227. How Economics Can Stop Us Making Stupid Choices

0:11Hello and welcome to The Rest is Money with me Robert Pest and Steph's away but I'm delighted to be joined by Richard Thaler. And Richard, it is an absolute pleasure and indeed a privilege to have you here today because you are that rarest of economists. You've not only changed thinking within economics, but you have had a profound influence on the real world. Governments have adopted your ideas. Businesses have adopted your ideas. And I guess where I wanted to start, So you've just published a new book called The Winner's Curse, which is a collection of, I think, essays written over a period of time, but brought up to date.

0:55I wanted to start by asking you, it seems to be always a problem for all economists, is you have come up with a sort of school of economics or big contribution to school of economics called behavioural economics. I guess the thing that I wondered about is when you expose to the world how you can, in your case, influence behavior in a benign, you hope in a benign way. Do you find that some of the insights that you had about, for example, how governments can encourage citizens to do the right thing without being seen to coerce them to do the right thing? Does consumer behavior then adapt in a way that then means you've got to rethink all of the sort of nudges and incentives?

1:42Obviously, the world is always changing, but human nature doesn't really change. So let me answer your question this way. One of the things we talked about in Nudge and a topic that comes up in this book is something that we call status quo bias, which is we as humans are very good at doing nothing. And if people are listening to this and it ends and some other show comes on, they may keep listening because they're good at doing nothing. Well, once you understand that, then you want to be aware of it in designing government policies and business policies. So it's not like we discovered it. Back in the 60s and 70s, television producers and television networks spent lots of money thinking about which show should follow which show, because they knew that the audience was sticky, and so you wanted to have the lineup take advantage of that.

3:03Now, when we were trying to help people save more for retirement, one of the innovations was to take advantage of this idea, just to say when you're first eligible for the plan, it used to be you'd have to fill out a bunch of forms. And we suggested, no, why don't we say you have to fill out a form to not join. Sure. And that is a system, in fact, that the British government adopted. They appointed somebody called Adair Turner to do a review, and Adair Turner recommended, and it's been introduced, this system in the UK when it comes to pension saving called auto-enrollment, which is broadly the default position is you're in the pension unless you choose not to be.

3:49And that very much flows from your insights. Right. And I remember talking to Adair Turner back in the day when he was working on this. Now, the same is true if you subscribe to a newspaper or a magazine or a gym that once you're in, they will automatically renew you, sometimes at a higher rate. It doesn't follow that every application of this idea benefits the people it's aimed at. And I suppose I wanted to ask you a bit about that, because to an extent, you know, there is an argument that says that once you understand the way the human mind works, that it's, you know, the innate laziness, the so-called heuristics, the things that you think you know, the shortcuts you make.

4:44That's very, you know, that's also fertile ground for, you know, bad actors. Absolutely. To do bad things. I mean, in my case, for example, this has happened again. There's a fake advert that's been created using my image and using, you know, made up words. And because, you know, I supposedly have a reputation for, you know, particularly knowing about finance, I know people who've fallen for it. I mean, it's awful. The book that I recently published is not a policy book. No. But it's sort of where things started because it's based on a series of columns I wrote in an economics journal back in the 80s and 90s on things like status quo bias.

5:36And economists at the time didn't recognize this as a phenomenon. They would say, you'll do what you prefer. So if you'd rather switch to the other show, you will. If you'd rather quit this subscription, you will. A pension, of course, you'll join because there's lots and lots of money in it. So the first step was to get economists to realize that this bit of human behavior is important. And it was also a real challenge to this idea that actors in markets are rational all the time. Well, that's what economics is. If you define economics as opposed to other social sciences, like psychology, sociology, anthropology, it's defined by the assumption that actors are rational and selfish and interact in markets.

