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Sunday, June 07, 2015

The science of human irrationality by Michael Lewis

Photo: Michael Lewis
Michael Lewis, a Bloomberg View columnist reports, "How Richard Thaler helped invent behavioral economics."

I'm not sure we're living in an age of disruption, or just an age that badly wants to think itself disruptive, but either way there's been a lot of rethinking going on the past decade or so. The biggest upheavals have come in industries in which managers have always made decisions more or less by gut instinct: political campaigns, health care, military campaigns, professional sports.

The obvious cause of the turmoil is the availability of ever-cheaper computing power: People looking for an edge in any business can now gather and analyze all sorts of previously unobtainable or unanalyzable data. The less obvious cause is an idea, that the data might trump the expertise of managers. People (even experts) and industries (even old ones) can make big, systematic mistakes. You don't set out to find better ways to value professional baseball players if you believe that the market already knows everything there is to know about their value.

Photo: Richard Thaler
There's now a fairly long list of intellectuals responsible for the spread of this subversive idea. Somewhere near the top is economist Richard Thaler, who has just published an odd and interesting professional memoir, "Misbehaving." It's odd because it's funnier and more personal than books by professors tend to be. It's interesting because it tells the story not just of Thaler's career but also of the field of behavioral economics - the study of actual human beings, rather than the rational optimizers of classical economic theory.

For a surprisingly long time, behavioral economics was little more than weird observations made by Richard Thaler, more or less to himself. What he calls his "first heretical thoughts" occurred while writing his graduate thesis in the 1970s. He'd set out to determine how to value a human life - so that, say, the government might decide how much to spend on some life-saving highway improvement. It sounds like a question without a clear answer but, as Thaler points out, people answer it clearly, if implicitly, when they accept money for a greater chance of dying on the job.

"Suppose I could get data on the death rates of various occupations, including dangerous ones like mining, logging and skyscraper window washing, and safer ones like farming, shop keeping and low rise window washing," Thaler recalls. "The risky jobs should pay more than the less risky ones: otherwise why would anyone do them?"

Using wage data and an actuarial table of mortality rates in those jobs, he calculated what people needed to be paid to risk their life. (The current implied value of an American life is $7 million.) Only he didn't stop there. He got distracted by a funny idea.


Additional resources 

Richard H. Thaler has spent his career studying the radical notion that the central agents in the economy are humans?predictable, error-prone individuals. Misbehaving is his arresting, frequently hilarious account of the struggle to bring an academic discipline back down to earth?and change the way we think about economics, ourselves, and our world.

Source: Milford Daily News