Behavioural Economics help
me to understand why people do some of the things that they do. One seemingly
irrational decision is about why people do not opt in to retirement plans when
given the opportunity to do so. Behavioral Economics helps us to understand
why, and this is important as governments look to changing retirement plans by
examining standard economic theory.
Many individuals deviate from
standard economic theory in another important way: they can be easily
influenced by decision framing. Rational economic agents would not be
expected to vary their responses to a question based on how it is asked.
But in practice, many people do
exactly that, both in the savings area and, as we show note later, in
investment decision-making as well. A by-now classic example of decision
framing arises with automatic enrollment in retirement saving plans. Under the traditional
(non-automatic) approach, the employee would have to make a “positive
election” to join the 401(k) plan.
By contrast, with automatic
enrollment, the employee would be signed up by the employer for the plan
at a given percentage contribution rate, and the employee retains
the right to opt out of this decision.
This simple rephrasing of
the saving question elicits a dramatically different response in plan participation
rates. Madrian
and Shea (2001) have
powerfully shown that when workers
are required to opt-in, the default decision (or the non-decision) is to
save nothing; by dramatic contrast, with automatic enrollment, the default decision
proves to be that people save at the rate specified by the employer.
For one large US firm, plan
participation rates jumped from 37 percent to 86 percent for new hires after automatic
enrollment was introduced. What this suggests, in the end, is that many workers
do not have particularly firm convictions about their desired savings
behavior. Merely by rephrasing the question, their preferences can be
changed—from not saving to saving.
The impact of automatic
enrollment is not just an illustration of framing questions but also part of a
broader behavioral phenomenon, namely the power of the “default option” and its
influence on decision-making. When confronted with difficult decisions,
individuals tend to adopt heuristics
(shortcuts) that simplify the
complex problems they face. One simple heuristic is to accept the available default
option—i.e., rather than making an active choice, accept the choice made by
others.
And, as noted in 401(k)
enrollment, the simplest default is the non-decision: do nothing. An
emerging literature indicates that individual behavior is easily swayed by
default choices.
Again, automatic enrollment
provides another illustration of the unexpected effects of default behavior. It turns
out that while automatic enrollment boosts the number of individuals saving in
a retirement plan, it might not actually increase total plan savings (Choi
et al. 2001b).
The reason is that, when
automatically enrolled, people who would have voluntarily enrolled in the
plan at higher contribution rates or chosen more aggressive investments decide
to stick with the low saving rate and conservative investment option set
by their employer. Thus the positive effect is that saving rises for people who
formerly did not participate, but an unexpectedly negative result is that
saving falls for those who would have enrolled at higher rates and in more
aggressive options, but instead elected to adopt the employer’s defaults.
On net, it appears that
these two effects can largely offset one another.
More broadly. develop a model of a
procrastination- and default-driven saver and the choice of optimal
savings rates. That study argues that optimal defaults for such savers are, in effect,
the corner points or defaults of the plan savings problem—a saving rate of 0
percent, a saving rate equal to the employer matching contribution, and a
saving rate at the maximum allowed by the plan.
Both their theoretical
models and the practical evidence on automatic enrollment underscore how profound
the impact can be of the selection of a default option.
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