On Our Best Behavior? Not!
Review by Oliver Vikbladh
The Making of Behavioral Economics
Book by Richard H. Thaler
At a time when we seem to have abandoned any semblance of a reasoned public discourse, you don’t get a prize for noticing that people aren’t always rational. Unless, of course, you are Richard Thaler. In the fall of 2017, he received a Nobel Prize for just that—his career-long study of irrational behavior and his contributions to behavioral economics. To understand Thaler’s achievement –and how the field of economics, until recently, considered the very notion of a non-rational human blasphemous– you might start by reading Thaler’s 2015 book Misbehaving. Thaler, a self-proclaimed “heretic,” offers a personal, idiosyncratic and impassioned account of how the field of behavioral economics came to be. Enlivened by rich anecdotes from the trenches of academic warfare, the book presents a chronological narrative of how the field evolved, seamlessly interwoven with an accessible overview of its most important insights.
Thaler sets the scene in the 1970s, in an academic climate dominated by the theories of “neoclassical” economics. According to this school of thought, people are perfectly rational and always capable of decisions that are in their greatest self-interest, like Mr. Spock in Star Trek. The problem is that Mr. Spock isn’t real, and neither are the “imaginary creatures” who, in Thaler’s mind, inhabit our economic models. Real humans fall prey to biases and fallacies all the time, and seem to be born with a congenital disposition for misbehavior. By focusing on these real and flawed humans, Thaler changed the discipline of economics.
Let’s consider two scenarios that Thaler presents to make his point. In the first scenario you are given $500 and then asked to choose between A) a 50% chance of losing $200 or B) a 100% chance of losing just $100. What would you choose? Most people choose A. Now consider a scenario where you are instead given $300 and then asked to choose between A) a 50% chance of earning 200 additional dollars or B) a 100% chance earning just $100 more. How about it?
Notice that the two scenarios are actually identical in terms of the money you are expected to walk away with when picking A or B. Only the verbal framing, the way of phrasing the question, has changed. Still, people are generally much more likely to choose the safe 100% option in the second scenario. Mr. Spock would not approve and neither would a neoclassical economist. Answering the two questions differently, even though they are actually identical in terms of outcomes, is simply not rational!
In the 1970s, psychologists Amos Tversky and Daniel Kahnemann had realized that in scenarios like this, people aren’t just bad at making decisions. There’s a method to their madness. Humans systematically make the same mistakes, or deviate from rational behavior in predictable ways. It’s as if we rely on hard-wired rules of thumb that are useful, but in particular circumstances lead us down the wrong paths. Learning of the work of this legendary duo, to whom the book is largely an unspoken homage, Thaler decided to join them and began a collaboration that would last a lifetime.
Misbehaving describes what came of it: a revolt against a reigning paradigm misguided by what Thaler deems “theory-induced blindness.” He insists that economics, and the public policy it so heavily informs, needs “an enriched approach… that acknowledges the existence and relevance of real Humans.” That enriched approach is behavioral economics, a discipline he helped to create, which incorporates psychology into economic models.Thaler has, since 1995, been a professor at the University of Chicago, the home of neoclassical economics. Unsurprisingly, it turns out he thrives behind enemy lines. About a heated exchange with a fellow economist in the Journal of Finance, he explains: ”I don’t know who won, but I do know that the unprecedented four-part pissing contest… attracted a lot of attention.” Always a controversial figure, he appears to have spent his entire working life arguing, provoking, and refining his arguments, no doubt iterating his pedagogical devices through thousands of undergraduate seminars, academic talks and consulting gigs.
As a reader you can certainly tell, because Misbehaving is tremendously effective at conveying the fundamentals of behavioral economics, making complex concepts both accessible and compelling. In addition to painting the historical, sociological and personal contexts for each of the findings, Thaler compiles an impressive list of anomalies or misbehaviors that are not usually captured by the classical models. Importantly, however, Misbehaving is not just for economists. Everyone will benefit from learning more about the ways that we systematically screw up.
Despite the grand rhetoric, Thaler remains mostly, and sometimes disappointingly, respectful of his intellectual adversaries. It is hard not to feel like he’s holding back. Remaining respectful, however, does not prevent this perennial agent-provocateur from poking fun at pretty much anyone who has crossed his path. In one of the most hilarious passages of the book, he describes an obscure procedure for allocating highly sought-after office spaces among the overblown egos that make up the faculty of the University of Chicago Economics Department. Without mentioning names, Thaler gleefully succeeds in portraying these towering intellects as greedy children.
Misbehaving succeeds not only as a survey of behavioral economics, but as a manual for academic gamesmanship. Thaler describes how he has navigated his emerging field and attained great heights by consolidating alliances, recruiting followers and provoking his enemies to the point where they couldn’t ignore him any more. “Nothing attracts attention more than a good fight,” he remarks, and it certainly seems to have worked. As the former president of the American Economic Association and now a Nobel laureate, Thaler celebrates his improbable ascent by noting that “The lunatics are running the asylum!”
But even in light of its success, behavioral economics is still a young branch of the discipline. In many areas of economics, behavioral considerations are non-existent or at least highly controversial. Many would argue that the behavioral economists primarily point out where standard economics is lacking rather than presenting any unifying, formal frameworks themselves that can be used to make predictions. Without such frameworks, knowing when a given behavioral phenomena applies becomes more an art than a science, and raises fears that the field will simply remain a collection of anecdotes.
Whether the critics are right or not, behavioral economics is a work in progress and Thaler acknowledges this fact. He hopes that the next generation of behavioral economists will unify rather than polarize the field and will succeed in enriching the neoclassical economists’ view of what variables determine people’s behaviors.
As a neuroscientist studying how brain processes underlie decision-making, I would go even farther: an improved understanding of the neural circuitry that supports such flawed economic behavior may prove pivotal in turning the growing list of anomalies into a unified theory. Early in the history of psychology, visual illusions were considered examples of failures of perception. They turned out to be powerful tools for uncovering the way the visual system of the brain is wired. With this understanding we can now not only explain the visual illusions that were known, but predict new ones. The growing list of “misbehaviors” that Thaler and others have identified could, in a similar fashion, lead the way to a unified theory of economic behavior and the brain, capable of powerful predictions.
Oliver Vikbladh is a cognitive neuroscientist from Sweden. He has also attempted science outreach through writing, story-telling and virtual reality.