>> Monique Shira: Thank you for coming. My name is Monique Shira, and I'm pleased to
welcome Richard Thaler to the Microsoft Research Visiting Speaker Series. Richard is the
Charles R. Walgreen distinguished Service Professor of Economics and Behavioral Science at the
University of Chicago's Graduate School of Business where he's the director of the Center for
Decision Research. Richard codirects the behavioral economics project at the National Bureau
of Economic Research, he is considered a pioneer in the field of behavioral economics and
finance, and he has authored numerous articles and three books. Tren Griffin will be
moderating today, and as a member of the OSG Finance Team at Microsoft he blogs at 25iq and
is the author of six books including the upcoming The Complete Charlie Munger. Thank you.
>> Tren Griffin: Thanks everyone. Welcome to this talk. This is a particularly wonderful talk
from me because Richard is one of my heroes, an intellectual hero in particular because I
studied economics in college, and although it was interesting and the math was interesting and
the theory was interesting it meant very little what I knew about the real world. It just seemed
odd. But it was a fun discipline and I learned to think it was enjoyable. But then, and I don't
exactly know how or why or when this whole sort of discipline of applying psychological and
behavioral [indiscernible] to economics sort of invaded my mindset, and at that point I was
investing and involved in business and it just appealed to me because it mapped to the real
world. It was like whoa, here's something that actually things like prospect theory and many of
the biases they were consistent with what I actually believed. And then as I started to put the
two together I realized that for me behavioral economics explains why what I learned in college
was only sort of right like first order something like that.
And then the other thing I appreciate is scale as a writer. We were just talking about it, but I try
to write myself, but he tells the stories and he tells funny stories and this book is everything
that I aspire to as a writer. He's funny, he's humble, and those two aspects of a book appeal to
me tremendously. Now what I've done I've gone very old school and I have some notecards
here, for the younger people that don't know what a note card is but I have note cards. The
reason I have note cards because I've always kind of wanted to be like James Lipton on Actor
Studio, right? So at the end of the interview I'm going to ask him what his favorite cuss words
are and we're going to talk in the beginning about the title of the book. So why that title?
>> Richard Thaler: So that's a good question. I must say that the hardest part of writing a book,
and all of it’s hard, two of the hardest parts were the cover and the title. The cover, I'll tell you
an interesting story, some of you have seen the cover. Publishers have a rule which is that
authors must not speak to cover designers. There are at least four intermediaries between the
author and the cover designer. I was going through this with two publishers because it’s
simultaneously published in the UK and the US and you need a separate publisher in the UK to
add the U’s. So some of the covers they came up with were abominations. I asked them I have
a great editor who I love and helped write the book and I'm allowed to talk to him and then he
is allowed to talk to the sales team and they are allowed to talk to the art department who talks
to the cover designer.
So the first version of this cover the look of it I liked but there is a flock of birds, in the current
version you'll see there's just one missing, but in the version they had that bird was just flying in
the opposite direction. I said no, that's not it. It's not just doing the opposite of everybody
else. For months I was trying to get them to think of something else to do with that bird but it
was all like telephone tag. So finally they were so desperate, and having written a book before
I'd put in the contract I have veto power over the title and the cover, so I finally got them to put
that bird down there and I'll explain what I think that bird is doing when I answer your question.
So the title that we were going all around with variations on it, but it sort of works at three
levels. The first is, as Tren already alluded to, and I'm sure as most of you know from some
undergraduate economics course at some point in your distant past, economists study some
weird creatures, I call them Econs, that are really smart, as smart as Nathan Myhrvold, perfect
self-control, not like Nathan. Nathan is a friend of mine who's interviewing tonight, but don't
pass any nasty things on to him between now and tonight because who knows what he's going
to ask me about; so perfect self-control, no emotions, and they are basically jerks. If they've
found your wallet lying on the street they would take the money and only if it were like super
convenient would they go out of their way to return it to you.
