Capitalisn’t: Nobel Economist Reveals Why Economic Models Keep Failing Us

(audience clapping)

Bethany McLean: So thank you all for being here for this very special live episode of Capital Isn’t, as our regular listeners know, well, for those of you who aren’t regular listeners, first of all, you should become a regular listener. For our regular listeners know that Luigi and I explore what’s working in capitalism and what isn’t. We’re both interested in this topic because I’m a long time business journalist, and Luigi is of course an economist. But we’re also interested because economic systems don’t exist independently of political systems and vice versa, or said differently throughout history when economic systems don’t work, political upheaval has often followed.

Luigi Zingales: Indeed, and there is a profound relationship between our economic system and our political system. One of the question we keep returning to is how capitalists relate to democracy. In other words, while our podcast is narrowly about economics, it’s broadly about much more than that and the times are where we are now, this is really an important question.

Bethany McLean: So yes, the study of economics is critical to understanding our world, and this said by a journalist who should I confess, this has never taken an econ course and has also become critical to trying to manage it. As economists have infiltrated, sorry Luigi. As economists have become part of the machinery of how decisions are made, but is the study of economics itself flawed?

Luigi Zingales: Much of the economic thinking has been predicted, predicated, sorry, on the belief that humans are rational actors and as our guest calls them, econs, as Richard describes in his intellectual memoir, “Misbehaving”, I think the title is very appropriate and the description of his life. The field he entered as a graduate student in the 1970s was founded on the belief that actors apply unbounded computational abilities to all available information in order to make optimal decision based on a stable set of preferences. Consideration of fairness don’t come into play in economic decisions and inertia and short term distractions never compromise the pursuit of long-term goals. He was one of the first people to challenge this way of thinking, to view economic behavior as an internal struggle among multiple cells with conflicting preferences.

Bethany McLean: This probably sounds instinctively right to most people in this audience. Of course, people are complicated. Our own Matt Lucky wrote in his research brief that the image that lodged in his mind for reading much of the Richard’s book, the Winner’s Curse was Plato’s description of minds as a menagerie of creatures contesting for dominance. Or as Richard has put it to Whit, there cannot be a unified theory of how minds work because unified minds do not exist in practice. And yet, despite how right this may seem, you’ve argued that the impact of your work has been more limited than it should be. That quote, mainstream economic textbooks remain firmly anchored in the standard neoclassical framework. And that when behavioral economics does sneak its way into economics textbooks, they report it most often contained in its own chapter as this annex of curiosities that is apart from the larger narrative, which raises the big question, how flawed is this whole endeavor of using economics to understand and to predict our world. So without further ado, here’s Richard Thaler.

Richard Thaler: I’d like to stop so you know, you know, I will make my first complaint, which is I did not use the word should.

Bethany McLean: Okay.

Richard Thaler: I said that in spite of, when we get to the end of the book, we say, there was no revolution and textbooks are pretty much the same as they were 30 years ago when I wrote the first version of this book. The profession is different.

Luigi Zingales: I think even the textbook, that’s coming. But anyway, I wanna start from the beginning.

Richard Thaler: I just was complaining about should.

Bethany McLean: You can complain all you want, that’s how this works. (person laughing)

Luigi Zingales: But I wanna start from the beginning because now you are at the peak of the profession and everybody sees you as this God, but.

Richard Thaler: Not everyone.

Luigi Zingales: At the beginning, wasn’t like that. And of course I wasn’t there at the beginning, but I heard stories and I would like you to share some of these stories. You were a graduate student at Rochester at the time where Rochester was the place to be. Mike Jensen just arrived and it was a very active place. Robert Barer was there, there a lot of, it was a very active place and you were hired as an assistant professor in the same place where you did your PhD, which meant you are remarkably good because at the time there wasn’t that that common. But then what happened? How did you choose to misbehave?

Richard Thaler: Well, so now I need to correct you. (person laughing) I was hired at the place where I got my PhD because when I went on the job market, I didn’t get a job and didn’t get an academic job that I liked. And I took a job at a consulting firm and a week before I was supposed to start, they decided to close the Washington branch of that firm and let me know that there was no job. And so my PhD was from the economics department, but I had taught over in the business school and they knew me and took pity on me. And so off offered me a job teaching cost benefit analysis over in the business school.

Luigi Zingales: No, but elaborate, but okay, that’s the beginning.

Richard Thaler: I remember, but there’s a famous quote from my advisor, Sherwin Rosen, who was a Chicago PhD and came back here that he said about me in the New York Times, that when I was a graduate student, they didn’t expect much of me.

Bethany McLean: Famous last words.

