University of Chicago economist Richard H. Thaler, probably the most important founder of "behavioral economics," is a fantastic storyteller. In his latest book, Misbehaving, he tells, roughly chronologically, of his initial doubts about the standard economist's "rational actor" model and how those doubts led him to set his research agenda for the next 40 years. In chapter after chapter, he tells of anomalies--bits of evidence that are inconsistent, sometimes wildly so--with the various economic models and of his debates with the proponents of those models. In Thaler's telling, he always won the debates. One would expect him to say that, but as someone who did not start out on his side of the debates, I think he often did win.
This is the opening paragraph of my "The Case for 'Misbehavior,'" my review of Richard H. Thaler's new book, Misbehaving. It appears in the Fall issue of Regulation. (Scroll down.)
An excerpt that illustrates one of his main themes:
Consider what he calls the endowment effect. In laying out the effect, Thaler presents the results of two versions of a question he asks his students. In version A, he tells them that they have been exposed to a rare disease that they have a 1 in 1,000 chance of contracting. If they get the disease, they will die within a week. They can take an antidote that, with certainty, will prevent death. How much, he asks, are they willing to pay for the antidote? A typical answer is $2,000.
Then he presents the same students with version B, telling them that they can choose whether or not to enter a room in which they will have a 1 in 1,000 chance of getting that same disease. The question: how much do they have to be paid to be willing to enter the room? The answer should be something close to $2,000, possibly a little higher to reflect what economists call the "wealth effect:" if they are paid to accept a small risk, they are slightly wealthier than if they must pay to avoid a small risk. But the typical answer? $500,000. Thaler calls this phenomenon the endowment effect because, he explains, "the stuff you own is part of your endowment" and "people valued things that were already part of their endowment more highly than things that could be part of their endowment." He gives numerous other examples that, I suspect, will ring true with most readers.
Thaler's response to those who think that people become more rational when the stakes are higher:
One of the arguments that economists often make against Thaler's view of humans is that most of his evidence comes from low-stakes situations in which the gains from being rational are not large. However, they assert, when the gains are large, humans tend to be much more careful. But, using evidence from the National Football League's entry draft, Thaler makes a strong argument against this view.
NFL teams are multi-multi-million-dollar enterprises, and their draft picks represent multi-million-dollar decisions. Surely, if there is strong evidence of rationality, it would be in the NFL. But Thaler shows that NFL owners and managers seem to make poor draft decisions. For instance, he discusses the considerable evidence that teams are better off "trading down"--that is, swapping a single early-round draft pick for multiple later picks--and trading away a draft pick this year for multiple picks in future drafts, and yet few teams do this. He even tells of a conversation he had about these issues with Dan Snyder, owner of the Washington Redskins, which led Snyder to send two of his top managers to talk to Thaler and his colleague Cade Massey. Their subsequent draft picks showed that they ignored Thaler's advice. And, as anyone who follows the Redskins knows, they paid dearly, highlighted by the bonanza of high-round draft choices they traded away for a single pick in 2012, which they used to draft Robert Griffin III.
But Thaler and Sunstein drastically understate the problems that arise because the people in government doing the nudging are also Humans, not Econs. And bureaucrats have generally bad incentives to nudge in the "right" direction. On this point, I laid out my criticisms in more detail in my review of Sunstein's 2013 book Simpler ("Simpler? Really?" Fall 2013.)
Thaler answers that he and Sunstein "went out of our way to say that if the government bureaucrat is the person trying to help, it must be recognized that the bureaucrat is also a Human, subject to biases." He expresses his frustration that "no matter how many times we repeat this refrain we continue to be accused of ignoring it." But the accusation is understandable, as they keep advocating government intervention.
The best way to show that they do not ignore this problem is for them to advocate taking large amounts of power out of the government's hands. As I've written elsewhere, one way to reduce government power and make people more aware of government's activities--after all, many of the problems Thaler cites are due to people's being unaware--is to get rid of tax withholding. That way, people can be more aware of their tax bill, which is one of the major costs of government. He has not yet advocated that idea.