Transcript
Behavioural Economics:
Closing the Gap between
Theory and Reality
Professor Richard H Thaler
Ralph and Dorothy Keller Distinguished Service Professor of Behavioural Science and Economics,
University of Chicago; Author, Misbehaving: The Making of Behavioural Economics
Chair: Lord Gus O'Donnell
Cabinet Secretary (2005-11); Senior Adviser, Frontier Economics
13 July 2015
The views expressed in this document are the sole responsibility of the speaker(s) and participants do not necessarily reflect the view of Chatham
House, its staff, associates or Council. Chatham House is independent and owes no allegiance to any government or to any political body. It does not
take institutional positions on policy issues. This document is issued on the understanding that if any extract is used, the author(s)/ speaker(s) and
Chatham House should be credited, preferably with the date of the publication or details of the event. Where this document refers to or reports
statements made by speakers at an event every effort has been made to provide a fair representation of their views and opinions. The published text of
speeches and presentations may differ from delivery.
10 St James’s Square, London SW1Y 4LE T +44 (0)20 7957 5700 F +44 (0)20 7957 5710
www.chathamhouse.org
Patron: Her Majesty The Queen Chairman: Stuart Popham QC Director: Dr Robin Niblett Charity Registration Number: 208223
2 Behavioural Economics
Gus O'Donnell
Welcome to this, I'm really looking forward to it. I have the great privilege of being in conversation with
Richard Thaler for the first 20 to 25 minutes, and then we'll open it up for all of you to join the
conversation. First of all, some disclaimers, because Richard and I are not unknown. We have worked
together in the 'Nudge Unit'. Richard is the hugely well paid adviser to the Nudge Unit, getting a round
figure –
Richard Thaler
Yes, very round.
Gus O'Donnell
A very round figure, with nothing in front of it. That contribution, I have to say, undervalues enormously
the input (surprise, surprise). But we've had some great times talking about nudge units. I remember
when Richard was over very early on, we decided that the discussion would work better down the pub, so
we went down the pub. We thought about – as Richard would, obviously – what was the issue about
buying rounds, do you remember that?
Richard Thaler
Oh right. I got into a lot of trouble with this.
Gus O'Donnell
You did. The question was: was our English habit of – actually they operate in Scotland too, and the rest
of the UK – the habit of buying in rounds meant that you would drink more than if you didn't buy in
rounds? Did it matter precisely how many people were in your friendship group? Because obviously if
three of you go out and you've all got to buy a round, that's only three drinks; but if you're really popular,
you see how it goes. So the whole question of whether we should be buying in rounds was quite important.
Anyway, I'm supposed to introduce you first, and I'm supposed to do various things. First of all, this is on
the record, so there's nothing about Chatham House Rules in all of this. Everything is on the record and
live-streamed. There is a Twitter channel for those who use such things: #CHEvents. The way we use
Twitter is during the question-and-answer session, you who are here physically get prominence, you get
first go, but the Twitterati will be allowed to put questions in by Twitter. We might take some of them, if
they're interesting.
I do need to formally introduce Professor Richard Thaler, the Ralph and Dorothy Keller Distinguished
Service Professor of Behavioural Science and Economics at the University of Chicago's Booth School of
Business. He is the author of Nudge – I'm sure many people in this audience will have read Nudge – and
a lot earlier, interestingly, ones like Quasi-Rational Economics, Winner's Curse (back in 1991). We might
come to the gap and what's happened. Has had a huge impact on policy in various areas. The one area I
pick out more than any other is pensions and saving for old age.
So we have 20 to 25 minutes. My first question comes out of the Nudge book, really. In Nudge you
established the two tribes: the econs and the humans. The econs were the ones that I used to teach when I
taught welfare theory. Basically, we maximize our utility, subject to budget constraints, and this leads to
3 Behavioural Economics
all sorts of good things. The discovery that humans aren't quite like that and they don't quite follow that
rational choice – isn't it obvious that humans are human?
