“They didn’t know anything about economics. I didn’t really know anything about psychology. We were equally ignorant of each other’s fields,” Thaler said.
Despite the lack of familiarity, or perhaps because of it, behavioral economics was born.
“In many ways, Dick played the key role in bringing behavioral economics to life, since he was the bridge between psychology and economics,” said Laibson, the Harvard professor.
Bringing concepts to life
During that academic year, the trio worked on several important concepts, including mental accounting and the endowment effect, putting labels and frameworks to some of the items on Thaler’s list of anomalies. They came up with examples that were obviously true but that flew in the face of traditional economics.
Resistance was more aimed at the ideas than the man, said Kahneman, who has described Thaler as “blessed with a sharp and irreverent mind” and having an “ironic eye” and “boisterous temperament.”
“People always took him seriously because he’s so obviously intelligent and so funny,” Kahneman said. “So, people never ignored him personally. They thought the ideas were not important. And that took some time.”
Eric Wanner has known Thaler for about 30 years and funded some of Thaler’s early work. He is president of the Russell Sage Foundation, a group devoted to research in social sciences. Wanner calls Thaler “the key ingredient, the indispensable person,” in the birthing of behavioral economics.
“Dick’s strong suit is this incredible, intuitive, innovative capacity to look at human economic behavior and see its quirks — and then make some good social science out of it,” Wanner said.
Eventually, Thaler landed a regular column about economic oddities in the well-respected Journal of Economic Perspectives. The columns, which ran from 1987 to 1990, “were beautifully written, and they tended to be quite funny,” Kahneman said. “I think that got behavioral economics started as a field. Then, it became respectable.”
Nicholas Barberis, a behavioral finance professor at Yale University, said the difficult early days should not be overlooked. “It is only now that he is rightly lionized,” he said of Thaler. “He took a lot of hits back then, but he paved the way and made life much easier for the next generation of behavioral scholars.”
Said Thaler: “I don’t want to give the impression that life has treated me unfairly. It’s obviously not true. I have a great job at a top university, live a good life. But like all new ideas, it was a struggle to get it accepted.”
A growing influence
Through the 1980s and 1990s, Thaler evangelized behavioral economics, carefully choosing research that would advance the field.
“I always say that one of the things that makes him great is he doesn’t like to work,” Kahneman said. “He hits only home runs, because the small stuff isn’t worth his time. If you want to tease him, you’ll say he’s lazy, but if you want to praise him, you’ll say he has very good taste in problems. He’s very selective in the things he invests energy in.”
Along the way, Thaler also contended that behavioral economics applies to financial markets, and a related field became known as behavioral finance. Indeed, Thaler is a principal of Fuller & Thaler Asset Management, a California firm that manages money for pension funds and other clients. It attempts to make money by investing in stocks that are mispriced because investors have biased expectations about a firm’s future.
Russell Fuller, who conducts daily operations of the firm, said Thaler has changed the economics profession. “People now accept that you have to think about human behavior when you’re thinking about economics … that’s a major contribution,” Fuller said. “He doesn’t write papers that are full of math. He writes papers that are full of common sense.”
As behavioral economics gained approval, applying it to governments and other organizations of power became a natural progression. And it was a way to help people make better decisions, given their sometimes irrational natures.
That’s what Thaler’s best-selling book was largely about.
“Nudge” was born during lunch at a booth in the back of the restaurant Noodles Etc. on East 57th Street in Chicago. That’s where Thaler and Sunstein, then a law professor at the University of Chicago, discussed an odd term Thaler had come up with, “libertarian paternalism,” a combination of seemingly opposite ideas. The phrase attempted to describe how a government or employer could structure choices for people so they were more likely to make good decisions.
In short, people would receive a “nudge.”
Skeptics say the whole thing sounds socialistic, that you can’t trust employers and government to be benevolent or competent enough to guide choices. That may be true, Thaler said, but any method of presenting options to consumers will inherently influence what they choose. Given a list of choices, for example, people will often choose the first one whether or not it’s a good one. So you might as well design a system that will likely lead to something good.
For example, most people agree that saving for retirement is good. But many young workers don’t sign up for their employer’s plan. What if employers made enrollment in a 401(k) plan automatic for new employees, requiring them to opt out if they didn’t want to participate? By changing the 401(k) default from opt-in to opt-out, participation grows.
Thaler, with frequent collaborator Shlomo Benartzi, went a step further with “Save More Tomorrow,” which invites participants to commit in advance to a series of automatic retirement contribution increases, timed to coincide with pay raises. That way, workers contribute more to savings but never see their take-home pay decrease.
The idea has been adopted by thousands of employer retirement plans, with an estimated 9 million workers enrolled.
“He has successfully challenged the assumption of economic theory, and, more importantly, he has explained otherwise unexplainable phenomena in the market,” Kahneman said. “He has provided a framework for understanding what happens when the housing market dries up, for understanding why people don’t save enough, for why negotiations quite often fail.”
Kahneman cites Thaler’s idea of applying behavioral economics to public policy as yet another major contribution.
Will his numerous accomplishments be enough to earn that Nobel Prize one day?
Richard Thaler, Nobel winner from Chicago, fought to get heretical economic theories published – Chicago Tribune