Richard Thaler: When your advisor is with you, you know, you can do anything.

Bethany McLean: So you’ve talked about this breakthrough moment that you had when you read Daniel Kahneman and Amos Tversky because they provided evidence that people’s departures from economic rationality are not just random quote, dumb stuff people do, but the result of systematic and therefore maybe predictable features of human psychology. Can you tell us more about this moment and what it meant, or if we got that wrong too?

Richard Thaler: No, no, very good. You know, yes. So there was, I went, Sherwin, my advisor and I went to a conference out in Monterey and I met one of Kahneman and Tversky’s students at this conference on the value of saving lives, which was what my thesis was about. And he told me, oh, you know, you might be interested in the research my advisors do. I had never heard of them, which was true of most economists in the 70s. And I went back home and students, you won’t know this part, that what you would have to do is go to a building called a library. And then I had to do exploring because I had to find the psychology section where I had never been. And then I found these articles that had written and it was like my hands were shaking. And so the insight was, yes, I had a list of dumb stuff people do, but Amos and Danny had this big idea, and the big idea was systematic bias. And what that means is that the mistakes that people make are predictable because if they’re random, then economists just wanna add that to the error term and then they can run their regressions. And it’s like people never, it’s back to the good old days where people don’t matter. So I read those papers and wrote a letter on a piece of paper, you know, all right, I’ll get off that. And I got a letter back from Amos and I learned that they were going to be at Stanford a year later. They were living in Jerusalem at the time, at the Hebrew University. And so I kind of made it my business to be at Stanford. And as I say, I stalked them and spent a year with them at Stanford that them teaching me psychology and me teaching them economics. There’s a pic old picture of Danny with Samuelson’s principals book in the background. So yeah, that’s where it all started. 1977, 78 in the hills up above Stanford.

Luigi Zingales: But you took a big gamble because interdisciplinary research is never easy and you took like the risk of doing it. But then in your book you say, even now, interdisciplinary research is still not easy. And there are now a lot of economists who use psychology and some psychologists use economics, but it’s very difficult to see a lot of collaboration across fields. And you know, we can say up to tenure, there is this business of tenure and publish a parish and you have to publish in a journal, blah, blah, blah. But thank God life is also after tenure and after tenure, you can do whatever you want. Why there so much resistance to that even today?

Richard Thaler: So I don’t know that there’s resistance. It’s just hard. So yeah, I mentioned in this book that Amos, Danny and I, if you asked us in the early 80s, suppose this field takes off, which we never thought it would, but suppose it did. How will it happen? We thought it would be collaborations between psychologists and economists. This, this was the availability heuristic. We thought that because that’s what we were doing. And in those early days, the stars of psychology were interested in doing it. We had a conference in New York at the Russell Sage Foundation, and you know, Walter Michel and Stanley Shachter and Leon Festinger, I mean these are the giants, this is Michael Jordan. And right that, you know, around a room we could get half a dozen of the greatest psychologists of the time interested. And one of them, Stanley Actor, tried writing a paper for the Journal of Finance and they just laughed at him. And basically it never happened. So I wrote papers with Amos and Danny, there are a couple psychologists, Elda Shafi at Princeton and at MIT, there are less than 10 psychologists that have written economics papers and there’s no reward in it for them. And to put it in economic, the entry barriers are really high. So there are some collaborations, but it’s a hard, you know, it would be like for us trying to write a paper in physics or engineering, we wouldn’t know how to do it. It might be an interesting collaboration, but it doesn’t really happen.

Luigi Zingales: Yeah, but so some of this bio to entry, they seem to be about jargon or who society, they’re not. In physics, the bio to entry is, I don’t nothing about physics, okay, but when it comes to psychology, economics, I tried to write a paper in psychology, I was rejected with insults from a journal and I decided it was not worth sort of fighting.

Richard Thaler: You know how many psychology papers I’ve published in my career? One, exactly one. The Journal of JPSB, Journal of Personality and Social Psychology, but I wrote it with three psychologists, you know, so including Jane Risen, one of our colleagues, and Tom Gilovich, a life long friend. So yes, it’s hard. And writing a psychology journal article is as hard as writing a physics article if you don’t know the language they wanna use and the methods. And so it doesn’t happen. I don’t know whether there are other branches of science. Some of the hard sciences overlap enough, so biology and medicine but basically we’re in silos. And look, it’s not even easy for a labor economist to write a Journal of Finance article, right? You, you better find a finance PhD student, which is how I started writing finance articles because I had a PhD student who wanted to do that. Young Belgian wearing a debunk, and he was well trained. And so we could produce, you know, in finance, you even have to make the tables in a certain way. And if they’re not done in that way, they’re gonna just send it back to you don’t know anything. So it’s hard, it doesn’t happen.

