Economists generally assume that more choices are better than fewer choices. But if that were so, argues Thaler, people would be upset, not happy, when the host at a dinner party removes the pre-dinner bowl of cashews. Yet many of us are happy that it’s gone. Purposely taking away our choice to eat more cashews, he argues, makes up for our lack of self-control. This simple contradiction between the economists’ model of rationality and actual human behavior, plus many more that Thaler has observed, leads him to divide the population into “Econs” and “Humans.” Econs, according to Thaler, are people who are economically rational and fit the model completely. Humans are the vast majority of people.
Thaler (1980) noticed another anomaly in people’s thinking that is inconsistent with the idea that people are rational. He called it the “endowment effect.” People must be paid much more to give something up (their “endowment”) than they are willing to pay to acquire it. So, to take one of his examples from a survey, people, when asked how much they are willing to accept to take on an added mortality risk of one in one thousand, would give, as a typical response, the number $10,000. But a typical response by people, when asked how much they would pay to reduce an existing risk of death by one in one thousand, was $200.
One of Thaler’s most-cited articles is Werner F. M. De Bondt and Richard Thaler (1985). In that paper they compared the stocks of “losers” and “winners.” They defined losers as stocks that had recently dropped in value and winners as stocks that had recently increased in value, and their hypothesis was that people overreact to news, driving the prices of winners too high and the prices of losers too low. Consistent with that hypothesis, they found that the portfolio of losers outperformed the portfolio of winners.
This is from the biography of Richard H. Thaler, the winner of the 2017 Nobel Prize in Economic Science. Read the whole thing here.
Thanks to Tyler Cowen and Lauren Landsburg for particularly helpful comments.
Richard and co-author Sendhil Mullainathan wrote the piece on behavioral economics in the 2008 edition of The Concise Encyclopedia of Economics.
READER COMMENTS
John Alcorn
Jul 28 2019 at 7:49pm
Re:
An amply explored area in economics (since the 1950s) is public choice (economic analysis of behavior in government). Many findings indicate government failure caused by rational, self-interested behaviors of people in government: regulatory capture, bureaucratic aggrandizement, and so on. No doubt, there is plenty of irrationality, too. Is there reason to trust that nudges will be implemented faithfully and efficiently?
In any case, we may reject paternalism in principle, even if we grant, for the sake of argument, good government. Robert Sugden makes the point by reference to traditional English wisdom:
Cooper H
Jul 29 2019 at 8:44am
After reading parts of Nudge, I now recognize how my father has been altering my “choice architecture” so I would make the best decision. My Dad had no knowledge of Thaler and Sunstein’s work (allegedly), and I am extremely grateful that Thaler and Sunstein researched and synthesized research to change the world in which they live. Without them, I may be less inspired to save $10k per year, and I may not know how to frame questions and choices to other people when I am the “choice architect”. Now I can be a better parent and human being.
John Alcorn
Jul 29 2019 at 9:49am
Again, Re:
Here is a start:
Ungated PDF here.
John Alcorn
Jul 29 2019 at 11:44am
Another relatively unexplored area is application of behavioral economics to paternalistic behaviors towards adults; i.e., empirical analysis of paternalism.
Does the real psychology of paternalism towards adults match Prof. Thaler’s standard? Do paternalists merely want to steer people to choices they would make if they were cool, calm, and collected — and well-informed?
A fascinating, groundbreaking contribution to the empirical study of paternalism is a new study by Sandro Ambuehl, B. Douglas Bernheim, and Axel Ockenfels, “Projective Paternalism,” Working Paper 26119 (National Bureau of Economic Research, July 2019; ungated version here.
It turns out that paternalists want to bring others in line with themselves, and have a propensity to believe, mistakenly, that there is consensus.
The authors conclude:
David Henderson
Jul 29 2019 at 12:55pm
John, The literature you cite–the NBER Working Paper and the APSR article–is really interesting. I hadn’t known about it. Thank you very much.
John Alcorn
Jul 29 2019 at 3:34pm
David, Thank you for the helpful bio of Prof. Thaler—and the cornucopia that is The Concise Encyclopedia of Economics!
AMT
Jul 29 2019 at 2:35pm
(Long story short: Thaler is right that most people are humans and not econs)
I don’t think paternalism has much to do with any kind of “consensus” “fallacy.” It’s based on the person’s belief or knowledge that such paternalism is beneficial for that other individual in the long run, and has absolutely nothing to do with what anyone else believes or any “consensus” (except indirectly, such as one’s own belief that an expert’s position is correct, or the political viability of a paternalistic suggestion). I’m not going to suggest we paternalistically “pray” for someone’s health, even if the majority are religious.
On paternalism generally, I hate when economists throw up the argument “Hey, he just has a discount rate of infinity percent, therefore, his preferences are still rational and optimal!” When obviously, you should focus on is the foundation of that discount rate or preference, which shows the irrationality. E.g. The complete inability to understand basic math or interest rates, extreme lack of self control, etc. Try working as a financial advisor, doing retirement planning with average people, and you soon realize that these are serious and not uncommon problems. The rapid increase of obesity rates is not because people don’t understand “fruits, vegetables and exercise = good; junk food = bad.” Every 8 year old can tell you that! It’s because junk food tastes better and laying on the couch feels better than running (for most people), and people have high discount rates, or appear to, as reflected through their lack of will power.
While completing my econ degree, I of course came to believe that things like the CPP (Canada Pension Plan) or social security were bad because they take away your freedom to make optimal individual decisions for your own retirement saving, but viewed as forced savings (paternalism), I now think it would probably be a big improvement for many people if it was expanded, and only a small detriment to some. People save less than they should, so their long run consumption curves will not be as flat as would be optimal for them.
Thaler is absolutely correct that most people are humans, and econs have a very hard time understanding that. I don’t really understand why, unless they never interacted with any non-nerds in high school? It seems to me a significant lack of understanding. Many people do not stop and perform a cost/benefit analysis beyond the most vague heuristic that pops into their head at the time.
So, paternalism is obviously justified in some circumstances on utilitarian grounds, the question is just about the implementation (the point about politicians in the previous post is a relevant concern), and how much we are willing to sacrifice individual autonomy. Very similar to the efficiency/equality tradeoff.
The best counterargument is that it is more about culture or public conceptions. E.g. people save so little for retirement because of social security or the CPP, look at the savings rate in China! But I’m not sure if attempting to change cultural attitudes is a more effective a strategy.
This leads to other implications, and one example may be payday loans and credit cards. Because they have the option to use a credit card or get a payday loan, they may not save as much as they should for an emergency. David, you had a post a while back about how it was detrimental for you when you could not get a credit card. I, and other economists would be in the same boat as you and prefer to have the option, but I think the average American is actually worse off having that option. Many, many people save nothing, “living paycheck to paycheck” no matter what their level of income is (implying it is about self-control, not an absolute necessity to spend that amount), and then run up credit card debt for some small emergency because they have no savings whatsoever. Or they just spend too much. They can’t pay it off and just end up with a long-run consumption level that is reduced by the amount they borrowed, times 29.99% interest (remember, these are not the most conscientious individuals, so they also will likely have missed a payment or two and are now paying a higher interest rate), basically forever.
Essentially, I feel pretty confident saying that the people who save nothing for retirement, or carry a significant credit card or payday loan balance would definitely benefit from some paternalism. The “different preferences or discount rates” argument is just not believable in many cases.
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