BackWhy Richard Thaler’s Nobel means a win for consumers
If behavioural economics begins to influence policy and regulation in retail finance, I anticipate changes in the way the game is set up
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If you have had the occasion to have economist and Nobel laureate Richard Thaler sign a book for you, it’s likely that you have one that says, “Nudge for good" or “Misbehave for good". Nudge and Misbehaving are books written by Thaler. Nudge, written earlier than Misbehaving, is about tweaking the choice architecture so that people make better decisions. For example, if we know that people will choose one item out of the first three on a menu card, a nudge would put healthy food in those spaces, while keeping all the other choices at number four and below. Nudges work to help us overcome our biases that prevent us making good decisions. Bad nudges have been used by corporations to trick us into doing what they want and may not be in our interest. For example, an auto tick on a travel insurance policy on an airline website is a bad nudge. Thaler wants nudges to be used for good. He wants them used for setting up the game so that average people take decisions that work for them. For example, a positive nudge is the Save More Tomorrow programme (bit.ly/2hYxfGy) that allows people to promise to save more next year.
Informally called the father of behavioural economics, Thaler’s second book Misbehaving documents the fight with traditional economics academia to get legitimacy for behavioural economics. Thaler’s 2017 Nobel win is the final coming of age for this branch of economics. The win is important not just for academics but for consumers as well. For example, look at the financial sector where the game is set up in a manner that the average consumer of retail financial products loses. It is set up in a ‘free market’ economic paradigm where rational economic agents maximize utility by analysing all available information to participate in market equilibrium. Sounds absurd to you? The theories get more and more stretched when complicated modelling is done to predict individual behaviour as savers, investors and consumers. To most people other than neo-classical economists (Econ), it sounds ridiculous. Writes Thaler in his book Misbehaving: “The idea of modeling the world as if it consisted of a nation of Econs who all have PhDs in economics is not the way psychologists would think about the problem. This was brought home to me when I gave a talk in the Cornell psychology department. I began my talk by sketching Modigliani’s life-cycle hypothesis. My description was straightforward, but to judge from the audience reaction, you would have thought this theory of savings was hilarious. Fortunately, the economist Bob Frank was there. When the bedlam subsided, he assured everyone that I had not made anything up. The psychologists remained stunned in disbelief, wondering how their economics department colleagues could have such wacky views of human behavior."
While the psychologists had their laugh and we can shake our heads about the strange assumptions that economists have used to model individual behaviour, the impact this vision of how the world works has been terrible for our experience as retail consumers, especially of financial products. The Econ version of the world influenced policy and regulatory thought deeply. Therefore, you have a buyer-beware market where firms will make enough disclosures so that you can figure out what you want to buy. Once disclosures have been made, or as it happens in the real world, opaque legalese is thrown by the kilo at the potential consumer, the responsibility of buying a product shifts to the buyer. We know how inadequate and one-sided this market is when we go to buy a medical cover, a life insurance policy, a mutual fund or a home loan. It has been the rigidly bookish view of economists who were desperate to be seen as physicists, which has led to the huge divergence between the models and actual human behaviour. When asked how the everyday observable human irrationality translates into a market equilibrium, the ‘hand wave’ was used to laugh off the question. The hand wave is the reference to Adam Smith’s invisible hand argument that sees invisible forces equating demand and supply in a market. Go to any academic conference or policy group and try and speak about observations from the real world and you still get attacked viciously with ironclad textbook logic of what the data is reporting and how what you have are just anecdotes. I put it down to sunk costs—these guys have spent their entire careers in modelling this kind of economics, what happens to the work already done?
Thaler’s Nobel prize win is a huge push back to this bull-headed sticking of market fundamentalists to a perfect vision that only they can see, of the world that flies in the face of the real world. If behavioural economics begins to influence policy and regulation in retail finance, I anticipate changes in the way the game is set up. The first thing to change will be disclosures that firms make on financial products. Disclosures will move to being machine readable and the manner of disclosure will take on a much bigger importance. Deeper reform will come with the acceptance that a retail market in finance needs to be a seller-beware market since buyer-beware has its roots in an economics that does not explain actual human behaviour.
Monika Halan works in the area of consumer protection in finance. She is consulting editor, Mint, and on the board of FPSB India. She can be reached at monika.h@livemint.com
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