Bethany McLean: Can we back up one step from why it won’t change to how it got that way in the first place? In other words, if it seems obvious to everybody that people aren’t 100 percent rational economic actors, why did the field of economics decide that they were?

Richard Thaler: Okay, that’s a great question. And I will say, this wasn’t the case before World War II. So if you read Adam Smith, let’s say economics starts in 1776 with the Wealth of Nations. Adam Smith talks about overconfidence, he talks about self-control problems, he talks about fairness. You know, it’s all in Adam Smith when George Stigler was, he was alive when I came, and he used to say it’s all in Adam Smith. And that’s true of behavioral economics, it was all in there. I think the idea of the optimizing agent kind of got carried away, starting with the process of economics becoming mathematical form mathematically formalized. So Paul Samuelson, Ken Arrow, the people who took over the profession, those two could have won the first 10 Nobel prizes if they had been giving them out appropriately. So there was a lot of work to do. And if you’re gonna write down a formal model, the easiest one to write down is of people choosing optimally. I mean, think about a simple task of you have a rectangle and I tell you the dimensions, and now we’re going to guess what will people think is the area, well, a really easy thing to do is to multiply the hype by the width, right? That’s a model even I can write down. Now it might be, no data on this. It might be that people have, width aversion, that the estimate they’ll give will overweight the height versus the width. I’m making all that up, right? But you can see that that model is getting more complicated. So people started writing down these formal models, and then a weird thing happened, which is like in the 70s and 80s, the agents in economic models kept getting smarter. I mean, they started out outsmart, right? Perfectly smart. But then somebody like Robert Barrow would come along and think of, oh, here’s a way that people could be even smarter. So instead of reacting to some tax change in the best possible way for you, well, you might also take into consideration your kids and their kids, right? No one in the history of the world had ever had that thought until Robert Bauer wrote it down in a model. And now it’s a model of everyone, right? And the norm, I would say in this period of the eighties and nineties was, my model is better than your model if my agents are smarter than your agents. And so that’s like when you came into the world, Luigi, in the 90s, that was the world and it was very heavily represented in our economics department. And you know, I think, and that’s kind of the world in which there was an opening for people like me because look, people try to optimize. I don’t say they don’t, it’s hard, you know, I mean, think of the model of saving for retirement. All you have to do is estimate how much you’re gonna earn over the rest of your lifetime, how long you’re gonna live, what rate of return you’re gonna get, solve, then never get tempted by a new car or a lavish vacation. Certainly never get divorced, that, right? So, and then you have to, you know, if you get as old as me each year, you have to update, oh, well I’ve made it this long, I might live too long, right? So I once at Cornell, I was giving a talk on saving for retirement and describe that model. And it was in the psych department. The audience starts laughing hysterically. And fortunately my friend Bob Frank, an economist there assured them, actually I was not making this up. This is not a caricature, this is the model. Two Nobel prizes were first Freedman and then Modigliani. So right, this is the model and there really isn’t an alternative one. I mean, we sketch one in the book, but so that’s where it was. And so perfect, people aren’t perfect, right? That shouldn’t be controversial. The idea that people have self-control problems, it’s in the Bible, right? I remember, I give a talk once in Jerusalem and I used the word temptation and somebody said define temptation. And somebody in the audience said, it’s in the Bible. So, right? So it’s not like I’m inventing new things, right? It’s in Homer, you know, it goes back to Bethany’s question, wasn’t this obvious to everyone? It was obvious to everyone who wasn’t an economist, but that didn’t mean that it was easy to convince economists that they should pay attention to it.

Luigi Zingales: Can I correct you slightly? I think that.

Richard Thaler: You can try.

Bethany McLean: I’m glad I’m sitting in the middle here.

Luigi Zingales: I think that what you underestimating this evolution is two facts. Number one is the tension in seminars. So the reason why the models escalating, becoming more and more rational is because at the time, there were very little data, everything was theory. And so you are confronted with other smart people in the room, and the only way in which you can win is by being smarter than the other. And so every model with agents smarter than the other because nobody confront the fact, because the fact, the data not there. We have some aggregate statistics, but it’s very difficult to make a sense of any of those. And plus certainly all these deviations are not like so big to, and so the game in town is, how can I outsmart you in this kind of a chess game? And so that’s the reason why the initial rational hypothesis escalate to the extreme.

Richard Thaler: Okay, but.

