Key Moments
Prof Richard Thaler | Full Q&A at The Oxford Union
Oxford UnionKey Moments
Behavioral economics reveals people are not rational, leading to 'nudges' that gently influence behavior, but 'sludge' can exploit these same principles for profit.
Key Insights
Economists largely abandoned the study of human behavior after World War II, opting for mathematical models assuming complete rationality, which made models less realistic.
Daniel Kahneman and Amos Tversky's work on heuristics and systematic mistakes provided the breakthrough for behavioral economics by showing predictable errors in human judgment.
The 'Save More Tomorrow' program, a 'nudge,' quadrupled retirement savings rates in some firms by allowing participants to increase contributions in the future.
Nudges, such as automatic enrollment in pension schemes, have led to high participation rates, with 92% of UK workers enrolled in the NEST pension scheme.
Examples of 'sludge' include complex cancellation policies for subscriptions, like the 14-day notice required for a one-month trial of The Times, designed to retain customers.
Injecting psychology into economic models is an ongoing process, with areas like behavioral macroeconomics and behavioral game theory still having vast unexplored domains.
Economics lost its way by assuming perfect rationality
Professor Richard Thaler argues that economics, while seemingly about human behavior, strayed from this focus after World War II with a "mathematical revolution." This shift led to models that assumed complete rationality, making agents in these models "smarter and smarter" each decade, and thus less realistic. Thaler contrasts this with his own approach, humorously stating, "in your models you assume that people are as smart as you are and in my models I assume there is dumb as I am." He points to Adam Smith as an early behavioral economist who discussed concepts like loss aversion and self-control, suggesting that economics was once inherently behavioral before the post-war mathematical turn.
The cashew nut anecdote and the endowment effect
Thaler illustrates the concept of self-control and its conflict with economic axioms using a personal anecdote from graduate school. He served a bowl of cashews during a dinner party, and guests, unable to stop themselves, consumed half the bowl. Thaler removed the nuts, and guests expressed relief, acknowledging they would have overeaten. This created a paradox for economists: the removal of choice (eating cashews) made people happier, contradicting the economic axiom that more choice is always better. This experience, along with observing his wine-collecting professor who wouldn't buy a $100 bottle but would drink one he bought for $5, fueled his research into the endowment effect – the tendency to value something more once we own it, a concept he humorously notes became the basis for his career.
Kahneman, Tversky, and the discovery of systematic mistakes
Thaler's 'aha moment' came in the late 1970s when he met psychologists Daniel Kahneman and Amos Tversky. Their pioneering work demonstrated that when people make judgments, they use simple rules of thumb (heuristics) that often lead to predictable, systematic mistakes, rather than random errors. This contrasted with existing economic theory, which assumed rational agents with error terms that would average out to zero. Kahneman and Tversky showed that these errors were not random but could be consistently observed, providing a theoretical framework for the real-world anomalies Thaler had been collecting. This insight was crucial for economists to understand and model non-rational behavior and paved the way for the development of behavioral economics as a distinct field.
Nudges and the 'Save More Tomorrow' program
One of the most famous applications of behavioral economics is the 'nudge,' a concept Thaler co-developed with Cass Sunstein. Thaler's concern about retirement savings led him to create the 'Save More Tomorrow' program. Instead of asking people to increase savings immediately, the program invites them to commit to increasing their savings rate in the future, often tied to pay raises. This strategy leverages the future-oriented self-control many people possess. At the University of Chicago, this program quadrupled savings rates in some firms, but faced criticism for being 'paternalistic.' Thaler and Sunstein then coined 'libertarian paternalism' to describe policies that steer people toward better choices without coercion, later popularizing the term 'nudge'.
Libertarian paternalism and its real-world impact
Libertarian paternalism aims to guide behavior without restricting freedom of choice. A key tool is setting defaults. For example, automatic enrollment in pension plans significantly increases participation. The UK's NEST pension scheme, for instance, achieved 92% worker enrollment through automatic enrollment, with plans to incorporate 'Save More Tomorrow' principles for gradual saving rate escalation. Other nudges include reminders, such as texts to parents about children's upcoming school assignments or exams, and feedback to doctors about their opioid prescription habits, which led to a 40% reduction in initial prescription sizes. These examples highlight how subtle changes in choice architecture can lead to substantial behavioral shifts, aligning with the principle of 'libertarian paternalism' because no one is forced.