So most of the people I know aren't like that. So misbehaving refers to the fact that most
people misbehave by economic standards. I call them humans in the book to distinguish them
from Econs. So it's a book about misbehaving in the sense that people aren't behaving the way
economists think they should. The other sense of what the title refers to is I've spent my career
pointing this out which was an act of professional misbehaving. I was the kid pointing out that
the naked Emperor and much of the book talks about the 40 year struggle to convince people
that this was a topic worth thinking about. And possibly the third level on which the title works
is, and Tren also alluded to this, this book is not written as a proper book; so it is kind of
structured as a memoir in the sense that it kind of has a bit of a chronological organization
although on my blackboard I have a map of what it is, but I mean it's sort of written as a
memoir, but it's a memoir that tries to teach you the field of behavioral economics and mostly
done by telling stories. It's supposed to be funny.
So my publisher has assured me that no one has ever written a funny substantive memoir that
has sold say in the two digits. So I didn't actually sell them this book. I sold them a book with
the title Snags. It was supposed to be like a prequel to Nudge, kind of stuff we trip on, but I
couldn't figure out how to write that book. So I wrote this book because I could figure out how
to write it and they like to something better than nothing. But they keep saying, with the head
of Norton keep saying, it's a high wire act, it's a high wire act. So anyway that's all the ways in
which misbehaving applies to this book.
>> Tren Griffin: That's great. One of the things that I admire you for or envy you before is the
fact that you get to hang out with people like Kahneman and Amos and people like that. The
thing that Kahneman, the thing that really strikes me about him is one comment he made in an
interview one time when he said I’ve been this stuff for decades and I still make the same
mistakes.
>> Richard Thaler: Yeah. I mean in thinking fast and slow he tells the story, and I got to watch
this firsthand because as I talk about in the book I really started taking this seriously when I had
a chance as a new assistant professor to go spend a year at Stanford hanging out with
Kahneman and Tversky who were then based in Israel and were visiting Stanford for a year, and
the three of us got to spend a year thinking about this stuff. I didn't know anything about
psychology, they didn't know anything about economics, so we were sort of tutoring each
other. I also got to watch them work. They were in the process of finishing the Paper Prospect
that would eventually win Kahneman the Nobel Prize and Tversky would have shared it had he
still been alive.
As Danny says in the book, they usually started with a problem that worked on them, a mistake
they found themselves making. Then they would assume that applied to everybody and try and
figure out what was going on and then they would test it just to confirm that they weren't
weirdos but they have pretty good intuitions. So one of the things I learned from them is just to
pay attention to what's going on in the world; and then the other thing I learned from them,
and there was one idea that I got from them from their early work about judgment that really
made the whole field of behavioral economics really possible, and it was the idea of predictable
bias.
So take their idea of the availability heuristic which is the idea that we judge frequency by ease
of recall. So if I ask you what's the ratio of the gun homicides to gun suicides in the US most
people think that gun homicides will be a lot bigger. It turns out there's about twice as many
gun suicides. Why do we make that mistake? Well, we read lots about gun homicides not
about gun suicides. And notice crucially that that error is systematic. If I had done a poll the
average guess of the ratio of homicides to suicides would have been three and the correct
answer was .5. So economists for a long time said yeah, yeah, we know people make mistakes
but they cancel out so life goes on. We know how to add an error term. And adding error term
doesn't work if the error terms are all in the same direction. So in a sense I've spent a life
studying predictable errors.
>> Tren Griffin: One of the things that when I think about how this whole get over or how do
you deal with these biases is how Nudge is relayed to that because in some sense is a checklist
a nudge?
>> Richard Thaler: Absolutely. All of us who are moderately functioning in society have learned
about the ways in which we need help in coping so most of us have alarm clocks if we want to
wake up on time. We make lists because we forget things. The older you get the more lists you
need. A checklist, Atul Gawande’s fantastic book the Checklist Manifesto, it’s a spectacular
book with the simplest possible idea which is that there are all kinds, as a doctor he focuses on
applications to medicine, but it's an idea that they took from pilots and your typical commercial
pilot has taken off and landed thousands of times you wouldn't think you would need a
checklist but it's precisely because he's done it 1000 times that he does need a checklist
because you can't afford to take off at one time without filling up the tank. So I have a checklist
before I take a trip because I've forgotten my passport. It's bad to forget your passport.
>> Tren Griffin: So you were with Nathan last night, you're going to see him tonight at your talk
downtown Seattle, and one of Nathan's famous speeches was called Roadkill on the
Information Highway and he made a lot of references of man with a hammer syndrome. So
let's take that sort of heuristic. How can you guard or lessen the chances that you're going to
fall for something like that?
