Libertarian Paternalism and the ‘Nudge’ Approach

This is article no. 4 in a series on behavioural economics. Next article: Effect of time (coming soon). Previous article- Loss aversion.

So far in our series of behavioural economics, we have discussed why and how people may make less favourable decisions than traditional economics assumes. We have spoken about how people can still be honest even when they are faced with a decision where they can be materially better off; and when someone loses their wallet, they feel more distaste than finding some money on the street; and how an endowment adds a bizarre sense of additional worth, that would cause you to think twice about trading it for something equally valuable.

In today’s article, we are going to address why this is important to policy makers, and subsequently you and I, by exploring how governments and institutions can influence our decisions in ways that may seem paternalistic yet still respect individual freedom. This idea lies at the heart of libertarian paternalism.

The idea behind the “Nudge”

Nudge is a book written by Nobel Prize–winning economist Richard Thaler and legal scholar Cass Sunstein. Building on their 2003 paper, the book develops the idea that people’s choices can be shaped not only by the options available, but also by the context in which those options are presented — even by factors that seem trivial or irrelevant.

This is where the concept of a “nudge” comes in: small design changes that steer people toward better decisions without restricting their freedom to choose.

A simple change: the pension example

A classic example comes from workplace pensions. Before 2008, when someone joined a new company, they were asked whether they wanted to join the company pension scheme. Most people didn’t — they took their full pay instead and failed to save for retirement.

This created a growing problem for the government: an ageing population without enough savings to maintain a comfortable lifestyle. The solution was remarkably simple. Instead of asking employees to opt in to a pension, companies began enrolling them automatically, giving them the option to opt out instead.

The choice remained exactly the same, pension or no pension, but the framing made all the difference. Opting out felt like losing something, and because people are naturally loss-averse, far fewer did so. In 2012, just under 50% of employees in the private sector had a pension. By 2018, after the introduction of auto-enrolment, that number had risen to around 80%.

All from a change in default wording on a form.

Libertarian Paternalism – a justification

Paternalism is generally considered the situation where the government interferes in our choices, for better or for worse, much like a parent telling their children what they can and cannot do. In many cases, society accepts paternalism as necessary: we ban harmful drugs, make theft illegal, and impose safety regulations. But should governments really be meddling with our personal financial decisions? Should they be influencing our choices about pensions, spending, or saving?

Whether they should or shouldn’t is ultimately a political question, not an economic one. However, what we can do is consider Richard Thaler and Cass Sunstein’s explanation of why policies such as pension defaults represent something fundamentally different.

When the government restricts drugs or criminalises theft, it removes our freedom to choose — these are examples of hard paternalism, enforced by law. But with pensions, the government doesn’t force participation. The choice remains entirely yours: you can stay enrolled or opt out. This preservation of choice embodies the libertarian element — the freedom to decide for oneself.

At the same time, by changing how the choice is presented, such as making enrolment the default option, policymakers can dramatically alter behaviour in a direction they consider beneficial. That is where the paternalistic element comes in. According to Thaler and Sunstein, this combination of freedom and gentle guidance is what defines libertarian paternalism.

In Thaler and Sunstein’s eyes, nudging individuals towards better decisions through the use of policy is better and less controversial than implementing outright bans and mandates. It respects our autonomy while encouraging outcomes that they believe will improve collective welfare. If the government genuinely believes certain decisions are in the public’s best interest, then libertarian paternalism provides a way to influence behaviour without infringing on people’s right to choose.

A question of freedom

I do, however, pose some questions to you. If the government can influence your decision making through manipulating people’s psychology, can it truly be called libertarian? And more fundamentally - does the government really know best?

In recent years, the 'Nudge' approach has faced criticism, particularly regarding the assumptions it makes about what constitutes a “better” decision and who gets to define it. Despite this, the research continues to shape public policy across the world — from pensions and health to energy use and education.

What’s crucial is that we remain aware of the ways our choices can be influenced. Recognising these nudges allows us to make decisions that best reflect our own values, circumstances, and goals. And on a deeper level, if every choice we make can be subtly shaped by those in power, how do we ensure that nudges serve the public interest — and not the interest of those who nudge?

Written by George Chant