Behavioural Economics and The Law of Unintended Consequences

One of the hottest trends to sweep Washington in recent years has been the behavioral economics movement. Popularized in books like Nudge, behavioral economics aims at improving outcomes by gently nudging individuals to make better choices about everything from their health to retirement savings. Nudge co-author Cass Sunstein, a Harvard Law Professor and close confidant of President Obama’s, even joined the Administration as head of the Office of Information and Regulatory Affairs to bring behavioral economics to the federal regulatory and rulemaking process.

Earlier this week, the Wall Street Journal reported on the results of one experiment in behavioral economics – a 2006 law that encouraged auto-enrollment in company 401(k) plans. Rather than requiring employees to opt-in to their corporate retirement plans, the law allowed companies to automatically enroll their employees, unless they affirmatively decided to opt-out. The goal was to encourage more people to take responsibility for their retirement savings by subtly shifting the 401(k) decision mechanism.

By many measures, the move has been remarkably successful. Since the law passed, the number of companies auto-enrolling employees has more than doubled – from 24 percent to 57 percent. Companies with auto-enrollment plans report that 85 percent of employees participate in 401(k) plans, compared to 67 percent at companies without automatic enrollment.

Yet, according to Harvard Professor Brigitte Madrian, automatic enrollment has been something of a “double-edged sword.” The Employee Benefit Research Institute studied the results of automatic enrollment and found that 40 percent of new hires are actually setting aside less money for retirement than if they had voluntarily enrolled.

“On the one hand, there’s more participation,” said Professor Madrian.  “On the other hand, lots of employees are stuck at whatever default the employer selects.”

Regulators are working to “nudge” companies to raise their default contribution rates – typically set at around 3 percent – to help auto-enrolled employees save more for retirement. While it’s too early to judge the full impact of behavioral economics on retirement decisions, one thing we can say for sure is that even the most well-meaning regulatory actions are still subject to the law of unintended consequences.


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