thaler

Nobel Prize awarded to Richard Thaler

This is a prize that is easy to understand.  It is a prize for behavioral economics, for the ongoing importance of psychology in economic decision-making, and for “Nudge,” his famous and also bestselliing book co-authored with Cass Sunstein.

Here are previous MR posts on Thaler, we’ve already covered a great deal of his research.  Here is Thaler on Twitter.  Here is Thaler on scholar.google.com.  Here is the Nobel press release, with a variety of excellent accompanying essays and materials.  Here is Cass Sunstein’s overview of Thaler’s work.

Perhaps unknown to many, Thaler’s most heavily cited piece is on whether the stock market overreacts.  He says yes this is possible for psychological reasons, and this article also uncovered some of the key evidence in favor of the now-vanquished “January effect” in stock returns, namely that for a while the market did very very well in the month of January.  (Once discovered the effect went away.)  Another excellent Thaler piece on finance is this one with Shleifer and Lee, on why closed end mutual funds sell at divergences from their true asset values.  This too likely has something to do with market psychology and sentiment, as the same “asset package,” in two separate and non-arbitrageable markets, can sell for quite different prices, sometimes premia but usually discounts.  This was one early and relative influential critique of the efficient markets hypothesis.

Another classic early Thaler piece is on a phenomenon known as “mental accounting,” for instance you might treat a dollar in your pocket as different from a dollar in your bank account.  Or earned money may be treated different from money you just chanced upon, or won that morning in the stock market.  This has significant implications for predicting consumer decisions concerning saving and spending; in particular, economists cannot simply measure income but must consider where the money came from and how it is perceived by consumers, namely how they are performing their mental accounting of the funds.  Have you ever gone on a vacation with a notion that you would spend so much money, and then treated all expenditures within that range as essentially already decided?  The initial piece on this topic was published in a marketing journal and it has funny terminology, a sign of how far from the mainstream this work once was.  It is nonetheless a brilliant piece.  Here is more Thaler on mental accounting.

Thaler, with Kahneman and Knetsch, was a major force behind discovering and measuring the so-called “endowment effect.”  Once you have something, you value it much more!  Maybe three or four times as much, possibly more than that.  It makes policy evaluation difficult, because as economists we are not sure how much to privilege the status quo.  Should we measure “willingness to pay” — what people are willing to pay for what they don’t already have?  Or “willingness to be paid” — namely how eager people are to give up what they already possess?  The latter magnitude will lead to much higher valuations for the assets in question.  This by the way helps explain status quo bias in politics and other spheres of life.  People value something much more highly once they view it as theirs.

This phenomenon also makes the Coase theorem tricky because the final allocation of resources may depend quite significantly on how the initial property rights are assigned, even when the initial wealth effect from such an allocation may appear to be quite small.  See this Thaler piece with Knetsch.  It’s not just that you assign property rights and let people trade, but rather how you assign the rights up front will create an endowment effect and thus significantly influence the final bargain that is struck.

With Jolls and Sunstein, here is Thaler on a behavioral approach to law and economics, a long survey but also constructive piece that became a major trend and has shaped law and economics for decades.  He has done plenty and had a truly far-ranging impact, not just in one or two narrow fields.

Thaler’s “Nudge” idea, developed in conjunction with Cass Sunstein over the course of a major book and some articles, has led policymakers all over the world to focus on “choice architecture” in designing better systems, the UK even setting up a “Nudge Unit.”  For instance, one way to encourage savings is to set up pension systems for employees so that the maximum contribution is the default, rather than an active choice people must make.  This is sometimes referred to as a form of “soft” or “libertarian paternalism,” since choice is still present.  Here is Thaler responding to some libertarian critiques of the nudge idea.

