The Need for Behavioural Economics in Indian Policy

Ritwik Tyagi

The behavioural aspect of economics has emerged into a full-fledged field of research and sustained study only in recent times. The rise of social media and e-commerce websites like Amazon and Flipkart kicked up a virtual storm and triggered the rise of personalised shopping, where each customer’s account is tailored in a manner most convenient to their shopping needs. On a larger scale, Google has been using an individual’s online footprint and behaviour to show them targeted advertisements which suit their interests.

The recent controversy involving Cambridge Analytica and Facebook was centred around the use of behavioural tracking by firms to push electoral propaganda. A user’s Facebook profile and online activity were analysed to understand their political affiliations and aspirations, which were then profiled and categorised into different scales of advertising. In the physical world too, a person’s behaviour is used by companies to cater to each person individually, with an aim to attract more business. A common example of this technique can be observed in the boom in transactions during festive seasons, when shops push heavy discounts on most products to cash in on customer spirits.

However, principles of behavioural economics are yet to be fully incorporated into the field of policy-making. It is the central argument of the author that the use of behavioural economics in law and policy-making would enhance the practicality of our laws, along with the efficiency in implementing them. The author has used the examples of the Framing Effect, the Nudge Theory and the Coase Theorem to drive the point home.

Behavioural Economics and Law 

Behavioural economics and law scholars undertake the work of understanding the effect of human behaviour on policy-making. The question they try to answer is how the actions and decisions of “real people” differ from the “homo economicus”?

These differences are quite apparent as real people display three significant qualities:

  1. Bounded Rationality – This concept is a reference to the inherent limitation of any person’s ability to be rational and cognitive. According to this theory, real people have a limited degree of computational skills and their memories are not perfect, thus limiting their rationality.
  2. Bounded Willpower – Real people are also restricted by bounded willpower, which invariably has an effect on their decision-making abilities. What this implies is that humans often willingly take such decisions which they know to be in contradiction of their interests.
  3. Bounded Self-interest – This refers to an essential facet of human nature, which is that we care about others in certain situations with a view towards maximising their own utility. For instance, in a market where bargaining is prevalent, most people care about obtaining a fair and suitable outcome not just for themselves, but also for the other parties involved.

By incorporating the study of behavioural economics into law, a system of rules and regulations can be developed which are more realistic and centred around the patterns of behaviour displayed by humans with respect to the three bounds.

The Framing Effect 

Daniel Kahneman and Amos Tversky designed certain experiments in order to test the predictions propounded by the rational choice theory. In one of these experiments, two groups of subjects were asked to choose between various schemes for countering a disease that could affect 600 people. The first group was given the options of choosing a scheme that would definitely save 200 lives (Option A), or one which offered a 33 percent chance of saving all 600 and a 67 percent chance of saving no one (Option B). Although both schemes had an expectation of saving 200 lives, 70 percent people preferred A to B. The second group had to choose between a scheme which would result in the death of 400 people (Option C), or another which had a 33 percent chance of no one dying and a 67 percent chance of all 600 dying (Option D). Since Option A and B are the same as C and D respectively, it was expected that both groups of people would behave in an identical manner. Yet, the result surprised the researchers when it was found that 78 percent preferred D over C.

This result was called by the researchers as the framing effect. As per the rational choice theory, both groups of people should have behaved in an identical manner. However, due to the fact that people suffer from inherent biases, in addition to their bounded rationality, willpower and self-interest, the result differed widely. Therefore, the fallacy in policy-making based upon the rational choice theory is quite evident from the result. Also, it becomes clear that policy-makers possess the ability to make people choose between options by framing them in a particular manner. Thus, the framing effect can be put to use by policy-makers to exploit the biases of people and grant them an incentive to behave in a better manner.

Public opinion can easily be swayed in favour of a law or policy, simply by altering the manner in which it is framed or portrayed to them. A positive opinion can be garnered even though the policy is ultimately designed to negatively impact the average person. An interesting example of this exercise is the Give it Up campaign launched by the Government of India for motivating households to give up their LPG subsidy. Even though the policy impacted households negatively by raising their cooking fuel expenses, it was immensely successful because of the way in which it was advertised, wherein people were labelled champions and told that by giving up their subsidies, they would be ensuring that another rural household could get a new gas connection.

