Another Nobel surprise for economics

The winner of this year’s Nobel Memorial Prize in Economic Sciences,Richard Thaler of the University of Chicago, is a controversial choice.Thaler is known for his lifelong pursuit of behavioural economics (andits subfield, behavioural finance), which is the study of economics (andfinance) from a psychological perspective. For some in the profession,the idea that psychological research should even be part of economicshas generated hostility for years.Not from me. I find it wonderful that the Nobel Foundation chose Thaler.The economics Nobel has already been awarded to a number of people whocan be classified as behavioural economists, including George Akerlof,Robert Fogel, Daniel Kahneman, Elinor Ostrom, and me. With the additionof Thaler, we now account for about 6% of all Nobel economics prizesever awarded.But many in economics and finance still believe that the best way todescribe human behaviour is to eschew psychology and instead model humanbehaviour as mathematical optimisation by separate and relentlesslyselfish individuals, subject to budget constraints. Of course, not alleconomists, or even a majority, are wedded to this view, as evidenced bythe fact that both Thaler and I have been elected president, insuccessive years, of the American Economic Association, the mainprofessional body for economists in the United States. But many of ourcolleagues unquestionably are.I first met Thaler in 1982, when he was a professor at CornellUniversity. I was visiting Cornell briefly, and he and I took a longwalk across the campus together, discovering along the way that we hadsimilar ideas and research goals. For 25 years, starting in 1991, he andI co-organised a series of academic conferences on behaviouraleconomics, under the auspices of the US National Bureau of EconomicResearch.Over all those years, however, there has been antagonism – and even whatappeared to be real animus – toward our research agenda. Thaler oncetold me that Merton Miller, who won the economics Nobel in 1990 (he diedin 2000), would not even make eye contact when passing him in thehallway at the University of Chicago.Miller explained his reasoning (if not his behaviour) in a widely cited1986 article called “Behavioural Rationality in Finance.” Millerconceded that sometimes people are victims of psychology, but heinsisted that stories about such mistakes are “almost totallyirrelevant” to finance. The concluding sentence of his review is widelyquoted by his admirers: “That we abstract from all these stories inbuilding our models is not because the stories are uninteresting butbecause they may be too interesting and thereby distract us from thepervasive market forces that should be our principal concern.”Stephen A Ross of MIT, another finance theorist who was a likely futureNobel laureate until he died unexpectedly in March, argued along similarlines. In his 2005 book Neoclassical Finance, he, too, eschewedpsychology, preferring to build a “methodology of finance as theimplication of the absence of arbitrage.” In other words, we can learn alot about people’s behaviour just from the observation that there areno ten-dollar bills lying around on public sidewalks. Howeverpsychologically bent some people are, one can bet that they will pick upthe money as soon as they spot it.Both Miller and Ross made wonderful contributions to financial theory.But their results are not the only descriptions of economic andfinancial forces that should interest us, and Thaler has been a majorcontributor to a behavioural research programme that has demonstratedthis.For example, in 1981, Thaler and Santa Clara University’s Hersh Shefrinadvanced an “economic theory of self-control” that describes economicphenomena in terms of people’s inability to control their impulses.Sure, people have no trouble motivating themselves to pick up aten-dollar bill that they might find on a sidewalk. There is noself-control issue there. But they will have trouble resisting theimpulse to spend it. As a result, most people save too little for theirretirement years.Economists need to know about such mistakes that people repeatedly make.During a long subsequent career, involving work with UCLA’s ShlomoBenartzi and others, Thaler has proposed mechanisms that will, as he andHarvard Law School’s Cass Sunstein put it in their book Nudge, changethe “choice architecture” of these decisions. The same people, with thesame self-control problems, could be enabled to make better decisions.Improving people’s saving behaviour is not a small or insignificantmatter. To some extent, it is a matter of life or death, and, morepervasively, it determines whether we achieve fulfilment andsatisfaction in life.Thaler has shown in his research how to focus economic inquiry moredecisively on real and important problems. His research program has beenboth compassionate and grounded, and he has established a researchtrajectory for young scholars and social engineers that marks thebeginning of a real and enduring scientific revolution. I couldn’t bemore pleased for him – or for the profession. – Project Syndicate* Robert J Shiller, a 2013 Nobel laureate in economics and Professor ofEconomics at Yale University, is co-author, with George Akerlof, ofPhishing for Phools: The Economics of Manipulation and Deception.