Irrational Humans: How Our Behaviour Shapes the Economy (Professor Richard Thaler)

0:00This BBC podcast is supported by ads outside the UK. If journalism is the first draft of history, what happens if that draft is flawed? In 1999, four Russian apartment buildings were bombed, hundreds killed. But even now, we still don't know for sure who did it. It's a mystery that sparked chilling theories. I'm Helena Merriman, and in a new BBC series, I'm talking to the reporters who first covered this story. What did they miss the first time? The History Bureau, Putin and the Apartment Bombs. Listen on BBC.com or wherever you get your podcasts. Right then, before we get started this week, let me just tell you about a very exciting new way for you to get very involved with this podcast.

0:52I always said right at the beginning, as we started and we launched Radical, that I really, really wanted to build a community where we all exchange ideas. We interrogate ideas, including dangerous ideas, including bad ideas in a safe space, which is why I love hearing your very thoughtful reflections on the conversations that we have here on Radical. But we want to go further and we believe in experimenting and we believe in experimenting with you, our lovely community of listeners and viewers. so in the next few weeks we are going to be experimenting with an extra question and answer episode where our guests our brilliant guests are going to be answering your brilliant questions and the first person that we've got on this extra Q &A episode he'll be on the main episode the main podcast as well of course is someone that many of you have asked us to invite on he is the farmer and author James Rebanks his latest book is called The Place of Tides he also wrote the shepherd's life and English pastoral and inheritance.

1:49He's a former guest editor of the Today programme, a very, very interesting man. And if you've got a burning question for him about, I don't know, farming in the UK, which he knows a lot about, food security, which he knows a lot about, rural life, which he knows a lot about, please do get in touch with your questions. WhatsApp us on 0330 123 9480 or email radical at bbc.co.uk and be part of the conversation. Connect with the fantastic minds who are coming on Radical for this quite exciting little extension of the Radical franchise, which is coming up in the next few weeks. Now, here is this week's episode.

2:25Hello and welcome to Radical. This is where we go deep inside the zeitgeist and explore the big ideas, the bad ideas, and the good ideas and trends that are reshaping the world. And we do so in the company of some of the smartest people on the planet. And we certainly got one of those today. we have got our first Nobel Prize winner that we've had so far on Radical. He is Richard Thaler. He's the author of, well, co-author of a book called The Winner's Curse, which he actually first published almost 30 odd years ago, and also most famously the co-author of a book called Nudge. And he won the Nobel Prize because he used behavioral economics to fundamentally change the idea of us as human beings, which was at the heart of economic thinking.

3:08So he thinks of us as loss averse. He thinks of us as prone to overconfidence, as hugely influenced by social norms, and perhaps a little bit silly and dumb at times. And what I do in this conversation is try and glean some of those insights and some of the experiments that yielded them from Richard Thaler, but also apply them to the problems affecting the UK today.

3:41Richard Thaler, Professor Thaler. Can I call you Richard? Yes, you may. Even though you're a Nobel Prize winner? You know, people have called me worse. But you don't go around saying to people, I'm a Nobel Prize winner now, you must call me Professor Thaler. I try that. You know, at the University of Chicago, it's so what? I have four on my floor. Four Nobel winners? living economist winners at University of Chicago Booth School of Business. So, you know. I think you should spend more time in the BBC and then you'll feel like you are actually the rarefied figure you are. I see. Can we start where your book, The Winner's Curse, the re-released The Winner's Curse begins, which is 1980s America, Cornell University, as opposed to Chicago, a world in which geopolitically there's a Cold War going on in America and Britain.

4:41The Thatcher Reagan revolutions seem to be championing free markets and free minds, they would say. And you had a sort of nagging suspicion, I think, based on some of your work from your PhD in the 1970s, that maybe the economics that was triumphant at the time had a slightly flawed idea of human nature. Is that right? Yes. More than slightly flawed. Totally flawed. Well, yeah, ill-conceived, yeah. And this was a human that was a rational agent who would optimize to achieve the best circumstances. When did you start thinking that actually maybe economics was based on an idea of we sapiens that was false?

5:29Grad school. What made you think that? I mean, the stuff I was learning just seemed wrong. I really often felt like the kid looking at the naked emperor and hearing descriptions of a three-piece suit. And I'm like, really? What? You know, economists are not known for their modesty. They're known as actually the nasty guys and are predominantly guys, less so than it used to be, thankfully, but other social scientists hate economists. And they really think most people are dumb because they're not economists. But in their models, there are no people. In fact, if you pick up an economics textbook, you may not see the word people.