6:36That's the definition of economics. If you remove the rational maximizing part, economists back in the 80s, I kept hearing, what you're doing isn't economics. So these columns that I was writing were presenting facts to throw into the faces of stubborn economists saying, look, you can't ignore this. It's a fact. Now, once we realize it is, then we should realize that it will manifest itself in markets. So, you know, I always say, Cass Sunstein and I did not invent nudging. It's in the Bible. So Adam and Eve, you know, the serpent, I don't know what the apple, right? There's a lot of nudging going on there.

7:45And, you know, Mr. Ponzi never took a class from me. So there have been people taking advantage of human nature as long as there have been humans and markets. And the first step is to do economics in a way with your eyes open and then say, all right, now what can we do about it? So what can we do about it? Here's an example. Something that happened in the waning months of the Biden administration was they instituted a rule that said, if you have opened a subscription online, say, by clicking a box and giving your credit card, then you have to be able to unsubscribe the same way, just with a click, not with a phone call or sitting on some chat for half an hour.

8:52Or in COVID, some gyms were requiring people to come to the gym where they were not allowed to work out, but to quit in person. So that's a law in the books. I'm not sure anyone in the White has noticed this law. So it's still there. But that's the sort of policy, right? It's very mild. It's just saying if you're going to let people in easily, you have to let them out easily. I mean, we have lots of scandals in this country of people not realizing they're actually signing up for a recurring payment. They think they're buying a free offer, and then they don't get notified that it's about to click into, or they don't notice that it's a paid offer and then they pay money for years.

9:43And, you know, it's all part of that, you know, lure people in and, you know, assume that they're not going to double check what's actually going on. Now, looping back to the question you began with, it is the case that people seem to be catching on. so people are less likely to subscribe to something if they can see that they can't get out so they're not dumb and you know the second or third time yeah that you notice some recurring bill on your credit card statement that you didn't know where it came from you start to pay more attention it's just like you know on my 15th visit to london i finally know which way to look for the oncoming traffic yeah uh well there's a for all like this going on at the moment there's a um a sort of consumer champion called martin lewis who's having a fight with a big mobile phone company that has been putting up mobile phone charges right in the middle of a contract by an enormous amount.

10:55And the reason they're getting away with it is because written into the small print, which nobody ever reads, is that there is effectively a break clause within the contract. But you have to know about the break clause to know that it also allows them to whack their prices up. And of course, nobody knows that there is a break clause there. So the company just doubles the price. So a policy that I have advocated And a little tiny steps in this direction were taken during the coalition government. When David Cameron was the prime minister, there was a rule that any company that's tracking your purchases has to be willing to share that information with you.

11:43That was a law. Now, if you asked for it, they would send you a 300-page PDF file. And I convinced them to change that law and add the phrase machine-readable. So you have to be able to get a machine-readable version. Now, a more comprehensive version of that, you should be able to have, let's say, an AI shopper helper that you would say, I'm thinking of joining this. Check all of the details of the contract and let me know if I want to do that. I mean, that's a brilliant idea because it takes me on to actually something which has been, you know, I suppose, slightly bothering me on the basis of this whole issue of how commercial interests, potentially sometimes fraudsters, exploit our frailties the way we think.

12:56because in many ways, you know, we do feel in this age of algorithms more vulnerable. I mean, if you just look at the way that social media companies have exploited human emotions, I mean, that seems to me to go to the heart of exploiting the kind of insights that you had and the social consequences of, for example, on a social media site, feeding people stuff that the social media companies know is going to get them angry or engaged in many cases in a very unhealthy way, but nonetheless gets them addicted. Are we living in an age where the combination of knowledge of psychology and then the use of algorithms to exploit that knowledge of psychology means that we're all much more capable of being manipulated and are indeed being manipulated to a far greater extent.

13:55Absolutely. I often say that the computers we carry around in our pockets, which are more powerful than the desktop I had on my desk 20 years ago, have changed our lives, mostly for the good. I'm geographically challenged, so GPS saves me wandering around the streets of London. But the ability to have massive amounts of data and the computational power to make use of that has created the opportunity to weaponize any kind of environment. Casinos have been doing this for years. They're carefully designed to create an environment that people want to keep going back, even though they're almost certain to lose money.

