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Regulation is defined as “a law, rule, or other order prescribed by authority, especially to conduct.”
And conduct is a really human thing… which is why I found a recent lecture by Dr Mike Walker so very interesting.
Walker is the Chief Economic Advisor at the Competition and Markets Authority (CMA) – one of our (many) regulators - and the lens he chose to peer through was that of Behavioural Economics – the study of the effects of psychological, social, cognitive, and emotional factors on people’s economic decisions, and the consequences for market prices, returns, and resource allocation.
Because economists know very well that people are not perfectly rational….
First, some home truths
See if you recognise yourself….:
- The choice we make is influenced by how the question is framed – we’re more likely to buy a £10 product with £1 shipping costs, than a £9 product with £2 shipping costs.
- We’re time inconsistent – this one will get a nod of recognition from anyone with a gym membership…
- We care more about losses than gains – we stick with products rather than switching.
- We are overwhelmed by complexity and obfuscation – meaning we make no decisions, or poor decisions. Walker illustrated this with the jam test – with 6 jams on display, 30 were purchased, but with 24 jams on display just 3 were purchased.
- We stick with defaults – think about organ donation; opting in results in lower donation rates than opting out.
- Drip pricing works – we become committed to a product once we have started the purchase process. This is how low cost airlines ramp up the price we end up paying…
- We value fairness – we don’t just care about profit or wealth. If it’s not fair, we don’t like it.
Now, the implication
We are predictably irrational – and firms can profit from this to our detriment. Think of where firms introduce an option that no-one takes – like travel insurance. Or where firms make choices incredibly complex and obfuscated, and use this as the ‘justification’ for ramping up prices.
Which means that there’s scope for regulators to intervene to improve consumer outcomes – because, as Walker said; “Assuming perfectly rational consumers will result in the wrong policy decision.”
Regulators and intervention
But regulators can’t just knit regulations on a whim – they need to think through some critical questions first:
1) Are people making sub-optimal decisions?
2) Why doesn’t the market solve the problem?
3) Would more competition solve the problem? Do private solutions exist (the answer’s yes if firms profit from consumers making good decisions, but not if they benefit from consumers making decisions that are to their detriment).
4) What is our attitude to consumer responsibility? Are there behavioural decision-making issues at play? Do we have reasonable estimates of consumer preferences? (markets work best when consumers are engaged, and we have to balance protecting disengaged consumers against undermining the incentive for consumers to become engaged. In extremis – where understanding is very poor and stakes are very high, regulators might have to trade off protecting the uninformed at cost of harm to the informed).
Lessons for regulators
1) Test, test, test – when obviously sensible demand-side remedies don’t work solutions need to be tested, and testing needs to be done using randomised control trials.
2) Test, learn, and adapt – evaluate post-implementation too, and focus on why it works as well as what works.
3) Go with the grain of the market – if consumers have shown little interest in communication, an information remedy will fail. Also, focus on getting the defaults right.
4) Use rules of thumb – consumers rely on heuristics. Keep it simple.
A final thought
Behavioural economics doesn’t just work for regulators – it works for everyone.
Dr Louise Beaumont is Vice Chair - Open Bank Working Group. ''is a collective of banking, open data and FinTech professionals, formed at the request of the UK Government.
Louise has over twenty yearsâ experience in growing companies - from initial spark, to operationalisation, results delivered, and value created. Having previously worked for organisations such as GLI Finance, Siemens, Hewlett Packard, Microsoft, and Capgemini. Louise has advised key UK government departments and units on FinTech and AltFin including; HM Treasury, British Business Bank, Government Office for Science, Cabinet Office, UK Trade & Industry, Department for Business, Innovation & Skills, and Number 10 Downing Street's Policy Unit.
