather than risk losses through change.)

Thaler and Sunstein apply the default nudge to a number of areas, including investment choices.

Defaults to Improve Investment Choices

Thaler and Sunstein note that not long ago, the most common retirement plan offered by employers was a “defined benefit” plan—that is, one that made fixed payments to the beneficiary based on tenure and salary. Now, the most common type of retirement benefit is a “defined contribution” plan, in which employees make periodic contributions to a tax-sheltered investment account, on the assumption that they’ll get back an increased return in later years.

(Shortform note: In 2020, 64% of private industry workers had access to a defined contribution plan while only 15% had access to defined benefit plans. In 1990, those numbers were 34% and 35%, respectively, showing that slightly more people used defined benefit plans in the past.)

This shift put a greater decision-making burden on workers. What level of risk am I willing to take, and how do I allocate my savings accordingly? Should I be investing in stocks or bonds or both? How often should I revisit my allocation of assets, and what real-world information should I be looking for to know when to change it?

According to classically trained economists, we should have no trouble making the right investment choices. This is because, in most economic models of human behavior, people are thought of as eminently rational and self-interested actors who consistently make the best decisions for themselves—that is, people are homo economicus.

The Critique of Homo Economicus

Introduced by classical economists like Adam Smith and John Stuart Mill, the term homo economicus—“economic man”—conceives of people as predictably rational and self-interested, thus able to make the most beneficial economic choices for themselves. In most of the economics research of the last century, people are modeled in just this way: as able to maximize their own economic benefit.

With the advent of behavioral psychology and economics, however, researchers have established that homo economicus is a fiction—that people’s rationality is limited by many cognitive and contextual factors. (In fact, one study determined that real people who meet all the criteria of homo economicus might be diagnosed as psychopathic.) Thus, much of the economics literature rests on a flawed assumption and so can’t be applied to real-world policy.

Debates are ongoing about the accuracy of economic models that rely on homo economicus. Some commentators find that people do in fact act consistently and self-interestedly when faced with decisions while others maintain homo economicus is a chimera. Thaler and Sunstein, for their part, fall into the latter camp, arguing that “Econs”—or “economic people”—simply do not exist.

If people indeed met the criteria of homo economicus, we would have no trouble (1) recognizing that stocks outperform bonds historically and (2) calculating our tolerance for risk based on the probability distribution of stock market returns. But, because we’re human, the complexities and variability of defined-contribution plans cause us to make mistakes that end up—quite literally—costing us.

One way to remedy these mistakes, Thaler and Sunstein argue, is better defaults, specifically “target maturity funds” that automatically reallocate their asset mix based on a worker’s age. A target maturity fund will have a riskier asset allocation—more stocks, fewer bonds—when a worker is young and gradually recalibrate as the worker ages. By the time the worker retires, his portfolio will be heavily weighted toward fixed income assets like bonds. In other words, the “target maturity fund” will have done all the benefit maximizing on behalf of its investor.

Nassim Nicholas Taleb explores the biases that make people bad at assessing risk in his book Fooled by Randomness, in which he argues that when we make decisions, we are typically guided by our primitive brain, which runs on emotion, likes simplicity, and has trouble understanding abstract concepts. When investing, we therefore do things like act impulsively, sell a stock too soon if it’s doing poorly (even if its long-term prospects are good), and misjudge our abilities to play the stock market—in reality, it’s luck that rules the market and determines most success, not our skill in choosing stocks.

Thaler and Sunstein’s solution of using targeted maturity funds to sidestep our natural impulses addresses Taleb’s concerns, as it takes the decision-making process away from our primitive brain and relies instead on rational algorithms.

Draw a Map

A carefully engineered default combats the human tendency toward inertia and the status quo, but how can a choice designer help active choosers navigate complicated decisions?

One way, according to Thaler and Sunstein, is to draw choosers a map that shows them where their options will bring them if they settle on one option or another—an outline that explicitly connects their choices to outcomes.

To help choice designers effectively draw a map, Thaler and Sunstein advise that regulators mandate transparency programs whereby companies would be required to provide consumers with more—and more clearly organized—information about their products so that consumers can better compare choices and make the right decision.

By presenting us with clearer information, a transparency program could help combat our tendency to use rules of thumb, and help us see more clearly the potential outcomes of our decisions.

Are Transparency Programs Actually a Nudge?

In some of Thaler and Sunstein’s examples of transparency programs, they conflate disclosures made before a transaction with those made after it. For example, Thaler and Sunstein categorize both of the following as transparency:

• A cellular service enumerating all of its fees, including real-life examples, before a person purchases the service

• A cellular service providing its customers with a detailed report listing all the ways a person actually used the service and the fees that person incurred

The problem with classifying the second example as a nudge is that it’s helpful only after the person has already made a choice. In other words, under that scenario, we might make a terrible initial choice and receive our “nudge” only when we get the detailed report. The transparency, therefore, doesn’t change our behavior during the decision-making process and therefore is not an actual nudge.