Nudge Theory

This theory was propounded by Richard Thaler and Cass Sunstein, who described a nudge as anything which impacted a person’s behaviour in a predetermined manner. A nudge pushes a person towards making a decision in favour of a particular outcome. Nudges are commonly used by e-commerce platforms to push users into buying a product by putting across tags, labels and positive customer feedback on display.

However, the usage of nudges is not limited to marketing. In fact, nudges have been increasingly experimented within the realm of governance as it offers a middle path between the extremes of libertarianism and paternalism. It is suggested that rather than forcing people into a certain kind of behaviour or leaving them as they are, the State can nudge people to make better choices themselves. Take, for instance, the warning messages and illustrations on cigarette packaging, which simply reinforce that smoking kills while respecting the liberty of the user to make rational decisions. The United Kingdom government also opted to rely on this theory to nudge people into washing hands and wearing masks, rather than enforcing strict quarantine measures, in light of the coronavirus outbreak.

The use of nudges is an extremely attractive option for governments. This is primarily because of two factors: first, nudges are quite inexpensive to design and enforce, thus saving on costs; and second, nudges do not fundamentally interfere with the freedom of people to make their own choices. Therefore, nudges should be inculcated into governance systems for more effective implementation of public policies. In fact, the Indian Government recognised the relevance of using nudges in its Economic Survey, released in July 2019, and even recommended the setting up of a Nudge Unit within the NITI Aayog. The government’s Swacch Bharat Abhiyan also seems to be based on the use of nudges, where citizens are being pushed towards securing a healthier and cleaner living environment for themselves.

Coase Theorem 

Based upon the work of Ronald H. Coase, this theorem suggests that when the conditions are ideal, i.e., the rights of each party are clearly assigned, and costs of negotiating are low, parties to litigation will always bargain for transferrable rights whatever the decision of the court. For example, Person A plays loud music in their apartment for enjoyment, but their neighbour B wants it to be quiet so as to be able to read. B takes A to court over the matter. Both parties can put a value to their respective rights. Let us assume that A would pay B Rs. 2000 for the right to play music and B would pay Rs. 3000 to have A keep it quiet.

According to the theorem, when they bargain, B will always win the right to have A keep quiet, regardless of the decision of the judge. If the judge decides in favour of B, A will have to stop playing music loudly. In case the judge decides in favour of A, B would offer Rs. 3000 to A to keep the latter from playing loud music. Thus, in a negotiation, B will always buy the right from A.

What the Coase theorem essentially posits is that the focus of policy-makers should be on creating such conditions where the transaction costs are negligible, so that parties to a matter can resolve their dispute through negotiation, rather than opting for litigation. The aim of the theorem is to establish efficiency in dispute resolution processes and thus, it is argued that when the transaction cost is reduced below a threshold, the parties would not feel the need to fix the legal liability, but instead focus on arriving at an economically efficient solution. An interesting facet of the Coase theorem could be the rule of presumptive mediation, which stresses that the default procedure for dispute resolution should mandatorily be mediation. This will ensure that the parties to a dispute attempt to resolve it amicably before opting to head for litigation.


In light of the above, it can be concluded that the use of behavioural economics in law-making would lend a more practical and hands-on approach to tackling the issues that plague our legal system. Various facets of behavioural economics, such as the Framing Effect, can be applied in law-making to ensure that desired social changes are brought about in a structured manner, based upon a sound economic model. The Nudge Theory can be effectively used by the policy makers to influence the choices made by people. Various social changes can be given effect to by nudging, such as for promoting the use of renewable sources of energy and reducing pollution. Lastly, by incorporating the Coase Theorem, the dispute resolution mechanism can be regulated in a more efficient manner so that parties can settle matters with more economic efficiency, rather than remaining caught up in long-winding court battles.

Thus, implementing such measures would increase the practicality of our governance and legal systems manifold, saving money and resources in the process. Moreover, the use of behavioural insights can help in making more realistic policies that can easily be brought into effect.

The author is a student at the Maharashtra National Law University, Nagpur.

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