Editor's note

International Internet Magazine. Baltic States news & analytics Sunday, 17.12.2017, 04:14

Nobel in economics can help business and governments

Eugene Eteris, BC, Riga/Copenhagen, 10.10.2017.Print version

Professor Richard H. Thaler (US), whose works persuaded many economists to pay more attention to human behavior, and many governments to pay more attention to economics, was awarded the 2017 Nobel Memorial Prize in economic sciences. His achievements demonstrate that standard economic theories do not describe actual human behavior, and that businesses/governments can use new approaches to increase growth.

Nobel Memorial Prize in economics for 2017 makes a significant message to science, governments, academia and businesses: behavioral approach wins over traditional approaches to economists’ roles. The Nobel Committee credited Professor Thaler, who teaches at the University of Chicago Booth School of Business, for moving economics toward a more realistic understanding of human behavior, and for using the resulting insights to improve public policies, notably a sweeping shift toward the automatic enrollment of employees in retirement savings programs.

 

The economics prize was established in 1968 in memory of Alfred Nobel by Sweden’s central bank and is awarded by the Royal Swedish Academy of Sciences.

 

Professor Thaler was recognized in the academic world of economics long before winning the prize. He authored a best-selling book, “Nudge,” about helping people to make better decisions. He also appeared in the 2015 film “The Big Short,” delivering what was one of the most widely viewed tutorials in the history of economics; it was about the causes of the 2008 financial and economy crisis. See more in:

https://www.nytimes.com/2017/10/09/business/nobel-economics-richard-thaler.html?emc=edit_mbe_20171010&nl=morning-briefing-europe&nlid=81778027&te=1 

 

The Committee acknowledges Mr. Thaler for his pioneering work in establishing that people are predictably irrational, and that they consistently behave in ways that openly resist traditional economic theory. For example, people will refuse to pay more for an umbrella during a rainstorm; they will use the savings from lower gas prices to buy premium gasoline; they will offer to buy a coffee mug for $3 and refuse to sell it for $6.

https://www.nytimes.com/2017/10/09/business/economy/richard-thaler-economics.html?_r=0


Thus, he has practiced the new branch of economic science - behavioral economics, which postulates that imperfect humans do not fit neatly into classic economic models; His works have explored the intersection between human quirks and economic forces.

One of Thaler’s frequent collaborators, Daniel Kahneman, was awarded the prize in 2002; another behavioral economist, Robert J. Shiller, was among the winners in 2013. The latter, for example, hailed prof. Thaler on the occasion of the prize as “one of the most creative spirits in modern economics”.   

 

Behavioral economy is on the rise…

Mainstream economics was built on the simplifying assumption that people behave rationally. Economists understood that this was not literally true, but they argued that it was close enough.

Professor Thaler has played a central role in pushing economists away from that assumption. He did not simply argue that humans are irrational, which has always been obvious but is not particularly helpful.

Rather, he showed that people depart from rationality in consistent ways, so their behavior can still be anticipated and modeled.

 

Some nudges are minor, some bigger: examples

= In a traditional economist’s view, hungry shoppers are not subconsciously influenced by their stomachs to buy more food, and most people are inclined to think of cash as the best gift idea. Seemingly irrelevant factors like human emotions often influence their choices, altering the course of the economy.

= He argues that he knows how to fix much of the retirement problem, and we can afford to, but need to figure out ways to help people who are just dropping the ball. He proposed automatically enrolling workers in the US tax office (I.R.A.) if their companies do not already provide sponsored retirement savings accounts. Automatic enrollment, with the freedom to opt-out, he argued, will solve one of the biggest barriers to saving: procrastination or delayed action.

= Many people in the US say they are willing to become organ donors but never take the steps required to do so — filling out a form or officially registering their consent in some other way. Mr. Thaler said organ donation rates would increase with methods like “mandated choice”: a requirement that you make your preference about organ donation known, one way or the other, or with smartphone apps that make such choices much easier.

=  Medical care is expensive, Mr. Thaler said, in part because there are too many incentives to do costly things that are unnecessary. As technology improves, for example, it is easier to investigate physical abnormalities — even when they are unlikely to cause problems. Extra testing increases costs, as do malpractice suits. Patients need to be better informed, he said, and should be empowered to opt out of procedures that are likely to rack up big bills without providing much benefit.

Examples from: https://www.nytimes.com/2017/10/09/business/economy/richard-thaler-economics.

 

Some changes could have a far-reaching effect: observing that inertia limited participation in beneficial programs, like retirement savings plans or school lunch programs, professor Thaler proposed that governments and employers should make participation the default option. People are free to opt out, but inertia is on the side of the preferred outcome. A similar proposal, “Save More Later,” offsets the tendency to place a relatively high value on current income by allowing people to commit to setting aside more money next year.

 

Examples for governments

His co-author in “Nudge”, Cass Sunstein, a Harvard law professor said that “Thaler more than anyone has disciplined the idea of animal spirits”. Thus authors already in 2008 argued that governments could use behavioral insights to improve the efficiency and quality of a wide range of public services.


Two years later, the British government created a department to pursue the experiment. Britain’s former UK’s Prime Minister, David Cameron described the inspiration as a “very simple, very conservative thought: to go with the grain of human nature.”


The British government found that people were more likely to pay automobile registration fees if billing letters included a picture of the vehicle.

 

Contradicting conservative economics

Professor Thaler began to have “deviant thoughts” already in a graduate school. He would ask people about their actual choices, an exercise that most economists regarded as irrelevant, and he found that the answers he got were different from what was in textbooks.


He cherished the idea that economics needed to grapple with actual human behavior; in this way he played a central role in bringing his work into the economic mainstream. His academic work can be summarized as a long series of demonstrations that standard economic theories do not describe actual human behavior.


For example, he showed that people do not regard all money as created equal. When gas prices decline, standard economic theory predicts that people will use the savings for whatever they need most, which is probably not additional gasoline. In reality, people still spend much of the money on gas. They buy premium gas even if it is bad for their car. In other words: They treat a certain slice of their budget as gas money.


He also showed that people place a higher value on their own possessions. In a famous experiment, he and two co-authors distributed coffee mugs to half of the students in a classroom, and then opened a market in mugs. Students randomly given a mug regarded it as twice as valuable as did the students who were not given a mug.


This “endowment effect” has since been demonstrated in a wide range of situations; it helps to explain why real markets do not work as well as traditional economists argued in their models.


One of Thaler’s most profound findings involves the importance of fairness: he showed that people will penalize unfair behavior even if they do not benefit from doing so. This has had important economic implications: it explains, for example, why an umbrella store may choose not to raise prices during a rainstorm.


His theories also illuminate the mechanics of unemployment: thus standard economic theory predicted that during an economic downturn, employers would cut wages to a level consistent with the demand for goods or services, meaning there was no reason to think a downturn would produce unemployment. But workers regard wage cuts as unfair; and so employers, seeking to avoid angering the workers they plan to keep, prefer to cut employees rather than wages.

 

In a presidential address to the American Economic Association in January 2016, Professor Thaler predicted behavioral economics would succeed so well it would eventually disappear and turn into a general way of making decisions. “I think it is time to stop thinking about behavioral economics as some kind of revolution; in time, all economics will be as behavioral as the topic requires, he concluded. 





Search site