Monday, October 7, 2019

Why we don't get more joy out of our super

When one of our top econocrats gives a speech about behavioural economics, you know we’re making progress. Take the ever-present problem of income in retirement. “BE” explains both why it’s a major area of government intervention in our lives and how that intervention can be made more effective.

One of the greatest limitations of conventional economics – based on the “neo-classical” model, which focuses on how prices are determined by the interaction of supply and demand – is its assumption that people are unfailingly “rational” – calculatingly self-interested – in their response to the prices they face.

Behavioural economics accepts that we’re not the financial automatons the model assumes us to be, and uses insights from the more empirical sciences of psychology and sociology to gain a much more realistic picture of the many non-monetary factors that also affect our behaviour in economic matters.

Behavioural economists draw on the long list of “heuristics” – mental shortcuts or biases in the way we think – developed by cognitive psychologists. In a recent speech, Dr David Gruen, top economics guy in the Department of Prime Minister and Cabinet, outlined the cognitive biases that limit many people’s ability to make adequate provisions for the income they’ll need in retirement.

For more than a century the government has provided the age pension, of course. But in the 1990s people began to worry that it wouldn’t be sufficient to meet the aspirations of the rising generation. So the Keating government introduced compulsory employee superannuation.

In those days before the spread of BE, most economists accepted the imposition of compulsory saving as a correction to the “market failure” of “myopia” – most of us are too short-sighted to save enough towards our retirement.

The BE way of putting it is that we suffer from “present bias” – we overvalue the present relative to the future. Gruen takes the idea further, noting that “while choosing a retirement plan is likely to influence literally decades of our lives, many of us spend little time – sometimes less than an hour – choosing our plan”.

Then there’s “confirmation bias” – we tend to remember events that confirm our existing views, but forget developments that cast doubt on those views. Gruen uses this to explain why many of us spend what little time we have set aside to choose a retirement plan looking for one with an investment strategy that supports our existing investing approach.

And “cognitive overload”. This occurs when people find it too hard to process a mass of information in order to make decisions. In the context of planning for retirement, it leads many of us to stick with choices we have arrived at by default.

“Together, these cognitive biases create a big gap between our intentions and our actions: although people intend to save for their retirement, they often don’t translate that into action. For most people, how much to save, and in what form, are difficult cognitive problems – because of both our limited calculation powers and the apparent enormity of the task,” Gruen says.

When the compulsory super system was first set up, the government adopted the conventional economics view that savers were rational economic agents who knew their own business best. So all it had to do was require the super funds to reveal relevant information about their investment options, and diligent savers would do the rest, ensuring they picked the option that best suited their circumstances.

Yeah sure. At the time of a review of super in 2009, 80 per cent of super fund members were invested in the default fund chosen by their employer. Of that 80 per cent, anecdotal evidence suggested that only about 20 per cent explicitly chose the default option, with the rest making no active choice whatsoever.

“When complicated decisions are required, people often stick with the status quo and take no decision at all. In that case, the default option becomes very important,” Gruen says. (This is actually one of the key “insights” of BE.)

So the review panel recommended creating a default option – called MySuper - with features that would promote the wellbeing of those who didn’t actively choose another option. MySuper funds must be simple and cost-effective, with a diversified portfolio of investment.

Of course, there are remaining challenges in the compulsory super system, which the latest review of retirement incomes, instigated by Treasurer Josh Frydenberg, will consider. Let’s hope it takes full advantage of the behavioural insights available to it.

As Gruen says, BE allows all government policymaking to be improved by starting with a richer understanding of human behaviour and building this into the design of measures.