“People make the best choices for themselves,” libertarians argue.

That may be true for Econs. Alas, most of us are Humans. (More)

Nudge, Part I – Humans and Econs

This week Morning Feature will discuss Nudge, the 2008 award-winning bestseller by Richard Thaler and Cass Sunstein. Today we consider the difference between Econs, the perfectly informed and perfectly rational economic actors of theory, and actual Humans. Tomorrow we’ll see how Humans can be nudged toward better decisions regarding money and health. Saturday we’ll conclude with issues of personal freedom and objections to nudging.

Note: Richard Thaler is a Professor of Behavioral Science and Economics at the University of Chicago. Cass Sunstein was a Professor of Law at the University of Chicago when the book was written; in 2009, President Obama appointed Sunstein to be the Administrator of the Office of Information and Regulatory Affairs.

Two kinds of thinking

You approach a door which has a vertical pole for a handle. Do you push or pull? You’re reading this, so you may think about it. But if you walk up to such a door in the real world, you’ll probably pull. What’s more, you will probably pull even if you’ve used this door many times and know it opens outward. You may also mutter aloud: “Why do I get that wrong every time?”

You’ll pull on that handle, and mutter, because in opening doors you rely on what Thaler and Sunstein call the Automatic System: responding to cues in habitual ways. Most of the time, if you see a door with a handle you can grip, the door will open toward you and pulling will be the right decision. If you see a door with a metal plate, the door will outward and you’ll push. A vertical pole is a handle you can grip, so you’ll pull … unless you pause to consciously think “No, this door opens outward so I should push.” Thaler and Sunstein call that conscious thinking the Reflective System.

Our brains are wired with both Automatic and Reflective Systems, but we rely on the Automatic System most of the time. It’s faster, easier, and it usually gives us good results. Indeed, if we’ve had lots of practice making that kind of decision, the Automatic System is often far better. Consider how poorly you drove – or played a sport like golf or tennis – when you first began and you still had to think through every action. The Reflective System takes time we often don’t have.

Oops….

But the Automatic System also makes mistakes and, like pulling on that door handle, many of those mistakes are predictable. We rely on rules of thumb and are subject to cognitive biases. We look for patterns, a very useful trait unless we’re dealing with random events. Then we’re likely to create patterns anyway. And we are overconfident: 90% of drivers think they are better than average, 90% of incoming MBA students expect to get better than average grades, and 90% of professors think they’re better than the average professor. And we tend to “leave well enough alone,” called status quo bias, even when “well enough” isn’t.

We also tend to overvalue short-term interests. We’re more likely to do things that are pleasant now but may harm us later than to do things that are less pleasant now but may benefit us later. No one puts “Eat more ice cream” on a New Year’s Resolution list. Instead we resolve to “Exercise more.” Ice cream is pleasant to eat, and we’re likely to discount the tradeoffs. We may even tell ourselves “I’ll work out tomorrow to burn off those calories.” But when it’s time for that workout, well, you’ll get all sweaty and that ankle is a bit twingy….

Finally, we’re a herd species. A clever study involved music by unknown artists, and almost 20,000 online users who could download songs for free. Half of the users were assigned to a control group and chose their downloads with no information about other users’ choices. The other half were randomly assigned to several ‘worlds’ and were given information on previous downloads and ratings within their own ‘world.’ (They didn’t know the other ‘worlds’ existed.) Information from early users in each ‘world’ created a ‘most popular’ list, and later users in each ‘world’ tended to download the most popular songs in their ‘world.’ The not-so-surprising results: the ‘most popular’ music in each world was completely different – even though each ‘world’ had the same overall list – and users in each ‘world’ were sure the music they chose ‘really was’ the best.

Humans in a system made for Econs

Those oopses are not (usually) “stupid.” Instead they are the predictable behaviors of Humans. Many of them even make sense. We know intellectually that half of marriages (and 95% of diets) fail, but to commit we need to believe that we’ll make ours work. We may not know the economic term transaction costs, but we know at an intuitive level that change is disruptive and we should have a good reason before switching things around. We may not talk about death, but at some level we know life is unpredictable and we may not be around to experience long-term benefits or risks. And lacking better information, it makes sense to follow the herd as that allows us to share experiences – celebrations, complaints, lessons, and burdens – with others.

But those actual Human behaviors don’t match up well with the theoretical behaviors of what Thaler and Sunstein call Econs, or Homo economicus. Econs seek out all relevant information about every decision, and apply their Reflective Systems to weigh pros and cons in a decision matrix, and choose the best decision in that matrix. Econs will do this independently of others’ decisions, except to the extent that others’ behavior affects their own decision matrices. In a world full of Econs, laissez faire capitalism would work well (except for the positional spending races we discussed last week).

Give a population of Econs as many choices as possible, and each will make the best choice for him/herself. What’s more, market factors such as supply, demand, and price will aggregate those individual choices into the most beneficial outcomes for all. If too many employees think a job is too dangerous for the wages offered, employers will either make the job safer or offer higher wages to compensate employees for the risk. Which the employer chooses will depend on which is more economically efficient, and that choice will leave more money to invest in growing the business. Everyone benefits.

Well, everyone except for those ‘stupid’ Humans. Which is almost all of us. As we’ll discuss tomorrow and Saturday, Thaler and Sunstein think we Humans can make better choices … given a helpful nudge….

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Happy Thursday!