Sticks, governance and nudges: why sustainable behaviour might just win out in the end

When Richard Thaler was awarded the Nobel Prize in Economics a few weeks ago, he was asked what he hoped he would be remembered for. ‘Making economics more human’ was his reply. He had in mind a world where agents are less rational than what has been assumed in economic modelling in the last half-century, and policies that are tailored to this reality. For encouraging sustainability, this means the menu has been expanded.

A legacy of Thaler and other behavioural economists is the encouragement to think outside the box when it comes to policymaking. The way I see it, that includes extending our toolbox beyond regulation and price incentives to a more pro-active use of board governance, shareholder activism as well as ‘nudges’ – the tweaking of behaviour by deploying intelligent designs that Thaler et al. have become famous for. 

For tackling climate change, economists have traditionally recommended a ‘stick’ approach in the form of carbon taxes or tradable emissions quotas. In theory these work well, but as the implosion of the EU-ETS and CDM have shown us, only if the price is high enough so that it sends a meaningful signal.

But other ways of influencing firm behaviour do exist. One is through governance, which in large part boils down to having a diverse and well-informed board who does a good job of challenging the executive team. In the context of ensuring long-term financial and environmental sustainability, this means that board members ask questions on the long-term benefits and risks of a firm’s business model. I don’t know for certain, but I have a feeling that Unilever’s board has been asking good questions for a long time, while I doubt the same can be said for Exxon.

Finally, nudges can and should play a role. Designing appliances so that their default is ‘standby mode’ rather than ‘on’ will reduce energy consumption. Offering loans on preferential terms for sustainable agricultural methods as the pre-selected option may nudge farmers to improve their environmental performance. You still have a choice – which is important to free market enthusiasts - but with a nudge you are more likely to choose what’s best for you, and ultimately the environment.

So it seems that we have a relatively rich menu of incentives, meaningful governance and nudges to choose from to guide firms towards sustainability. This is very positive, and it would be reasonable to expect companies to eventually do the right thing. Especially since from this menu, choosing ‘all of the above’ would be perfectly legitimate (and indeed intended).