>> Richard Thaler: It's certainly the case that there are a lot of guys with hammers out there
looking for nails or looking for anything that resembles a nail. We were talking before, this is
the end of a two week book tour and it started in New York, and I'm doing them all as
conversations just because it's more interesting for me. It started with a conversation with
Malcolm Gladwell, who insisted on psychoanalyzing me. We were on the uppery[phonetic] side
and now I've forgotten where was I going to go with this? You can see my brain is completely
fried.
>> Tren Griffin: Man with the hammer.
>> Richard Thaler: Yeah. So economists have a hammer and they want to use it all the time
and there are some places where it works and there are some places where it doesn't. In some
ways I guess Malcolm's question to me was why did I go into economics because I admit to
being not the best economist in the world. And I think what he was getting at was in part I
ended up doing this because I wasn't a great economist and I had to think of something to do.
So I wasn't as good with a hammer as most of my fellow economists so I looked for places
where you needed something other than a hammer.
>> Tren Griffin: So this building here has some of the best and most thoughtful people working
on machine learning in the world. So the intersection of machine learning and what you do you
have any general thoughts on that?
>> Richard Thaler: Well, it's [indiscernible]. I often say that over 40 years I haven't changed
anybody's mind about anything. That there's this old Mocks Plonk[phonetic] line science
marches on funeral by funeral. So the guys my age that think I'm full of shit still think I'm full of
shit but they're going to die and the ones older than me some of them already have. So my
strategy all along has been to corrupt the youth. And Sendhil was, it’s m-u-l-l-a-i-n-t-h-o-n, but
your search engine will find it. He was a student of mine at Cornell. He was an undergraduate.
He was doing economics, computer science, and math majors in three years and I noticed he
was a bright kid and so I tried to corrupt him. And it turns out right now he's trying to do
machine learning and behavioral economics. So look at some of the stuff he's doing. I would
botch it if I tried to explain it but there is that intersection and he's it.
>> Tren Griffin: So the other thing people do here is obviously write software. So can you think
of or have your experienced situations where people writing a web service of some kind have
been able to use a nudge to achieve an objective? Now the famous one of course is automatic
opt in on the 401K.
>> Richard Thaler: Well, one of my favorite nudges actually comes from Google where I was
yesterday, and I don't use Gmail but I'm almost tempted to do it precisely because of this which
is we mentioned this in Nudge, and I think it caused them to actually incorporate in Gmail, how
many people here have written an e-mail saying I have attached x and then forgotten the
attachment? So at my age you do this about once a day. In Gmail now if you use the word
attachment and don't attach something you’ll get a message, did you forget the attachment?
>>: [inaudible].
>> Richard Thaler: That's what Nathan tells me about everything. So anyway, there are good
and bad nudges. So automatic enrollment in pension plans is something that it's probably the
most important influence behavioral economics has had on the world is to change the way
401K plans are organized. So it used to be that the standard procedure was you get a pile of
forms to fill out, if you don't fill them out you're not in. We convinced companies to try
switching the default to if you don't fill out this pile of forms you're in. That ups enrollments in
the first company that a colleague of mine, Bridget Majorin[phonetic], studied. Employees
within the first year were signing up at 49 percent and it went to 86 percent. This is a standard
thing that economists would say would have no effect. I call them in the book supposedly
irrelevant factors. So the default is a supposedly irrelevant factor that matters a lot.
The other thing we did was, along with one of my students, we invented something we call save
more tomorrow. So you ask people whether they would want to agree to increase their 401K
contribution later because we all have more self-control in the future. Personally I'm planning
to die after the book tour, well after. So lots of people who say I can't afford to increase their
savings right now can do it later. But whenever anybody asks me to sign a copy of Nudge I
always sign it nudge for good because it's very easy to manage for evil or certainly nudge not
for the good of the person that is responding. So one of the first reviews of this book appeared
in a publication based in the London. That’s all I’ll say about it. It had a paywall as the most evil
paywall I've seen yet and this was the first review so you can imagine I was anxious.
>>: [inaudible].