I first encountered Thaler’s work in graduate school, in the mid-1980s, in particular some of his pieces in the Journal of Economic Behavior and Organization; here is his early 1980 manifesto on how to think about consumer choice.  I thought “this is great stuff,” and I gobbled it up, as it was pretty consistent with some of what I was imbibing from Thomas Schelling, in particular Thaler’s 1981 piece with Shefrin on the economics of self-control, a foundation for many later discussions of paternalism.  I also thought “a shame this work isn’t going to become mainstream,” because at the time it wasn’t.  It was seen as odd, under-demonstrated, and often it wasn’t in top journals.  For some time Thaler taught at Cornell, a very good school but not a top top school of the kind where many Laureates might teach, such as Harvard or Chicago or MIT.  Many people were surprised when finally he received an offer from the University of Chicago Business School, noting of course this was not the economics department.  Obviously this Prize is a sign that Thaler truly has arrived at the very high levels of recognition, and I would note Thaler has been pegged as one of the favorites at least since 2010 or so.  When Daniel Kahneman won some while ago and Thaler didn’t, many people thought “ah, that is it” because many of Thaler’s most famous pieces were written with Kahneman.  Yet as time passed it became clear that Thaler’s work was holding up and spreading far and wide in influence, and he moved into a position of being a clear favorite to win.

Here is Thaler’s book on the making of behavioral economics.  Excerpt:

…my thesis advisor, Sherwin Rosen, gave the following as an assessment of my career as a graduate student: “We did not expect much of him.”

Very lately Thaler on Twitter has been making some critical remarks about price gouging, suggesting we also must take into account what customers perceive as fair.  Here is his earlier piece about fairness constraints on profit-seeking, still a classic.

Thaler has written many columns for The New York Times, here is one on boosting access to health care.  Here are many more of them.  Here is “Unless you are Spock, Irrelevant Things Matter for Investment Behavior.”  Here is Thaler on making good citizenship fun.  He also told us that trading up in the NFL draft isn’t worth it.

Thaler is underrated as a policy economist, here is an excellent NYT piece on the “public option” for health insurance, excerpt: “…instead of arguing about whether to have a public option, argue about the ground rules.”

His last pre-Nobel tweet was: “The web site is using lots of . Advertised rates include cashing in of “points”, cancellation policies not salient if bad…”

A well-deserved prize and one that is relatively easy to explain, and most of Thaler’s works are easy to read even if you are not an economist.  I would stress that Thaler has done more than even many of his fans may realize.

Richard Thaler Wins Nobel!

Richard Thaler wins the Nobel for behavioral economics! An excellent choice and one that makes my life easier because you probably already know his work. Indeed his work may already have influenced how much you save for retirement, how you pay your taxes and whether you will donate a kidney or not. In Britain, Thaler’s work was one of the inspirations for the Behavioral Insights Team which applies behavioral economics to public policy. Since being established in 2010 similar teams have been created around the world including in the United States.

Thaler’s intellectual biography Misbehaving (available free as kindle for Amazon Prime members is this a nudge?) is a fun guide to his work. Thaler will be the first to tell you he isn’t that smart. Relative to other Nobel prize winners that might even be true. None of his papers are technically difficult or excessively math heavy and most of his ideas are pretty obvious–obvious once you have heard them! Thaler cannot have been the first person in the world to notice that people like cashews but also like it when you take the cashews away to prevent them from eating more than they really want to eat (preferences Thaler noted at a dinner party of economists). But other people, especially economists, dismissed the evidence in front of their noses that people weren’t as rational as their theories suggested–People will be more careful with big decisions. Errors will cancel. Markets will take care of that–There were plenty of reasons to go back to pondering the beautiful austerity of theory. Thaler, however, especially after reading Kahneman and Tversky’s Judgment under Uncertainty: Heuristics and Biases realized that their could be a theory of misbehaving, a theory of irrational choice.

That theory is now called behavioral economics. It’s not as clean and straight as neo-classical theory. We still don’t know when one bias, of the many that have been documented, applies and when another applies. So much depends on context and what we bring to it that perhaps we never will. Nevertheless, there is no longer any question that some features of choice and the economy are better explained via systematic biases than by purely rational decision making.

In addition to Misbehaving and Nudge (the latter with Cass Sunstein who brought these ideas to law and government) you can find many of Thaler’s key ideas in the Anomalies column of the Journal of Economic Perspectives. Probably this is the first economics Nobel to be given for a popular column! In many ways, however, these columns made Thaler’s reputation. The anomalies column was always a highlight of the issue and I remember discussing and debating these columns with Tyler and many others as they appeared. The same was true throughout the economics profession. Even economists like an anomaly.

