Author: Richard Thaler
Started reading: 10.January.2016
Finished reading: 09.June.2016
The title of Misbehaving: The Making of Behavioral Economics is actually a triple pun – nice! First, Thaler considers himself misbehaved as one of the founding fathers of the field of behavioural economics, which challenged the classical economic thinking entrenched in universities and governments.
Second, the book is about how people are irrational, often far apart from the homo economicus who populates traditional models.
Finally, the book’s style is unconventional. It is semi-autobiographical, tracking Thaler’s career and his attempts from 1977 to today to convince economists that they’re (partially) wrong. It is academic at the same time, explaining key concepts in each chapter. Yet it remains funny and conversational.
One of the core ideas in the book is ‘prospect theory’ (originally discovered by Danny Kahneman and Amos Tversky), a psychological phenomenon which Thaler tried to inject into a recalcitrant economics. The theory holds that people hate losses roughly twice as much as they love gains.
In other words, you’d dislike losing a $50 note just as much as you’d enjoy finding a $100 note. This observation leads to a whole raft of irrationality and odd behaviours, and is well worth learning.
Another concept is ‘mental accounting’, the idea that people forget that money is fungible and instead keep fenced-off budgets in their heads. This is one explanation for why, during the Global Financial Crisis, consumption of premium petrol went up as petrol prices fell. People thought, “Ah! I can now afford the premium stuff within my petrol budget, so I’ll buy that.”
A rational homo economicus would instead have said, “I’ll continue buying the standard petrol and keep the savings, or transfer them over to my utility, services or groceries budgets, in which costs have gone up.”
Thaler’s efforts to enhance the discipline of economics have ultimately been successful. In 2015, Barack Obama signed an executive order decreeing all government bodies need to take behavioural insights into account when designing policy.
And in 2010, the UK Government contacted Thaler to help with establishing the Behavioural Insights Team, or ‘Nudge Unit’, within the Department of Prime Minister and Cabinet. Some of its famous recommendations to government have included using social pressure to decrease the proportion of people not paying their taxes and offering a lottery prize to increase participation in elections (by the way, the locality where this method was trialled saw its electoral registration rate increase by 4.2%, confirming once and for all that scratchies are more popular than ballots).
Thaler’s parting advice is for researchers to explore the application of behavioural insights to macroeconomics, a so-far poorly understood area.
Ignore sunk costs in your personal and professional lives. When money or time is irrevocably spent it is ‘sunk’. A sunk cost should be ignored. It shouldn’t become a factor is deciding whether to continue with whatever it is you purchased. Yet people don’t always act like this. Think of the friend who continues studying the degree they dislike because they’ve “already put a year-and-a-half into it”, or remember the time you finished that extra plate of food because it cost a lot of money, even though you were full and on a diet. (On a grander scale, consider England’s persistence in the Dardanelles campaign, or America’s stubbornness in Vietnam.)
Be aware of ‘regression to the mean’ when investing in the stock market. Investors, due to their human biases, tend to overvalue ‘good’ companies and undervalue ‘bad’ ones. This means that over time, low value stocks should generally grow whereas high value will usually become more average.
Meeting of the Behavioural Insights Team outside of No. 10 Downing Street, evidently before they were welcome at the decision-making table