Richard Thaler
It is, unless you're an economist. I often say that if you get a PhD in economics, as you know, you learn all
kinds of things – mathematics and econometrics and economic theory. But somehow in the process of
learning those things, common sense is removed. So after four or five years of that study, you start to
believe these models – that people can forecast what they're going to earn over their entire lifetime, what
rate of return they will get on their saving, what consumption path they would like. At 25, you can figure
all of that out and then implement that plan. Then when you retire, just switch gears and optimally spend
the money down. I've never met anyone that seriously thinks they've solved that problem but we
economists assume everyone can, and it's sort of preposterous.
Gus O'Donnell
It's a bit like when you meet that potential partner for life and you say: do you want to jointly maximize
our utility?
Richard Thaler
Yeah. Is that the way you proposed, Gus?
Gus O'Donnell
That's why you have a lot of single economists out there. So I mentioned the 'humans' part of it, and this is
a very human book, in a sense. You're not just telling an economics story here. You're actually telling a
story about struggles against an economics profession that seems not to have warmly welcomed your
ideas at the start. What were the big obstacles?
Richard Thaler
I think part of it was sunk costs. Economists teach us to ignore sunk costs but aren't that good at it
themselves. I had a conversation once at an early conference, somebody asked me: you know, if you're
right, what I do for a living is solve optimization problems – what am I supposed to do? Well, it's not
really my problem, you know. But I think that was it.
But more seriously, I think economists – and this is true in all fields – the establishment gives itself the
benefit of the null hypothesis. So you're right until proven wrong. I started with stories about people
having very different buying and selling prices, which is a taboo in economics. People would say, well,
that's just a story. So then I'd run an experiment. Well, that's just an experiment. It's been a 40-year
process of constantly raising the stakes and saying: okay, you didn't buy that argument, how about this
one? It was part of why I ended up getting interested in financial markets, because everybody said –
Gus O'Donnell
They're supposed to be the best.
4 Behavioural Economics
Richard Thaler
Yeah. You're certainly not going to have any success there. Okay, that's an invitation to enter that fray.
Gus O'Donnell
The whole idea of human behaviour and how they make these decisions – the psychologists, curiously
enough, seem to have been at this game rather longer than us and have come up with some different sorts
of answers. How did you find it working – people like Danny Kahneman, obviously – working across the
disciplines? Because people are always talking to me about government, saying: you're all in silos. I've
actually found that academia is more silo-ed than government.
Richard Thaler
Yeah. I make this comment in the book that early on, we thought what now is called behavioural
economics would be interdisciplinary, because Kahneman and Tversky and I were working together. They
were teaching me psychology and I was teaching them economics. We started writing some papers
together and we thought, this is what it will be. There will be psychologists and economists and they'll talk
to each other. It's basically not happened at all. I remember an early meeting we held in New York where
we had five or six of the world's greatest psychologists. It would be like having Murray, Federer, Djokovic
– we had the top people in the world. They were willing to engage but they didn't really know what to do.
The entry barriers to economics are very high. And we need economics. One point I make repeatedly is
I'm not in favour of getting rid of economics, I don't think we can replace economics with psychology –
because frankly, psychologists are bored with economics. I don't know a psychologist who has a view of
what we should be doing with the EU or the Chinese stock market or climate change, or any of the other
issues that economists have dug into.
So we need economics and we need the standard theory, because none of what we've done would have
been possible to do without the benchmark. So if you take Kahneman and Tversky's masterpiece, prospect
theory, which is a theory of how people make decisions under uncertainty, it really couldn't have existed
without expected utility theory (the rational theory) as a benchmark. The same with behavioural finance. I
wouldn't know how to do behavioural finance without the efficient market hypothesis. So I was happy to
say, all right, we'll give you the null hypothesis, because that gives us something to test. Then we can make
fun of the efficient market hypothesis and then we can start to make some progress.
Gus O'Donnell
A lot of the ideas about how people actually behave, as opposed to how the models assume they behave,
come out of experiments, it seems to me, done on American students – psychology and economics
students. Someone has described this as weird, in the sense of Western-educated, industrialized, rich,
democratic – you can't extrapolate from those sorts of behavioural assumptions to what might happen in
China or Singapore. What do you make of that?