One of the most important applications of behavioral economics has been to savings. Savings decisions are difficult because it’s not obvious how much to save or even how to save (bank accounts, mutual funds, Roth IRA, 401k etc. etc.). In addition, the decision can be administratively complex with annoying paperwork, and the benefits of good decision making don’t occur until decades into the future. Perhaps most importantly, we don’t receive clear and quick feedback about our choices. We don’t know whether we have saved too little or too much until it’s too late to change our decision. As a result, many of us fall back on defaults. These are the motivating ideas behind Thaler’s recommendations to set default rules such that people are automatically enrolled in pension plans that invest in low-cost market indices. Such default rules have changed saving behavior in the United States and around the world. Thaler’s Save More Tomorrow plans also ask people whether they want to plan today to save more of their raises, a simple yet profound change in default that makes it easier to save by lowering the perceived cost.

Thaler’s research is even changing football. His paper with Cade Massey, Overconfidence vs. Market Efficiency in the National Football League looked at “right to choose decisions” in the player draft. On the one hand, millions of dollars are made and lost on these decisions and they are being made repeatedly by professionals; thus, the case for rational decisions would seem to be strong. But on other hand, people are overconfident, they tend to make extreme forecasts, there is a winner’s curse, there is a false consensus effect (you think that everyone likes what you like), and there is present bias. These biases all suggest that decisions might be made poorly, even given the big stakes. Massey and Thaler find that it’s the latter.

Using archival data on draft-day trades, player performance and compensation, we compare the market value of draft picks with the historical value of drafted players. We find that top draft picks are overvalued in a manner that is inconsistent with rational expectations and efficient markets and consistent with psychological research.

Moreover, and this is the kicker, Massey and Thaler’s research has passed the market test! Bill Belichick started to pay attention first (econ undergrad natch) and now other smart teams are applying Thaler’s research to improve their choices.

Few economists have had more practical influence than Richard Thaler and behavioral economics is still on the upswing.

Career advice from Richard Thaler

My advice for young researchers at the start of their career is… Work on your own ideas, not your advisor’s ideas (or at least in addition to her ideas). And spend more time thinking and less time reading. Too much reading leads people to think of small variations on existing studies. Admittedly my strategy of writing the paper first and only then reading the literature (or, more likely, letting the referees tell me what they think I should have read) is an extreme one, but it is better than trying to read everything. Try writing the first paper on some topic, not the tenth, and never the 50th.

Here is the rest of the interview.

Richard Thaler prefers a playoff system to BCS

Even if you think the tradition of the bowl games is worth preserving, going to an eight-team playoff would help such bowls. Here is how it might work. In an eight-team playoff there are seven games. Give each of the existing bowl games one of the first-round games, played the first weekend in December. These games would attract more attention than any of the nonchampionship BCS games now because they determine who keeps playing. Then rotate the semifinal and final games among various locations, much as is done with the Super Bowl and the NCAA basketball tournament. For traditionalists, restore the championship game to New Year’s Day, thereby shortening the season by a week even for the teams that play in the championship.

This system would not only be attractive to college-football fans, it would also help curtail high-stakes conference-jumping by colleges that want a share of that BCS money. This turmoil is leaving some conferences desperately short of teams. Rumor has it that the Big East has offered a spot to the Sorbonne.

Here is more.

Richard Thaler’s question

I am doing research for a new book and would like to hope to elicit informed responses to the following question:

The flat earth and geocentric world are examples of wrong scientific beliefs that were held for long periods. Can you name your favorite example and for extra credit why it was believed to be true?

Please note that I am interested in things we once thought were true and took forever to unlearn. I am looking for wrong scientific beliefs that we've already learned were wrong, rather than those the respondent is predicting will be wrong which makes it different from the usual Edge prediction sort of question.

There are many answers here (scroll down).  Hat tip goes to Edge on Twitter.

Thaler Nudges the Brits (and the Swedes?)

Guardian.co.uk: A "nudge unit" set up by David Cameron in the Cabinet Office is working on how to use behavioural economics and market signals to persuade citizens to behave in a more socially integrated way.

