24 June 2015

Misbehaving: How Economics Became Behavioural

Richard Thaler
2014, Allen Lane (Penguin Books), 415 pages, £20
ISBN 9781846144035

Reviewer: Ian Bright

Those moderately well versed in the ideas of decision making and their relevance to economics may not learn much new from Richard Thaler’s Misbehaving. But the book is still worth buying and reading.

At the end of the first chapter, Thaler writes: “My only advice for reading the book is to stop reading when it is no longer fun.” Written in an easy and personal style, with bite-sized chapters, Thaler explains many key papers and ideas behind behavioural economics in non-technical language. The pages do keep turning. If you can define that as fun, Thaler has succeeded. For those seeking detail, extensive references are included in the end notes.

Some may compare Misbehaving with Daniel Kahneman’s best-selling Thinking Fast and Slow as they cover much the same ground. Thaler worked closely with Kahneman (and the late Amos Tversky). All three are recognised as pioneers of behavioural economics. Kahneman’s book is more detailed, however, and adopts a viewpoint from psychology. Perhaps Thaler felt less need for detail, simply adding the particular perspective of an economist. For example, there are useful summaries of how issues associated with self-control can affect the permanent income and life-cycle hypotheses of consumption and how endowment effects may contribute to asset prices diverging from fair value.

Thaler’s reminiscences begin over 40 years ago, in 1970 as a graduate economics student. He explains how he increasingly questioned economic theory because what he saw in real life differed. He kept a list of these differences. For example, consider the common practice of dinner hosts removing pre-dinner snacks from guests to stop them over-eating before the main meal. This appears to violate the assumption of basic economic models that people optimise consumption over time.  Thaler argued that his list indicated the existence of ‘seemingly insignificant factors’ that challenge the assumptions beneath many basic economic models. Over-consumption of pre-dinner snacks, for example, suggests that maintaining self-control is difficult and affects inter-temporal allocation of consumption.

Thaler says his challenge to the basic models met stiff resistance from traditional economists. He admits though that progress has been made and that behavioural economics is going mainstream. Economics has become more evidence-based, partly because of the questions asked and approaches adopted by behaviouralists.

However, in macroeconomics, where many important questions need to be addressed, the behavioural approach has not had much impact. Thaler notes this in his conclusion. Thaler gives the impression that there is still much resistance; many believe that anomalies can be incorporated into traditional models, simply by adding a few tweaks to the equations. For example, the three factors of the Fama-French model of asset pricing are now being expanded to five.

As readable as the book is, its style will not please all. Reminiscences may not be entirely accurate and a personal style may grate on some people. John Cochrane, a professor of finance and economics at the same University of Chicago as Thaler, blogs similarly  http://johnhcochrane.blogspot.co.uk/2015/05/homo-economicus-or-homo-paleas.html responding to an article by Thaler based on the book. He argues that using words such as ‘treacherous’ and ‘inflammatory’ remove objectivity from the description of how behavioural economics has developed, noting that academic seminars often involve the asking of sharp