6:24There are agents. Who are these agents that dominated economics in the first world? So they're consumers and managers and bureaucrats. So there are people there, but the consumers aren't like anybody you've met. They calculate, well, they wouldn't need AI because they think like AI without the hallucinations. and they are perfect forecasters, as good as any econometrician. They have no emotions. They have no self-control problems. They're not lazy. They're not lazy. They are well-informed. They're not omniscient, but their forecasts are as good as a good statistical model. And, you know, that's not anybody you know.

7:23And nobody you've ever met actually thinks or behaves in that way. And you spent now, I guess, nearly 50 years in very clear and lucid prose, which also makes you unusual for an academic. And I say that being married to one. You've really debunked that idea of these perfect rational agents. And we're going to get into some of the common traits of humans that you've discerned in your work and alongside truly great collaborators like Danny Kahneman, author of Thinking Fast and Slow, another Nobel Prize winner, people like Amos Tversky, who sadly died in the 1990s. Before we come to the reality of human beings, are you a bit surprised at some of the insights of behavioral economics?

8:04Are you a bit surprised they've not been more widely adopted? I mean, for instance, a lot of people will get onto this will know that auto enrollment on pensions, which is not an original Thaler idea. People like Adair Turner suggested it in 2006. Paul Johnson, a very prominent economist here in the UK, went on to run something called the Institute of Fiscal Studies. A lot of people advocated for it, but it was largely based on some of your work and the work that you and Cass Sunstein did. Why, even though there are 400 so-called nudge units around the world, why isn't there more nudging? Why haven't more people adopted the insights of behavioral economics?

8:41Let me answer that in two ways. One way you might have asked that question is, really? I mean, you won a Nobel Prize for this? You know, I mean, and so in some ways, the insights about humans were obvious to anyone who wasn't an economist. And as to the impact that it's had, there are two ways to talk about that. In some ways, the ideas are being used very widely in the private sector and not always for good. So let's take the example of automatic enrollment. The idea that I had and wrote in a little essay in the American Economic Review was, well, if we want to get people to join these new defined contribution pension plans, how about if we just make that the default and let them up out?

9:50and you know in nowhere has adopted that uh more broadly than in the uk and it has worked wonderfully now suppose you sign up for a gym you can do it online they really they want to make it easy and they have an introductory plan 10 quid a month for six months and i'm betting these will be widely available starting in December, right? Because New Year's resolutions. And then nicely, because they really care about you, they will automatically enroll you in a normal membership after the six months. You won't have to do anything. Yeah, it's going to be a hundred quid a month, but you know, they've got your data, they've got your email, they've signed you up.

10:46And your credit card. And your credit card. And it takes effort and friction to pull out by then. Right. Now, suppose you say, oh, wait, I've only been to the gym twice in the last three months. Maybe I don't really want to pay 100 quid a month. Then you find out that you have to go to the gym in person and fill in some form. I proposed a couple of years ago that there ought to be a rule in the U.S. that anything you join online, you should be able to unjoin the same way. And this was adopted by the Biden administration. I mean, this is an example of your work having huge policy consequences. If it doesn't get killed.

11:40Fortunately, I don't think anyone in the Trump administration is going to be listening to this podcast. You'd be surprised. If you are, please, you know, go get something from the refrigerator. Well, I revealed that so far that law seems to be on the books and has not been repealed. I'm not sure it's being enforced. so uh but the the point is that the private sector when they see an idea they use it and another example of that i think which i should have checked sorry in preparation for this is attributed to both you and danny kahneman another nobel late great economist who is very very very dear and close friend of yours sadly died a few years ago was um the influence of social norms we're going to get onto this jeff bezos was very influenced by the idea that you could use the power of social norms to make people buy more stuff from amazon so which is why you see on amazon um this idea that if you bought a book you know you buy a book by richard thaler at the bottom it says a lot of other people who bought richard thaler's book also bought books by danny kahneman and amos tversky and that's a way of making you think that kind of there is a social norm around this other behavior if you like that you'll love this jeff bezos actually took a day and a half class from danny and me and he and a few other billionaires were uh the students in this class jimmy wales the guy who we can beat it we have one of the twitter founders jack was he was it uh wasn't it was ev williams evan williams right um elon musk then elon was there for the first day and then he split he seemed bored what did these billionaires come to you uh our agent had organized this uh our agent specialized in knowing academics who could write and billionaires and then introducing them but they came to you because they wanted was there something very other than a general refresher course or um no they were there to be stimulated they didn't have any idea what we did oh it wasn't because they wanted specific ideas no growing their business no no no no no i mean no um but what followed of that meeting because it may be the well certainly i did have an interesting exchange once nudge came out with Bezos, I noticed that the price of the book was$9.99 in dollars, pounds, and euros.

