Cutting green path via behavioural economics [News]
November 22, 2011 by Eugene Tay
Filed under News
By Tilak K Doshi, The Business Times, 22 Nov 2011.
What is behavioural economics? Behavioural economics is an increasingly popular branch of economics that incorporates elements from psychology to explain why people make seemingly irrational decisions, such as buying energy-inefficient light bulbs and appliances.
Typically, behavioural economics integrates insights from psychology as well as cognitive experiments into economic theory. In mainstream economic theory, it was long assumed that people are rational utility maximisers and that they depart from rationality only when emotions such as love or fear distort their reasoning.
In the 1960s, psychologists made it known that the brain was an information processing apparatus. In particular, Nobel laureate Daniel Kahneman and his colleague, the late Amos Tversky, began to compare cognitive models of decision-making under risk and uncertainty to the prevailing economic models of rational behaviour.
Their work yielded many examples of anecdotes and stereotypes that individuals rely on to understand and respond to events and economic choices. They documented unconscious biases and rules of thumb that people typically employed to decide on alternative economic choices in their daily life.
In the process, the authors increasingly found a discontinuity between the standard tools of economic theory and the actual decision-making processes commonly used by ordinary people in the real world.
Economists and cognitive psychologists have built on the work of Mr Kahneman and Mr Tversky to yield a wealth of insight into how consumers and businesses make decisions on the energy consumption patterns and energy technologies that they choose.
Some behavioural failures prevail, according to James Sweeney, director of the precourt energy efficiency centre at Stanford University, when there is poor information on price and energy use.
Typically, consumers are only aware of their consumption of electricity when paying their monthly bills, but do not have information on the quantity and price of electricity consumption at the ‘point of purchase’. Thus, the consumer tends to make suboptimal energy decisions.
Comparing this to grocery shopping without price tags on individual food items but only a monthly grocery bill, Prof Sweeney explained that such a system made it difficult for the consumer to make optimal decisions.
Even when items are priced individually, calculating energy use requires considerable cognitive effort and thus tends not to happen spontaneously during decision-making. In addition, when the cost of energy is a small percentage of a person’s disposable income, the effort to use energy efficiently becomes a low priority.
In essence, one has to recognise that humans do not always make perfectly rational decisions and we can use ‘nudges’ to encourage smarter choices among consumers. Lucia Reisch, chair for intercultural behaviour and consumer policy at the Copenhagen Business School, gave an example from ‘euroeconomics’ experiments, where real-time brain scans are performed using new neuro-imaging devices in order to compare the roles of the different brain areas that contribute to economic decision-making: 90 per cent of daily shopping is done based on routine and emotion and only 10 per cent involves cognitive calculative efforts.
Not only is the brain lazy and takes available short-cuts but it needs immediate feedback for it to respond efficiently. So, for example, the third EU energy package adopted by the European Parliament in 2009 suggests that 80 per cent of consumers should have smart metering systems for their homes, so that the immediate feedback on their energy use can aid energy conservation efforts.
‘Green envy’ phenomenon
Kenneth Gillingham, assistant professor of economics at Yale University, gave the example of how energy consumption is affected by social norms and peer group effects. For example, he found that a one per cent increase in photovoltaic solar panels installed in a neighbourhood would lead to a one per cent increase in the likelihood that other residents in the same neighbourhood would also install photovoltaic solar panels – a phenomenon Prof Gillingham described as ‘green envy’.
Prof Sweeney cautioned that energy policy formulation is not a single issue problem and solutions should likewise be multidimensional. Behavioural economics is best thought of as a complement rather than a substitute to mainstream economic approaches to energy policy.
For example, perhaps Singapore Power could change the way monthly utility charges are displayed towards a more emotive or ‘behaviourist’ style to promote energy and water conservation. In addition, perhaps the mandatory labels for refrigerators and other electrical appliances sold in Singapore could be subject to cognitive experiments to see if they are effective in promoting smart energy choices.
In a recent New York Times op-ed, David Brooks referred to the work of Mr Kahneman and Mr Tversky as explorations of the ‘inner wilderness’, analogous to the famous adventures of the explorers Lewis and Clark who tracked the natural wilderness of the American West in the early 19th century. What was the broad conclusion of the panel of experts at an Energy Studies Institute roundtable? Market prices are important energy policy instruments and Singapore is an excellent example of a country that allows competitive market prices to guide efficient choices in the energy sector; but it is time to look deeper into the ‘inner wilderness’ of the human mind to see if complementary behavioural policies can improve energy efficiency and energy conservation efforts in Singapore.
The writer is principal fellow & head, economics division, Energy Studies Institute, National University of Singapore
Source: The Business Times
