When Money Meets Irrationality

When Money Meets Irrationality

Dan Jacobson discusses the work of 2017 Nobel Prize winner Richard Thaler, and the valuable lesson he teaches us all

The Monty Hall problem, a thought experiment inspired by the game show Let’s Make A Deal, puts forward an interesting proposition: you are in front of three doors. Behind one is a shiny new car; behind the other two, goats. You pick a door. The host then reveals one of the doors with a goat behind it, and gives you the option to swap your initial choice with the remaining door… is it in your best interest to switch?

The problem rose to prominence in 1990 when columnist Marilyn vos Savant showed, with simple probability, that you have a 2 in 3 chance of winning the car if you switch. This result sounds counter-intuitive, yet vos Savant’s proof is undeniable. This problem has become the most famous example of ostensive human irrationality that, without our knowing, pervades every choice we make. Analysis of this phenomenon is known as “behavioural economics”, and this year, one of its most prolific players, Richard Thaler, won The Nobel Prize in Economic Sciences 2017.

The first examples of behavioural economics were seen in Adam Smith’s The Theory of Moral Sentiments, and in the work of our favourite utilitarian Jeremy Bentham, who applied psychology to explain individual behaviour. This led to a model individual known as ‘homo economicus’, who acts solely to obtain maximum profit from their decisions. However, recent publications, such as psychologist and economist Dan Ariely’s book Predictably Irrational, have highlighted the plethora of ways in which this model is inaccurate. Ariely’s book is full of examples of people’s decisions being determined by everything from false incentives to irrelevant contextualisation. Even within the scientific community, Ariely showed that researchers react differently to outliers if they support the original hypothesis.

This is where Richard Thaler’s work becomes relevant. First developed in the 1990’s, he is most well-known for work in “nudge theory”, which gained prominence in 2008 via the publication of his book Nudge: Improving Decisions about Health, Wealth, and Happiness, which he co-wrote with Cass R. Sunstein. Nudge theory concerns the way in which we can influence the decisions of the public without being intrusive. This may sound oxymoronic, and that’s because it is. However, this technique, which Thaler referred to as ‘libertarian paternalism’, has been shown to be impressively effective. To refer to an example from his book, in an experiment conducted amongst Minnesota taxpayers, researchers found that people were more likely to pay their taxes after being informed that 90% of Minnesotans had already complied.

The applications of nudge theory, however, spread far beyond Minnesota tax law. Recent developments in medical policy have been designed to “nudge” people into organ donation, by reverting to an opt-out system. According to the European Commission, as of 2012 Spain, one of the first countries in Europe to implement this policy, had 33.8 deceased donors per million, almost three times as many as in the UK. In 2010, even the UK Cabinet Office jumped on the bandwagon by creating the Behavioural Insight Team, known as the “nudge unit”, under Thaler’s guidance. Its results have been impressive, having been used to encourage everything from quitting smoking to loft insulation.

Of course, this theory has been subject to intense criticism, namely regarding its somewhat toxic concoction of naivety and condescension. In a scathing Financial Post article written by Peter Foster, he expresses discontent in the call to move power from the hands of people to the “rational” government. In response to Thaler’s coining of the term “Homer economicus” (as opposed to the original “homo economicus”), Foster writes, “If Homer Simpson represents the average human, does not Springfield’s Mayor Quimby cast doubts on the wisdom, competence, and morality of the average politician?”. In this way, the naivete of the public is mirrored by that of the theory itself which, in the past, has proven detrimental.

Overall, whilst the validity of Thaler’s win is still very much in question, what his past work has encouraged is a re-analysis of our rationalism. By studying behavioural economics, it may be possible for us to escape from the cycle of irrationality which result in our being conned, misled, and taken for granted. At the very least, it would save us from heading home with a goat on the back seat.

Featured image: unsplash

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