Richard Thaler's Nobel Prize

Richard Thaler won this year's Nobel Prize in economics. I'm in no position to judge the merits of his work, far less to compare it to the rest of the field. His book Misbehaving was a fun read. I guess it's probably important work. If economic models have these "rational behavior" assumptions built into them, I suppose someone should be looking into how rational we really are and exactly in what ways this assumption breaks down. Props to Thaler for doing this important work, extending the work of Daniel Kahneman and Amos Tversky.

(Amos and Tversky also won the Nobel prize back in 2002. I don't understand why the prize is offered on different years to different people for very similar work. Was Thaler's work that much different from Amos and Tversky's? I have read Kahneman's Thinking Fast and Slow and Thaler's Misbehaving, and based on those surveys of their work I don't understand the difference. Thaler worked extensively with Tversky, presumably also with Kahneman.)

What bothers me is how Thaler's work is sometimes used in arguments. "People are irrational, therefore none of these economic models work at all." Or "People are irrational, therefore markets don't work very well. Therefore, we need government intervention in the marketplace." I get that people sometimes make bone-headed decisions. I understand that we don't have a strictly ordered set of preferences, such that if A is preferable to B and B is preferable to C, then A is always preferable to C. But it seems like the "humans-are-irrational" crowd are giving up far too much. Shouldn't we assume that people want things, and that they somehow try to get what they want? What's the alternative here? Should we assume people act randomly? That they pick the course of action that is most contrary to "getting what they want"? It's fine to tell stories about how perfect rationality breaks down, but this can be taken too far. I imagine the "humans-are-irrational" crowd looking into every shopping basket, laughing hysterically and saying, "It's all wrong!" Maybe the contents of the basket don't make total sense. Maybe there should be fewer cookies and more vegetables. Maybe they shouldn't have made those impulse buys. Maybe they should be buying batteries in bulk rather than two-at-a-time at inflated prices from the rack at the checkout lane. But it mostly works to look at the items in someone's basket and say, "That person wants those things."

I often see versions of the "People are irrational, therefore we need government interventions in the marketplace" argument. I don't know what the proponents of this position are thinking. These irrational people apparently can't be trusted to make decisions for themselves in the marketplace, where they are directly harmed by their own poor decisions. But these same people can be entrusted to elect competent politicians? These irrational actors in the market will become a super-rational electorate,  incisively analyzing government policy and strictly disciplining policymakers? I don't think so. The consequences of poor decision-making in the political marketplace are less keenly felt than the consequences of poor decision-making in the marketplace for goods and services. (Or perhaps it's more accurate to say most of the cost of your bad decisions are keenly felt by other people, who probably fail to connect the harm to a specific bad policy that you voted for.) Government turns decision-making into a commons, in which everyone else bears the burden of your poor decisions. Likewise, if you do rigorous policy analysis, the benefits of your hard work accrue mostly to everyone else in society and not to you. Maybe people who are making this argument think that the market will be regulated by an apolitical bureaucracy staffed with society-optimizing technocrats? That this will be relatively immune to political tampering when "the wrong party" gets in power? I'm really not sure. If this argument has been fleshed out somewhere to answer these points, I'd like to read that full version.

None of this is to knock Thaler. Figuring out empirically just where and how rationality fails seems like a worthwhile undertaking. My problem is with the know-nothing critics who just like to take pot-shots at economics. I think what's going on here is that economics as a discipline tends to recommend free-market, libertarian policies. People who don't like these conclusions want to paint this straw-man: the economist is an uncritical slave to unreasonable assumptions about human behavior. Everything that follows from these faulty assumptions is therefore totally wrong. The economics-critic gets to feel wise (even superior) for seeing though such a silly assumption. But in fact it is economists who are articulating arguments against the rationality assumption. It is economists, the people who actually spend their time and energy thinking deeply about these issues, who are refining these ideas. By and large, they are not jettisoning free trade and free markets. They are just placing some boundaries on human rationality.

I enjoyed the commentary of David Henderson and Scott Sumner on Thaler's prize. Here is Henderson:

Mr. Thaler has yet to apply in a serious way his theory of irrationality to government officials. Their bad decisions are even worse because citizens bear most of the costs. It would be great if Mr. Thaler explored this area more. Someone should nudge him.

And here is Sumner, reacting to Thaler's apparent repudiation of "price gouging" after natural disasters:

 I had thought that the point of behavioral finance was to try to identify areas where the publics' intuition is in some sense "wrong" and design public policies to nudge them in the right direction. In that case, shouldn't we be encouraging price gouging, not discouraging it? Especially with public policy. Perhaps President Trump could "name and shame" companies that run out of essential supplies because of an unwillingness to price gouge. (Yes, not likely, I'm just trying to show the logical implications of behavioral economics.)

I wrote this post thinking that maybe I was being unfair to some of the critics of human rationality. But it seems like this is something of a blind spot for Thaler himself. Read the Sumner piece. Thaler points out that maybe businesses shouldn't "price-gouge" during natural disasters, because irrational consumers see this (economically efficient and necessary) price rise as something that harms them. Um, shouldn't we push back against irrational anti-market sentiments? Isn't the goal to fix or mitigate irrationality? Thaler seems to think we should actually indulge it.

Don't take any of this to mean I'm disparaging this line of research. Thinking Fast and Slow is one of my favorite books. Misbehaving by Thaler and Predictably Irrational by Dan Ariely are also excellent books. You should read them. That thing between your ears sometimes lies to you and systematically leads you astray. It would be wonderfully rational to figure out how it does so.