>> Richard Thaler: So my editor sends me a link to this and I see the first paragraph
[indiscernible] damn paywall. So there's a place you can sign up for a one month subscription
for one pound. Now I wrote the book so I'm going to read the fine print on this and you can
quit after, if you don't quit you are automatically enrolled at 27 quid a month which is about
1000 dollars at current exchange rates, and to quit you have to give them 15 days’ notice. 15
days’ notice and I don't even want to think about what hoops you have, you probably have to
call between 1 and 2 PM and hope there's somebody there to answer the phone. So there was
no way I was going past that paywall. I got somebody else. My editor said he would do it and
he's poor and he'll remember to unsubscribe an hour later.
So I think business firms, like if you guys invented the attachment reminder God bless you. We
can all think of ways of making products easier to use. David Cameron's government in the UK
read Nudge and created a tiny unit of government called the Behavioral Insights Team. It
started out as five people with me as an unpaid advisor. It's now grown to 50, and when I first
started working with them we'd go and have a meeting with some minister and I found myself
repeating the same phrase so often this became known as the team mantra. The phrase is
make it easy. If you want to get somebody to do something make it easy. Now that sounds
blatantly obvious. But most truth once you hear it is blatantly obvious and so many, automatic
enrollment, that's a great example of making it easy. So many times we see people failing to do
something that's in their best interest and we can solve the problem by making it easy. One of
the ways we can do that now is through technology.
Let's just to take one domain: health. We're sending one out of six dollars in this country on
health care. There are lots of reasons for that, and a lot of it has to do with the healthcare
delivery system, but a lot of it has to do with we as a society don't take a care of ourselves as
well as we could. Most of us would like to be healthier and things like Fitbit technology. It's not
even 1.0 it’s such a primitive technology, but it's clear that that's the tip of a very big iceberg.
And I think the people who harness that technology in ways that I can't possibly imagine any
more than I can imagine having a computer into my pocket 15 years ago I think will change the
world and make the world a healthier place. So you guys can all play a role in that.
>> Tren Griffin: So let's change the subject a little bit. Let's talk about the academy and cross
disciplinary work. So one of the things that’s so beautiful about your work is the fact that
you've dabbled in multiple domains and you're probably wandering around the campus dealing
with different departments and that's probably not encouraged in places like the faculty club. I
know that. So what's the importance of multiple disciplinary thinking and research and how
has that benefited you?
>> Richard Thaler: I will say, so I haven't done as much of that as it might seem and I've found it
to be extraordinarily difficult. One of the things I talk about in the book is something that the
way that field has emerged was a complete surprise to Amos, Danny, and me 40 years ago. And
the surprising thing is that it’s a field done almost exclusively by economists. There are half a
dozen psychologists that have made contributions, they're all friends of mine, I mean it’s just a
tiny group and it didn't start out that way.
So one of the first meetings we organized was a little meeting in New York where we had six of
the greatest psychologists on earth. Think about the dream team of psychology. We had them
in one room. And Amos and Danny were two of them but Leon Festinger, who invented
cognitive dissonance, and other people that you probably wouldn't know but were household
names at the time. And we thought because Amos, Danny and I are working together that
that's the way the field would be. That hasn't been true. I think one of the reasons is that the
entry barriers to economics are so high that it's very hard for psychologists to enter. You can
do collaborations but even that psychologists don't get rewarded for co-authoring papers with
economists that get published in economics journals and economists don't get rewarded for
publishing papers in psychology journals and so pretty much of the fields are separate.
It may be that in places like this there's more room for true interdisciplinary research than
there is in the academy because the academy doesn't really reward it and doesn't facilitate it.
It's hard at a large research university to know people outside of your own department. I had a
colleague in the law school that I wrote a book with, I'm in the business school, I know people
in the economics department. Highly interdisciplinary of me. I know a few people in the psych
department and that's about it. So there are a couple thousand faculty members and I've may
know 10 that aren't right in my inner circle and I’m an interdisciplinary guy. I mean it's a
problem and there's no easy solution. Again, it may be that places like this, places like the old
Bell Labs, are where it can happen better than at a university because the output is something
real, rather than a journal article and the professional goals are something other than getting
tenure in a particular department.
>> Tren Griffin: Well, we have a situation in the field where people bring a certain biases,
political biases as well as disciplinary biases, so we had a funny conversation before we started.
He said well, people think that I'm a Communist so I should sit on the left seat.