The unit, formally known as the Behavioural Insight Team, is being run by David Halpern, a former adviser in Tony Blair's strategy unit, and is taking advice from Richard Thaler, the Chicago professor generally recognised as popularising "nudge" theory – the idea that governments can design environments that make it easier for people to choose what is best for themselves and society.

Thaler is a good bet for the Nobel.  Hat tip Martin Ryan at Geary.

Richard Thaler joins *Economic View*

His first column is on behavioral economics and mortgages; excerpt:

Some critics contend that behavioral economists have neglected the
obvious fact that bureaucrats make errors, too. But this misses the
point. After all, wouldn’t you prefer to have a qualified, albeit
human, technician inspect your aircraft’s engines rather than do it
yourself?

The owners of ski resorts hire experts who have
previously skied the runs, under various conditions, to decide which
trails should be designated for advanced skiers. These experts know
more than a newcomer to the mountain. Bureaucrats are human, too, but
they can also hire experts and conduct research.

The Nobel Prize in Economic Science Goes to Banerjee, Duflo, and Kremer

The Nobel Prize goes to Abhijit Banerjee, Esther Duflo and Michael Kremer (links to home pages) for field experiments in development economics. Esther Duflo was a John Bates Clark Medal winner, a MacArthur “genius” award winner, and is now the second woman to win the economics Nobel and by far the youngest person to ever win the economics Nobel (Arrow was the previous youngest winner!). Duflo and Banerjee are married so these are also the first spouses to win the economics Nobel although not the first spouses to win Nobel prizes–there was even one member of a Nobel prize winning spouse-couple who won the Nobel prize in economics. Can you name the spouses?

Michael Kremer wrote two of my favorite papers ever. The first is Patent Buyouts which you can find in my book Entrepreneurial Economics: Bright Ideas from the Dismal Science. The idea of a patent buyout is for the government to buy a patent and rip it up, opening the idea to the public domain. How much should the government pay? To decide this they can hold an auction. Anyone can bid in the auction but the winner receives the patent only say 10% of the time–the other 90% of the time the patent is bought by the government at the market price. The value of this procedure is that 90% of the time we get all the incentive properties of the patent without any of the monopoly costs. Thus, we eliminate the innovation tradeoff. Indeed, the government can even top the market price up by say 15% in order to increase the incentive to innovate. You might think the patent buyout idea is unrealistic. But in fact, Kremer went on to pioneer an important version of the idea, the Advance Market Commitment for Vaccines which was used to guarantee a market for the pneumococcal vaccine which has now been given to some 143 million children. Bill Gates was involved with governments in supporting the project.

My second Kremer paper is Population Growth and Technological Change: One Million B.C. to 1990. An economist examining one million years of the economy! I like to say that there are two views of humanity, people are stomachs or people are brains. In the people are stomachs view, more people means more eaters, more takers, less for everyone else. In the people are brains view, more people means more brains, more ideas, more for everyone else. The people are brains view is my view and Paul Romer’s view (ideas are nonrivalrous). Kremer tests the two views. He shows that over the long run economic growth increased with population growth. People are brains.

Oh, and can I add a third Kremer paper? The O-Ring Model of Development is a great and deep paper. (MRU video on the O-ring model).

The work for which the Nobel was given is for field experiments in development economics. Kremer began this area of research with randomized trials of educational policies in Kenya. Duflo and Banerjee then deepened and broadened the use of field experiments and in 2003 established the Poverty Action Lab which has been the nexus for field experiments in development economics carried on by hundreds of researchers around the world.

Much has been learned in field experiments about what does and also doesn’t work. In Incentives Work, Dufflo, Hanna and Ryan created a successful program to monitor and reduce teacher absenteeism in India, a problem that Michael Kremer had shown in Missing in Action was very serious with some 30% of teachers not showing up on a typical day. But when they tried to institute a similar program for nurses in Putting a Band-Aid on A Corpse the program was soon undermined by local politicians and “Eighteen months after its inception, the program had become completely ineffective.” Similarly, Banerjee, Duflo, Glennerster and Kinnan find that Microfinance is ok but no miracle (sorry fellow laureate Muhammad Yunus). A frustrating lesson has been the context dependent nature of results and the difficult of finding external validity. (Lant Pritchett in a critique of the “randomistas” argues that real development is based on macro-policy rather than micro-experiment. See also Bill Easterly on the success of the Washington Consensus.)