Luigi Zingales: No, no, to your credit, the difficulty is saying the obvious. Somebody who was saying is very, the most difficult thing is to say what is in front of you. Okay, and but why, is because you get a lot of negative sort of reaction. So when you are going to the room and you are saying the obvious thing that you’re saying today, most people say that’s too easy, you’re not smart enough, okay? And they did not consider you so much so that you didn’t get the first sort of offer on the job market. And only with the explosion of data, particularly individual data, then you see that all these things are pervasive and first order and you can demonstrate with the data. Because honestly, even in your book, there is no real grand theory. So they’re just a bunch of facts, but very important. And I think that that’s what in my view, has brought the transformation is the availability of data. Because today in seminars, there’s no debate I’m smarter than you because my agent is more rational, is I have better data than you have.

Richard Thaler: Yeah, no, that’s right. So there’s an old story of, I gave a talk over in the economics department and the workshop Gary Becker used to run, and I was talking about retirement saving, and I pointed out data, as you said, you have to win with data. I pointed out that the evidence is very strong, that the saving rate increases with permanent income. And now everybody says, of course that’s true. You know, where does Bezos have time to spend it? How many weddings in Venice can the guy have? So.

Luigi Zingales: Actually in with a divorce, you can.

Richard Thaler: Right, so how many yachts? You know, so look, that’s a obvious fact, you know, the low income people are basically spending everything and then as income levels go up, the percentage that get saved goes up. So I had presented data to show that, and Gary says, well, maybe the poor are saving via their children’s human capital. So, you know, I tried to keep a straight face and, you know, didn’t notice that many kids of poor people and going to Andover, you know, but so I said, well, okay, what about the childless poor? What are their saving rates? And he responded, he was so fast, and he says, they might have nieces and nephews. (people laughing) So my friend Amos, this became like a thing with Amos and me that he used to say, when they start talking about the nieces and nephews, you stop, you won, but you’re not gonna get a concession. You’ve won, time to move on. But yes, you win with data. And look, in this book, Alex and I, what we do, and what I mean by we is Alex, go back to these articles that I wrote 30 years ago on anomalies, and we go back and say, were we making this up? Does it hold out of sample? Can you replicate it? And, you know, I think that was the key thing was to keep showing that it works. And you know, originally we’re running experiments. Now you get data on individual data and like big data with millions of people. And so it’s harder to make arguments about nieces and nephews when you have seven million data points.

Bethany McLean: So I wanna explore some of the ramifications of this. If many of the theoretical justifications of the efficiency of capitalism are based on this assumption of a fully rational economic actor. So if you incorporate your contributions into that framework, what’s left of these theories?

Richard Thaler: Well, I’d say we have to enrich the theories and we as economists, I’m gonna put my economist hat on, I think economists are not famous for humility, I would say.

Luigi Zingales: Fair enough.

Bethany McLean: You say so.

Richard Thaler: And so, you know, if we get into, if we had a hard line economist here, they would say, well, you know, as if the most dangerous two words ever uttered in economics by Milton Friedman, who he argued people, yeah, maybe they don’t know how to maximize, but they’re behaving as if they’re maximizing. No, they’re not. They’re not, it’s not close. So you need to say, all right, how robust are the models and how far are you pushing the idea that people are optimizing? And in a lot of models, again, the new version of being smarter is models that are like structural models. And I’m not gonna say what that is, but it’s sort of embedding the rational theory into the assumptions of the econometrics. And then that just kind of gets hidden. So if look, supply and demand is still true, that comparative advantage is still true. It’s not popular in some parts of the country, let’s say right now, but I’m pretty sure comparative advantage is true. I am better at being a behavioral economist than a quarterback say, you know? And so I think economics still has a role and we can still do economics based on basic economic principles, but we don’t wanna push it too far and say, you know, the old joke, I think you know this story that when I came here to do give a job interview, we walked out of Rosenwald and there was a $20 bill, I mean people think I’m making this story up, honest to God, we walk out, there’s a $20 bill, I’m the only one that picks it up. Now, you know, there were people here who thought that the kind of stuff I write about cannot happen. It happens. All right, so now we need to modify the models in a way that can incorporate what real people are doing. And then it comes down to very, very practical things like, okay, there’s a financial crisis and we’re gonna send people money. Should we send it all in one lump or should we spread it out? Now, traditional economic theory makes a very precise prediction about that, which is, it doesn’t matter, it’s exactly the same. Well, it matters, but then we need data. And so there’s a lot more for economists to do, and they can use all this wonderful data and their models will work better.

Luigi Zingales: But following up on what Bethany was saying, and you’re not modest either, however, in when it comes to policy prescriptions, you have been incredibly modest and it says you are venturing policy prescription is not, and as the title says, is very gentle. You don’t really intervene by saying, look, if people really procrastinate, for example, we should have a law that bans credit card company to force you to register forever and reiterate subscription all over the place. I’m saying something silly, but I think is actually important because we all get rip off with this office, right? And so why you are not being more aggressive on that front?

