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The city of Greensboro, N.C., has experimented with a program designed for teenage mothers. To prevent these teens from having another child, the city offered each of them $1 a day for every day they were not pregnant. It turns out that the psychological power of that small daily payment is huge. A single dollar a day was enough to push the rate of teen pregnancy down, saving all the incredible costs — human and financial — that go with teen parenting.
Cass Sunstein, President Obama's pick to head the Office of Information and Regulatory Affairs, was a vocal supporter of the program, because it was an economic policy that shaped itself around human psychology. Sunstein is just one of a number of high-level appointees now working in the Obama administration who favors this kind of approach.
All are devotees of behavioral economics — a school of economic thought greatly influenced by psychological research — which argues that the human animal is hard-wired to make errors when it comes to decision-making, and therefore people need a little "nudge" to make decisions that are in their own best interests.
And that is exactly what Obama administration officials plan to do: By taking account of human psychology, they hope to save you from yourself.
This is the story of how obscure psychological research into human decision-making first revolutionized economics and now appears poised to remake the relationship between the government and its citizens.
How Behavioral Economics Came To Be
The ideas that underlie the Obama administration's approach to social policies got their start in 1955 with Daniel Kahneman. Then a young psychologist in the Israeli army, Kahneman's primary job was to try to figure out which of his fellow soldiers might make good officers. To do this, Kahneman ran the men through an unusual exercise: He organized them into groups of eight, took away all their insignia so know one knew who had a higher rank, and told them to lift an enormous telephone pole over a 6-foot wall.
Kahneman felt the exercise was incredibly revealing. "We could see who was a leader, who was taking charge," Kahneman says. "We could see who was a quitter, who gave up. And we thought that what we saw before us is how they would behave in combat."
Certain of their wisdom, Kahneman and his fellow psychologists would make recommendations after the exercise. The chosen men would go to officer school, and Kahneman would move on to the next batch of soldiers. There was only one problem: Kahneman and his colleagues were terrible at it.
Every month or so, Kahneman would get feedback from the school about his picks, and "there was absolutely no relationship between what we saw and what people saw who examined them for six months in officer training school," he says.
But here's the remarkable thing: Despite the negative feedback, Kahneman's faith in his own ability was unshaken.
"The next day after getting those statistics, we put them there in front of the wall, gave them a telephone pole, and we were just as convinced as ever that we knew what kind of officer they were going to be."
People Make Irrational Choices
Kahneman was surprised by the pure visceral power of his own certainty. He eventually coined a phrase for it: "illusion of validity."
It's a problem that afflicts us all, says Kahneman, who won the 2002 Nobel Prize in economics for his work on this subject. From stockbrokers to baseball scouts, people have a huge amount of confidence in their own judgment, even in the face of evidence that their judgment is wrong.
But that mistake is just one of many cognitive errors identified by Kahneman and his frequent collaborator, psychologist Amos Tversky. For more than a decade, the two worked together cataloging the ways the human mind systematically misjudges the world around it.
For instance, Kahneman and Tversky identified "anchoring bias." It turns out that whenever you are exposed to a number, you are influenced by that number whether you intend to be influenced or not.
This is why, for example, the minimum payments suggested on your credit card bill tend to be low. That number frames your expectation, so you pay less of the bill than you might otherwise, your interest continues to grow, and your credit card company makes more money than if you had not had your expectations influenced by the low number.
Through their research, Kahneman and Tversky identified dozens of these biases and errors in judgment, which together painted a certain picture of the human animal. Human beings, it turns out, don't always make good decisions, and frequently the choices they do make aren't in their best interest.
In the realm of academic psychology, this isn't much of a revelation — psychologists see people as flawed in all kinds of ways. So, if the ideas of Kahneman and Tversky had simply stayed in the realm of academic psychology, there wouldn't be much of a story to tell.