14:30And I sent Jeff an email and said, you seem to think the right price is$9.99. Regardless of currency. Yes. And I did get a reply and the price changed. Fantastic. But he was just on the Amazon thing. I think it's fair. Maybe it comes from that. He was influenced by this idea that you could use some of the insights of behavioral economics to drive more expenditure in spending on Amazon. Yeah. And look, I think Amazon now has the largest economics department in the world. They have more than 100 economics PhDs running experiments every millisecond. Some of your colleagues in the Chicago school, you know, when you're presenting a paper would say, if, for instance, you auto enroll people into pensions, even if you tell them about it, they'd say that's a bit paternalistic.

15:26That's a bit sort of the nanny state, big brother coming along and making a decision for you. Who the hell are you to to change things? To which you said, well, hang on a second. It's quite a gentle power. Secondly, they've still got quite a lot of freedom, because if they want to pull out of their auto-enrollment, they can do that any time they want, and it should be pretty easy. And the third thing is, there's a pretty strong consensus, really, and a democratic consensus, that people should save for their pensions. And that's where this idea of it being not paternalism, but libertarian paternalism came on, a kind of middle way sort of thing.

16:01Right. It felt like there was room for a middle way. I'm a little less optimistic about that now with the rise of populism and governments moving towards authoritarian. But, yeah, we thought that our ideas were a sensible compromise. And, you know, we were criticized. We're still criticized now. Some people say, you're too wimpy. Why don't you tell people how much they have to save? And my answer to that is two reasons. One is, let's have a bit of humility. Do I know for sure what you ought to be saving? No, I don't. You know, maybe you've got rich parents that are going to give you a pile of money.

17:03Or maybe your wife has a great pension. Or maybe you've got some illness. And, right, there could be lots of reasons. You could have a lot of student debt that you are going to pay off. And then, right, so I don't want to presume that I know what's best for you. And so I think these kinds of policies, if we can get 90 % of the people going, going for it, and still having some agency, some freedom to do what they want, first of all, it's more likely to pass. Can we turn to the human that you have, I wouldn't say built because the humans were there already, but the human that you have revealed over 40 years.

17:54And this is where, so The Winner's Curse, now re-released, is a book which, when did you first write it? I mean, this comes out of the Anomalies column. So the book was published originally in 1992. And it's a collection of these very clear, cogent, but lucid columns, which you had the wonderful title, Anomalies, which works on a few different levels. And I'll just say, I could say this so you don't have to. They are unusually readable. And you obviously have a writing style, which has a bit of mischief, a few jokes. It's plain English. It's not very academic. it. And I think maybe one of the things that allowed your work to reach so many people was that people found that, you know, it wasn't scary.

18:38You might have won a Nobel Prize for economics, but you're not going to get lost in sort of econometric theory. But also you revealed an awful lot about what it is to be human. And I wonder if we can go through some of the things that you've understood. And let's do this like this. I'm going to say an idea or a phrase. And could you tell me what you've discovered about humans? And then maybe give us one of your experiments that revealed it. Sure. Loss aversion. You have discovered that we humans have what I think you call status quo bias, and we really don't like losing stuff. Right. So, yeah, my friends Kahneman and Tversky called this loss aversion.

19:17I called it the endowment effect. Here's an experiment Danny Kahneman and I did using coffee mugs. In fact, the last one I had now resides in the Nobel Museum in Stockholm. If you ever go visit, they ask you if you want to donate anything. And that's what I gave them is a mug. So here's the experiment. You're in a classroom and we distribute these coffee mugs and put them on every other seat. So I have a mug and you don't. And I'm told you own this mug. at each of the following prices indicate whether you want to keep it or sell it. So 10 pounds, no, 9.50, no, whatever. Yeah, if we're selling it, we go up until, all right, I'll sell it at 9 pounds.

20:21I won't sell it for less. You don't have a mug. You had the same price list. At each of the prices, are you willing to buy? 50 pence, yes, five pounds, no, whatever. Now, the mugs were distributed at random. So the people who get mugs should be no different than the ones who didn't. And economic theory predicts the mugs will end up in the hands of the people who like mugs most. What do you find? The people who have a mug demand twice as much to give it up as the people who don't have a mug are willing to pay to get one. And that's an anomaly. But what those cups reveal is the endowment effect is that if you own something, you develop an attachment and affection for it, which makes you very resistant to losing it.