Duflo, Kremer and Robinson study How High Are Rates of Return to Fertilizer? Evidence from Field Experiments in Kenya. This is an especially interest piece of research because they find that rates of return are very high but that farmers don’t use much fertilizer. Why not? The reasons seem to have much more to do with behavioral biases than rationality. Some interventions help:

Our findings suggest that simple interventions that affect neither the cost of, nor the payoff to, fertilizer can substantially increase fertilizer use. In particular, offering farmers the option to buy fertilizer (at the full market price, but with free delivery) immediately after the harvest leads to an increase of at least 33 percent in the proportion of farmers using fertilizer, an effect comparable to that of a 50 percent reduction in the price of fertilizer (in contrast, there is no impact on fertilizer adoption of offering free delivery at the time fertilizer is actually needed for top dressing). This finding seems inconsistent with the idea that low adoption is due to low returns or credit constraints, and suggests there may be a role for non–fully rational behavior in explaining production decisions.

This is reminiscent of people in developed countries who don’t adjust their retirement savings rates to take advantage of employer matches. (A connection to Thaler’s work).

Duflo and Banerjee have conducted many of their field experiments in India and have looked at not just conventional questions of development economics but also at politics. In 1993, India introduced a constitutional rule that said that each state had to reserve a third of all positions as chair of village councils for women. In a series of papers, Duflo studies this natural experiment which involved randomization of villages with women chairs. In Women as Policy Makers (with Chattopadhyay) she finds that female politicians change the allocation of resources towards infrastructure of relevance to women. In Powerful Women (Beaman et al.) she finds that having once had a female village leader increases the prospects of future female leaders, i.e. exposure reduces bias.

Before Banerjee became a randomistas he was a theorist. His A Simple Model of Herd Behavior is also a favorite. The essence of the model can be explained in a simple example (from the paper). Suppose there are two restaurants A and B. The prior probability is that A is slightly more likely to be a better restaurant than B but in fact B is the better restaurant. People arrive at the restaurants in sequence and as they do they get a signal of which restaurant is better and they also see what choice the person in front of them made. Suppose the first person in line gets a signal that the better restaurant is A (contrary to fact). They choose A. The second person then gets a signal that the better restaurant is B. The second person in line also sees that the first person chose A, so they now know one signal is for A and one is for B and the prior is A so the weight of the evidence is for A—the second person also chooses restaurant A. The next person in line also gets the B signal but for the same reasons they also choose A. In fact, everyone chooses A even if 99 out of 100 signals are B. We get a herd. The sequential information structure means that the information is wasted. Thus, how information is distributed can make a huge difference to what happens. A lot of lessons here for tweeting and Facebook!

Banerjee is also the author of some original and key pieces on Indian economic history, most notably History, Institutions, and Economic Performance: The Legacy of Colonial Land Tenure Systems in India (with Iyer).

Duflo’s TED Talk. Previous Duflo posts; Kremer posts; Banerjee posts on MR.

Before last year’s Nobel announcement Tyler wrote:

I’ve never once gotten it right, at least not for exact timing, so my apologies to anyone I pick (sorry Bill Baumol!). Nonetheless this year I am in for Esther Duflo and Abihijit Banerjee, possibly with Michael Kremer, for randomized control trials in development economics.

As Tyler predicted he was wrong and also right. Thus, this years win is well-timed and well-deserved. Congratulations to all.

Does aversion to change predict support for Donald Trump?

Donald Trump won the American presidency in 2016 by overperforming expectations in upper Midwest states, surprising even Republican political elites. We argue that attitudes toward social change were an underappreciated dividing line between supporters of Trump and Hillary Clinton as well as between Republicans at the mass and elite levels. We introduce a concept and measure of aversion to (or acceptance of) social diversification and value change, assess the prevalence of these attitudes in the mass public and among political elites, and demonstrate its effects on support for Trump. Our research uses paired surveys of Michigan’s adult population and community of political elites in the Fall of 2016. Aversion to social change is strongly predictive of support for Trump at the mass level, even among racial minorities. But attitudes are far more accepting of social change among elites than the public and aversion to social change is not a factor explaining elite Trump support. If elites were as averse to social change as the electorate—and if that attitude mattered to their vote choice—they might have been as supportive of Trump. Views of social change were not as strongly related to congressional voting choices.

