Well-deserved ‘nudge’

Wed 11 Oct 2017

Economics as a discipline is not infrequently accused of being fairly removed from reality. The activities of societies, countries, corporations and the global macroeconomy itself are meant to fit certain models, at the heart of which are rational agents maximising their utility or welfare. However, economic models are, to varying degrees, abstractions of the real world in which economic agents are all too often not rational. For decades, American economist Richard H. Thaler has studied how decision-making deviates from rational behaviour in the real world and how this can actually be incorporated into economic modelling. His analysis married economics to human psychology and his work has formed the core of the field of behavioural economics. It is for his pioneering contributions to this field that Prof. Thaler was awarded the Economics Nobel on Monday. The Royal Swedish Academy of Sciences cited his analysis of how decision-makers deviate systematically from rational behaviour as conceived in traditional economic theory. For instance, individuals experience bounded rationality due to cognitive limitations. Two, they have social preferences such as caring for others. And three, they sometimes lack self-control. These are situations that every individual can relate to. In explaining the relevance of Prof. Thaler’s work and their decision to award him the prize, the committee highlighted its everyday relevance. Consider, for instance, the existence of social preferences. It would be rational for a shop to increase the price of umbrellas on a rainy day but customers would probably think of this as an unfair or exploitative policy if they were aware of the regular price. Their preference for fairness is thus a factor that keeps the shop from increasing the price of umbrellas according to the weather, when rational behaviour in traditional economic theory would warrant an increase. It is through such applications that behavioural economics has made economics as a whole more accessible and familiar. Richard Thaler had, as the Nobel committee put it, made economics more human.

Behavioural economics, like any other, is not free of criticism — in this case, of being a patchwork of cognitive psychology and mathematics, with so many individual exceptions that it neither has the rigour of mathematics nor is free enough of modelling to be pure psychology. There are several psychologists and economists with whom Prof. Thaler has collaborated, including Amos Tversky and the 2002 Economics Nobel winner Daniel Kahneman. In a 2008 book Nudge , Prof. Thaler and Cass Sunstein show how behavioural economics can be used in policy-making to influence behaviours. It is here that they introduce the concept of libertarian paternalism, where “choice architects” influence the behaviour of individuals to make their lives “longer, healthier and better” but in a way that gives individuals the freedom to not participate in arrangements that are not to their taste. And with governments slowly incorporating it into policy, behavioural economics has not been restricted to campuses.


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