Russell Lynch: Goodbye (and good riddance) to Mr Homo Economicus

Russell Lynch
US economist Richard Thaler has won this year's Nobel Prize for Economics: REUTERS

For far too long, practitioners of the dismal science were in thrall to a mythical creature called “homo economicus”. This being was driven always and everywhere by utterly self-interested ends — either as a consumer or a producer — and endowed with an infinite ability to make rational decisions.

The trouble is, he doesn’t exist. And hats off to behavioural economist Richard Thaler, who fully deserves his Nobel prize this week for finally killing him off.

Thanks to him, and his pioneering predecessors Daniel Kahneman and Amos Tversky, we have a profession that is more finely attuned to what humans are, rather than what they ought to be, meshing the worlds of psychology and economics.

And in Misbehaving, Thaler produced a grippingly readable account of the move of the discipline from the margins to the mainstream.

From cafés and coffee shops to Government policy, getting inside people’s heads and understanding their real motivation is delivering practical insight — and results.

Pensions

If you’re saving in a private pension now, it might well be because of Thaler. He inspired the creation of the Government’s Behavioural Insights Team — also known as the Nudge Unit after another Thaler book — in 2010.

Following that, the Coalition introduced auto-enrolment pensions in 2012, meaning contributors have to opt out of paying rather than opting in. Given the previous fears about how people aren’t saving enough for their retirement, this simple change has virtually trebled the membership of private-sector pension schemes to 7.7 million as of last year.

In the words of BIT chief executive David Halpern: “Harness the power of defaults. We have a strong tendency to go with the default or pre-set option, since it is easy to do so.”

Charities

According to academics, charities have also cottoned on to the power of the easy “default” option. The reason why those desperate chuggers are so eager to win your direct-debit details is that once you’re signed up, you’re less likely to cancel, something which Thaler would call the “status quo bias”.

“Charities should make available automatic recurring donations and generally facilitate recurring donations as much as possible,” claim researchers from the US and Singapore in a paper on the topic of “nudging charitable giving”.

How to sell more beer

Pensions and charities are all very well but behavioural insights have had commercial benefits. For example, when we’re presented with too much choice, our brains can get scrambled — information overload or an “excessive choice effect”, according to American psychologist Barry Schwartz in his book The Paradox of Choice.

Thirsty US researchers chose an experiment involving craft beer — precisely because of the explosion of choice in the category in recent years — changing the number of beers on offer. Broadly, pubs sell more booze when there’s six beers on the menu instead of 12, easing the “excessive choice effect”.

Pay-what-you-want

If homo economicus regularly frequented a coffee shop that allowed its customers to pay whatever they wanted, the place wouldn’t be in business for very long. Lo and behold, homo sapiens behaved differently. In South Korea, a trio of academics experimented with different pricing strategies at a coffee shop. When they introduced pay-what-you-want along with a suggested price and a part-donation of the proceeds to charity, revenues were just as high as under a traditional model.

Customers were also keen to gain reference points from others on suggested prices, showing that societal norms play a role alongside self-interest.

Hands off

A key concept in behavioural economics is the “endowment effect”: we place a higher value on things that we already own than things we don’t — partly because of loss aversion.

How willing are you to sell a house at a loss if it’s worth less than you paid for it, even if other properties have fallen in value? Or sell shares at a loss even though there may be a better investment? Understanding endowment effects also has potential commercial impact. Researchers have found that even touching products — say through a touchscreen rather than clicking on them with a desktop mouse — increases the endowment effect through a kind of proxy “ownership”.

So all hail Thaler for injecting humanity and common sense into the profession.

True to form, he said that he would be spending his £845,000 prize money “irrationally”. Amen to that.

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