Richard Thaler: Well, because if you try to be more aggressive, you fail. So look, my most recent policy initiative, and I was very proud, this actually got implemented in the waning days of the Biden administration, was a rule I proposed, which is that you have to be able to cancel any subscription the same way you joined. So if it’s one click, it’s one click, instead of you join with one click and then you have to go in person. There were gyms during COVID that were making people show up in person to quit their subscription to a gym that they couldn’t go into. All right, so I don’t know whether, this is a very modest proposal. In fact, you’re saying that my problem is that my proposals are too modest. I’m pretty sure when somebody in the current administration figures out that this rule is there, that they’ll get rid of it. So, you know, with retirement saving, there was a big deal. There was a law that was passed in 2006. So this is in the George W. Bush administration. At that time, there was no automatic enrollment, there were no target date funds in retirement plans because there was a rule that for a default fund, it couldn’t go down. So the only thing you were allowed to have as a default fund in a retirement account was a money market account. And believe it or not, there was a bipartisan bill passed that we got them to say it would be legal for a company to automatically enroll people, automatically increase the contributions and default them into a prudent fund like a target date fund. Okay, now what did we have to give up? If companies did those three things, they got out of some nasty paperwork called non-discrimination rules. So there’s a rule that says you can’t give too large a percentage of the benefits to the highest paid workers and filling out that form is a nightmare. So there was some guy, a republican senator from Utah who I testified, and I convinced him and he says, all right, what should we do? And I said, here’s what you can do. Give back, get people out of the non-discrimination if they do all this stuff. Now, you know, I have colleagues who are criticizing me like you, why are you so modest? Why aren’t you telling people they have to save, instead of automatic enrollment? Why don’t you make them save like in social security? And my answer is, good luck with that. You know, how many laws have you passed? So, and you know, it’s like when Obamacare passed, it was by one vote. So, you know, you can say, well why didn’t they do all these other things? That was exactly as much as you could get. Maybe it wasn’t the best. I think they made a lot of mistakes in there, but it was what they could get passed. And you know, I’ve tried to get stuff passed and then sometimes it gets repealed.

Bethany McLean: So there’s a question of what you can make people do. Is there also a question of what you should make people do? In other words, is there in your mind a distinction between a good nudge and a bad nudge given that the democracy is predicated on the notion of individual liberty? Is there a point where nudging becomes manipulation and.

Richard Thaler: Well, yeah, we call it sludge. So, you know, I think, it’s like the subscription thing. If I get you to enroll, join for six months at a dollar a month and then we’ll automatically enroll you at $30 a month, that’s a nudge. You know, Cass and I like to say we didn’t invent nudging, back to the Bible, you know, the serpent and the apple, you know, it’s all there. So Bernie Madoff didn’t take any lessons from me, neither did Ponzi, right? So there have been scoundrels as long as there have been people, and I think, I mean, you you say I’ve been too modest or too timid. I don’t think, I mean the UK kind of adopted close to what I would say is the ideal system for retirement saving. And they were heavily influenced by this research. I don’t think, but it’s not required. It’s automatic enrollment. So you get 90 percent, you don’t get 100 percent, but if you try for 100 percent, you get zero because it doesn’t pass.

Luigi Zingales: So one last question because I think we need to open to the audience. And my last question is, you said of course that the scandals have been around since the Bible, but I think some of the more recent scandals, like the big tech companies, I think they seem to have adopted behavioral economics much more than our colleagues in IO. So you go to IO and they basically say there’s perfect competition because competition is a click away, but then you have Google paying billions of dollars to Apple to get the default because they know that the default matters. But in IO economics, they default don’t matter. So how do you explain that your research is more influential in Silicon Valley than in the academic department?

Richard Thaler: Well, I deny that. (person laughing) Look, the American Economics Association, if you join, you get your membership includes subscriptions to the journals. And they were all printed until about 20 years ago. They started offering electronic subscriptions, but the default was you got them all and they switched the default. And lo and behold, almost everybody took electronic. So I mean, economists, even economists are humans. And as you know, in the book, we end each chapter with a little bit of advice and we have the So What for economists and then a different one for humans.

Bethany McLean: I have a last question too, since you’ve pointed out mistakes that both Luigi and I have made, I think it’s only fair if you own up to a mistake of yours. Is there anything you’ve done throughout your career that you wish you had said differently?