>> Richard Thaler: No, no. I should sit in the seat that you will see as the right. You see, Tren,
you have to think about this>> Tren Griffin: I got it wrong, but it's sort of like this nudge thing with 401Ks which is if you
don't do anything you’re just nudging the other direction so to me there's no political judgment
in making that>> Richard Thaler: I mean you probably know this completely drives me crazy that how many
times I've heard that Cass and I are meddlers and in our book Nudge it must take us until page 4
to address this question. And we start with a description of a cafeteria and we say suppose that
the head of Seattle school districts has done research that shows that the order in which the
food is displayed influences what the kids eat. What should she do with that information? We
suggest maybe putting the healthier food in more salient locations. The cafeteria in the Booth
School of Business where I work you have to walk by the salad bar to get into the burgers and
that's good.
Now people think we're meddlers. I say how would you do it? Should we have the salad bar all
in one place or should we scatter it around the cafeteria so the lettuce is there, tomatoes there,
olive oil here, vinegar there. This is a catastrophe. So we describe the tools we use to nudge as
choice architecture, and like architecture there is no neutral choice architecture anymore then
there's neutral architecture. Any building has features because it has to have doors and
windows and stairwells and elevators and bathrooms all of those things influence where people
go.
There's a colleague of mine at Booth when she chose her office she chose one near the
bathrooms not because she goes to the bathroom a lot but because she's social and she knew
that everybody would be walking by her office a couple times a day. So you can't have neutral
choice architecture. So if you're going to have a pension plan you’ve got to decide what is the
default? What's going to happen if people do nothing?
The same is true for, you must have an open enrollment period for benefits in November.
Somebody has to decide what happens if you don't go onto the website and I'll tell you a funny
story. It used to be at Chicago we have a supplemental retirement plan and the default setting
was that if you do nothing it goes back to zero. Almost all the defaults are one of two types:
same as last year or back to zero. Fortunately we don't have healthcare back to zero or a third
of the faculty would have no healthcare but the supplemental retirement was back in to zero.
So I had set up a meeting with the president, the provost, and the CFO to talk to them about
this, and by pure coincidence and luck it happened to be the last day you could go on to this
website and open enroll. I mentioned that. Isn't it funny we're having this discussion this day?
The president says oh, really? It's today? And then the provost says my wife is going to do it.
And then the CFO says I'm doing it right as soon as I leave the room. Now I had them eating out
of my hands and we switched the default for the supplemental retirement to the same as last
year and I think I have many colleagues who have probably 100,000 dollars more in retirement
savings than they would have had had we not had that meeting on that particular day.
>> Tren Griffin: So I'm going to ask one more question here and then we're going to have
questions from the audience in here so if you want to get ready to do your question I'll ask one
more here and then maybe you can go to the microphone here. But I want to ask this question,
again changing the subject about writing a book and the process of writing a book. Now we
have such smart people in this audience and they've probably written lots of papers but if you
take someone out here who is maybe always thought about writing a book what can you say
about the process and its rewards and can you nudge them in the right direction about whether
they should or they shouldn't?
>> Richard Thaler: Don't do it. Let me give you some useful advice which is if you are as
disorganized as I am the most important thing I did in finishing this book was there was a
student of mine who was finishing up her MBA and was super smart. We were trying to recruit
her into the PhD program, she said no she wants to be a consultant, but she was my teaching
assistant and whipped me into shape, my classes, and I asked her if she would help me finish
the book and she was basically my project manager. In the acknowledgments you'll see that I
say that I don't think I could have ever finished this book without her and then I have in
parentheses neither does she. So get some help. I also hired a guy, there are beautiful figures
in this book, I hired a guy who works for the New York Times who draws those fantastic data
visualizations that they use. So get help. So let's open it up to the crowd. Don't be shy.
>> Tren Griffin: Any questions? Let me fill here while maybe someone’s walking up.
>> Richard Thaler: No, no. Walk up. Otherwise he'll filibuster.
>>: So you said an underlying reason why humans need to be nudged is there something built
into us that's lazy?
