Nobel for Thaler

For the second time in less than 20 years, the Nobel Prize panellists have recognised the uses of behavioural economics in both policymaking and the running of businesses, by conferring the economics award on Chicago-based Richard Thaler. Thaler’s work, building on that of Daniel Kahnemann who won the Nobel in 2002, overturns the assumption of standard economic theory that individuals act ‘rationally’ by maximising their economic gain in any situation. For long considered an outcast in economic circles, Thaler has now got governments to tailor policies such as pension plans and welfare schemes keeping in mind how people actually make less-than-rational economic choices. The theories for which he is best known are mental accounting effect, endowment effect and the availability heuristic. The first depicts how all organisations and individuals have explicit and implicit accounting systems, with decisions often driven by the latter. The most important implication of this is how individuals perceive fairness in business behaviour by having a mental reference price. Therefore, if prices are ramped up in a situation of shortage, or wages reduced in another context, it would be seen as unfair if that exceeds or falls below the mental reference price or wage. The travails of Uber are instructive in this regard. In another situation of mental accounting, money is linked to certain uses and is not fungible as economists believe. This implies cash transfers may work if they are accompanied by the suggestion that they be used for a specific purpose. The second tells us that individuals would demand what might seem an irrationally high price to forgo what they own — in other words, risk aversion. The third, availability heuristic, tells us that people assess future risk on the basis of what they know or experience, in the process often underestimating a major looming risk such as climate change or the need for future savings, or overestimating less serious ones such as being robbed on a road. Thaler says organisations can ‘nudge’ individuals to correct these assessments of risk with respect to persuasive health and pension plans. However, whether ‘nudging’ erodes consumer choice and tilts power towards organisations is a debatable point.

Thaler, along with Kahnemann and others, have shown through these theories that irrational behaviour is not random, and that if their psychological basis is understood, future behaviour can be channelised along desirable lines through the right nudges. However, there is a dark, cynical side to their inquiries. Critics have pointed out that corporations have profited from the convergence of Big Data and such behavioural insights by tapping into the irrational fears and desires of consumers. The same has been noticed in recent political campaigns.

The moot question is whether these behavioural observations are culture-specific. Eastern societies are known to be more frugal than western ones. The challenge is to expand the scope of behavioural economics to include other social, political and cultural contexts.

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