“Misbehaving” Richard Thaler “Nudges” his way into Economics Nobel

By Amar Yumnam

IMPHAL | Oct 10

Richard Thaler has won this year’s Nobel Prize in Economics. Before we come to his main ideas, let us note a few things about him as a person: He was born in New Jersey in 1945; he is strongly influenced by Daniel Kahneman, Herbert Simon and Robert Lucas Jr – all Nobel Prize Winners in Economics; he works at the University of Chicago.

Economists in Chicago University and the Nobel Prize in the subject are almost like synonymous. In fact, we have lost count of the Nobel Prize winning Economists at the University of Chicago; he is at the same school where our own Raghuram Rajan also works; unlike in India, schools are also used to mean Departments or groups of Departments in colleges and Universities in the Unites States of America; and his most read works are Nudge: Improving Decisions About Health, Wealth, and Happiness (co-authored with Cass Sunstein.in 2008, and (ii) Misbehaving: The Making of Behavioural Economics (2015).

Economics as a subject today is endeavouring hard to reconstruct herself to be more alive to the contextual realities of the society. In this effort, learning and incorporating from other subjects to understand more about people and society is a robust endeavour. 

In this Economics is regaining its earlier strong relationship with Psychology. Richard Thaler is a researcher in this area and is considered to be the founder of Behavioural Economics. Economics has been under the spell of Rationality Assumption (Utility Maximisation) under which we assume that everybody works to enhance his own benefits under all circumstances, and without absorbing any lessons from the experiences and any impact from the surrounding milieu.

This Thaler says is wrong. In his 2016 Presidential Address to the American Economic Association on Behavioural Economics: Past, Present and Future, he writes: “..the methodology of Behavioural economics returns economic thinking to the way it began, with Adam Smith, and continued through the time of Irving Fisher and John Maynard Keynes in the 1930s.

In spite of this early tradition within the field, the behavioural approach to economics met with considerable resistance within the profession until relatively recently. ….. [T]he idealized model of Homo economicus even in the face of apparently contradictory evidence.

I argue that such arguments have been refuted, both theoretically and empirically, including in the realm where we might expect rationality to abound: the financial markets. As such, it is time to move on to a more constructive approach. On the theory side, the basic problem is that we are relying on one theory to accomplish two rather different goals, namely to characterize optimal behaviour and to predict actual behaviour.

We should not abandon the first type of theories as they are essential building blocks for any kind of economic analysis, but we must augment them with additional descriptive theories that are derived from data rather than axioms….As for empirical work, the behavioural approach offers the opportunity to develop better models of economic behaviour by incorporating insights from other social science disciplines.

 To illustrate this more constructive approach, I focus on one strong prediction made by the traditional model, namely that there is a set of factors that will have no effect on economic behaviour. I refer to these as supposedly irrelevant factors or SIFs. Contrary to the predictions of traditional theory, SIFs matter; in fact, in some situations the single most important determinant of behaviour is a SIF.”

Thaler has had a strong influence in policy making and formation of laws. The most impactful work is his theory of the Nudge. He asks: “How can we be so ingenious at some tasks and so clueless at others? Beethoven wrote his incredible ninth symphony while he was deaf, but we would not be at all surprised if we learned that he often misplaced his house keys. How can people be simultaneously so smart and so dumb?”

Thaler and his co-workers in the Behavioural Economics feel that both public and private institutions can positively impact on individual choices through nudging. They say there is a third way, Libertarian Paternalism, of influencing the Choice Architecture of individuals through nudging. In this the liberty of the individual is protected while at the same time working for enhancing the welfare milieu of the society. The orientation of public policy should be to address the cognitive biases of individuals.

Well, the approach has the capability of protecting the democratic values in a society. But, as Milton Friedman and the Austrian School of Thought, we cannot always be sure of the neutrality of government and thus public policy. One criticism of the theory is that “nudging works by manipulating citizens’ choices”.  Further, “is itself just a sexy ad campaign designed to nudge gullible readers into thinking that there is no conflict between libertarianism and welfare utilitarianism. But no one should lose sight of the fact that welfare utilitarianism just is welfare utilitarianism only if it sacrifices individual liberty whenever it is at odds with maximizing societal welfare.

And thus no one who believes that people have rights to craft their own lives through the exercise of their own choices ought to be duped into thinking that just because paternalistic nudges are cleverly manipulative and often invisible, rather than overtly coercive, standard welfare utilitarianism can lay claim to being libertarian.”

In fine, incorporating psychology in policy formulation in a way appreciating the context and cultural values of that context is paramount. This appreciation is the logic behind the award of the Nobel Prize in Economics to Thaler.