How do we save for retirement? Are we rational actors, putting aside precisely the amount we need to live comfortable lives in our later years? Or do we act irrationally, even irresponsibly, failing to account for our future needs by not saving enough in the present?
These are the questions that occupy the mind of economist Richard Thaler, a professor at the University of Chicago’s Booth School of Business. For decades now, Thaler has dedicated himself to understanding the decisions behind everyday actions. His work, and the contributions of other behavioral economists, has influenced everything from which foods are offered to children in school lunch lines, to how highways are designed, to how we make critical decisions about our hard-earned money.
Thaler outlines his thinking on the subject in his 2008 book Nudge: Improving Decision About Health, Wealth, and Happiness. Authored with his University of Chicago colleague Cass Sunstein (who now serves as President Obama’s administrator of the Office of Information and Regulatory Affairs), Thaler show us how the public and private sectors can “nudge” people into better decision making.
For his contributions to the field of retirement planning, Thaler will be honored at the 2011 Retirement Income Industry Association fall meeting in Boston. Research magazine will present Thaler with the 2011 Award for Achievement in Applied Retirement Research, recognizing his outstanding contributions to the field.
“Of course it is pleasing to be honored by an industry that I have spent some many years trying to ‘nudge,’” Thaler said in an e-mail interview. “I am glad they have taken to the lessons of behavioral economics.”
Behavorial economics is a field that occupies a place between economics and psychology. Economists of this ilk want to understand the way the world really works, not the way it should work.
In Nudge, Thaler rests his ideas about economic decision making on four main pillars. The first is understanding the difference between “Econs” and “Humans.” “Econs” are the fictional creation of the rational school of economics, people who should theoretically make good decisions most of the time for the right reasons. In fact, the University of Chicago — and specifically economist Milton Friedman — is the epicenter of this movement. While Thaler does not totally reject the rationalist school, he insists that people do not make perfect decisions. In fact, we all make “human” decisions, full of foibles and miscalculations and outright mistakes. Therefore, he argues, we need the public and private sectors to “nudge” us in the right direction to arrive at outcomes that benefit us individually and collectively.
To do so, he writes, we need skilled “choice architects,” people who design systems that help us arrive at beneficial outcomes. For instance, on a very small scale, I am acting as a choice architect as the writer of this article. I am deciding which information to include and which to exclude to best provide readers with the information they need to appreciate Richard Thaler’s contributions to the field of retirement research.
So, according to Thaler, “Humans” need “nudges” designed by “choice architects” to make good decisions. He calls this system of policy making “libertarian paternalism.” “Libertarian” because people deserve and expect choices to suit their particular circumstances and “paternalistic” because, try as we might to make perfect decisions ourselves, the presence of a guiding hand often helps.
This is nowhere truer than in the realm of retirement savings. Starting as far back as 1996, Thaler began outlining his ideas on the subject in a number of academic papers that sought to shift the ground in retirement planning. Ultimately, his work influenced the Pension Protection Act of 2006, a bill signed into law by President George W. Bush that offers employers an incentive to automatically enroll employees in a retirement plan and automatically increase their contributions over time.
Thaler’s thinking on the subject begins with a simple premise: Americans don’t save enough. From 1950 to 1980, for instance, Americans saved an average of 8 to 10 percent per year. However, even in those good times, savings didn’t come in the form of cash. Rather, people put their money in pensions, cash-value life insurance and mortgage payments to pare down debt. By 2005, for the first time since 1932-33, the savings rate in the United States was negative. Easy access to credit cards and loans didn’t help matters. In addition, 401(k) plans, unlike old-fashioned pensions, required employees both to sign up and make intelligent choices about how to invest their money.
Into this mess, Thaler arrives with two central recommendations: automatic savings plans and a scheme named the Save More Tomorrow program.