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.