University of Chicago economist Richard Thaler was honoured with the 2017 Nobel Memorial Prize in Economic Sciences.
For a surprisingly long time, behavioural economics wasn’t much more than a bunch of weird observations made by Thaler — more or less to himself. What he calls his “first heretical thoughts” occurred in graduate school, while writing his thesis. He’d set out to determine how to value a human life — so that, say, the government might decide how much to spend on some life-saving highway improvement. It sounds like a question without a clear answer but, as Thaler points out, people answer it clearly, if implicitly, every day, when they accept money for a greater chance of dying on the job. “Suppose I could get data on the death rates of various occupations, including dangerous ones like mining, logging and skyscraper window washing, and safer ones like farming, shop-keeping and low-rise window washing,” recalls Thaler. “The risky jobs should pay more than the less risky ones: Otherwise, why would anyone do them?” Using wage data, and an actuarial table of mortality rates in those jobs, he was able to work out what people needed to be paid to risk their life. (The current implied value of an American life is $7 million or Dh25.74 million.) Only he didn’t stop there. He got distracted by a funny idea.
This willingness to allow oneself to be distracted from one’s assigned task would later turn out to be a chief characteristic of behavioural economists, along with a bunch of other traits not normally found in economists, though often found in children: A sense of wonder, a tendency to ask embarrassing questions, and a mistrust of grown-ups’ ideas about what’s worth spending time thinking about and what is not. They’re the sort of people whose day is made when they discover that health club members are most likely to hit the gym the day after they have received their monthly bill, or that racetrack gamblers are a lot more likely to bet on the long-shot the last race of the day than the first.
At any rate, in addition to calculating the market’s price for a human life, Thaler got distracted by how much fun he might have if he asked actual human beings how much they needed to be paid to run the risk of dying. He began with his own students, telling them to imagine that by attending his lecture, they had exposed themselves to a rare fatal disease. There was a 1 in 1,000 chance they had caught it. There was a single dose of the antidote: How much would they be willing to pay for it?
Then he asked them the same question, in a different way: How much would they demand to be paid to attend a lecture in which there is a 1 in 1,000 chance of contracting a rare fatal disease, for which there was no antidote?
The questions were practically identical, but the answers people gave to them were — and are — wildly different. People would say they would pay two grand for the antidote, for instance, but would need to be paid half a million dollars to expose themselves to the virus. “Economic theory is not alone in saying that the answers should be identical,” writes Thaler. “Logical consistency demands it. To an economist, these findings are somewhere between puzzling and preposterous. I showed them to (his thesis adviser) and he told me to stop wasting my time and get back to work on my thesis.”
Instead, Thaler began to keep a list of things that people did that made a mockery of economic models of rational choice. There was the guy who planned to go to the football game, changed his mind when he saw it was snowing, and then, when he realised he had already bought the ticket, changed his mind again. There was the other guy who refused to pay $10 to have someone mow his lawn, but wouldn’t accept $20 to mow his neighbour’s. There was the woman who drove 10 minutes to a store in order to save $10 on a $45 clock radio, but wouldn’t drive the same amount of time to save $10 on a $495 television. There were the people Thaler invited over to dinner, to whom he offered, before dinner, a giant bowl of nuts. They ate so many nuts they had no appetite for the far more appealing meal. The next time they came to dinner Thaler didn’t offer nuts — and his guests were happier.
And so on. People who read Thaler’s list might well just shrug and say, “There isn’t anything here that any good used car salesman doesn’t know.” That’s the point: It’s obvious to anyone who pays any attention at all to himself or his fellow human beings that we are not maximisers, or optimisers, or logical, or even all that sensible. In the early 1970s, when Thaler was a student, his professors didn’t argue that human beings were perfectly rational. They argued that human irrationality didn’t matter, for the purpose of economic theory, because it wasn’t systematic. It could be treated as self-cancelling noise.
Twenty years ago, after Thaler was given a tenured job at the University of Chicago, a newspaper reporter asked an older, more distinguished Chicago economist, who clearly saw little of use in behavioural economics, why he hadn’t blocked Thaler’s appointment. “Because each generation has got to make its own mistakes,” he said. Today Thaler is the president of the American Economic Association, and a perennial candidate for the Nobel. His rise may be just another example of the power of human misjudgement. Or he might be onto something. Either way, he’s been wildly disruptive.
Michael Lewis is a Bloomberg View columnist. He is a contributing editor at Vanity Fair, and his books include Flash Boys: A Wall Street Revolt, Moneyball: The Art of Winning an Unfair Game and Liar’s Poker.