Tuesday, February 2, 2016

Interview with Richard Thaler: More on Behavioral Economics

James Guszcza has a lively interview with Richard Thaler in the Deloitte Review (Issue 18, published January 26, 2016). Last week I offered a link to video and slides from Thaler's Presidential Address to the American Economic Association in early January on the subject of "Behavioral Economics: Past, Present and Future." The interview covers the same broad subject, but in a more free-flowing way. Here are a few of Thaler's comments.

On life among the Econ: 
"Economists assume that the people they study, so called homo economicus, or what I call Econs, are really smart. They know as much economics as the best economist. They make perfect forecasts, have no self-control problems and are complete jerks. They’ll steal your money if they can and get away with it. Most of the people I meet don’t have any of those qualities. They have trouble balancing their checkbook without a spreadsheet. They eat too much and save too little. But nevertheless they’ll leave a tip at a restaurant even if they don’t plan to go back. So for the last four decades I’ve been pleading with economists that we should be studying Humans, not these mythical Econ creatures." 
(The description of economists as a tribe of Econ traces back to a very funny satire written in 1973 by an economist named Axel Leijonhufvud, called "Life Among the Econ," which was published in what was then called the Western Economic Journal, now known as Economic Inquiry (Septermber 1973, 11:3, pp. 327-337). The opening lines are: "The Econ tribe occupies a vast territory in the far North. Their land appears bleak and dismal to the outsider, and travelling through it makes for rough sledding; but the Econ, through a long period of adaptation, have learned to wrest a living of sorts from it. They are not without some genuine and sometimes even fierce attachment to their ancestral grounds, and their young are brought up to feel contempt for the softer living in the warmer lands of their neighbours. such as the Polscis and the Sociogs." Now back to Thaler.)

On whether financial markets are efficient:
"The efficient market hypothesis has two components that I call the “no free lunch” component and the “price is right.” The no-free-lunch component says you can’t beat the market. And I would say that component of the hypothesis is at least approximately true. Most active managers fail to beat their passive benchmarks. The active management industry as a whole doesn’t really provide much in the way of value. I say that as a principal in an active money management firm where we do think we provide value. But the industry we belong to as a whole doesn’t seem to. So I think that part is reasonably true. And nobody’s ever really been hurt by assuming that they can’t beat the market. Certainly individual investors would probably be better off if they believed that.
"The more important part is the “price is right” component, which is saying that asset prices are equal to the true intrinsic value. ... But there are these little cases where we can see “misbehaving” up close and personal. Here’s a current one involving a closed-end mutual fund. I should say a closed-end mutual fund is a kind of mutual fund where the managers collect a pot of money and invest it and then the shares in the fund are traded and the prices of the fund can diverge from the value of the assets that they own. ...  One of these closed-end funds happens to have the ticker symbol CUBA. Now, in spite of having the CUBA ticker symbol, it of course has never invested in Cuba, which would be illegal. And even if it weren’t illegal, there are no securities to buy. So it really has nothing to do with Cuba. For years it was selling for about a 10 or 15 percent discount. The day that President Obama announced his intention to relax relations with Cuba, it went to a 70 percent premium. And it’s now selling for about a 40 percent premium. If anybody can explain to me why that’s rational and what it would have to do with the possible relaxation of relations with Cuba, let me know."
Fairness and long-term profit maximization
"It seems clear to me that firms have lots of social responsibilities that are perfectly consistent with profit maximization if they care about the long run. ... Here’s an example ...The morning after a blizzard, a hardware store that has been selling snow shovels for $15 raises the price to $20. Is that fair? People hate it. Now I asked my MBA students that question and most of them thought it was just fine. After all, that was the correct answer in a different course, right? In their microeconomics class, they would say there’s a fixed supply, demand shifts to the right, and the price goes up. Now what do real firms do? ... Home Depot . . . whoever else is doing this, they want to be around for the long run. And if they double the price of plywood the day after a hurricane, good luck getting people to come in and buy all the stuff they’re going to need to remodel their house. So firms that act responsibly are going to have loyal customers over the long run. And that just makes sense. And so maximize profits, sure, but make sure you’re maximizing  profits over the long run, not over a week."
Nudging for good or evil
"In the book Nudge we coined the term “choice architecture.” The idea is you can design the environment in which people choose to help them make better decisions. ... Now, that said, whenever anybody asks me to sign a copy of Nudge I always write “nudge for good.” And that’s a plea, not an expectation. Firms can nudge for good or for evil."
Rationality May Need Some Nudging
"Keep in mind that I am still an economist at heart. I would like markets to be more efficient. ... I’m a believer in rational behavior as a goal. I just don’t think people are very good at it on their own, so we should help if we can."