Congratulations to Professor Richard Thaler who was announced as the winner of the 2017 Nobel Prize in Economics yesterday. Linked here is a piece I wrote for the Sunday Business Post on his contribution to Economics (pre-edited text and some more links below).
Richard Thaler, 2017 Nobel Laureate in Economics
Richard Thaler was recently named as the 2017 Nobel laureate in Economics. Thaler is responsible for a shift in mainstream economics towards more psychological realism in modelling consumer and investor behaviour. He has spent the bulk of his career at the University of Chicago and is seen as the leading figure in the discipline known as behavioural economics.
Thaler’s ideas are relevant to many areas of public policy in Ireland, in particular pensions. Along with his colleague Benartzi, Thaler designed and evaluated a pension participation scheme called Save More Tomorrow, where people sign up to a pension that starts with zero contributions and then progressively increases along with their salary increases. This type of “auto-escalation” is based on two key human decision making factors studied by Thaler – loss aversion whereby people do not want to part with income they have grown accustomed to, and myopia whereby present losses are felt to a far greater extent than future losses. Save More Tomorrow turns these biases on their head and has proven a remarkable way of countering many of the human factors that lead people to under-save.
Thaler has also written a great deal about how decision biases leave people open to influence from marketing techniques, and the implications of this work is at the core of a lot of modern regulatory debate. With this in mind, along with Cass Sunstein, Thaler has sought to develop the policy, legal, and regulatory implications of behavioural economics. Their popular book Nudge advocates a widespread reform of policy and regulation around principles of using psychologically-informed interventions to “unstick” markets and enable people to make more empowered decisions. The ideas in this book have led to agencies being formed throughout the world, most notably the UK Behavioural Insights team that was established in the Cabinet Office during the Conservative and LibDem coalition administration. As well as niche teams like this, the work has also had an increasing influence on regulation, in particular in light of the financial crisis, and has also come to be more influential in the design of policies across areas such as health, education, and development.
There are several ways that the ideas coming from Thaler and colleagues’ work could potentially improve policy in Ireland, including making pension policy more robust to low levels of active decision making, substantially simplifying compliance with administrative requirements, protecting consumers more from exploitative marketing, putting in place safeguards in investment organisations to guard against herding and related biases, and many other policy initiatives. Agencies such as DPER, Department of Finance, Revenue Commissioners, and the Central Bank have published work on this area in the last number of years. The ESRI Pricelab led by Pete Lunn has conducted a wide range of studies on the implications of behavioural economics for regulation. The potential introduction of pension autoenrolment in Ireland comes directly from the behavioural literature and most regulators and government departments are developing capacities to apply behavioural evidence.
Thaler’s work on policy is based around a number of core academic ideas. His most famous early papers examined phenomena such as mental accounting, whereby people partition their budgets into separate psychological pockets, something that affects their behaviour in many different ways. For example, people tend to be more likely to spend windfall amounts on luxuries, something that is intuitive psychologically but not accounted for in standard models. One of his most cited early papers also looked at the implications of limited self-control for consumer decision making, including the extent to which people might prefer to “tie their hands” to overcome the tendency to be present-biased.
His collaboration with the previous Nobel winner Daniel Kahneman built on previous Nobel-winning work by Kahneman and Tverksy and sought to understand how people evaluate gains and losses differently. This research has generally shown that people value losses to a far greater extent, something that has substantial implications for investment and consumption. The related idea of an endowment effect, namely that people tend to place more value on things they already own rather than gains they could make by speculating, has been used to explain phenomena such as low levels of switching in consumer markets and the tendency for well-being to be more influenced by income decreases than by income increases.
Throughout the 1990s, Thaler was at the vanguard of a group of scholars that sought to broaden the psychological foundations of economics, away from the dominant models of rational choice. He was by no means the first to do this. Indeed, previous Nobel winners include Amartya Sen, Herbert Simon, Maurice Allais, and Kahneman himself, all of whom pushed back against the assumptions of rationality and self-interested behaviour inherent in textbook economic models. However, it is clear that nobody was more successful than Thaler in gaining acceptance of psychologically-informed models across many areas of economics. As well as those mentioned above, his contributions stretch across many areas of economics and finance including studies examining why stock markets tend to overreact to news, how fairness acts as a constraint on choice and markets, and how pension decisions are made.
In terms of learning more about his ideas and why they are important for policy and business, Thaler’s recent book Misbehaving is an accessible and personal account of his role in the development of behavioural economics. Nudge, referred to above, describes his and Sunstein’s ideas for applying behavioural research to real-world problems of policy and business. While already a popular set of ideas, the award of the Nobel to Thaler is likely to substantially further accelerate the degree of interest in applications in this area internationally.
Liam Delaney is Professor of Economics at UCD and directs the MSc programme in Behavioural Economics.
This blogpost by Tyler Cowen on Marginal Revolution contains many useful links to Thaler’s work and why he was awarded the prize.
Students in our undergraduate and postgraduate behavioural economics modules will already have encountered Thaler’s work in a number of places, and will come across it more later in the semester as we examine behavioural law and regulation.
Thaler’s major collaborator on law, regulation, and public policy, Cass Sunstein, will speak here in Dublin on November 10th – details here.