>> Richard Thaler: Yeah. It's interesting you use that word. The book starts with the following
story that I'm sitting in the living room of my good friend Daniel Kahneman and he says, damn, I
forgot. I have an appointment with a reporter today who's writing a story about you and he
wants to talk to me. What should we do? So I thought about going to another room or taking a
walk. He said no, stick around it could be amusing, just keep quiet. So I said okay, fine. So he's
there talking and I pick up a magazine to read or something. And then I hear him saying to the
reporter the best thing about Thaler, what really makes him special, is that he’s lazy. So I'm
going like this and I say Danny, ok, I’m lazy. I admit I'm lazy. But is it my best feature? Can’t
you think of anything else? So he claims, he defends this to this day, I saw him last week and
this story came up and he insists that this is true, so his argument is that because I'm lazy I only
work on things that are sufficiently interesting to overcome my natural tendency to sloth.
Whether that's a compliment or not I don't know but all of the things we need nudges for are
because of the way we're hardwired. I mean, I'm not really into evolutionary psychology
because I'm not sure unless we get a, maybe Nathan will invent a time machine but otherwise I
don't know how to test anything, but there are certain things that are obviously true which is
for almost all of the time we've been on Earth a good rule of thumb is eat everything you can
any chance you get and that served us well until about 100 years ago and it got really bad about
50 years ago. So we need not just because it didn't used to be that you could walk out your
door and be confronted with lots of cheap fattening food. You had to hunt and gather for it.
We all have our strengths and weaknesses and figuring out what you're good at and what
you're bad at, like I said before I became a behavioral economist because you think I'm just
being self-deprecating; my thesis advisor, in that same article that was written by, the author
was Roger Lowenstein the guy who wrote the book When Genius Failed, about the fall of LTCM,
he was writing the article that Danny Kahneman was talking about. He also talked my thesis
advisor who said of Thaler, as a graduate student we didn't expect much of him. It's always
good to have your advisor supporting you and so you’ve got to find something you're good at
and then cover your weaknesses. Yeah?
>>: I'm super happy to hear you talk and I myself have discovered a lot about behavioral
economics in the last couple of years about thinking first [inaudible] and I just learned there’s
something relatively, I mean you having working the last 40 years in this. Now looking at the
state of the field what are the areas that you feel excited about or the questions that you would
like to keep working on and this is something really that excites me and moves me?
>> Richard Thaler: Well, at the end of the book I say that my hope is that the field turns to
macro. So I mentioned we were surprised that the field didn't turn out to be interdisciplinary.
Another big surprise was of all the sub-disciplines of economics the domain in which behavioral
economics has had its biggest success is the one that seemed least likely 30 years ago and that’s
finance. And it seemed least likely because economists knew that markets are efficient.
Michael Jensen, who has a several cameo appearances in this book, wrote a sentence saying
the efficient market hypothesis is the best established fact in social science. So obviously we
weren't going to find any misbehaving there. But we did and it's worthwhile asking why. The
reason was A, amazingly good data. Daily stock price data going back in 1926 and then zillions
of countries, right? So amazing data. And second, very precise testable predictions like you
cannot predict the future.
Well, great data and precise predictions that happen to be false is a recipe for success. Macro,
unfortunately, has a paucity of data and I say that because there's zillions of numbers but there
are a countable number of recessions and maybe two financial crises in the US so basically no
know well-specified testable hypothesis. So there are even colleagues of mine who don't think
the Great Depression is a counter example of the basic principles of economics where this was
a decade of 20 percent plus unemployment. Prices are supposed to adjust, right? So if that's
not an embarrassment, what is? So I think it's harder because it's harder to prove. We've had
to have in your face counter examples and it's harder to do that in macro, but I think the field
now is sufficiently established that there are people who will be able to do behavioral macro
and I hope they do.
Another very exciting field is behavioral public policy. If you want a great introduction into
where the field is headed Tren mentioned I'm president of the American Economic Association
which meant I organized their annual meeting last year. You get to pick one person to give a
big named lecture and I picked a 35-year-old kid, part of my corrupt the youth movement,
named Raj Chetty, C-h-e-t-t-y. You can watch his lecture on the AEA website or read his paper
that’s just recently been published and that's a great place to see where the field is going. Give
me 10 more Raj Chettys and we'll be off and running.
>>: I think you've been covering what I was going to ask about already in your most recent
remarks, but I've got some friends that have virtually no economics background but have paid
attention to the behavioral economics literature and especially to things like our persistent
cognitive biases and ways in which as an individual we want to hold onto something for a price
that's rather higher than the market would give you and you want to buy for much less. How is
it that the actual aggregate effect of the efficient market hypothesis arises out of our individual
wants to keep on with what we have self or more than it’s worth? I'm curious. My friends will
say that they don't really believe in this but the economics has still had an incredible predictive
power and people do behave like you see in the scissors[phonetic] of the supply and demand
graphs. Where does that come from?
