Economist Richards Thaler is today the president of the American Economic Association, and a perennial candidate for the Nobel. To his fellow economists, Thaler’s way of thinking during his career has been wildly disruptive compared to classical economists.
Selected observations: from the book: “The Economist Who Realized How Crazy We Are” By Michael Lewis
“The biggest upheavals have come in industries in which managers have always made decisions more or less by gut instinct: political campaigns, health care, military campaigns, professional sports.”
The obvious cause of the turmoil is the availability of ever-cheaper computing power: People looking for an edge in any business can now gather and analyze all sorts of previously unobtainable or unanalyzable data.
But does more data trump the expertise of managers?
People (even experts) and industries (even old ones) can make big, systematic mistakes.
There’s now a fairly long list of intellectuals responsible for the spread of this subversive idea. Somewhere near the top of it is the economist Richard Thaler, who has just published an odd and interesting professional memoir, “Misbehaving.”
Thaler is the president of the American Economic Association, and a perennial candidate for the Nobel. His rise may be just another example of the power of human misjudgment. Or he might be onto something. Either way, he’s been wildly disruptive.
The author Michael Lewis had a book out on Thaler’s career as an economist.
It’s interesting because it tells the story not just of Thaler’s career but also of the field of behavioral economics —
That is the study of actual human beings making decisions rather than overview of rational optimization as classical economic theory.
For a surprisingly long time behavioral economics wasn’t much more than a bunch of weird observations made by Richard Thaler, more or less to himself.
What he calls his “first heretical thoughts” occurred in graduate school, while writing his thesis. HOW TO VALUE a LIFE? Thaler set out to determine how to value a human life — so that, say, the government might decide how much to spend on some life-saving highway improvement.
Or a railroad on PTC.
Thaler collected behavior evidence that people answer this value of life question implicitly, every day, when they accept money for a greater chance of dying on the job. “Suppose I could get data on the death rates of various occupations, including dangerous ones like mining, logging and skyscraper window washing, and safer ones like farming, shop keeping and low rise window washing” reports Thaler. “The risky jobs should pay more than the less risky ones: otherwise why would anyone do them?” Using wage data, and an actuarial table of mortality rates in those jobs, he was able to work out what people needed to be paid to risk their life.
Thaler calculated that the current implied value of an American life is $7 million.
In addition to calculating the market’s price for a human life, Thaler got distracted by how much fun he might have if he asked actual human beings how much they needed to be paid to run the risk of dying. He began with his own students, telling them to imagine that by attending his lecture, they had exposed themselves to a rare fatal disease. “There was a 1 in 1,000 chance they had caught it. There was a single dose of the antidote: How much would they be willing to pay for it?” Then he asked them the same question, in a different way: “How much would they demand to be paid to attend a lecture in which there is a 1 in 1,000 chance of contracting a rare fatal disease, for which there was no antidote?”
The questions were practically identical, but the answers people gave to them were — and are — wildly different. People would say they would pay two grand for the antidote, for instance, but would need to be paid half a million dollars to expose themselves to the virus.
“Economic theory is not alone in saying that the answers should be identical,” writes Thaler. “Logical consistency demands it. …”. To an economist, these findings are somewhere between puzzling and preposterous. They were so different in value that when Thaler showed them to his thesis professor “he told me to stop wasting my time and get back to work on my thesis.” It did not fit the professor’s view of reality and hus fundamental training. So he wanted to ignore it.
Instead, Thaler began to keep a list of things that people did that made a mockery of economic models of rational classical thought about making choices. There was the guy who planned to go to the football game, changed his mind when he saw it was snowing, and then, when he realized he had already bought the ticket, changed his mind again.
There was the woman who drove 10 minutes to a store in order to save $10 on a $45 clock radio but wouldn’t drive the same amount of time to save $10 on a $495 television.
the early 1970s, when Thaler was a student, his professors didn’t argue that human beings were perfectly rational. They argued that human irrationality didn’t matter, for the purpose of economic theory, because it wasn’t systematic. It could be treated as self-cancelling noise.
Mr Lewis cites other interesting experts — some of whom concluded “that people responded very differently when a choice was framed as a loss than when it was framed as a gain”.
Tell a person that he had a 95 percent chance of surviving some medical procedure and he was far more likely to submit to it than if you told him he had a 5 percent chance of dying.
So what could we learn from this about selecting which big mine resource and railway projects to invest in?
For more — go to Michael Lewis at firstname.lastname@example.org