Wharton’s Katherine Milkman discusses the awarding of the Nobel Prize to behavioral economist Richard H. Thaler.
Richard H. Thaler, the “father of behavioral economics,” won the 2017 Nobel Prize in Economics for his work in that field. Thaler has long been known for challenging a foundational concept in mainstream economics — namely, that people by-and-large behave rationally when making purchasing and financial decisions. Thaler’s research upended the conventional wisdom and showed that human decisions are sometimes less rational than assumed, and that psychology in general — and concepts such as impulsiveness — influence many consumer choices in often-predictable ways.
Once considered an outlier, behavioral economics today has become part of generally accepted economic thinking, in large part thanks to Thaler’s ideas. His research also has immediate practical implications. One of Thaler’s big ideas – his “nudge theory” – suggests that the government and corporations, to take one example, can greatly influence levels of retirement savings with unobtrusive paperwork changes that make higher levels of savings an opt-out rather than an op-in choice. In fact, he co-authored a book, Nudge, Improving Decisions About Health, Wealth and Happiness, which became a best-seller.
In this [email protected] interview, Katherine Milkman, a Wharton professor of operations, information and decisions — and a behavioral economist herself — discusses Thaler’s influence in economics and the practical applications of his ideas already underway. She attributes part of his success to his great clarity in thinking and in writing. She had interviewed professor Thaler for [email protected] in 2016 regarding his then-new book, Misbehaving: The Making of Behavioral Economics.
An edited transcript of the conversation follows.
[email protected]: It must be an exciting time for behavioral economists such as yourself to see one of their leading lights recognized this way. Could you give us a brief sketch of the key concepts in behavioral economics, and how they differ from mainstream views of economics? And also why Thaler is such a leader in the field?
Milkman: Standard economics makes assumptions about the rationality of all of us, and essentially assumes that we all make decisions like perfect decision-making machines, like Captain Spock from Star Trek who can process information at the speed of light, and crunch numbers, come up with exactly the right solution.
“Humans are not perfectly rational…. We have impulse-control problems, we have social preferences. We care about what happens to other people instead of being entirely selfish.”
In reality, that’s not the way humans make decisions. We often make mistakes. And Richard Thaler’s major contribution to economics was to introduce a series of predictable ways that people make errors, and to make it acceptable to begin modeling those kinds of deviations to make for a richer and more accurate description of human behavior in the field of economics.
[email protected]: What would be a classic example of a decision that an economist would expect someone to make rationally, but in fact they don’t?
Milkman: Well, a great example from Richard’s own work relates to self-control challenges. And he has talked about the cashew problem, or the challenge, if you’re at a dinner party, of resisting the bowl of cashews that you know will spoil your dinner.
A traditional economist would expect that’s not a challenge. No one should have any difficulty withstanding that temptation. They should know it will spoil their dinner; we don’t need the cashews. And Thaler noted that, in fact, everyone struggles with this, and everyone breathes a sigh of relief when a host puts away that bowl of cashews so they’re not reachable and they’re not in front of everyone anymore.
It seems small, but it actually highlights a major challenge for humans with self-control, which can perhaps explain the obesity epidemic, and under-saving for retirement, the under-education among many groups. So the range of things that this simple observation can begin to shed light on is just extraordinary. And that’s only one of his contributions.
[email protected]: It’s this idea that human beings happen to be impulsive a lot of times, and that should be taken into account. They aren’t sitting there with calculators all of the time figuring out an economic decision or a financial decision.
Milkman: That’s exactly right. That’s exactly the contribution that Richard Thaler made to economics in a nutshell: that humans are not perfectly rational, sitting there with calculators. We have impulse-control problems, we have social preferences. We care about what happens to other people instead of being entirely selfish. We are limited in our rationality in a number of ways, and he has pointed that out over the last 50 years, and highlighted opportunities for policy makers to improve the lives of billions of people by taking these insights into account.
[email protected]: It appears a little odd that these ideas were consigned to the corner for so long. Now people are talking about them more.
Milkman: I think that’s right. At some level it took a personality like Richard Thaler; he’s someone who likes to break the mold and misbehave, which is the title of his autobiography. It took someone like that to point out the absurdity of the assumptions in a standard economic model, and help change the assumptions so that we could start doing the science better.
[email protected]: And those standard models, they worked really well a lot of the time, maybe even most of the time — it’s just that when they didn’t work, it could be a major failing. Is that right?
Milkman: I think that’s right. And it also meant there was an opportunity for improvement. So even if they were working fairly well much of the time, they weren’t actually fully accurate. And so the more accurate we can make them, the more opportunities we have to make better policy and so on.
[email protected]: Let’s talk about some of the practical applications of his ideas. Thaler was a government advisor not long ago. Perhaps you could tell us about his contributions and about how he has a lot of practical ideas for how his concepts can be put to use.
Milkman: In 2008, along with Cass Sunstein, he wrote a book called Nudge which was a bestseller. The book articulated an opportunity for governments by using behavioral economics. And the basic idea was that there are all of these ways in which people make sub-optimal choices, and governments have an opportunity to use their knowledge and insights about those errors to actually try to improve decision making.
“It took a personality like Richard Thaler … to point out the absurdity of the assumptions in a standard economic model.”
Let me give you a really concrete example from that book that I think is incredibly powerful. He points out that whenever we walk into a cafeteria, we’re faced with a wide range of options about what to put on our tray. Something comes first, something comes last, and the first thing we encounter is much more likely to be the thing we purchase and eat than the last thing, because we have an empty tray when we encounter that very first option.
What this means is that whoever laid out the cafeteria was actually, whether or not they meant to, influencing our choices dramatically depending on where they place certain foods. The first thing we encounter is much