That is from Matt Grossman and Daniel Thaler.

Reverse nudge theory — when the many nudge the few

Nudge Theory, popularised by Thaler & Sunstein, proposes that our decisions can be biased by relatively small changes in choice architecture. While we might be well intentioned, our human fallibility and modern environments sometimes require ‘choice architects’ to nudge us back on the path toward individual and collective wellbeing. Whether used for good or bad, Nudge Theory is most often applied downhill – the few (state or commercial players) nudge the many (citizens or consumers).

I would like to propose that Reverse Nudge Theory might be a good term for nudging uphill. For governments and corporations are also made up of individuals – and these individuals are equally prone to political, economic, and career forces which may get in the way of them making decisions that would be in our best interests.

Such reverse nudging is not a new endeavour of course. The formation of labour unions, the democratic process, and ‘voting with your wallet‘ are all good examples of this. So while well-intentioned choice architects nudge us, perhaps we need to be equally creative in nudging them back for their (and our) own good.

That is from Benjamin Vincent at Journal of Brief Ideas.

Most Popular MR Posts of 2017

The most popular post on MR for 2017 was my post, Switzerland is Prepared for Civilizational Collapse. Who can tell what will go viral? I suppose people are thinking a lot about civilizational collapse in recent times.

Next was Tyler’s post on Richard Thaler’s Nobel Prize.

There’s a lot of interest in Tyler’s religious beliefs as What is the Strongest Argument for the Existence of God? and Why I Don’t Believe in God were both widely read and commented upon.

Next came a bunch of econ posts from both Tyler and myself including:

Not surprisingly politics was also popular, including Tyler’s The Show so Far and Who Should be Shamed? and my post Authoritarians Distract Rather than Debate.

Overall, what strikes me is how normal 2017 seems. Compare with last year’s top posts, which are crazy. I don’t think 2017 was any less crazy than 2016 but–god help us–crazy has become normal.

Pass-through of minimum wages into U.S. retail prices

That is studied by Renkin, Montialoux, and Siegenthaler in a recent paper, which is also a job market paper for Tobias Renkin from the University of Zurich.  Here is the abstract:

We study the impact of increases in local minimum wages on the dynamics of prices in local grocery stores in the US during the 2001-2012 period. We find a signifi cant impact of increasing minimum wages on prices in grocery stores. Our baseline estimate of the minimum wage elasticity of grocery prices is 0.02. This magnitude is consistent with a full pass-through of cost increases into prices. We show that price adjustments occur mostly in the months following the passage of minimum wage legislation rather than at the actual implementation of higher minimum wages. This forward-looking pattern of price adjustments is qualitatively consistent with pricing models that feature nominal rigidities. We fi nd no differential price effect for products consumed by poorer and richer households, and no evidence for demand effects. Our results suggest that consumers rather than firms bear the cost of minimum wage increases. Moreover, poor households are most negatively affected by the price response. Price increases in grocery stores alone offset at least 10% of the nominal income gains of the poorest households.

Of course this also would suggest the sector is relatively competitive.  And if you are wondering, here is the full slate of job candidates from Zurich.

Tuesday assorted links

1. Self-driving cars will be better for wheelchairs.

2. “U.S. House of Representatives Financial Services Committee considered many important banking reforms in 2009-2010 including the Dodd-Frank Act. We show that during this period, the foreclosure starts on delinquent mortgages were delayed in the districts of committee members even though there was no difference in delinquency rates between committee and non-committee districts.”  Link here.

3. Reexamining the economics of NFL draft picks.

4. Bershidsky on Merkel and Germany.

5. Is George Orwell overrated?  I claimed this to Cardiff Garcia just yesterday, at least relative to Huxley.

6. What is up with Northern Ireland? (NYT)  A good and important piece.

7. How a made-up article garnered hundreds of citations.

Thursday assorted links