Richard Thaler: No. (people laughing)

Bethany McLean: Well on that note. (audience clapping) So it’s time for Q&A. We have people running around the room with mics. I think the best thing to do is to raise your hand and someone will come to you. Let’s see, there’s a hand there, there are lots of hands people, so whoever gets there first.

Richard Thaler: So when you get a mic, stand up so we can see you, yes.

Speaker: Thank you for the talk. I have a question about cultural differences. All the research you’ve done, how applicable it is across the countries, across the cultures is, you know, a theory about retirement savings equally applicable in the US, in Europe, in Madagascar, how different societies, I guess behave in that way.

Richard Thaler: So to a first approximation, cross-cultural differences are second order. Yes, there are differences, but there’s a chapter in the book about the ultimatum game, which is I give Luigi 100 dollars and I tell him he can share that with Bethany and he can make her an offer. And if she say he offers her $20, if she says yes, she gets 20, he gets 80. If she says no, they both get nothing. So that was an early experiment that I wrote one of these anomalies columns about years ago. And there was follow up work doing that all around the world. Interestingly, if I got your accent right, it might be an Israeli accent, but the only significant difference was Israelis were a little bit more like game theorists. And I speculated in the original piece that that might be because Israel has more game theorists per capita than any other country. But I don’t have any evidence on that. So yes, I mean, in psychology there’s a whole field of cultural psychology, but I think things like overconfidence, loss aversion, mental accounting, they’re true everywhere. Yes, they’ll be a little different in one place or another, but we’re all humans.

Speaker 2: Hi, so I have a question about how you consolidate having like really irrational behavior and how like sometimes this irrational behavior might not be consistent with other behaviors, like kind of adding onto that cultural question. But how do you build a model around kind of inconsistent irrational behavior?

Richard Thaler: Yeah, so let me answer that and sort of pick up to one little slide dig Luigi had earlier about when he said that we don’t have a grand theory and I’ll make a prediction, which is there will never be a grand theory. We have one. I mean if you want a grand theory of economic behavior, it’s optimizing selfish agents with rational expectations. I mean, if you try to write down a model that incorporates all of the departures, it just gets too messy. So what’s happened over the 30 years, say since the I published these anomalies, there have been theories of each part. So like the ultimatum game, we now have theories that say, well Bethany is not likely to accept an offer she views as unfair. And so if Luigi tries to offer $10, she’s gonna say no. And yes, she realizes $10 is more than zero, but it’s worth $10 to tell Luigi you’re not gonna get away with that. (person laughing)

Luigi Zingales: Probably even more than that.

Richard Thaler: So there are lots of papers about fairness but those papers don’t explain why people are overconfident or overreact in some situations and underreact in others. And they certainly don’t explain some of the anomalies we see in financial markets. So there’s not gonna be a grand theory. Maybe the grand theory will be hey chat, what’s gonna happen happen, but that’s not really a theory.

Speaker 3: I would like your perspective on if rational models are worth keeping around and if they are, what makes them worth keeping around.

Richard Thaler: So yes, and in fact I’ll say they’re essential. So my good friend and golf buddy, Gene Fama always likes to tell me that he was the most important person for behavioral finance because we would’ve had nothing without the efficient market hypothesis. And that’s true. And then I remind him that he would’ve had nothing to do the last 30 years if he didn’t have me giving him things to refute. So, but so look, I mean it’s related to the answer to the previous question, which is since we don’t have a new grand theory, what we have are departures from the standard model. So the standard model of decision making under uncertainty is expected utility theory. It was created by John von Neumann, possibly the smartest person of the 20th century. And he wrote down a model, here’s what you should do if you wanna be smart in risky situations. I think it’s the right model. When I was still teaching, I taught my students do that, but you know, do that, but assume no one else does. And that’s kind of the lesson. That’s my meta lesson. Ignore some costs, but assume no one else does.

Luigi Zingales: Can I add to anecdote? The first one is when Richard joined Chicago, I was a young assistant professor.

Richard Thaler: Yeah.

Luigi Zingales: And I sat through his class.

Richard Thaler: Yes. And not quietly. (people laughing)

Luigi Zingales: He actually still remembers a question I asked, which is pretty remarkable. But the most amazing thing is at the end of the class, he invited Gene Fama and they debated in front of the class their different views. And I think that this is the essence of Chicago is that two people that disagree on some issues, but they do it in a very civilized way in front of the class. And I think it was really very, very exciting.

Richard Thaler: Now that was not true of every member of your department.

Luigi Zingales: That’s true. You’re absolutely right.

Richard Thaler: Or maybe another plug for Chicago. We had Fama on the podcast and I thought one of the most astounding things was that he says the efficient market hypothesis isn’t always right. It’s not always efficient, but it’s a model. And so I think he’d agree with you actually, weirdly on the limitations of models, anyway.

