A Default Solution to Pension Problems

I mentioned before that John McHale wrote a paper a few years summarising the behavioural economics solutions to pension underfunding.
McHale Article

The literature has progressed a lot even since then. The IFS in London are holding an event on June 15th to discuss, among other things, mass “opt-out” pension schemes being rolled out over the next five years in the UK where having a pension is the default position for new employees rather than not having a pension. Such pensions are designed based on simple psychological insights about how people make future decisions, the insights being mostly that we overweight current pain and have a tendency to procrastinate. This sounds pretty simple but incorporating these insights does make a big difference to policy design.

This literature is the most advanced, in my view, application of behavioural economics to real-world policy problems and it will be very interesting to see how this evolves. A link to their report is also available on the link below. I have constructed reading lists and so on for students and they are available below. They might be useful if people are interested in the general area of applying behavioural economics to policy.

Link to IFS


8 replies on “A Default Solution to Pension Problems”

Also, worth looking at the Quick Enrollment stuff in the US. Absolutely amazing the effect that just simplifying some of the instruments can have.

With regards to defaults, organ donations are one of the most striking examples


Though, people should be careful about championing defaults as the miracle solution to all behavioural ills. Defaults can, of course, be bad as well hence the advice to always read the small print. Daniel Goldstein has written some very useful papers about the nuances of using defaults. Computer people have also become very good at designing referral systems like those used in Amazon and they are massively underused in core policy areas.


Behavioural economics is a bit of slur by university elites against the lower classes(meaning me). There are rational reasons for not saving for the future.

People who were not financing their pensions were in their minds investing in real estate, the investment you can live in. Saving with each mortgage payment as they say. Investing in personal property has the advantage that at least the owner can understand its operation.

Many individuals are small business people that would prefer to invest in their own business, rather than diversify with paper assets. These people have had very bad experiences with paper assets and tend to avoid them.

People who are busted flat will opt out. I would guess the majority of single mothers. The only class of people with significant extra money, that are not wealthy, are government employees who have no incentive to save as they have pensions. I think many will stay in due to inertia and union pressure to be patriotic assuming the plan applies to them.

It is not clear that individuals really understand investments, or can be expected to understand them. I don’t. They have had bad experiences with paper assets. It is easy for ‘elites’ to shake their heads at this, but remember, the ‘elites’ have demonstrated they do not understand investments.

In the US I see news stories of people opting out. To keep greedy bosses from hogging all the lush benefits, there is a requirement for minimum participation from all employees. Those rules are being relaxed due to the slow down, and I assume low paid workers opting out.

Treasury Allows More Flexibility on Small-Business 401(k)s

The opt out -> opt in thing is an attempt to avoid something very painful, diverting money from the government to private sector pensions. What does work is matching a large percent (50% or more) of each worker payment. Most workers realize that it would take a 33% drop in value for them to come up a loser if they had a 50% match. The problem is where does the match come from? Neither the government nor the employer are currently willing or able to sacrifice. So university elites have cooked up this ‘free of charge’ opt out plan. Good luck.

There is very little evidence of saving accomplishing very much beyond enriching the people behind the investment schemes, and governments. In other words saving is not deferring current income for future use, it is transferring it to someone else. In the past 30 years the most universally available successful personal financial scheme has been a government job, at a young age. That may change with the current crisis.

Finally a structural problem with the opt out plan might be that many ‘weak hands’ who were in the plan due to inertia might try to exit the plan at the same time. This might cause people who otherwise would have held tight, to bail out too. There might be a flaw in using herd psychology, stampedes.

Becker and Posner had a blog discussion a few years back (which references some of the main critique papers out there). George, you will be happy to learn that many serious academics share your belief that policy interventions based on psychology are elitist and flawed. In the US, this has largely translated into a very interesting and vital debate. In the UK, the debate has mostly been a silly punch and judy show with people either giving glossy overview of Thaler and Sunnstein’s book Nudge or lambasting everything behavioural as a return to either Thatcherism or Socialism. You are currently looking at most of the Irish debate. To dismiss the whole lot is as silly as embracing it all.


George – here is one for you to through at the next egghead like me you get into a debate with on behavioural economics. It comes from Edward Glaeser


“The real case for laissez-faire is not that the individual is perfect, but that the state will do worse than the private individual, and the strength of this case has always relied more on the fallibility of the state than on the perfection of markets. Adam Smith’s case for laissez-faire was grounded in the unarguable historical fact that governments often pursue policies that impoverish and slaughter their own citizenry. Human beings surely make mistakes about their own welfare, but the welfare losses created by these errors are surely second order relative to the welfare losses created by governments which not only make errors, but also pursue objectives far from welfare maximization. Individuals may procrastinate and foolishly invest, but they tend not to voluntarily enroll in concentration camps.”

I would suggest that the whole pension(both private and public) and social welfare infrastructure should be aboilshed and replaced with a comination of Singapores excellent CPF model and CORIs minimum income scheme.

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