The dismal science cheers up

Economists now embrace irrationality and have discovered their inner party animals. At last, says Richard Reeves.

by Richard Reeves
Last Updated: 27 May 2015

Something strange has happened. Economics has became fun and is now full of people investigating human frailties and quirks, following hunches, sharing anecdotes, and playing lots of games. Many of them are also able to write with real verve.

Two strands of the new humanism sweeping economics are 'behavioural economics' and 'freakonomics'. Each gets a fresh treatment in two new books: Misbehaving: The making of behavioural economics and When to Rob a Bank: A Rogue Economist's Guide to the World from the duo who brought us Freakonomics.

Thaler is the co-author of Nudge, the book that put behavioural economics on the map. He is also president of the American Economics Association, a sign of how a once maverick movement has entered the mainstream. His new book is a compelling blend of personal memoir and intellectual history, telling the story of how even as a doctoral student, he was obsessed with the refusal of ordinary people to behave as economic models predicted.

The head of Thaler's department, Richard Rossett, inadvertently encouraged Thaler in his heretical thoughts. Rossett was a wine buff and had bought some wine for $10 a bottle and laid it down; it was now worth $100 a bottle and a merchant was offering to buy some at that price.

As Thaler recalls: 'Rossett said he occasionally drank one of these bottles on a special occasion, but would never dream of paying $100 to acquire one. He also did not sell any of his bottles. This is illogical ... As an economist, Rossett knew such behaviour was not rational, but he couldn't help himself.'

Rossett's other students shrugged their shoulders and went back to work. But Thaler could not let it go. Later he conducted a survey of wine buyers, most of whom were also economists, and confirmed that Rossett was the rule, not the exception. Deeply influenced by psychology, Thaler and his tribe have since been giving injections of realism to economic analysis by taking account of such biases in decision-making.

Far from acting as rational maximisers of utility, most of us are myopic (giving too little weight to our future welfare), loss averse, partial to the status quo and prone to inertia and procrastination, among other weaknesses. Thaler shows how financiers, NFL players and gameshow participants demonstrate predictable but irrational behaviour.

Nor has the influence been purely academic. Thaler and Nudge co-author Cass Sunstein inspired the creation of David Cameron's 'nudge unit' - formally the Behavioural Insights Team. This group has experimented with low-cost ways of improving public policy by making use of predictable biases. An early example was trying out different kinds of language in tax demand letters.

Simply telling late payers that most people pay their tax on time and that they are in a small minority quickly increases the proportion settling their dues by 5%. As Thaler points out this is 'a highly cost-effective strategy'. Perhaps the best-known nudge is automatic enrolment of employees in occupational pensions, now a requirement for most British firms.

Like Thaler, Steven Levitt is a Chicago economist and, like Thaler, is attracted to the quirks of human life. Following the success of Freakonomics, co-written with journalist Stephen Dubner, the pair started a blog, from which most of When to Rob a Bank is taken. They were apparently inspired by drinks companies managing to sell water in plastic bottles: 'So, we've decided to bottle something that is freely available and charge you money for it.'

Their pieces cover a dizzying array of subjects: sex taxes, abolishing the US penny, why we don't tip airline stewardesses, child car seats, the Pittsburgh Steelers, The Wire, bowling, obesity, and gun safety. Oh, and of course when to rob a bank: the morning, apparently, when the average haul is $5,180, rather than the afternoon, when the take drops. Although given the one in three chance of being caught, bank-robbing turns out to be, well, irrational. Levitt and Dubner are also very serious about poker - as both researchers and players. As they admit, 'somehow we keep ending up together in Las Vegas'.

The book also contains a moving account of the death of Levitt's sister from cancer: it was she, we are reminded, who coined the term 'Freakonomics' to describe their work. It is a reminder of the need to celebrate life, in all its richness, messiness and weirdness. Who'd have thought that it would be economists throwing the party?

Richard Reeves is a senior fellow at the Brookings Institution and an MT editor at large.

Misbehaving: The making of behavioural economics, by Richard H Thaler is published by Faber and Faber at £20. When to Rob a Bank: A Rogue Economist's Guide to the World, by Steven D Levitt and Stephen J Dubner is published by Penguin at £14.99.

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