21:23Yes. What was the ultimatum game? The ultimatum game is, suppose I give you 100 pounds. Lovely. But you have to share it with my friend Fiona, who brought me here today. You're a brilliant publicist. Yes. And we're going to play the following game. You offer Fiona some share of the 100 pounds. She can accept it, in which case she gets what you offered and you get the rest. Or she can reject it, in which case you both get nothing. Now, you've read your Adam Smith. Let's say The Wealth of Nations, maybe not. The Theory of Moral Sentiments. The Theory of Moral Sentiments. Yeah. And you say, well, Fiona, you know, she's a publicist.

22:21She's not an investment banker. 10 pounds, I'm sure she could use a couple flat whites. I'll offer her that. And 10 pounds is better than nothing. And so she'll take it. She says, 10 pounds? What a jerk that ammo guy is. I'll pay 10 pounds to tell him where to put his 90. So when we play out that game, economic theory and game theorists predicted that you'll offer one pound and it'll be accepted. But if you play the game, first of all, most of the people in the allocator position offer half. So most people given£100 by Richard Thaler and told that I've got to share some of it with his friend Fiona, most people will just move towards thinking I should give her half.

23:25And partly because they want to be nice and partly because they're worried about being rejected. So we have a deep ingrained sense of fairness. We're loss averse. We like to cling on to that which we own and we attach greater value to things that we own than things that we don't. We also are pretty keen as homo sapiens on confirmation bias. Before we get to confirmation bias, let's talk about overconfidence. Overconfidence. Yeah. If we ask people, say, trivia questions, what we find is people overestimate how much they know. So they'll give limits that are much too narrow. Surprisingly, there's only one occupation that has been shown not to display overconfidence.

24:11And you'll never guess what. Meteorologists. Meteorologists. Okay. And the reason is, if they say that there's a 90 % chance of sunshine tomorrow, and then it rains, you find out, boom, right? So people who make forecasts and then find out what happened, they get cured of overconfidence pretty quickly. Everybody else, not so much. And one of the reasons they don't learn is confirmation bias. And confirmation bias is the tendency for us to look for evidence that confirms what we already thought. You make the facts subject to your prejudice rather than the other way around. Exactly. Exactly. So, you know.

25:04And this is a real observable phenomenon. Yeah. And, you know, we're all guilty of this, especially in hindsight. So if I ask you now, what did you think would happen first, a black president or a woman president? Obviously, I always did think, Richard, that it would be a black president long before we had a woman president. So lots of people think that now. And I can tell you in 1980, no one, no one, including Barack Obama. Yeah. Or even in 2007 when Hillary Clinton seemed the favorite to beat Obama. Right, right. We rearrange our memories. There's another bias called hindsight bias. Yeah. Which is that we remember things happening the way we predicted.

26:00All of this is conspiring to feed the overconfidence. So the book is full of these magnificent anomalies. And the one that I found most interesting is mental accounting, which, as I understand it, is that we think about money differently according to how we can buy it. So for instance, if I got£10 as a tax rebate, I might think, oh, great, this is like free money. I can spend that£10 on that cocktail, which is a huge amount of money for a cocktail. Whereas if I got that£10 not through a tax rebate, but by some other means, I might think I want to grab hold of it. Is that right? Right. So I had the experience recently of putting on a pair of pants I hadn't worn in a long time and found some money in the pocket.

26:50Right? So this is exactly right. So it was a hundred dollar bill. Why did I have a hundred dollar bill? I don't know. Amazing. But there it was in my pocket. Great morning. What a win. Okay. You know. Good to go. Lunch is on me. Right? Now, fortunately, you know, if my wife were around, she would remind me I had invented this concept called mental accounting. And really, it's no different than any other money. But of course, that's not the way people think. So the money you find in your pocket feels like a windfall. If, on the other hand, your credit card company realized that there was some fee that had been charged twice and refunded it, and so you now owe$100 less off this month's bill, that doesn't feel like an excuse.

27:49to go to the pub, right? One does and one doesn't, and it's the same. So economic theory, there's this thing, W, wealth, and it's just a number. And it's like all you have. And your tendency to spend it, economists have to give complicated terms for everything. So it's the marginal propensity to consume. But you can just think of it as, what are you going to do with it. The theory is no matter where it came from or where it sits, it will have the same effect on your behavior. And that's clearly wrong.

