Econs and Nudges
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I finally finished Richard Thaler's book "Misbehaving: The making of Behavioral Economics". It took a while to get through the book. There are two main reasons that a book would become a "long" read for me. The first is that the book is generally dull and uninteresting. It becomes painful to pick up the book and read it. However since I started it I feel compelled to finish it. Usually hoping it will get better. Rarely it does. The second reason is that the book and the ideas are so compelling that I find myself constantly rereading sections. This was definitely the case with Thaler's book. I found myself constantly going back and rereading sections. I would also spend time searching some of the concepts and ideas presented to deepen my understanding of them. I shall reread the entire book in the very near future.
The book is basically a chronological recap of him creating a new field of study. That field of study as the book title states is behavioral economics. As I stated I was completely captivated by the concepts and ideas presented in this book and I will be rereading it very soon. By rereading it I hope to gain a much deeper understanding of the concepts and conclusions Thaler presents. However, I do feel obliged to convey some of my thoughts on the topic of behavioral economics. I am confident enough in my understanding of Thaler's book that I can share my thoughts and insights. Starting with what I view as Behavioral Economics.
Traditionally economic theories relied on the premise that all parties made calculated rational decisions. Traditional theories were also predicated on the fact that the parties would always "maximize" their returns. Some of these assumptions may have been well founded when the theories were developed. For example saving for retirement is an issue that Thaler addresses several times in his book. It is the basic issue I have posted about previously. Why do those who have the means (good incomes) ignore saving for retirement. A very rational person would invest an adequate amount of money in a 401k and allow that savings to grow to retirement. As an added incentive many companies match a certain amount that the employee invests. Why would a "rational" person turn down free money. Traditional economic theory would have all people contributing the maximum amount to their 401k's. Statistics show that this is not the case. One reason could be that this vehicle for savings has only been around for a very short while. Prior to the 20th century very few people retired in the traditional sense. People either died while still working (usually in agriculture) or become too impaired to work the family farm and were supported by younger members of the family. As the industrial revolution continued to affect the world economy and people began to live longer pensions began to support peoples golden years. Although some people continue to benefit from pensions they have all but disappeared from the private sector. So the concept of living 20 years after your career AND being responsible for paying for it is relatively new. A conceivable explanation is simply that as a society we have yet to fully understand this concept.
This lack of understanding is also something Thaler addresses. Economists that disputed Thaler's early works conceded that a person may make mistakes when encountering concepts for the first time but they will learn to maximize their returns over time. Basically saying that we will learn from our mistakes. Taking retirement as an example, how many times will I retire to learn from my mistakes. As for retirement how many do overs will I get to maximize my returns. Some people do return to work after retiring but I doubt very few return a third time. Face it you only have so much time after retiring. Thaler's uses the example of purchasing a home. Can you buy and sell your family home enough times to fully comprehend all the ins and outs of real estate? Thaler's response to his critics was that some things could not be fully understood in a life time and that we are prone to violating the traditional rules of economics.
Thaler even coined a term for the mythical creature that fits all the economic theories. He calls this creature an "Econ". Econs are the 100% rational maximizer that nicely supports traditional economic theories. In behavioral economics Econs do not exist. Humans exist and they are neither rational nor maximizers.
Fast forwarding to the end of the book. How do we use behavior economics to help people. Aiding people by either allowing them to make better decisions or enacting government policies to achieve similar favorable goals. This is where Thaler introduces the concept of a "Nudge" Thaler fully acknowledges that you cannot force people into good decisions. You force a person to a course of action they are instinctively going to oppose it. So a vehicle is needed that "nudges' people in the right direction. Again Thaler uses retirement and 401k savings plans as examples. Currently an employee has to opt in to the company's 401k plan. One such "nudge" is to make enrollment in company 401k's the default option. Enrollment is not mandatory since the employee could still chose to opt out. To me this is less than a gentle nudge. Another nudge Thaler offers is a very low contribution rate when the employee is hired and each year the contribution rate increases. This nudges employees to increase contributions without them having to contact HR and fill out a form. One of the secrets of a Nudge is to simplify the path to a rational decision.
The best nudge example Thaler offers is the Urinal fly target. In order to decrease the cost of cleaning urine from the floors of the Amsterdam airport's male rest room they installed stickers of flies in the men's urinals. This nudged males to aim directly at the fly when using the urinal. This resulted in an 85% reduction in spillage. This is according to Thaler his favorite example to nudge theory. Nudge theory states:
"positive reinforcement and indirect suggestions can influence the behavior and decision-making of groups or individuals in predictable ways, without using rigid rules"
When it comes to our ability to urinate we males are so predictable.
Thaler's book on Nudge theory definitely on my future read list
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