Richard Thaler
I would say that the research suggests that, first of all, we know we're one species. Yes, there are cultural
differences, but I think for much of what we studied, they are second-order. Loss aversion, the fact that
losses hurt more than gains make us feel good – universal. Amos Tversky had this joke he used to say:
5 Behavioural Economics
there once were species that didn't have loss aversion, and they're now extinct. So if you're living at
subsistence, then it makes a lot of sense to be loss-averse.
Gus O'Donnell
This fits with my theory about the first time around, it was the men that gave birth. Only ever did it once.
Richard Thaler
So I think, first of all, the original studies were done in Israel. But there are academics doing this research
all over the world. It's now possible to do research from your lab all over the world using things like
Amazon Mechanical Turk. If you don't know what that is, people can go to work for Amazon – you can
work on all kind of things but you can work filling out surveys or participating in experiments. It's been
fantastic for researchers. Very cheaply, you can get a subject pool that's global.
Gus O'Donnell
You and I talked about organ donation quite a lot. You had this brilliant video about a Brazilian football
club called Recife and trying to get them to donate more organs. The Nudge Unit here did some work on
various different messages, as to which one would work best. I took that work out with me when I was
doing a lecture in Australia and said to them, which one works best for you? I got a different answer. So
that, for me, reinforces the point you make in the book quite a lot, that you just have to test these things.
Behavioural theory doesn't give you exact answers.
Richard Thaler
Gus was very instrumental in the creation and curation of the Nudge Unit. As I'm sure everyone knows,
Gus was the cabinet secretary when this all got started. When I would go around talking to various
ministers, I had my two mantras. One, if you want to encourage people to do something, make it easy.
Two, we can't do evidence-based policy without evidence. The second one, people thought I was a wiseass.
But it's true. People think about the Nudge Unit as bringing behavioural science in; oftentimes, the
behavioural science is as simple as 'make it easy'. So things like automatic enrolment into pension plans,
like NEST – Danny Kahneman says you're using first-grade psychology, which he doesn't mean as a
compliment, but that's all we need, right? So for many of the things, you don't need a PhD in psychology
to make it easier for people to do the right thing.
We talk about raising the stakes. The NEST experiment is a huge experiment about the power of default
options. You will certainly remember the enormous scepticism and debate about whether that programme
should be mandatory or whether automatic enrolment would be enough. Adair Turner was a brave man
and said automatic enrolment is enough. It's proven to be right. The opt-out rate, the last I heard, is about
12 or 13 per cent. If you can get 87 per cent of the people opting in, or failing to opt out, some of those
people who are not joining may have good reasons. That was the whole idea of Nudge: how much can we
do without forcing anybody to do anything? It turns out to be a lot. Not everything. Fraud is against the
law. Assault. We're not going to nudge those things. But we can accomplish a lot of things without bans
and mandates.
6 Behavioural Economics
Gus O'Donnell
One of the biggest arguments against Nudge that we often hear is: who are you to say what's best for
people? How do you know – that person might have perfectly rational reasons for doing this and nudging
is just paternalism. There's nothing libertarian about it.
Richard Thaler
As long as there's no bans and mandates, you're not forcing anybody to do anything. That was the whole
premise of the book. Sometimes you do want to require things. We want to require everyone to drive on
one side of the road. You guys picked the wrong side but, you know.
Gus O'Donnell
We were there first.
Richard Thaler
Most people didn't follow this one, Gus. But whether or not we can agree on which is the best side to drive
on, it is a coordination problem that we all pick the same one when we're in the same country. That's
mandatory, we don't let people say, well, I'm an American, I'm going to drive on the right-hand side of the
road. But I don't think anything that we have done at the Behavioural Insight Team or the US equivalent,
or now they're popping up all over the world, has forced anybody to do anything.
The question of how you know what's best – you don't always. But oftentimes you have a pretty good
guess. If I see a 45-year-old who has zero retirement saving, I'm pretty sure that's too little. Maybe they
have a big inheritance coming, that's possible. But I have a guess that zero is too low. It's too low for my
consulting rate but that's all you were willing to pay, so what can I do. And it's too low for saving for
retirement. So we offer a nudge, we create a pension plan, we make it easy to join. You have to opt out but
you're allowed to opt out.
