On Monday the Nobel Economic Prize was awarded to Richard Thaler, a University of Chicago professor specializing in behavioral economics. Thaler’s work received the prize due to its recent influence on government policy making, as it challenges past paradigms of economic thought in favor of one that accommodates human psychology and market mechanisms.
The Nobel committee credited Thaler with influencing the policy of governments and large corporations to account for the ways that people consistently skirt rational thinking. One example cited by the committee recognized the influence of his proposals such as Save More Tomorrow, a pension plan which had employees commit a portion of future raises to saving ahead in the future. His website, Nudge Blog, features some of the latest ways that governments, companies and nonprofits have implemented his research.
Daniel Kahneman, fellow behavioral economist and 2002 Nobel Economics Prize recipient, was shocked to hear that Thaler was awarded the prize. Kahneman described Thaler’s early career in an interview with The New Yorker:
Everybody knew that he was bright, that he was brilliant. But he wasn’t doing anything considered to be economic research.
Why wasn’t it considered economic research?
Because he wasn’t doing anything mathematical. His story is the success of behavioral economics.
Instead of creating abstract mathematical models, Thaler’s studied how psychological factors cause people to deviate from rational economic behavior. The Nobel Economics Prize committee paid particular attention to three themes in Thaler’s work: mental accounting, self-control and perceptions of fairness.
Thaler’s work challenged mainstream views of our own decision-making ability. Mainstream economics views individuals as being able to track the small factors and individual transactions, eventually adding up to the way of life as we experience it. Thaler defies this assumption, pointing out that we are constrained by our material resources, arguing that the same logic applies to our cognitive resources.
Mainstream economic theories argue that rational people plan in order to efficiently meet their needs and desire, but it pays little attention to how capable human beings are at sticking to their plans, even if they are able. Thaler questions our ability to stick to our goals, especially when they conflict with one another.
In the original paper, Thaler used smoking clinics to illustrate his point. If you consider the cost of visiting a smoking clinic, it is far more expensive than remaining a smoker. Over time it is much cheaper to quit smoking, but we bear the costs upfront, making the decision that is best for our long-term economic benefit even less enticing.
Fairness isn’t an objective metric, but Thaler’s work shows that people view of what is and isn’t fair is relatively consistent. In surveys conducted by Thaler and his colleagues, firms that cut back on hours or employees to preserve profits were generally considered fair by respondents. But if firms raised prices or cut wages to increase profits when a company’s products were flying off the shelves, respondents would call this unfair.