14:56Social networks feed people what they want, even though it makes them unhappy. um it's not at all clear how to regulate so how do we fight back that's the question i mean i just wondered given that you have given a lot of thought to how governments for example can encourage benign actions by citizens without being seen to be paternalistic and anti-liberal anti-libertarian How do we fight back against essentially algorithms that are tearing us apart? Well, the first step is to say that they need to be auditable. It has to be possible to audit what they're doing. So take a social media site. I think it would make sense to say that they don't have to share their algorithm in the sense that Facebook has to let Twitter know how they do their business, but the regulator should be able to test what they're doing and see to what extent people are being manipulated and maybe publicize it.

16:15So this, look, with AI coming, the power to do all of this is growing exponentially, but the ability of regulators to have any influence is shrinking, in part because the human capital, people aren't getting seven-figure bonuses to go work for a regulator. So I think it's a challenge going forward. And of course, the problem is that the people who control these companies have a lot of money and a lot of influence. And it's not clear who's going to be on the other side. So, look, I'm still an economist. I still believe in market forces. But markets work best when consumers can see what's happening.

17:21Is it realistic that any of us, including actually when it comes to it, governments, right, given the enormous financial resource of your alphabets or your metas or your open AIs, right, you know, financial resources on a scale that actually dwarfs the financial resources of many governments, frankly, particularly in the relevant space we're talking about, you know, I worry that we've lost the battle. Well, if we have AI on our laptop, there's no reason in principle why I can't say, hey, chat, tell Facebook that I want my feed to have more diversity or I want to have fewer people screaming at each other.

18:17It should be that the customer can adjust the dial. Right on our old television set, we just turned the channel or flipped the remote control. We have very little ability to adjust the feed on social media. And if we have AI on our side and we've paid our$20 a month to get a subscription, why shouldn't it be able to go in and fine tune what music were being played and whose voices we're reading and so forth? We have to even out the balance. It seems to me that you're an optimist in the end. That's what my wife tells me. I think you are an optimist because I just worry that in the end, you know, despite the fact I'm a massive user of AI myself, I do slightly worry that the providers of the toxic services, as it were, will stay one step ahead of us.

19:24but I want to come back to these issues. In particular, I want to talk about the title of your book, which refers to a particular bit of your thinking over a period of years, which the title of the book is The Winner's Curse. I just want to talk a little bit about why you decided to present this book as The Winner's Curse, because it's a slightly narrow version of quite a lot of the work that you've done. So let's talk about that in just a minute. this episode is brought to you by wealthify if you've ever thought i should really do more with my savings you're not alone most of us are busy juggling work and family life so investing can feel complicated thankfully wealthify makes it simple you put your money in their experts take care of the rest no picking your own stocks no jargon just a managed investment plan you can keep track of 24-7.

20:16Open a Stocks and Shares ISA personal pension or a Junior ISA for the kids and with over 100 ,000 customers and the backing of Aviva, you know your money's in experienced hands. Plus, when you deposit or transfer to a Wealthify Stocks and Shares ISA, you could earn between 50 and 1 ,000 pounds cash back. Please note that minimum investments apply and cash back varies by the total amount of your deposit or transfer. So for investing, savings and pensions, the smart moneys with Wealthify. Open your account today at wealthify.com. Wealthify is authorised and regulated by the Financial Conduct Authority.

20:53Offer registration closes on the 2nd of March 2026. T's and C's apply. With investing, your capital is at risk.

21:03Welcome back to The Rest is Money with me, Robert Pest, and I'm delighted that the influential economist Richard Thaler is still with me. Richard, this book is called the winner's curse. And, you know, this is the idea which, you know, seems to be proven in practice that quite often in, for example, in auctions, the person who wins, yeah, in one sense, they're the winner, but they quite often end up overpaying. And that's the curse bit of it. It is borne out, as you say, by lots of evidence. But why, for you, is this an important idea? As you know, this book stems from a collection of essays that was published originally in 1992.