Luigi Zingales: But also to the point of what Richard was saying, ironically, Richard is one of the most rational people in his behavior. And some of my colleagues who claims to be very rational in their analysis or predicated rationale in their analysis. They’re the mostly irrational on their personal behavior. Thank you.

Bethany McLean: Back to audience questions. I’ve seen a couple of hands up here for a while, so.

Speaker 4: You were saying that we are all humans and humans are irrational.

Richard Thaler: I don’t use the word irrational. I would say that we’re human and we don’t behave according to the models that economists write down and call rational. But I’m not saying it’s irrational.

Speaker 4: Got it, okay. And I think it’s like very, very, it’s an incredible honor to win the Nobel Prize and out of my own curiosity. And I think also asking for some of our audience, how do you plan to spend your Nobel Prize award grant? (people laughing)

Richard Thaler: So it’s a funny story. You know, when you find out you won the Nobel Prize, it’s four in the morning and the phone rings. And so now if you’re one of the thousand people that think that they might win, you’re aware that it’s that day because the economics day is always the Monday after the week of announcements and all your so-called friends are saying, oh, good luck. I think, this is your year. You know, they’ve been saying that for 20 years. So you get woke up at four in the morning, in my case, we still had a landline, the landline rang and that phone was on my wife’s side of the bed. She finds the headset and it’s dead. And she’s hearing the phone ring and I am asleep and she’s running around the apartment looking for a headset that works. ‘Cause there she hears something and then it stops. And I think she’s thinking, okay, Taylor, no, Doug Diamond, they’re looking for Doug’s phone number. But then my cell phone started ringing and the only concession I had made to the remote possibility that this would be my ear was to turn the ringer on the cell phone. But then, so, you know, she’s waking me up and I talk, I see on the phone it says Sweden, oh, this could be good. (audience laughing) So then they say, all right, go drink some coffee. You have a press conference in half an hour. And at the press conference somebody asks me that question, they say, what are you gonna do with the money? And you know, my instinct was to say, well, you know, as an economist, that’s a stupid question, because, how am I gonna know which money? Like, you know, if I go buy a new car, was it with that money or with the money the school pays me or from some book, right? So I answered it, I’ll spend it as irrationally as possible. And I don’t know how I’ve spent it, I haven’t been keeping track. What I should have done in hindsight.

Bethany McLean: A mental accounting.

Richard Thaler: Yes, I should have got a special credit card, the Nobel credit card, and then if I wanna buy a really expensive bottle of wine, boom, put it on that card. But I wasn’t that smart. Yes, sir.

Speaker 5: We are living in capital market society, at least since Chestnut Street, Philadelphia, Pennsylvania, when the market has been established for trade, which is close to 235 years. My question is why students in American colleges and in universities are thought that capitalism is bad, sorry. Is it to create a new kind of behavior so that we will assume do not make profit because you may lose, the last thing I will say, will you advise me to divest, I mean sell my stocks and say, oh, capitalism is bad. I will not make anything out of it.

Richard Thaler: Okay, so I am smart enough not to give investing advice. (people laughing) I have been quoted on occasion, somebody’s asked me about some meme stock or a stable coin, and I’ve said that it’s irrationally high, but it might go up. And that’s the way I feel about the stock market right now. I think when people complain about capitalism, I don’t think that they’re really complaining about capitalism. I think they’re complaining about, say, the distribution of income because we tried the other system and it doesn’t work. And by the way, I mean this is a point that Ken Harrow made, that if you think about a planned economy, the social planner better not be boundedly rational, right? And if you think about like the Russian economy, it was a catastrophic failure because the problem of how many widgets you should build here, and I mean, it’s just too hard. So, you know, capitalism is like democracy. It’s, you know, the worst of all problems. But it’s better than any alternative or whatever the expression goes, any system can be improved. There’s an interesting book, Luigi and I were talking about earlier, what is it?

Luigi Zingales: Break-Neck.

