Tuesday, May 22, 2018

Misbehaving: The Making of Behavioral Economics, by Richard H. Thaler (author), L.J. Ganser (narrator)

Audible Studios, May 2015

Richard Thaler is one of the founders of behavioral economics, and he gives us a clear, enlightening, and entertaining account of its origins, principles, and findings.

Traditional economics operates on the theory of the rational economic person--homo economicus, or as Thaler shortens it for convenience, Econs. For the purposes of economic theory, Econs are assumed to always make rational and fully informed choices, for maximum economic benefit. The problems should be obvious; we are rarely fully rational in our decision-making, and almost never have complete, and completely accurate, information. The more important our decisions are--career choice, marriage, retirement planning, the less likely we are to have enough information to make "correct" economic choices.

Over a period of forty years, Thaler and others, recognizing, sometimes dimly, sometimes clearly, that humans don't make purely rational decisions, often not even when we do have "enough" information, began to tease this out. They needed to prove not only that humans make economic decisions based on incomplete information, emotion, impulse, and what economists consider irrelevant factors, but that it matters. If the collective effect of all our individual decisions adds up to the same result as if we had made those decisions rationally, it wouldn't matter, and rational economic theory, "efficient market theory," would still be fully sufficient for economic analysis.

The book is lively, filled with stories and anecdotes, but also clear explanations of the basic principles. It's clear, and in some ways more rational than traditional economic theory that assumes human economic behavior can be accurately predicted based on a model of human behavior that resembles no human being who has ever lived. As an example of the divergence between Econs and humans, Thaler offers the example of a bowl of cashews on the coffee table before dinner. You may like cashews. You may enjoy having cashews before dinner--but you probably don't want to eat so many that you spoil your dinner. What's the sensible thing to do?

The Econ, homo economicus, who always makes completely rational decisions, just stops eating the cashews when he decides he's had enough. The ordinary, real, human being who really wants to stop eating before eating enough to spoil dinner, is more likely to take that cashew bowl and put it away, so that it's not sitting there as a temptation.

And, once you allow for the fact of real human beings rather than Econs, that's a completely rational decision. It's also one that the Econ would never understand. Either you prefer to stop eating cashews, so you do, or you prefer to keep eating cashews, so you do. No need to move the bowl!

More directly economic matters are the cab driver who works each day until he's hit his target income for the day, and then ends his work day. This means he works more hours when earning is low, and fewer hours on the days when earning is good. From the point of view of homo economicus, this is insane. It's just not worth working that many hours when pay is bad, but on the days when pay is good, he could boost his total income by working more hours! From the viewpoint of income maximization, this is completely rational, and Thaler agrees. It's a mistake not to take advantage of the high-pay days, and knock off early when the pay is bad. I'm not sure income maximization is the only consideration here, but it's quite reasonable for an economist to think it should be.

More interesting are strange anomalies in the part of the economy that, it would seem, should be most rational, the stock market. Surely most of the money in the stock market is invested or managed by professionals able to master all available information and make rational decisions, right?

Turns out, not so much. Even the professionals can succumb to irrational exuberance, over- or under-estimate value and risk, and find themselves unable to properly exploit market inefficiencies (which are not supposed to exist), even when they recognize them.

It's a fascinating, enlightening, entertaining book, well worth your time. Recommended.

I bought this audiobook.