We're All Smart. And Dumb. Sometimes.
Richard Thaler, one of the founders of the field of behavioral economics, has written a book about the history of the subject he helped create. If you want to get a quick overview of the book’s main thesis, check out Thaler’s post at the New York Times’ Upshot blog.
Behavioral economics is an important advance. The most significant thing it did was to challenge the idea that economists could just dream up axioms of human behavior and proceed without looking at the evidence. It cast much-needed doubt on the idea that markets are a magical force that will make a large number of irrational humans behave like one super-rational human when you average them all together.
There are a lot of people who are highly critical of the field. Roughly, their criticisms fall into two categories, one of which is a good criticism and one of which is way overblown.
The good criticism of behavioral econ is that it’s very hard to go from the lab to the real world. Just because you can show the existence of an effect in the lab, with careful controls and powerful manipulations, doesn’t mean that the effect is going to show up in the real world. This, in fact, is one of the biggest and oldest problems with experimental psychology.
Because of this problem, developing real workable economic theories based on psychology has proven difficult. A little bit of progress has been made -- for example, the idea of making corporate savings plans opt-out instead of opt-in, in order to nudge people into saving more, has gained a lot of currency. It’s the idea of the “nudge” -- the title of a 2009 book by Thaler and my Bloomberg View colleague Cass Sunstein -- where behavioral econ looks the most promising.
But here we come to the second criticism -- the bad one. People are way, way too afraid of the soft paternalism of nudges.
One reason for this fear is that nudging sounds elitist. William Easterly, a celebrated development economist, expressed this fear when he tweeted: “Behavioral econ [Thaler] says we are too dumb to fix our own mistakes but smart enough to fix everyone else's[.]”
Easterly later apologized, even though his tweet wasn't particularly rude. The real problem is that he mischaracterized behavioral economics. Behavioral econ isn’t about smart people knowing what’s best for dumb people. It’s about all people being smart some of the time and dumb at other times. Or strong-willed some of the time and weak-willed at other times.
This is common in everyday life. If you’re on a diet, you probably rid your house of foods such as candy and cookies. You know that if you walk by the cookie jar, there will be days when you just won’t be able to resist -- or days when you’re so distracted by other things that you won’t even bother trying to resist. Getting rid of the cookies is what’s known as a commitment device. Commitment devices are an important idea in behavioral econ, and they’re definitely not about smart people versus dumb people -- there’s only one person involved!
Another reason people fear nudges is that they sound like the oppressive hand of big government. Financial engineer and Columbia University professor Emanuel Derman expresses this fear when he writes:
[T]he liberal paternalist Nudgers of today, postmodern behavioralists, use their minor insights to suggest how government and authorities can simply tilt the pinball table so that people will do what authorities think is right.
But this concern, too, is misplaced. First of all, nudges are designed not to affect the behavior of rational people. If you think about your 401(k) contribution in a rational way, it won’t make a bit of difference whether your plan is opt-in or opt-out -- you’ll just save the amount that you want to save, and that will be that. Only if you are suffering from a behavioral bias will the nudge actually nudge you.
Even more importantly, critics of soft paternalism should realize that people are already being nudged all the time, and not by government. The true masters of behavioral economics are marketers in the private sector. Marketers have been studying behavioral economics for ages, and have never had any compunction about using it to take your money.
Ever wonder why prices in stores are $9.99 instead of $10? Behavioral economics. How about sales and discounts? Just raise the base price and treat the real price as a discount, and behavioral economics will make people more eager to buy. That yogurt that advertises itself as fat-free? Check out how many grams of sugar it has. And so on.
Marketing is by far the biggest application of behavioral economics, it’s perfectly legal and it’s already everywhere. You are being nudged 24/7. If you stop to think about it, it's ludicrous that behavioral econ skeptics are up in arms about government nudges, but blithely unconcerned about corporate nudges.
But stopping to think about things is something we rarely do. And that’s why behavioral economics is important.
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