Richard Thaler: Breakneck about China, and it’s written by a Chinese Canadian. And he describes the difference between China and the US is China is run by engineers and the US is run by lawyers, which is stealing a line, I used to say, US is run by lawyers, advised by economists. But I think, I haven’t finished reading this book, but the premise is certainly correct, but he doesn’t say that one is better than the other, right? So the, the Chinese economy, I think he has a very good point that they’ve developed process knowledge, so they don’t invent things, but they can build anything and we invent things and we can’t build anything. And he blames it on the lawyers. I mean that’s kind of a snappy one liner. But the political system has made it impossible to build anything. And I think those are just obvious facts, it costs 10 times as much to build high speed rail here as it does in China and five times as much as in Europe. And nobody really likes it. And even some liberals like Ezra Klein complain about how much it costs to build, but he doesn’t say, all right, which of the 50 regulations that make it hard to build and rules about whether you have use unions, which of those are we gonna get rid of? And again, what Cas Sunstein and I call sludge, the thing that makes it so hard to build, sludge is a bipartisan. The left have all the rules on pollution and climate change and so forth. But there’s also all kinds of rules that basically protect businesses. In Illinois, the rules determining who can be a distributor of alcohol were written to enrich the people who are distributors of alcohol. And so I don’t know who wrote those. I mean, it’s a blue state but it’s a corrupt system. And so the regulations that protect incumbents, that’s bipartisan. And I don’t see anybody on either side that is ready to tear down the position that the incumbents have. And you know, like mergers and how Google was allowed to buy Waze. I mean, I don’t know, how do we say we have an antitrust system when somebody has a monopoly on GPS and they’re allowed to buy their competitor, right? So yeah, I am pro capitalism. I don’t know what this capital isn’t, but I’m pro.

Bethany McLean: It’s a question mark.

Richard Thaler: But I think it could be improved.

Bethany McLean: Luigi.

Speaker 5: Why capitalism is bad? Why is it bad?

Richard Thaler: I’m saying that when people protest, they think, can’t Jeff Bezos get by with only 100 billion? And there are too many people starving and housing is expensive. That’s all true. But do we know how to create a better system? No, we don’t. So you know, again, Luigi complains that I’m too modest. I don’t know what the perfect system is, but I can improve it a little at a time.

Bethany McLean: I think we have time for one more question.

Speaker 6: So a lot of your theories have influenced the Affordable Care Act, and you were speaking about it a little bit before. I would love to hear your perspective on what things you would keep and what things you feel like you would take out for the system and how you would just make it more efficient in your opinion.

Richard Thaler: I’m Oh, well, that’s.

Luigi Zingales: An easy one.

Richard Thaler: Yeah, I’ll tell you one, they set up these plans and there are, I don’t know whether you’ve ever had to buy healthcare from that system, but there are different plans and they’re coated by metal. There’s a platinum plan and gold and silver and bronze. And so I was in Washington visiting friends, and I asked somebody who was designing the website, can I go see what they’re doing? And so the person designing it shows me, and I have no idea what they thought that these metal categories, how that was gonna help. But then at the bottom, there’s another category, it doesn’t get a medal, it’s called catastrophic. And I said, no, wait, we’re not gonna call one category catastrophic, are we? And he said, yeah, no, that’s what economists, so it’s a high deductible plan, right? And he said, that’s what economists call a catastrophic insurance, right? Now, I can tell you, when you go get a job or if you’re an employee at the University of Chicago, the healthcare plan you want is catastrophic. It’s like guaranteed to save you money, at least $800 a year or more. If you don’t spend any healthcare, it saves even more. But at least it saves you a few hundred dollars a year. So we’re gonna give this horrible brand name to a plan that many people should choose. So the other thing I criticized in real time was the mandate. So economists said, you gotta have a mandate. You gotta have a mandate because if you don’t, only sick people will get health insurance. And then the rates will go up and we’ll have a catastrophic spiral. I’m using that word again. So there’ll be a death spiral in the plans. Then the Supreme Court decided that the mandate was illegal and they got rid of it. Nothing happened. There was no death spiral in healthcare plans. Why, people like to have health insurance. So I think if they had listened a little bit less to economists on that, what would I have done? Big surprise. I would’ve automatically enrolled people into health insurance with an optout. I think that that would’ve, there’s no reason why giving people the opportunity for affordable healthcare should be something that we makes seem like it’s evil. Now, yes, the system, the American healthcare system is a nightmare for sure. We spend twice as much as any other country and we get average results, right? That’s unambiguously true. But is there any agreement on what system you want instead? No, you go to Canada, you get national health insurance and there are queues and you might have to wait six months for a hip, a new hip. And so rich people come to the US or India, right? But there was a series in the New York Times a few years ago where some five health economists we’re debating which system, which country system would be the best. And there’s no agreement. So nobody has the perfect system. There’s no perfect economy, there’s no perfect economic system. You know, it’s meh versus meh. And you know what, that’s life.

Bethany McLean: I wanted to close with a question for the audience and for my two fellow people on the stage. How many people out there think the world would be a better place if humans were perfectly efficient, rational animals? How many like our world the way it is? Messy people being people. (person laughing) Thank you all very much for coming.

Richard Thaler: Thank you. (audience clapping)