Nudging Toward Trust : Libertarian Paternalism as Economic Policy
Anusuya Avadhanam (Bsc 2023-27)
When we were younger, we would often leave the big decisions to our parents. They picked the school we went to, the kind of clothes we wore and every other major decision was already taken for us with or without considering the consequences of alternative choices. As we grow older, we see more choices, we understand our preferences and appreciate the trade offs involved in selecting one option over the other. If you loved pink as a child but later developed a preference for olive green, you might have gradually replaced your entire wardrobe to reflect this change. Our choices evolve and we expect the freedom to adjust our behavior as our preferences shift. Can we make a similar argument for an economy? The question that arises then is who should be given such a responsibility, who should be the parent for an economy with diversified tastes and preferences. The answer, at first glance, may seem obvious: the government.
When the state completely makes its decisions for each and every citizen, the state acts like the father figure and indulges in paternalistic patterns to ensure certain ends are met. The fundamental focus then is towards long term harmony, where the state considers actions that seem to have a social benefit component. Policies of this sort often infringe on an individual’s freedom and do not consider the heterogeneity in preferences of individuals. When homogeneity is assumed, a part of the population whose preferences do not align with the policies set forth by the government would be worse off. Certain choices are forced onto individuals as a direct consequence to being a member of a civilized economy. The basic right to life is contested when one poses a threat to someone else’s life. In such spaces, the government’s intervention to protect and preserve life is justified. John Stuart Mill’s Harm principle where the state’s intervention and infringement on an individual’s freedom is accepted if and only if the lack of such intervention would harm another person’s life.
A paternalistic state meets with information limitations and faces difficulties in identifying preferences of individuals. Sometimes individuals themselves are unaware of their tastes and may develop them through an ecological process. To formulate policy for such an audience becomes a hassle and the target may not derive the desired utility.
When blanket interventionism does not account for individual choices and preferences, there is a need for a system that does not infringe on individual preferences but also understands the limitations of human rationality. Individuals are boundedly rational, subjected to cognitive biases, limited information and decision fatigue. This is where the concept of Libertarian Paternalism comes into the picture. The government here is not the strict parent, dictating terms and conditions, but
rather a benevolent architect, designing choice structures. The government uses certain tools at its disposal to direct the economy towards certain choices. Nudges are such tools that alter the choice architecture, to stir behaviour of individuals in a socially beneficial direction while also preserving the original choice set of individuals. This concept is libertarian in the sense that nudges mostly don’t interfere with freedom of choice but is also paternalistic as it tries to alter private wellbeing of individuals using pro-self nudges.
Such nudges are already in place, ones so subtle that we may not notice unless specifically needed to. One example is default settings, where an individual can opt out of a plan rather than opt in. In order to induce more savings in the economy, the government may automatically include individuals in savings programs with an opt out option. Another tool regularly used are information providing nudges like SMS to promote financial literacy, highlighting the benefits of long term savings.
The Pradhan Mantri Jeevan Bima Yojana is a life insurance scheme with an annual premium of 330 rupees and is linked to the Jan Dhan accounts using the auto-debit mechanisms. This encourages individuals to maintain account balances sufficient for deductions, also indirectly nudging savings to retain coverage. While the primary focus of the scheme is to provide affordable insurance, its design naturally drives individuals to develop consistent saving habits. The fear of losing insurance coverage due to insufficient balance at the time of automatic premium deduction serves as a behavioral prompt, pushing account holders to regularly deposit small amounts. Such schemes are clear examples of how policy design can align incentives and behavior in a low friction, trust based way, encouraging citizens to act in their best interest without the burden of regulatory coercion.
The Goods and Services Tax Act brought even the small and medium enterprises into the tax net. Compliance then became challenging considering limited digital literacy and complexity in the filing processes. Identifying these frictions, the government introduced a Compliance Rating Score, one where businesses are graded on timeliness and accuracy of return filing. This rating system plays with the social component of goodwill associated with a company and replaces enforcement with peer pressure, driving compliance.
Libertarian Paternalism is not without its limitations. Nudges often rely on the assumption that the state can accurately predict and anticipate individual preference which remains untrue, especially in a country like India with diversified tastes and differentiated demographic features. However, they serve as pragmatic tools for building voluntary compliance rather than the traditional methods which use coercion, almost asserting regulation. The true test of modern governance is not how effectively it coerces compliance but how intelligently it earns it. Nudges are not about softer control, they are about smarter trust.
The Jan Vishwas Bill aimed at decriminalizing minor economic offences and simplifying compliance signals a shift towards trust based governance, moving away from the traditional punitive relationship seen between the state and the citizen. The true potential of such reforms can be realized effectively when paired with behavioral insights. There is a need for the government to create an environment for high trust. Once such efforts are undertaken then the citizens will willfully sacrifice their short term sacrifices to enjoy long term gains.