Posts Tagged ‘nobel prize’

This week, it was announced that Richard Thaler had been awarded the Nobel prize for economics. It is long overdue. Here is why.

Thaler is best known for his 2008 book Nudge: Improving Decisions About Health, Wealth and Happiness which he co-authored with Cass Sunstein. He was a summation of his many years of work on behavioural economics. You can read my review here.

This understates his contribution though: Thaler is considered by many to be the father of behavioural economics.

To understand why that is important, we need to look at what behavioural economics is. Economics, as a subject, has been around for thousands of years. Except that in many ways it really hasn’t. Traditionally, at least in recent tradition, it has focused on building financial models based on people making perfectly rational decisions.

Take the free market, for example. If you put prices up, you decrease demand. It’s nice and simple.

But then Thaler came along and said: “hang on, do people act like rational beings all of the time?” The answer, of course, was no. And a new field of economics was born: behavioural economics. The study of what people actually do.

But what exactly is non-behavioural economics? The more you think about it, the more you realise that we can basically can anything we thought we knew about economics beforehand, because all economics should be behavioural economics. Models that use “econs” rather than “humans” do not work in the real world. Which is where all research should eventually have some kind of relevance.

So, well done to the Nobel prize selection committee for making such an excellent choice. In a perfect world, it would have happened much sooner. But the selection committee, like the rest of us, are humans, not econs.

Daniel Kahneman is a psychologist who won the 2002 Nobel Prize in Economics. His book “Thinking, Fast and Slow” summarises a lot of the research he has done and proves to be a fascinating reading.

As someone who isn’t a psychologist I found some of it heavy going, but very interesting. The book is arranged into sections and these are then broken down into short chapters, which made it more readable.

Some of it was shocking too. For example, when it comes to making parol decisions, one of the biggest factors is how recently the parol office has eaten! Just after a meal they are far likely to grand you parol than just before a meal.

His discussion on priming reminded me a lot of what Richard Wiseman talks about in his book Rip It Up. Behaviour can drive emotion, even though we always think of it as emotion that drives behaviour.

The question of how effective pure branding advertising is gains some support. “Familiarity is not easy to distinguish from truth”. The more you show something to people the more confident they feel about it. Other times a lack of clarity is helpful. For example, using a bad font makes exam scores go up, because people have to concentrate more than they normally would and so make less mistakes.

Much of the book discusses the differences between System 1 (that does the fast thinking) and System 2 (that does the slower, more considered thinking). Elina often reproaches me for not noticing snails on the path, suggesting that I need to notice things or one day I will be eaten by a lion (metaphorically, these days). I now maintain that my System 1 is keeping an eye on things and simply not bothering to engage my System 2 because there is no danger.

Kahneman also adds weight o Burton Malkiel’s book A Random Walk Down Wall Street, which both discuss how the stock market is almost entirely unpredictable and therefore stock market traders actually add no value to what they do. Indeed, as 60% of mutual funds do worse-than-guessing, they actually subtract value.

Ultimately, people are just really bad at making judgements. 90% of drivers rate themselves as above average. Similarly, the majority of new businesses fail, yet the people who start them almost always believe they are exempt from such rules.

The answer to many of these issues is to replace judgement with a formula. This is essentially the entire point of Michael Lewis’s book Moneyball. Even a simple formula will do, according to Kahneman multiple regression does not even make it much more accurate.

One of the most useful points I took away from the book (almost certainly not the objectively most useful) is the idea of taking small gambles. In one chapter, Kahneman describes how people are unwilling to take profitable one-off gambles, such as a 50/50 chance of winning £20 or losing £10, but would be willing to take it if they knew they could take it 100 times in a row. The larger sample size means they are very likely to come out on top. However, they fear doing it once because there is a 50% chance they will lose and that will go down in their mental accounting.

Kahneman makes the point that we are “not on our death bed” and thus we will get chance to get even with the universe over time. Extended warranties are a great example of this. You pay a premium to insure your products, so it costs you money in the long term. A better strategy is not to buy the warranty and accept that sometimes you are going to have to replace a product – but over your lifetime you will almost certainly be up.

Having finished the very serious, adult and deep prose of J. K. Rowling’s Harry Potter series recently, I decided it was time to read something a bit more lighthearted. John Steinbeck’s The Grapes of Wrath seemed a good choice. I had already read Of Mice and Men, which is enjoyable and I would recommend if only so people get my references, and was eager to read his works further.

It’s considered Steinbeck’s seminal work, winning the Pulitzer Prize and being cited as a key reason for Steinbeck being awarded the Nobel Prize for Literature in 1962. It’s easy to see why – the powerful, touching and vivid description of people struggling through the Great Depression is one of the most moving texts I have ever read.

The book tells the family of the Joad family, who lose their farm in Oklahoma, and are forced to travel to California to find work, only to find the grass isn’t so green as they were lead to believe. Or, more accurately, that the grass is greener, but the machinery of society we have build up – the banks, the economics and the systems of government – prevent the poorest from walking on it.

Steinbeck’s vivid language paints a detailed picture of life during the Great Depression, providing a thought provoking insight to the suffering, without dwelling on it any longer than required. The monster of the system we have created is deconstructed in a way still relevant today. As the story goes on, you feel their frustration, their anger and the unfairness of their plight.

Like many for the Great Depression, the novel doesn’t have a happy ending. Or more accurately, an ending. It isn’t an unhappy one – just one without conclusion, as the family are left to continue to struggle on, without much food or money, and with winter on the way.

On a lighter note though, I have fallen in love with the name Rose of Sharon, pronounced Rosasharn. Definitely a contentor if I ever have a daughter.