The concept of 'sludge' and how to combat it
While nudges can be used for good, Thaler also describes 'sludge' as the flip side – practices that exploit behavioral biases for profit or convenience, often making things difficult for consumers. He cites the example of subscribing to The Times newspaper: a one-month trial requires a pound, but canceling involves 14 days' notice, a phone call to London during business hours, and potential long wait times. This complexity is designed to retain subscribers. Thaler advocates for making it as easy to cancel a service as it is to sign up. He also notes that awareness of nudges can reduce their effectiveness on oneself, a phenomenon he calls 'self-nudging' or 'smudges,' though he humorously questions its universal applicability by referencing the need for an alarm clock.
Integrating behavioral insights into economic models
The integration of behavioral insights into formal economic and mathematical frameworks is an active and growing field, pioneered by economists like Matthew Rabin and David Laibson. Thaler acknowledges that vast domains, such as behavioral macroeconomics and behavioral game theory, are still being explored. He suggests that John Maynard Keynes's work could serve as a foundation for behavioral macroeconomics. In behavioral game theory, the assumption of perfect rationality in all players is often unrealistic; real-world interactions involve agents with bounded rationality. The successful method in this integration often involves changing only one aspect of traditional models at a time, such as introducing self-control problems or overconfidence in otherwise rational agents. Thaler predicts that a complete theory of behavioral economics is unlikely, as it would require a complete theory of psychology, sociology, and other social sciences, recommending students focus on one specific area to make progress.
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Behavioral Economics: Nudges vs. Sludge
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Common Questions
Traditional economics often assumes people are perfectly rational, selfish, and smart. Behavioral economics, however, acknowledges that people have biases, self-control problems, and use rules of thumb, leading to systematic mistakes. It integrates psychological insights into economic models.
Topics
Mentioned in this video
An economics columnist who interviewed Richard Thaler and playfully taunted him with salted almonds, illustrating Thaler's own self-control challenges.
Co-winner of the Nobel Prize in Economics for his work using field experiments in developing countries to inform policy, cited as an example of scientifically informing policy.
A pioneer in integrating behavioral insights into economic models, working in the Harvard economics department.
Cited as one of the economists who started the mathematical revolution in economics after World War II, focusing on models of rational agents.
Described as the world's greatest behavioral macroeconomist, with a suggestion to read his work seriously as a starting point for behavioral macroeconomics.
A good friend of Richard Thaler and a pioneer in the field of behavioral game theory.
An audience member whose research focuses on public policy failure and administrative failure, asking how to nudge governments towards better decision-making.
An economist mentioned in the context of highly rational models, with Thaler humorously contrasting his own models by assuming people are as dumb as he is.
Cited as one of the economists who started the mathematical revolution in economics after World War II, focusing on models of rational agents.
Referred to as the first behavioral economist, whose 'Theory of Moral Sentiments' discussed concepts like loss aversion and self-control problems.
A pioneering psychologist with whom Richard Thaler met in the late 70s, whose work on heuristics and biases provided Thaler's 'aha moment' for behavioral economics.
A law professor and friend of Thaler's who collaborated on the concept of 'libertarian paternalism' and the book 'Nudge'.
A pioneer in integrating behavioral insights into economic models, working in the Harvard economics department.
A pioneering psychologist with whom Richard Thaler met in the late 70s, whose work on heuristics and biases provided Thaler's 'aha moment' for behavioral economics.
Co-winner of the Nobel Prize in Economics for his work using field experiments in developing countries to inform policy, cited as an example of scientifically informing policy.
Lord Adair Turner, who was in charge of the details of the UK's Nest retirement scheme and made the decision to use automatic enrollment.
Co-winner of the Nobel Prize in Economics for her work using field experiments in developing countries to inform policy, cited as an example of scientifically informing policy.
Mentioned as an example of 'sludge' or potentially 'evil nudges' where it automatically plays the next show unless the user intervenes.
Mentioned in the context of default settings on phones, illustrating how default choices can powerfully influence user behavior.
The UK's nationwide retirement saving plan that utilizes automatic enrollment, a key nudge strategy, leading to high participation rates.
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