Some critics of the book have pointed out as much, arguing that some of what Thaler and Sunstein press for is merely more transparency, which is hardly a revolutionary idea.

Credit Cards

Thaler and Sunstein note that transparency programs would be especially helpful for consumers with credit cards.

Credit cards are a primary vehicle for US indebtedness, and Thaler and Sunstein produce an array of statistics that illustrate their centrality to Americans’ personal finances, including the average number of credit cards per cardholder (8.5) and the average American’s credit card debt ($8,000).

(Shortform note: However, Americans’ debt situation has changed significantly since Nudge’s publication (and the corrective of the 2008 financial crisis). Whereas, in 2007, the credit card debt of the average American household was around $8,000, as of March 2021 it was $6,741.)

Thaler and Sunstein’s solution to the spendthrift effects of credit cards is a credit card-specific transparency program.

They propose requiring credit card companies to send cardholders a detailed annual statement featuring not only the year’s purchases but also the year’s fees, interest charges, and penalties. This information would make the true cost of our credit card spending clearer to us and allow us to more easily compare cards.

(Shortform note: The Credit Card Accountability Responsibility and Disclosure Act of 2009 (Credit CARD act) took steps toward making their idea a reality. The act outlawed many of credit card companies’ most unsavory practices, including raising interest rates arbitrarily and giving cardholders insufficient time to pay their debts before incurring a penalty. It also nudged credit card companies to provide (1) simpler and more transparent agreements and (2) more information in their statements, including target dates for paying off the card if the cardholder only made minimum payments. In addition, most credit cards’ online banking interfaces offer annual reports as well as real-time transaction information.)

Narrow the Field

Thaler and Sunstein are firm believers in people’s right to choose (hence the libertarian half of libertarian paternalism). But they also recognize that too much choice can be overwhelming and counterproductive. (Shortform note: Researchers refer to this as choice overload or the Paradox of Choice: We want more options because we think it maximizes our chances of making the best choice, but having too many choices paralyzes us.)

One way to narrow the field is simply to offer fewer options. However, since this limits choices, which Thaler and Sunstein oppose (as it contradicts libertarianism), they propose another way of narrowing the field of options: grouping and structuring the choice set to make it more manageable.

For example, many retirement plans offer “tiered” investment choices. Rather than hand enrollees a voluminous and undifferentiated list of funds to choose from, retirement plans will offer, say, three different tiers, each corresponding to enrollees’ level of investment interest and experience.

(Shortform note: Because choices aren’t limited in a tiered system, this type of nudge isn’t foolproof: If an inexpert but risk-seeking enrollee wants to bet her retirement on the most aggressive and fee-laden actively managed fund, she’s free to do so, even if it could result in catastrophe.)

Offer Incentives

Old-fashioned incentives, financial or otherwise, can nudge choosers toward better decisions. The key to a successful incentive, argue Thaler and Sunstein, is to make its benefits relevant and obvious to the person making the choice.

Economists have long noted the power of incentives in driving human behavior—the concept underpins a capitalist society. Most economists agree that the primary incentives that drive behavior are self-interested incentives. As outlined in Charles Wheelan’s Naked Economics, when people work to benefit themselves, they generally benefit others as well (as when they work to earn a salary, what they produce raises the standard of living for others).

This is not always cut-and-dried, though—different people will be motivated by different wants, which makes an economist’s job difficult when identifying incentives that will motivate large numbers of people. However, Thaler and Sunstein’s proposals aim to appeal to the majority through simplicity: No one wants to pay more than they need to for an item or service, and the authors’ nudges bank on that.

Thaler and Sunstein suggest that an area ripe for incentives is environmental policy, in particular policies to reduce carbon emissions.

Reducing Atmospheric Carbon Through Incentives

Thaler and Sunstein are advocates of a “cap-and-trade” mechanism for reducing greenhouse gases.

In a cap-and-trade system, the government sets a ceiling (the “cap”) on a certain pollutant—say, carbon dioxide—and confers on industries and firms rights to pollute up to that amount. If a firm chooses to reduce its emissions below the cap, it can “trade” its excess cap space to other companies for cash. According to Thaler and Sunstein, a cap-and-trade system meets the principles of libertarian paternalism because it preserves choice while nudging firms, through economic incentives, to clean up their operations.

(Shortform note: While a cap-and-trade system in operation might conform to the precepts of libertarian paternalism, its creation and implementation almost certainly don’t. That is, there’s no way to “nudge” Thaler and Sunstein’s cap-and-trade model into existence—it has to be created by top-down government rulemaking (in other words, paternalism). Moreover, cap-and-trade, at least when instituted at the state level, has produced mixed results, leading many commentators to advocate broader and more explicitly paternalistic interventions.)