EDITORIAL – A Nobel prize for normal people

“In order to do good economics, you have to keep in mind that people are human.”
– Richard Thaler, winner, 2017 Nobel prize in economics

Amid a characteristically erudite field of academics, thinkers, and scientists, University of Chicago economist Richard Thaler may be the most “relatable” scholar in this year’s class of Nobel prize winners.

All of the awardees have made important contributions to the advancement of human understanding, and are deserving of their laurels.

That being said, “cryo-electron microscopy for the high-resolution structure determination of biomolecules in solution” and “uncover[ing] the abyss beneath our illusory sense of connection with the world” don’t exactly make for compelling conversation around the dinner table. (In most circles, holding forth on the molecular mechanisms controlling circadian rhythms of fruit flies is a surefire way to put your guests to sleep.)

Mr. Thaler’s work, meanwhile, not only makes for good talk at dinner, but has incorporated behavior observed at dinner parties. In a column we published on Monday’s opinion page, Cass R. Sunstein (a collaborator of Mr. Thaler’s) wrote, “Who else would develop a theory of human behavior by observing how, at a dinner party, supposedly rational economists gobble up cashews before dinner – and are immensely grateful when the host takes the half-eaten bowl away?”

More specifically, Mr. Thaler’s Nobel award was attributed to “his contributions to behavioral economics” – which can be boiled down to the investigation of why people do irrational things. For example, a gambler on a “hot streak” will continue to place big bet after big bet. Similarly, investors will keep putting their money on soaring stocks, even while a price collapse seems inevitable, and then after shares plummet, will demonstrate a reluctance to “cut their losses” by selling.

Pool sharks, payday lenders and blackjack dealers have made small fortunes by capitalizing on these human foibles.

Mr. Thaler is a leader in the species of economists who seek to explain how people depart from “rational” behavior as predicted by standard economic theories – and also, how that “irrationality” isn’t unpredictable or necessarily bad, merely “human.”

In terms of impact on people’s everyday lives, Mr. Thaler’s work has assisted in the promotion of “auto-enrollment” savings plans for retirement, for example. (As we in the Cayman Islands know, with our mandatory pensions schemes, many people won’t “opt-in” to savings plans … but also, many people won’t bother to “opt out” of those same plans.)

In the Summer 2017 issue of Harvard Business Review, CEO Michael D. Harris explores the split personalities in people’s emotional subconscious, calling them “Mr. Intuitive” and “Mr. Rational.”

Mr. Harris writes that we, who as rational beings of course identify with Mr. Rational, tend to dismiss Mr. Intuitive as being irrational and irresponsible.

But perhaps somewhat counterintuitively, Mr. Intuitive often proves to be a superior decision-maker to Mr. Rational, particularly in complex matters.

The advantage is this: “[U]nconscious decisions follow their own logic. They are based on a deeply empirical mental processing system that effortlessly filters millions of bits of data without getting overwhelmed. Our conscious mind, on the other hand, has a strict bottleneck, because it can process only three or four new pieces of information at a time due to the limitations of our working memory.”

Mr. Harris cites a study, involving the selection of used cars, that in simple situations with only four variables, “rational” deciders were 15 percent better at choosing the best car than “intuitive” types. But when the number of variables was increased to 12, intuitive deciders were 42 percent better than rational deciders.

This is all to say that, many times in your life (actually many times a day), you will find yourself making decisions without the luxuries of attention, clarity and time that would be necessary to make a “rational” judgment as prescribed by standard economists in their sanitary ivory towers.

In those circumstances, you can be comfortable “going with your gut” instead of your head, and getting on with living your life, leaving it to behavioral economists such as Mr. Thaler to figure out the fine print.