28:33I really hope you're enjoying this conversation with Richard Thaler, our first Nobel Prize winner on this podcast. I wanted to interrupt just briefly to give you a little, how can I put this, a little nudge to subscribe to this podcast, because if you do that it helps us reach more people particularly if you then go so far as to review and rate the podcast too we're massively grateful for that it just helps more people discover the work that we're doing on radical which we really care about so if you search for radical the malrajan on bbc sounds hit subscribe and just make sure you've got your push notifications turned on and that way you will get a lovely little juicy alert every time we release a new episode and that will you know adjust your choice architecture so that you're nudged towards listening to more of this podcast right enough for me back to richard thaler we go

29:25can we apply some of this to the problems in the country that we're speaking in you spend a lot of time in the uk you're you spend a lot of time advising the coalition government um i think after this you're going off to be interrogated by the the great people of oxford um this is a country that faces some pretty big issues. I mean, many countries, Western democracies, have chronic problems and more immediate problems, perhaps, with the rise of populism and so on, which comes from a public dissatisfaction with how things are turning out. I just want to put a couple of Britain's big problems to you and see if you've got some ideas, maybe some radical ideas, or maybe some ideas which seem radical, but are actually just eminently sensible.

30:03One of them concerns a massive national crisis, I think you could call it, with young people and welfare whether you call it welfare or benefits or social security we have now in this country april to june of this year 948 000 people age 16 to 24 nearly a million people age 16 to 24 who are not in their so-called needs not in education employment or training that's 12.8 percent of all 16 to 24 year olds and there has been a slow steady but consistent rise in recent years how does a behavioral economics nobel prize winning economist think about stopping people who are young should be in the prime of their lives stopping people going from the column called work into the column called welfare mindful as you would be that for every individual that you could get from welfare back into work and it's very hard to do that because once you go into welfare you're often stuck there.

31:02But for every individual, you could move from welfare back into work. You transform a single life, but then you possibly make savings which will compound. I will quickly say that I don't have a snappy solution to this problem. I will say, if you want to encourage somebody to do something, make it easy, make it fun. We can think about getting people into the situations that are going to be good for them. and then adopting those situations so they'll, I don't know whether we can make it fun. We can make it as much fun as possible, at least not odious. Not every kid wants to read a lot of stuffy books.

31:49So, you know, think about the fact that retail investing apps now look like video games, there's a lesson there. There are jobs that could be made to be more like a video game. We're not going to just change the kids, but we can make the world friendlier. It's like my, I go back to GPS. The streets of London haven't changed in the past 20 years, but I'm lost less often. So can we take those 17-year-old boys and girls that are feeling lost and give them something more like a GPS glide path? You know, when I talk to kids that age, I'm always asking, don't think about what subject you like studying.

32:44Think about what job um you can imagine doing every day no kid is probably sitting there thinking oh i want to be interviewing old professors on the radio but you know it's not a bad gig it's a dream job i tell you you know but it's not something you know little kids grow up wanting to be a fireman or right uh change how people think about it and make them make it easier for them to visualize as it were, with the aid of a kind of job GPS, a glide path toward the passion. And the corollary of if you want people to do something, make it easy, make it fun. The inverse, the flip side of that is if you want people not to do something, make it hard.

33:29And this is where you get into the trouble of something called politics. But one of the big issues people are talking about in the UK is making it harder for people to move into that welfare column, that welfare bracket, for instance, by reintroducing in-person meetings, as opposed to being able to do it through a phone call. What about debt? Because the big change between 2008 and now in a macroeconomic level looking at governments is that governments don't have the fiscal buffers or cushions to ride to the rescue if something goes badly wrong. And many countries, your own in America, this country, are in levels of debt which were not just unimaginable but were actively warned against by government 17 years ago.

34:16We have a situation in this country where debt interest is the second biggest item of spending that the government has. I think we're approaching 110, 115 billion. What do you need to do, maybe using the power of social norms, to make it easier for governments to cut spending? And let me load that question by saying, let's look at the example of winter fuel allowance. because maybe the issue is loss aversion. And the UK government found in a very painful way that when they tried to change winter fuel allowance, the endowment effect meant people really didn't want to let go. Yeah, so, you know, winter fuel allowance, it almost seems like a joke.

35:01That, you know, when I first heard about this concept, when I first started coming over here and those, like Cameron here. What? There's a winter fuel allowance? And, you know, those old furnaces where you had to put a coin in to get the heater to come on? I kept thinking, is this in Dickens or is this really? Mote of Britain. Yeah, 21st century. You know, this year, when I heard that, oh, the austerity move is going to be to cut winter fuel allowance, we talked about mental accounting. We're not talking about tens of thousands of pounds. We're talking about a relatively modest amount of money that happens to come with a label.