Economics Mixes With Psychology
The economist Richard Thaler, frequently mentioned as a contender for a Nobel, was the one who integrated Kahneman and Tversky's ideas about human irrationality into economics. Now a well-respected professor at the University of Chicago, Thaler was first introduced to the work of Kahneman and Tversky when he was still a young professor.
Thaler was so smitten with their ideas that he contrived to spend a year at Stanford, where the two psychologists would also be teaching for the year.
"I remember Dick showing up to my office and our friendship really started immediately — and it has gone on to this day," Kahneman says.
The three of them spent a year walking the hills of Stanford. Kahneman and Tversky taught Thaler about psychology; Thaler, in turn, taught Kahneman and Tversky about economics.
In the early '80s, they began to publish their ideas — an integration of psychological research and economics with this new flawed decision-maker at the center. But initially, mainstream economists largely rejected the work.
The main point of contention, says Thaler, was the suggestion that humans are less than perfectly rational when it comes to decision-making. For the majority of the 20th century, and for the most part even today, the human beings imagined by economists and placed at the center of their economic models have had a Spock-like rationality.
"Economists literally assume that the agents in the economy are as smart as the smartest economist," Thaler says. "And not just smart: We're not overweight; we never overdrink; and we save just enough for retirement. But, of course, the people we know aren't like that."
So why wouldeconomists assume that human beings are so hyper-rational?
Because using a rational human in their mathematical models works. For decades, economists have been using idealized humans to predict everything from international trade to market prices, and they've done pretty well. They've been able to figure out all kinds of things. Also, it's hard to include more realistic human behavior in an economic model.
The Challenges Of Modeling An Irrational Human
"Behavioral economics has identified a dizzying array of human foibles. We clearly can't incorporate all of them, and because of that, people feel that incorporating one error into your model may be just as unrealistic as incorporating none," saysEd Glaeser, a professor of economics at Harvard University.
But there's probably another reason for economists' resistance. An imperfectly rational human being challenges a really important idea: the notion that markets work well because individuals can be counted on to make the best choice for themselves.
"Merely accepting the fact that people do not necessarily make the best decisions for themselves is politically very explosive. The moment that you admit that, you have to start protecting people," Kahneman says.
In other words, if the human brain is hard-wired to make serious errors, that implies all kinds of things about the need for regulation and protection.
Thaler and Sunstein wrote a book on exactly this issue called Nudge: Improving Decisions About Health, Wealth and Happiness.
The book proposed that if you want people to save for retirement, for example, it's important to take account of the fact that people are easily overwhelmed by information and so are likely to simply opt for the status quo. The lesson for policymakers is clear, says Thaler.
"If you want people to enroll in the pension plan, then automatically enroll them — and let them opt out if they want to." You must push them in the right direction.
The Psychological Research Jumps To Policy
But critics like Glaeser are worried. Glaeser, as well as many Republican critics, believes that our current economic predicament is the product of government intervening in the markets in a way that distorted incentives. Glaeser says that, if anything, the current crisis is proof that the Obama administration has drawn just the wrong conclusions from Kahneman and Thaler's work.
"Just understanding that human beings don't make perfect decisions does not make the case for government by any stretch of the imagination," Glaeser says. "After all, governments are made up of people, too. They are subject to the same foibles and weakness as the rest of us."
But Thaler argues that government policymakers don't need to be hyper-rational to help people make better choices.
He offers this example: Any American who goes to London realizes that they are endangering their lives every time they try to cross the street, because the traffic comes from the wrong direction. Our instinct is to look left, but if you look left, you'll get run over by a double-decker bus.
To help us, Thaler says, someone in the British government decided to write on the sidewalks of busy intersections filled with American tourists the words "look right."
"British bureaucrats are no smarter than American bureaucrats," says Thaler, "but they know that tourists tend to look the wrong way and could use a helpful nudge to avoid getting hit by a truck."
The Obama administration believes it needs to shape policy in a way that will keep us all from getting hit by trucks — health care trucks, financial trucks, trucks that come from every direction and affect every aspect of our lives.