Behavioural economics and legislative policy: deciding on policy options

This post in brief

• Policy officers try to generate many options to solve a policy problem.
• It's common to present decision-makers with variations of the same type of option.
• In theory, if one of the similar options is clearly inferior it shouldn't affect how we assess the other options.
• In practice, a clearly inferior option makes the other similar option look even better in comparison to other dissimilar options.
• To avoid this, don't present inferior options to the decision-maker 'for completeness' or out of an abundance of caution.

Behavioural economics and legislative policy: deciding on policy options

In an ideal world, the policy development process goes something like this:[i]

1. Define the problem.

2. Identify several viable solutions.

3. Assess the costs and benefits of each solution.

4. Choose the best solution.

All very organised and rational. Of course, the actual process may vary in practice, but this model is often followed (and generally should be followed).

How do we choose the best solution? Obviously, assessing the costs and benefits should be the main consideration. 

However, what if the way we present options inadvertently triggers a cognitive bias that makes the decision making process misfire? Could behavioural economics provide any insight into how we could improve the process of choosing legislative policy options? Let’s explore one possibility.

Presenting policy options for decision

Once the policy problem is identified, typically policy officers will then try to identify a range of viable options for solution - usually as least three. After assessing the costs and benefits of each option, the options are then presented to senior decision makers (typically agency senior executives and then to the Minister), with a recommendation for a decision.[ii] In Australia, for most significant policy decisions this is done through a Regulation Impact Statement (or a ‘RIS’ as it’s more commonly known).[iii] In order to be comprehensive, policy officers may present different variations on a type of option. 

Insider trading as a hypothetical example

Say the policy problem we’re trying to address is the unfair advantage and economic distortion caused by insider trading. Let’s assume that, on average, a person who engages in insider trading profits by $50 000 for each instance. We might propose the following options:

Option1: Make it an offence to engage in insider trading with a substantial maximum penalty ($100 000 fine or jail).

Option 2: Make it an offence to engage in insider trading with a smaller nominal penalty ($1 000 fine).

Option 3: Create a civil cause of action for private citizens who are harmed by insider trading. They can sue the trader for the amount the trader has gained (an account of profits).

Options 1 and 2 are different variations on the same type of solution (criminal penalty), which only differ in the degree of consequence. Option 3 is a different kind of solution (civil proceedings).

If each instance of insider trading makes the trader $50 000 (on average) then option 2 seems clearly inferior to option 1. The cost of the fine is so small in proportion to the gain that some traders are likely to take the risk and continue to engage in insider trading. So it seems like the real choice is between 1 and 3.

Marginal or borderline options

Why include option 2 then? Often policy officers will put in a marginal option, such as option 2, ‘for completeness’: they will err on the side of caution by including a borderline-viable option so that the decision maker has a complete picture. 

It’s a cliché, but public servants often tend to be cautious: why risk excluding an option that the decision maker may have wanted to consider? It’s not always easy to decide what options are genuinely viable - different people will have different views of what is viable. In theory, the cost to the decision maker is small (the time taken to briefly consider and rule out the inferior option). The imperative to be thorough and consider all potentially viable options seems to outweigh the cost to the decision maker’s time (provided that really unviable options aren’t presented). 

Does it matter? However we choose between 1 and 3, the existence of the inferior option 2 shouldn’t affect the choice, should it? Previously I would have answered “no”. A rational decision maker would just ignore 2, and assess 1 and 3 on their merits.

Unfortunately decision makers (and all humans, for that matter) are not always rational …

Relativity in comparing decisions

We turn now to behavioural economics. In his book Predictably Irrational, Dan Ariely makes the case that when humans decide between options they consider benefits in relative terms, not absolute terms. This affects how we choose and often influences us to make an irrational choice.

As an example, Ariely put a subscription offer for The Economist magazine to his students. They could choose between an internet-only subscription for $59, a print-only subscription for $125, and a print-and-internet subscription for $125. In this case the print-only offer is clearly inferior to the print-and-internet offer for the same price. Theoretically, the existence of the inferior print-only option should not affect the choice between the two more attractive options.

What happened in practice? When Ariely presented all three options to his students, 84% chose the more expensive print-and-internet option. However, when he removed the inferior print-only option, only 32% chose the print-and-internet option. What is going on?

The option you don't choose does matter 

Ariely’s explanation is that when you have two options of the same type (in this case, the options with the same price of $125), the inferior option makes the superior option seem even better than when considered on its own … or against some other third option of a different type (the cheaper subscription). So even though the print-only option is dismissed, it makes the print-and-internet option look better against the internet-only option. This influences some people to choose the print-and-internet option that they would not have chosen in a straight comparison between the two clearly superior options.[iv]

How does this affect legislative policy decisions?

When we return to our insider trading example above, we can see that the options follow a similar structure: two plausible options of a different type (1 and 3), and one option that is of a similar type, but also clearly inferior, to one of the previous options (option 2).

Including option 2 isn’t only wasting the time of the decision maker. Because of our preference for easy comparisons between the same type of option, option 2 makes option 1 look better in contrast. And option 2 makes option 1 look better in comparison with option 3: better than if options 1 and 3 were considered on their own. Including option 2 subtly tilts the scales in favour of option 1.

How can we get better at making legislative policy decisions?

The implications of this research for policy officers now seem obvious: avoid including marginal or borderline options out of an abundance of caution, particularly when the option is of a similar type to another more plausible option. Of course this is a balancing act (all genuinely viable options should be considered). But erring too much on the side of caution and completeness doesn’t just waste the decision maker’s time: it also distorts the decision making process. 

The cautious among us (and I include myself here) will find it hard to do this, but carefully pruning borderline unviable options will help decision makers to make better policy decisions.

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Notes

[i] For brevity’s sake, I’m skipping some of the steps in the Australian Government Guide to Regulation that are not particularly relevant to the topic.

[ii] Of course, there are often many intervening iterations of preliminary decisions and consultation before the final decision.

[iii] Other documents such as internal policy papers, public consultation papers and ministerial briefs may also be used during the policy development process. However, under the Australian Government’s Guide to Regulation the RIS is intended to be the key document informing the ultimate decision maker before they choose a policy solution.

[iv] A different explanation for a similar phenomenon has been offered by mathematician Jordan Ellenberg in Chapter 17 of How Not to Be Wrong. Believe it or not, it relies on the democratic decision making processes of slime mould. While I don’t deal with it here, given it seems less applicable to human decision making, it is worth a read for those interested.