>> Richard Thaler: So part of that comes from it turns out economists are easy graders when it
comes to grading themselves. So one of my former colleagues, or soon-to-be former
colleagues, John Cochran, has written an absurd blog post. If you think I'm making up the views
of some of my critics just go look at that blog post. Tren can point you to it if you have trouble
finding it. He has in there the following sentence that it's still the case that if the price of
tomatoes goes up people buy less tomatoes. Now in 1961 Gary Becker, my colleague who just
died last year, one of the great economists of the 20th century, in a sense somebody just doing
the opposite of me, but he wrote a paper, I think he came to regret it because I cited it so often,
but he wrote a paper showing that if people choose at random but have limited resources then
demand curves slope down. So the fact that people buy less tomatoes when the price goes up
would follow if we were choosing at random.
So I have a PhD course in behavioral economics that I teach with a couple of my colleagues
and I started every year with an assignment for day one which is to bring in the best empirical
evidence supporting the hypothesis that people optimize. I've yet to have a satisfactory test of
that shown to me because there aren't any. So yeah, demand curves slope down. Fine. But we
don't need people optimizing for that to be true. Now when it comes to the efficient market
hypothesis I like to describe the two components of it that I call the no free lunch component
and the price is right component. The no free lunch component is that you can't beat the
market and that I say is approximately true.
I'm a principal in an active money management firm called Fuller and Taylor so we think we can
beat the market, and we've been around for more than 20 years so there's some evidence to
suggest we can; but not by a huge amount maybe three or four percent a year, not every year,
we've had some terrible years. I think that's where we are. It's not impossible but really hard,
and if you assume it's impossible and put all of your money in index funds it’s not a bad strategy
at all.
Now as far as the price is right component, fail. Just look at what we've seen in the last 30
years. In 1987 the market crashes worldwide 20 percent on a day with no news whatsoever
other than the fact that prices are crashing. Then we had the tech bubble where the NASDAQ
went to 5000 and fell to 1500. It surely wasn't because the Internet turned out to be a
disappointment, right? In fact the Internet has been shockingly, I mentioned before who would
have thought we'd all have powerful computers in our pockets? We never would have
dreamed that in 2000. So it’s not been a disappointment but the price seemed to be off by a
factor of three. That's pretty big. And then we’ve had the real estate crisis that led to real
estate bubble that led to a gigantic worldwide financial crisis. So prices can be very wrong and
it can be hard to test that.
I'll give you one amusing recent illustration of how to test the price is right component. There is
a closed-end mutual fund, let me explain in one sentence what a closed-end mutual fund is.
Most mutual funds you send them money and they invest it and you buy what they own at the
value of those securities what's called net asset value, and then when you want your money
back they sell those securities and give you back your money. In a closed-end fund they raise a
certain amount of money and then the shares of the fund trade and they can trade for a price
above or below net asset value which in and of itself is an embarrassment to the efficient
market hypothesis, one first pointed out by Benjamin Graham in the 1930s.
Now there's a closed-end mutual fund that happens to have the ticker symbol CUBA. Needless
to say it does not invest in Cuba. A, that's against the law, B, there's nothing to invest in.
Maybe some cigar factories. So four years this is trading at a 15 percent discount. The day
President Obama makes his announcement it goes to a 70 percent premium. So on Monday
you could buy 100 dollars’ worth of assets for 85 dollars, on Tuesday, 170 dollars. Is that an
efficient market? I don't think so.
>>: Hi. So you keep talking about like how you're trying to corrupt the youth, and I guess I
would consider myself a corrupted youth although I have to say I've never read any of your
books.
>> Richard Thaler: There's competition for in the corrupting the youth.
