An honour well-earned
Economics meets behaviour,
The Sveriges Riksbank prize in economic sciences – commonly referred to as the Nobel Prize for economics – has been awarded to Richard Thaler for his contributions to behavioural economics.
It reinforces the importance of humanity in economics and the area it affects massively, public policy making.
His work has been used to develop policy, to use our behavioural biases to nudge people in the right direction.
His book, Nudge: Improving Decisions About Health, Wealth, and Happiness, co-authored with Cass Sunstein, is an approachable look at using behavioural economics in public policy making.
Of course, our behavioural biases are also used by people trying to sell us stuff – to appeal to our non-rational side and press our psychological buttons to spend, spend, spend.
This honour follows the 2002 prize made to Daniel Kahneman, who is widely considered to be the godfather of behavioural economics.
His book Thinking, Fast and Slow is worth a read.
Behavioural economics, which tries to make economics more real, is an important development in the field.
It revels in the complexity of humanity, rather than the extreme simplification which orthodox economics requires for mathematical models to work.
One huge assumption often used in introductory economics is that humans are rational. While we can think rationally and critically, we do not always do so. Thaler’s work demonstrated this.
His work showed that people are risk-averse. They would rather accept the chance of a smaller gain, as long as losses were capped.
We see this in the housing market. When the market was going up, people were happy to sell. But as the market has cooled, listed houses are not selling. Auctions are not clearing like they did even a year ago. Buyers aren’t willing to pay ever higher prices, and rather than accept a loss, many listings simply won’t sell.
Advertising for insurance plays on this – by hammering home the idea that your losses will be capped. This appeals to our natural bias.
His work also showed how bad we are at long-term financial planning. Even though we are living longer, left to their own devices, most people will not plan sufficiently for their retirement.
This was the reason behind automatic enrolment of KiwiSaver: we wouldn’t actively choose this form of retirement saving.
If we were rational about our long-term health, then we would make good choices and eat healthily. But we don’t.
New Zealand has the thirdhighest obesity rate in the OECD, a club of mainly rich countries. We must be more proactive about junk food, sugar and knowledge about healthy eating and exercise. Left to our own devices, we will be a country of unhealthy people.
Our rational side thinks things through carefully. But our reactive side tends to like the easy option.
That plays beautifully into the hands of gyms, for example. Our rational side wants to exercise and live a healthy lifestyle. So, we sign up.
But many of us will not go regularly.
The gym still gets its regular fees but won’t see most members using their facilities – that’s where the profits are.
Thaler developed ‘‘nudge’’ policies, that nudge people towards making better decisions. This riles many people, who think that we should be free to choose what we want.
But Thaler’s work shows that if we used our rational side, we would make decisions that are better for our health, wealth and happiness. Left to our devices, quite often we will not.
The idea that given freedom we will all make the best possible decision flies in the face of evidence that has been gathered by Thaler and others working in the fields of psychology and behavioural economics.
Their work encourages a closer look at a more deliberate and interventionist approach to policy making – and is a rebuke against the economic consensus of the last three decades of small government and deregulation as the answer for every problem.
We make many irrational decisions. We know this. We know this better now because of the work by people like Thaler.
A thoroughly deserved Nobel Prize in economics.