21:51And along with a young, brilliant economist, Alex Emis, we went back and looked at all those old essays and tried to say, are they still right? Do they, has human nature changed? Have markets changed? And I had originally chosen this as the title essay, partly because it's a fun term, the winner's curse, and partly because it's unique among all of the anomalies. This is a book about anomalies, which are things that embarrass economists. Right. And this one was not discovered by psychologists or by economists. It was discovered by engineers at a big petroleum company, Atlantic Richfield. And what they discovered was there were auctions for the rights to drill for oil.

22:56And there would be hundreds of sites, many bidders. and they found that the auctions they won, there was less oil than they expected. And they thought, well, maybe we have lousy geologists or something. But then worked out something that's quite subtle, which is if you win the auction, it's not a random one of your bids. It's a bid that was the highest bid submitted and the highest bid submitted is suspiciously likely to be an overbid because it's probably your geologists happen to be more optimistic about this particular site. And it was found in the field. It was later demonstrated in experiments.

23:55I've done it in class many times. you bring in a jar of coins and you say, we're going to auction off this jar. You don't get the coins, you get the money. And let's say the jar of coins is worth 25 pounds.

24:16Now we have everybody bid. The people tend to be conservative, so they'll bid less than 25. but the high bidder almost always bids too much. And that's the winner's curse. And we can find it everywhere. Publishers, I'm always telling my publishers that they should worry about this, but not when bidding for one of my books. This is what's interesting to me. So I can sort of see why in publishing, for example, publishers sometimes massively overbid because you can't be 100 % certain. There's no absolutely rigorous empirical test for working out whether X or Y, particularly, let's say, celebrity author, is actually going to sort of gel with the public.

25:17There is just an element of luck about these things. So I sort of understand why you quite often get overbidding in a market like that. Where I'm more intrigued is, so we're going back a long time now, but something like 25 years ago, there was an auction in the UK for mobile phone spectrum. And this was an auction of sophisticated companies who ought to have been able to understand the potential of the spectrum, ought to have been able to do some really rigorous analysis of what this stuff was worth. in the end. They massively overbid. There was an enormous windfall for the government and they were writing off, you know, this did a lot of damage to the, you know, the winners paid so much that it actually damaged them for quite a few years afterwards in terms of their profitability.

26:14Why in the circumstances where you get, you know, players who ought to have a lot of really rigorous information, do they still end up overbidding like that? Because the intuition that if there are lots of bidders, I need to bid less is very counterintuitive. And there's another problem, which is the people who are doing the bidding, if they don't buy anything, their bosses are going to say, hey, your job was to buy us some spectrum. And making these low bids and not winning anything, what are we going to do? So it's, and the same is true in the sports teams that will overpay for some aging superstar.

27:16you don't get fired for that. You get fired for not doing anything. But it is interesting because that then takes us on to this question of whether it really is a curse. Because I'll give you a different example, right? But I think it stems from the same psychology, as it were. If you go to Silicon Valley, right, you will get into, quite often, a massive bidding war between these venture capital firms to get a slice of a young business that everybody thinks is going to be, you know, the next Google or the next OpenAI. And, you know, quite often these venture capital firms end up paying astonishing sums of money to get in at an early stage with these companies.

28:04And actually, you know, for some of these investments turn out to be disastrous. In fact, for every one that goes right, there are many tens that are completely written off. But the one that goes right makes so much money that it totally renders irrelevant all the other losses. And I suppose the point I'm making is there are some, in a sense, competitions where this irrational euphoria or enthusiasm to just get in at any cost pays off. And you might also argue in terms of human progress that this psychology that says, I've just got to have that because it's going to be amazing, also drives a lot of progress.