I've taken it a step further with what I call 'Save More Tomorrow'. I think that will be Mach-2 for NEST.
Automatic escalation. Especially in America this is important, because most of the automatic enrolment
plans start people out at a very low saving rate. So we invite people to sign up for a plan to save more
every time they get a raise. Now, we always felt it was important to put a cap on that, because I've got
some friends that if you enrolled them on that, they would be saving 140 per cent of their income if you let
it run long enough.
People raise things like diet, that we're constantly changing our minds about whether fat is good for us or
bad for us. Yes, that's true. We see somebody 100 pounds overweight, you can ask them: do you think you
weigh the right amount? Most of them will say no. You ask smokers, most of them have tried to quit 20
times. So what can we do short of banning cigarettes? Prohibition, we ran a big experiment on that in the
US, it was a failure. So I'm against bans. But if you can help people – I always say that those little signs
you have on the sidewalk reminding me which way to look has saved my life on numerous occasions.
Gus O'Donnell
That's because you chose the wrong way to drive.
7 Behavioural Economics
Richard Thaler
That's right. But that's now become a habit. So I look the wrong way but then I say, oh yeah, okay.
Gus O'Donnell
This is my last question, because we need to open it up. Of all those nudges that have been implemented
in various countries – as you say, lots of nudge units cropping up around the world – what is your
favourite? What do you think has been the neatest example?
Richard Thaler
I would have various answers. Of course, the most fun example is the fly in the urinal, in the Amsterdam
airport. This was after you left. On one of my infrequent actual meetings with the prime minister, I
actually ran into him in the men's room outside his office. I was shocked to see him there. That doesn't
happen in the White House, I can tell you. So there he is and there I am.
Gus O'Donnell
This is before the nine o'clock threshold, right?
Richard Thaler
Yeah. I said: Mr Prime Minister, where's the fly? He promised he would get right on that.
But I think the changes in retirement plans have had the biggest effect, as you've suggested. I think of the
work the Nudge Unit has done, the domain that's most exciting – and it's not finished, by any means – is
the work in the jobcentres. This is a big project aimed at getting people to find new jobs faster. Let me say
one more thing about that and then we'll open it up.
Saving was an easy problem because automatic enrolment is what I call a one-click answer. It's actually a
zero-click because you do nothing, and people are really good at doing nothing. If you give them a oneclick out, then the costs you're imposing on people are minute. I think automatic enrolment plus
automatic escalation plus sensible default investments has made a huge change in the design of defined
contribution plans.
Now, there's no one-click diet. There's no one-click way of getting a job for somebody who's been out of
work for two years. I have no miracle to announce, but there are lots of things that the jobcentres were
doing that they could be doing better. One was just getting people looking forward rather than backward.
So the rules were, in order to get your cheque, you had to show that you had done at least N interviews in
the last two weeks, and they changed it to, in order to get your cheque, you had to show us your plan of
what you're going to be doing over the next few weeks. Little things like that can – you won't get huge
effect sizes in these things but if you can do 3 or 4 per cent faster, can make a big difference. A big
difference.
Gus O'Donnell
We have just made, in this last budget, some enormous differences to the incentive effects at the low end,
through changes in tax credits and planned changes in the minimum wage, which I know as president of
the American Economic Association you had [indiscernible] do the lecture. You pointed out to me, and it's
8 Behavioural Economics
got a lot of evidence, about the Earned Income Tax Credit, which is very relevant to the changes that were
in the UK budget. I'm sure the evidence base for all those changes is absolutely fantastic. Hasn't yet been
published but I'm looking forward to seeing precisely what behavioural assumptions were behind those
changes. We shall see how effective they are. Because I'm not sure it's quite understood how little people
understand on the [indiscernible] effect.
Richard Thaler
Can I make clear that I was not consulted by the chancellor on this particular question.
Gus O'Donnell
Indeed. Nor me, I'm afraid, but why should he. We can now open it up.