Sunday, October 13, 2019

Misbehaving: The Making of Behavioral Economics I

I'm halfway through this book by Richard Thaler, which was published in 2015. Thaler is an economist and one of the founders of the field of behavioral economics. He won the Nobel Prize in Economics in 2017. Economics is not an especially interesting topic for me, and I generally prefer macroeconomics, such as that found in Thomas Piketty's Capital, to more circumscribed areas such as this. I am making an exception for Thaler in order to understand behavioral economics better. The book is partly autobiographical, and it describes the development of his career starting in 1970 up to the present. That adds a dimension in that you can see many of the pitfalls of academic life, which relates to my interest in the sociology of academia.

Early in his career, Thaler noticed that the actual decision-making processes used by people are often not rational in the sense that economists understand the term. There are different schools of economic thought, but the predominant one in the twentieth century entailed the idea that humans are rational agents who collectively make rational choices with respect to maximizing utility. This means that people usually make optimal choices regarding whatever it is that they value, and economists have traditionally focused on their financial decisions. From an economic standpoint, it is mathematically convenient to assume that people are rational, because that allow economists to predict collective human behavior with relatively straightforward mathematical tools.

The early behavioral economists conducted simple experiments like the ones described by Daniel Kahneman in Thinking, Fast and Slow, demonstrating unequivocally that human decisions are often not rational in a quantitative sense. Thaler collaborated with Kahneman, Amos Tversky and others, and behavioral economics arose as a bridge between the academic disciplines of economics and psychology. In Thaler's language, Kahneman's "fast" or "System 1" thinking very roughly corresponds with Thaler's "Human," and Kahneman's "slow" or "System 2" thinking very roughly corresponds with Thaler's "Econ." Humans are fuzzy thinkers and Econs are ultra-rational. There are many examples of people arriving at answers that are mathematically or logically incorrect. Thaler differs somewhat from Kahneman in his search for what might be called extenuating circumstances or non-numerical values that affect how actual decisions are made. One example involves the way that Uber's pricing algorithm can alienate consumers. Uber increases fares automatically when the number of passengers in a particular area goes up and there is an insufficient number of drivers available. It is possible for fares to become ten times the normal rate. This formula can backfire when customers believe that they were treated unfairly and when anti-gouging laws provoke lawsuits. In the past, economists favored the Econ types for all of their models, because that type makes purely rational decisions based on maximizing value, which in most cases means money. Thaler in particular helped demonstrate that factors having nothing to do with maximization go into the decisions that most people make. In other respects, Thaler's discussion covers some familiar concepts such as confirmation bias and the endowment effect, the latter indicating that people value things that are currently in their possession more highly than they ought to rationally.

Reading about Thaler's career, you get a sense of how one might fail in academia. In his early years, he was conflicted between making enough money to support his family and pursuing his area of interest in research, which, at the time, was barely on the fringes of economics and was frowned upon by most economists. If he hadn't met Kahneman and Tversky and a few others and participated in research with them, behavioral economics may have remained an undeveloped field. As it turned out, it took off and has produced several Nobels. In this book, Thaler seems like a very ordinary sort of person with plebeian interests, and one can readily imagine him finishing off his career teaching traditional economics in a humdrum economics department somewhere. It is even possible that he would never have obtained tenure and may have switched to a different career.

Though my enthusiasm for the book is limited, I am holding out for the later chapters that cover the uses of behavioral economics for social benefit. Since I have visitors arriving soon, it will take me a while to finish, but I will eventually make another post.

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