New Thoughts on Nudges

A new debate is emerging about the economic effects of regulation. In a forthcoming article, Brian Galle, a professor at Boston College Law School, argues that regulatory “nudges” are often more efficient than price based regulations. He reaches a different conclusion from economist Ed Glaeser, who previously argued that nudges are inefficient. Professor Galle’s article compares the theoretical costs created by “nudging” regulations, such as New York City’s proposed soda size regulation, with those created when the government alters the price of a good or service through taxes and subsidies, such as a tax on cigarettes. The new article recognizes the benefits of price based regulations, which are generally thought to reveal information and help fund important wealth transfers. For example, Professor Galle notes that a firm’s behavior in response to a tax encouraging it to modernize its antipollution equipment will reveal important information about the costs that firm is facing in making a switch. The revenue generated from the tax can be used as a subsidy in some other regulatory setting. However, Professor Galle points out that proponents of price based regulations may be assuming away the possibility that information on subjective costs could be attained in other ways, such as through small scale experiments conducted by the government. He also believes that proponents are not placing enough weight on the shortfalls inherent in price based strategies, particularly in terms of deadweight loss. Professor Galle is concerned with the effect price based regulations have on an individual’s incentive to work. He notes that as the price of goods like soda rises, a person’s income decreases in purchasing power. Faced with goods priced artificially high because of taxes, a person may decline to work an extra hour that will not yield as much for them as it had before the taxes were put in place. By contrast, a regulation on the size of a soda cup is unlikely to affect an individual’s leisure-work decision making process in the same way, Professor Galle argues. He notes that effective nudges play on our “automatic” responses to certain situations that deviate from what one would expect from a purely rational actor. Based on this, he suggests that consumers may not change their labor output because they will be unable to anticipate either that they will be nudged or the degree to which they will be. He calls for new research to assess the degree to which nudging regulations change labor supply. Professor Galle also notes that nudges may be better targeted at individuals who are likely to respond to regulation than price-based strategies. To illustrate this point, he looks at the poor performance of government programs designed to encourage individuals to save for retirement. He points out that in order to receive preferential tax treatment, an individual is required to fill out a lot of paperwork and invest time in the process – something procrastinators who would benefit from the program are unlikely to do. A nudging system that sets savings as a default choice will be far more likely to change outcomes. Galle concludes by pointing out areas where nudging regulations may be the optimal policy choice. He suggests that soda consumption, retirement savings, and pollution are all negative externalities that might be best remedied through nudges. He also notes that nudges may be effective at promoting activities with positive externalities like charitable donations by individuals