28:47So it's not always the psychology that makes you overpay is not always a curse, is it? It's true that a stupidly high price can make money if you're sufficiently lucky. And if you're a venture capital firm, you are concerned about the big tail. So if you invested in Uber or Amazon or Apple at the beginning. You're now very, very, very, very, very wealthy. Yes, although the prices look stupidly high in the late 90s. When we talk about the winner's curse, we're talking about average returns, including the big winners. What's interesting in terms of a problem for any individual auction is still nonetheless probably a good thing when it comes to economic progress.

29:44Well, in the class I teach on managerial decision making, we have a long discussion about overconfidence. And there's lots of evidence that people are overconfident. And I ask the class, if we're looking for a new CEO, should we get one who's overconfident? And there's always some students who say, absolutely, and make exactly the argument you're making that, well, we need somebody who's going to have the courage to take risks. And I say, no. We want somebody who's aptly confident and who's willing to take risks when the potential rewards are high enough, but not foolishly so. Now, the question of why do we still see investments that have negative expected returns, I think it's because of A, human nature, and B, the structure within organizations that people who appear to be aggressive can get rewarded.

31:08supported because the returns will happen only a decade from now and they'll have moved on to some other job. Certainly, we've all got examples of leaders, chief executives, making unbelievably stupid decisions. There was this period right at the heart of the financial craziness before the great financial crisis that a number of investment banks knew they were behaving recklessly, but just didn't know when the bubble was going to burst. So they just rationed, they thought they were being rational and deciding, well, I'm going to continue to make these crazy investments in these newfangled products, and we're going to continue to pump money out to subprime.

31:50And, you know, even though they knew that the bubble was going to burst. And that is plainly an example of where the incentives are all wrong, because broadly, they were doing that because they thought on a personal level, there's going to be no benefit to me if I slow down now and slow our rate of growth, my bonus is going to be smaller, but the personal rewards will be less, so I'm not going to do the right thing. So that's absolutely an example of the kind of madness that over-optimism induces, as it were, that we sort of know it's all going to come to an end, but we don't know when and therefore we're not going to care.

32:30You often talk about what institutions can do to exploit these tendencies that we all have. Do you also think about what any of us as individuals can do to make sure that we're not vulnerable to being exploited indeed by others, sometimes for good, sometimes for bad, as it were? But how do we take control of our own fast and slow thinking in that sense? Look, my career has been that of contrarian, and it's not always the friendliest place to be. It's an important place to be. Well, if you're lucky, but, you know, there's safety in the herd. And if you're out there on your own, it's understandable that most people go stick in the herd.

33:23and lots of people think there's a bubble right now in AI. I can understand why people would go along with the crowd. If you're worried about making a certain kind of mistake, then you have to keep track and see whether you're doing it. Take an hour and go through a year's worth of your credit card bills and see how many subscriptions you're paying for that you don't want. And, you know, as I said before, I think there's lots of talk about the dangers of AI and not enough talk about the ways that we could all harness it to help us avoid these human biases. But then the AI has to be trained in a way that is benign to that extent.

34:17And one of the things that causes many of us anxiety is we can't see the training. Well, and in fact, OpenAI was criticized because chat GPT-4 was too nice. And they said, oh, great, great idea. It was a bit annoying, actually, I'll be completely frank. Well, so then they tweaked it, and the users complained. Oh, what happened to the nice guy? You know, this one is saying my idea is dumb. So we're back to a marketplace. There's all this money in social media because even though it may be making us miserable, people spend a lot of time staring at their phones. And my message is that we have to understand human psychology to understand how the economy works.

35:18The answers to your difficult questions, you know, your version of open AI is not going to be very popular either because you're asking me difficult questions. I want you to just keep saying how brilliant I am. Well, I have been doing a bit of that as well, because as I said right at the beginning, I do think you've made an incredibly important contribution. It's been a fascinating conversation. Thank you so much for joining us today. That is it for this edition of The Rest is Money. See you soon. Bye bye.