I first heard about Richard Thaler in the 1980s, in a locker room at the University of Chicago.
I had run into Steve Shavell, an economist at Harvard Law School, who asked me what I was working on. I mumbled some question I had, about whether people really behaved as rationally as economists said they do. Shavell responded without a lot of enthusiasm: “Oh, you should be reading Thaler, that guy from Cornell.”
That afternoon, I looked up Thaler’s work. It was like a burst of sunlight, or the first chord of the Beatles’ “A Hard Day’s Night.”
Focusing on what he called “mental illusions,” Thaler explained that human beings make a lot of blunders. With clear examples, a sense of play and a little math, he showed that people just don’t act in the way predicted by standard economic theory.
If you give people a mug or a lottery ticket, they will demand a lot more to give it up than they would pay to get it in the first place. People are planners as well as doers, and their decisions can be radically different depending on whether they are planning or doing.
Because people have self-control problems, they adopt “precommitment strategies” like the ones used by Alcoholics Anonymous, drug abuse centers, diet clubs and smoking-cessation clinics. People care about fairness, and they will punish people who have acted unfairly, even at their own expense. People choose not to choose, because they do not want to suffer regret. Investors overreact to the most recent, dramatic events.
Each one of these ideas – and there were plenty more – opened up a whole new world. They did not mean that people are “irrational,” but they did show that we aren’t nearly as rational as economic theories assume, in ways both concrete and predictable. Drawing on psychological findings, above all on the work of Daniel Kahneman and Amos Tversky, Thaler became the most important force behind the creation of behavioral economics.
Eventually, Thaler, who was awarded the Nobel Memorial Prize in Economic Science on Monday, brought his ideas to bear on public policy and law.
He developed the idea of “Save More Tomorrow” – a retirement plan by which employees are asked if they want some portion of their future wage increases to be devoted to savings. Save More Tomorrow plans build directly on findings in psychology, which suggest that while people will be reluctant to lose access to current earnings, they don’t care so much about future gains.