Using Nudges to Regulate New Technologies

In recent years, the rate of innovation has increased dramatically, and new technologies are being introduced in almost all markets around the globe. Disruptive innovations such as blockchain, cryptocurrencies, the ‘Internet of things’, automated cars and other products that support decision-making based on artificial intelligence (AI) are offering a creative take on traditional markets, significantly affecting the market functions like never before. These technologies are changing the way the world works and frequently require regulatory intervention in order to protect consumers or prevent systemic risks for society at large.

One of the main challenges for regulating new technologies is insufficient technological knowledge by the regulators. The industry is usually more informed about the subject matter than the regulators, and is more likely to tailor regulation by private ordering. Creating a favorable ecosystem that promotes innovation is key for enhancing the motivation and ability of firms to innovate. As we argue in our recent Article, in such cases, when uncertainty is extremely high, the use of nudges is a desirable policy tool in order to regulate new technologies. A nudge is ‘any aspect of the choice architecture that alters people’s behavior in a predictable way without forbidding any options or significantly changing their economic incentives’ (Thaler & Sustein (2008) and Sunstein (2014)). Nudging can be used to steer the industry and/or consumers towards or away from the new technology and can be useful for mitigating potential harm caused by technologies to users and third parties. According to the literature, in the regulatory area several forms of nudge exist, ranging from disclosure requirements, through default rules and simplification to increased salience and to using the power of social norms to direct people in the desired direction. A few examples of how to use these techniques when regulating new technologies are the following:

• Disclosure requirements: Take, for example, peer-to-peer (P2P) lending platforms. On such a platform information is crucial. Lenders need the credit history of the borrowers. Borrowers need to know the interest rate they will be required to pay, understand the number of payments they will have to make, and the other fees the platform charges. In addition, a comparison to bank fees may be in order. All participants should be notified of any change the platform makes to the terms and receive advance notice, and should have the option to easily opt out in case they do not agree to the new terms. An example of similar requirements with regard to old technology exists in the field of the regulation of credit cards. Another example may be requirements to provide information through labeling. In the area of new technologies, we might require manufacturers to label a new product, such as drones, with details about their safety, height, and durability. A second example may be regulators’ announcement at important conferences that the state believes the future lies in technology ‘x’ or that technology ‘y’ is dangerous.
   
• Default rules and simplifications: If a new technology-based financial product is introduced, regulators can offer a default contract to govern the relationship between consumers and producers. Studies have shown that, when a default exists, deviating from it is more difficult and therefore would occur only with the careful consideration of both sides.
   
• Increased salience: It is often possible to influence consumers’ behavior by drawing attention to certain features of a product or presenting a situation that makes such features more salient. In the area of new technologies, take for example electric bikes, also known as e-bikes. Forcing the manufacturer to place a picture on the e-bike box of someone hurt by riding without a helmet together with a warning that helmets should be used might prompt consumers to wear helmets when using the product. A good example of a regulatory authority already using this technique is the mock ICO called ‘HoweyCoin’ by the SEC. The SEC launched a fake ICO website in order to educate investors. Users who try to invest in ‘HoweyCoin’ are directed instead to the regulators’ educational tools, which highlight the signs for a fraudulent token sale.
   
• Using social norms: Assume that sometime in the future you will be able to fuel your car with energy produced from waste. Social pressure might prove beneficial in encouraging people to do that. Advertisements presenting people who do not make this choice as polluting the environment might have a positive effect on consumers’ behavior and push them to do so.

The choice of the direction of the nudge would still, as always, be based on the ‘gut instinct’ of the regulators. However, unlike binding regulations, if that gut instinct is wrong, room is left for the ‘Wisdom of the Crowd’ to ignore the nudge, or to accept part of the solution thus tailoring the private ordering to each business model in the industry.

Nissim Cohen is Assistant Professor at the Department of Public Administration & Policy, the University of Haifa, Israel.

Hadar Y. Jabotinsky is a Cegla Visiting Research Fellow at Tel Aviv University Law School, Israel.