Book Review: Misbehaving: The Making of Behavioral Economics

Misbehaving: The Making of Behavioral Economics by Richard Thaler

Published by W.W. Norton & Company, Inc.
500 Fifth Avenue, New York, N.Y. 10110
2015
415 pages

Dr. Richard Thaler was recently awarded the 2017 Nobel Prize for Economics. A resident of Chicago and the popular coauthor of Nudge: Improving Decisions About Health, Wealth, and Happiness with Harvard law professor Cass Sunstein, Thaler’s most recent book published in 2015 entitled Misbehaving: The Making of Behavioral Economics offers more insight into his personal experiences and writing style.

Misbehaving is structured in roughly chronological order, following the Thaler’s career path and his gradual findings as a pioneer in the field of behavioral economics, from when ideas were first conceived as a fringe movement, to scientific analysis and research, to the expansion of its exercise in the real world as a recognized field of study today. The central idea of behavioral economics is that standard economic models for predicting human behavior, based on assumptions that everybody makes rational decisions in their own self-interest for monetary profit-- are wrong, and in fact humans make decisions based on their biases, emotions, and situations. The foundation behind these economic theories is the field of psychology. As a result, as the book progresses, we observe findings from the economic community used less and less, and psychological studies applied more and more to economic decisions. Indeed, Thaler was awarded the Nobel Prize in 2017 for his contributions which have “built a bridge between the economic and psychological analyses of individual decision-making.”

The story’s major conflict is the prevalent struggle against classical economics purists from Thaler and his colleagues, an enterprising group of renegade academics defying the norm. Misbehaving as a whole is riddled with humorous anecdotes and interesting footnotes. Thaler’s writing style is affable and self-deprecating. He has a natural dry wit, freely admitting throughout his book to cutesy vices, like how he couldn’t resist a bowl of cashew nuts, is supposedly bad at math, and that his “single best quality” is laziness. At first glance, concepts are scattered and disjointed, but they come together into a coherent, solid argument, much like the field of behavioral economics itself. In this way, Thaler’s writing is refreshingly (sometimes confusingly) coherent, relating back to ideas presented from the beginning so a slow reader with a tendency to forget things far in the past will sometimes need to flip back to the page where it was first introduced. Happily, there’s also an extensive index for hapless Humans. It’s clear Misbehaving is intended for the general population, like its predecessor Nudge. However, after reading Nudge myself, more mathematical economic concepts are brought to the table in Misbehaving than its more well-received counterpart, and the pace at which they are introduced is also faster. Furthermore, Nudge aimed to provide a plethora of practical applications for behavioral economics, while Misbehaving did not necessarily need to give that many examples. Some basic financial concepts went over my head, such as some sections about taxes and mortgage, which I presume is common knowledge for normal adults. For the practical thinker, I advise reading Nudge first to get a more complete understanding of the scope of applications, but for the more analytical person, Misbehaving’s a good place to start for an in-depth study into the field.

The beginning of the book struck a similar note as Nudge, introducing many of the same anecdotes. In those early days, young Dr. Thaler put together a List of behavioral anomalies unexplainable by classical economics. These observed phenomena make up the beginning, accompanied by many graphs. One visual which stood out to me was the s-shaped curve illustrating the diminishing marginal utility of wealth, which is a fancy way of saying a rich person would value getting $5,000 a lot less than a poor person, and the difference between losing $1,000,000 and $1,005,000 somehow seems less than the difference between losing $0 and losing $5,000. This really got me thinking about how I, and other people, didn’t actually think as rationally about economic choices as economists say we do.
Throughout the book, counterarguments from economists who supported using the classical models are laid out and addressed, mostly that Professor Thaler’s findings all seemed to be interesting but unconnected examples. The first application of behavioral economics described was when Thaler was hired to give economic advice to a small New York ski resort, Greek Peak. Along with giving advice to General Motors, his experience at these places show that companies could use Thaler’s behavioral advice to generate profit. The ticket packages he came up with at Greek Peak, plus GM’s loan deal for unsold cars, on average had customers pay more without thinking it’s unfair-- both showing how behavioral economics can be applied. A psychological phenomenon, loss aversion, was illustrated with 23 managers each working in separate divisions in one big company. When asked if they would take on a project with a 50% chance of a $2 million profit, and a 50% risk of losing $1 million, even though the mathematical expected payoff is half a million dollars, most managers would not take the project, because if the project fails, there was a chance they would lose their jobs. However, when the company’s CEO was asked how many of the 23 projects he would like to take, he said all of them-- because the company expects to make $11.5 million from the 23 projects, when half fail and half succeed. This shows there’s a big lack of communication between principals and agents, or leaders and the people below them. It may be why companies don’t take enough risk-- probably one of Thaler’s most important concepts.

Another practical use of behavioral economics is the “Save More Tomorrow” plan, developed by Thaler for employers to combat the problem that some employees do not save enough for retirement. Thaler calls the idea that governments and corporations could somehow influence people’s choices using behavioral science “libertarian paternalism,” which he admits has suspicious connotations while also sounding oxymoronic-- but simply put, libertarian paternalism is voluntary-- meaning people could drop out of it any time, and it doesn’t restrict their choices, but it sets a default best option. People could be mentally “nudged” to make better choices for themselves-- that was the point where Thaler and Cass Sunstein decided to write Nudge. Thaler concludes that an effective solution to simple problems constitutes removing any barriers to make a choice easier-- the Save More Tomorrow Plan is set as the default for all employees, so nothing is required to join--- and one-time solutions, meaning no further action is needed to keep it going. Here, Thaler admits behavioral economics uses a lot less economics and a lot more psychology. Classical economic principles have been gradually dropped from the book as behavioral economic history takes a new turn to practical applications. It shows how all social sciences are connected, with each supporting the other.

One other thing addressed here is Thaler’s phrase, “nudge for good.” Nudges could influence people to make good decisions, but swindlers could also use behavioral science to rip people off. In fact, the examples I found within the book were the Greek Peak and GM corporations, where the goal was to make profits from ski tickets or cars. Although libertarian paternalism implies making a voluntary choice, some people would likely think it’s unfair if they take GM’s 2.9% interest loan deal on unsold cars, then find out later the rebate option (getting some amount back after the purchase) saved them more money. It’s why Thaler also argues for transparency in nudging-- if people understood clearly what they’re paying for, they would end up making the best choices after all. Thaler acknowledges ethical questions do come up. He redirects the reader to Sunstein’s 2014 article, “The Ethics of Nudging.”

Thaler concludes his book with a wishlist for behavioral economics going forward. What pleasantly surprised me was his hope for behavioral economics to be utilized in the field of macroeconomics. It’s satisfying that he recognized macroeconomics is an area behavioral economics largely fails to touch on because there’s so many ambiguities in the field, making it difficult to conduct scientific research. Since I’m uninitiated in economic academia, this book taught me scientific experimentation is more important to social studies than I realized. Scientific thinking was prominent throughout the book, and used to refute arguments from all sides. Thaler emphasizes the need for new data to fuel new theories. Further, he returns to his early anecdote about the risk-taking CEO and his 23 risk-averse managers, encouraging the rest of us to better communicate with our superiors and each other, and in collaboration avoid disasters and contribute to the flow of new ideas.

At the end, I was left with positive feelings. Behavioral economics will definitely help make our government and our businesses more streamlined, letting them do their job more effectively. I’m doubtful it will cause a huge change in the way we run things, cure cancer, or eliminate poverty-- but Misbehaving does not purport to such massive, ongoing endeavors. Instead, society’s improved one step at a time.