NOT long ago, the starting assumption of any economic theory was that humans are rational actors who maximise their utility. Economists summarily dismissed anyone insisting otherwise. But over the past few decades, behavioural economists like Richard Thaler have progressively chipped away at this notion. They combine economics with insights from psychology to show how heavily economic decisions are influenced by cognitive biases. On September 9th Mr Thaler’s work was recognised at the highest level when the Nobel Committee awarded him this year’s prize in economics. Mr Thaler thus becomes one of very few behavioural economists to win the prize.

Mr Thaler’s has been a prolific career, spanning over four decades, the last two of them at the University of Chicago’s Booth School of Business. His research has touched on subjects as varied as asset prices, personal savings and property crime. For example, Mr Thaler developed a theory of mental accounting, which explains how people making financial decisions look only at the narrow effect of individual decisions rather than the whole effect. (Indeed, he is one of the founders of the sub-discipline of behavioural finance.) The Nobel committee also highlighted Mr Thaler’s research on self-control, that is, the tension between long-term planning and short-term temptations.

The new laureate has also worked to bring his arguments to a wider audience. For the benefit of fellow economists not well versed in (or dismissive of) behavioural theories, he wrote a regular column for the Journal of Economic Perspectives, a prestigious journal, recounting instances of economic behaviour that violated classical microeconomic theory. For a general audience, he wrote several books on behavioural economics, starting with “Quasi-Rational Economics” in 1991.

But Mr Thaler is perhaps most famous as a pioneer of “nudging”: the use of behavioural insights as a public-policy tool. Although the idea of nudging is not new, and firms have long employed behavioural science to shape their customers’ behaviour, governments of the past used psychology only sporadically. 

That started to change when Mr Thaler and Cass Sunstein, a legal scholar at Harvard University, co-authored a book, “Nudge”, in 2008. The book attacked the assumption of rational decision-making in economic models and showed how context could be changed to “nudge” people to make better choices. In 2010 Mr Thaler advised the British government on the creation of the Behavioural Insights Team, a unit that sought to put their ideas into practice. The wildly successful government unit has since been spun out into a quasi-private company and now advises governments around the world. 

From a renegade offshoot within economics departments just a few decades ago, behavioural economics has gained an established place not only within academia, but also within government departments around the world. From Australia to America, as well as within organisations like the World Bank and UN, the approach has been copied. The Nobel Committee’s decision to honour Mr Thaler is of course a recognition of his personal achievements. But it is also a testament to the newfound importance of his discipline.

Source: economist
The Nobel in economics rewards a pioneer of “nudges”