>>: That's true. So I'm a recent graduate in economics and I didn't study it because I was good
at it or because I even really liked it; I just needed to pick something. I don't know. While I was
studying it I was sort of like I worked really hard in the intro classes and I got the grades and
stuff but I was sort of like I don't know. I should have done psychology. Like that's really what I
wanted to do and I didn't really know that there was so much, there were these people that
were sort of doing both at once. I was like so I've gone this far in Econ I should probably just
finish. And while I was studying I read a book called the Righteous Mind by Jonathan Haidt
which was by far the most influential book I've ever read. And basically one of the main points
of that book is that we think that we sort of reason our way to the truth but really most of our
judgments are intuitive and then we make up reasons to support the intuition. And I thought, I
was basically convinced that if that's true then economics is about we do optimization
problems in our head and then arrive at something. I was like I think Jonathan Haidt is right and
if he's right then none of what I'm learning in my classes makes sense. But if I change majors I'll
be in college for even a more extra time and I don't want to drop out and I was just like, so
anyways I finished, just finished. I don't work here.
>> Tren Griffin: So what's your question?
>>: My question is one, do you sort of think that economics has to sort of admit that humans
are just animals and we sort of, we think we are smart because the only tool we have to analyze
our intelligence is our intelligence? And also what advice would you have for me?
>> Richard Thaler: My advice is I will buy you a copy of my book.
>>: I already bought one.
>> Richard Thaler: Read it.
>>: Okay.
>> Richard Thaler: Next question.
>>: So it's probably a little bit of a plug to your next book, to an upcoming. It’s just a question
that interests me.
>> Richard Thaler: In your book.
>>: No, no, no. You have been observing the field for a long, long time and Charlie Munger has
come up with his own list of biases. Who is watching who here?
>> Richard Thaler: Charlie Munger has been an observer of this field for a long time. I met him
probably 25 years ago. He once wrote something congratulating the University of Chicago for
being willing to hire a renegade like me. I think we think along similar lines. He and Buffett are
smart enough to have intuited a lot of these things, and a lot of behavioral economics is just
common sense, and when you are as smart as they are and you have a lot of common sense
then you can kind of intuit much of what we've done. So we're fellow travelers. I think they
should give me 10 percent of their wealth. So far they haven't, but I can always hope.
Tren Griffin: Let's have one more question and then we'll give time to sign books.
>>: I took your managerial decision making class at Chicago and you did use a lot of sports to
teach the concepts. One of the things I remember clearly was in the NFL going for two-point
conversion. How is that thinking going to change with them talking about extending the link of
the extra point?
>> Richard Thaler: Actually I don't think we talked about the two-point conversion. So there is
a chapter about football in this book. It's about the NFL draft. We don't have time to go into it.
I will say that I, probably what you're remembering is I talked about going forward on fourth
down and there's a paper written by David Romer, an economist at Berkeley, it was published
nearly 20 years ago, showing that teams don't go for a fourth down nearly enough. A good rule
of thumb is if it's fourth and one go for it anywhere on the field. If it's fourth and goal on the
one going for it gives you an expected 1.5 points more than kicking a field goal.
>> Tren Griffin: What about passing in that situation? Asking for a friend.
>> Richard Thaler: I will say, in the coach’s defense, there are mixed strategy equilibria. That
was not that situation. So the point I was going to make is, and I've worked with three different
NFL teams over the last decade or so, and here's kind of a sad fact and I suspect it's true in the
domains other than sports, so Romer wrote this paper, the paper has been replicated and
extended and refined and no one in the sports analytics community questions his results; and I
think he understates the case because he leaves out the fact that if you know you're going to go
for it on fourth down you have more options on third down. But here's the fact. If you plot
frequency of going for it on fourth and one over the last 20 years it's a flat line. Nothing.
Nothing.
And the same is true for our NFL draft paper where we say teams should be trading down. The
Redskins gave away a lifetime supply of first-round draft picks to get RG3 where they could
have had that other guy who made a bad pass in the Super Bowl but has gone to two super
Bowls which is two more than RG3; and one of the reasons why the Seahawks have been so
good the last three years is they have a cheap quarterback. The patriots had the same thing the
first few years of the Brady year because he was the 199th pick. When you have a quarterback
that you're paying 1 million a year and other teams are paying Joe Flacco over 20 million a year
that gives you 19 million a year to build the best defense in the league. So the bad news is you
guys are going to have to re-sign Russell Wilson and that major defense isn't going to be as
good. But there is some sports in the book. There’s also some game shows that I think we
probably need to let you guys go back and push some frontiers.
>> Tren Griffin: And buy some books.
>> Richard Thaler: And buy some books. Thanks a lot.
.