The Mini-Malcolms

NUDGE: IMPROVING DECISIONS ABOUT HEALTH, WEALTH AND HAPPINESS
By Richard H. Thaler and Cass R. Sunstein
Yale University Press, 293 pages, $26

SWAY: THE IRRESISTIBLE PULL OF IRRATIONAL BEHAVIOR
By Ori Brafman and Rom Brafman
Doubleday, 206 pages, $21.95

THE DRUNKARD'S WALK: HOW RANDOMNESS RULES OUR LIVES
By Leonard Mlodinow
Pantheon, 252 pages, $24.95

ABOUT 30 YEARS AGO, THE WORLD of economics took a zinging slap. Daniel Kahneman and Amos Tversky, two Israeli psychologists, published a paper about how we actually make decisions, rather than how we should. If standard economic theory assumes that we’re perfect judges of our own best interests—that more choice leads to better choices, and the market corrects for flaws—these two academics found otherwise. After a series of experiments, they discovered that we’re bumblingly irrational actors: We hate losing more than we enjoy winning; emotion often trumps reason; and our decisions depend on how the options are framed. Essentially, at times we’re a little dumb.

"Prospect Theory: An Analysis of Decision Under Risk" was the first paper to introduce psychology into the study of economics—a landmark moment. If economics is based on human behavior, why not empirically examine actual human behavior? Alas, in economic theory, it takes time for common-sense lessons to trickle down. Few practitioners wanted to give up those beautiful, abstract models of human decision-making, the clean calculation of supply, demand, cost and utility. So pure—untarnished by our silliness.

The tide has turned. Early adopters cited Kahneman and Tversky in the late ’80s, but psychology really began informing the discipline only about 10 years ago. (Mr. Kahneman received the Nobel Prize for his work in 2002; Tversky had died some years earlier.) Now behavioral economics—sometimes called neuroeconomics—is gaining traction in academia and clogging best-seller lists. Practical books with snappy one-word titles expose our daily blunders and their larger consequences. It’s a near irresistible mixture of "gee-whiz" science, dinner-party-ready questions (why do placebos work? why do I procrastinate?) and self-help advice. Malcolm Gladwell, author of Blink (2005), is the patron saint of this trend. Economics, once the preserve of market-loving, equation-wielding ideologues, is suddenly cool again.

"INDIVIDUALS MAKE PRETTY BAD DECISIONS," observe Richard Thaler and Cass Sunstein in Nudge. From their offices at the University of Chicago, where Mr. Thaler teaches in the Graduate School of Business and Mr. Sunstein is at the law school, they take pains to skewer the traditional idea that freedom of choice enables smart choices. In fact, we’re lazy, impressionable and biased in favor of the status quo. We spend less time on important financial decisions—like how to invest in a 401(k)—than on picking out a new tennis racket. Everyone plans to exercise, diet or save money, but few actually delay gratification or read the fine print.

That we live in a time of unprecedented prosperity and opportunity makes our hamfisted decisions more embarrassing. We really only have ourselves to blame. Yet part of the problem is the sheer quantity of choices we now have, which makes it harder to pick the right one. People get suckered into things like subprime mortgages in part because the market has become more complicated. (That the market also creates incentives for mortgage brokers to exploit human frailty hardly helps.) Choosing the best credit-card plan seems to require voodoo powers.

But all’s not lost. Mr. Thaler, a founder of behavioral economics, and Mr. Sunstein, an impressive jack of all trades (both of whom occasionally advise Barack Obama), have a solution: "libertarian paternalism." This is a system for arranging choices that encourages (or "nudges") people toward the one that serves their best interests. An example of "choice architecture" is the way food is arranged in a cafeteria. The director of food services for a large city school system found that she had the power to change consumption of specific foods by as much as 25 percent: If she put carrots at eye level, for example, she could influence healthier decisions without limiting choices.

Libertarian paternalism "alters people’s behavior in a predictable way without forbidding any options," write Messrs. Thaler and Sunstein. The authors first outline our irrational instincts, then use these lessons to make detailed policy recommendations (so detailed as to nudge some readers to skip to the conclusion, surely). For example, given that people tend to stick with their current situation ("status-quo bias"), few take the time to halt the automatic renewal of a magazine subscription. That same inertia could be harnessed to get people to save more money, by having companies adopt an automatic enrollment plan for a retirement account, which employees could "opt out" of. For particularly complicated choices (e.g., investment portfolios, software downloads), sensible default options are best. As for all those byzantine pricing schemes for insurance policies and credit cards, businesses should be forced to become as transparent as possible, and provide customers with itemized receipts of costs and fees.

Much of this makes sense. Nudge also describes something called "the spotlight effect," which is the misguided feeling that everyone notices what we’re doing. This is what motivates us to conform socially, and what moves us to apologize for faux pas no one else picks up on. Choice architects should understand that the best way to get people to do something (exchange plastic bags for canvas totes, say) is to convince them that they’ll look foolish if they don’t. Next Page >