Lynne Malcolm: Hello, It's All in the Mind on RN, I'm Lynne Malcolm. Today, the economics of misbehaviour.

Lynne Malcolm: Mary Poppins, 'a spoonful of sugar helps the medicine go down', has been used as an example of behavioural economics. What do you think of that idea and how does it apply?

Richard Thaler: When I first started working with the UK Behavioural Insights Team, in virtually every meeting I said a phrase that became known as the team mantra, which is if you want to encourage someone to do something, make it easy. Figure out what the barriers are that are preventing somebody from doing something, and remove them, make it easy. And adding a little sugar to the medicine is making it easier to go down. I think there's a lot of truth to that.

Lynne Malcolm: Richard Thaler, Professor of Economics and Behavioural Science at the University of Chicago. He brought the field of behavioural economics under the spotlight in 2008 with his global bestselling book Nudge which he wrote with Cass Sunstein. Richard Thaler investigates the interplay between economic theory and the psychology of irrational human behaviour. He's applied his insights in tackling many of society's major problems. Richard Thaler is known

as one of the founding fathers of behavioural economics.

Richard Thaler: Well, it's really just economics with people instead of these fictional creatures that pop up in economics textbooks. So the people we study have trouble saving for retirement, occasionally have a bit too much to drink, are absent minded, forget to fill in some form, are a bit lazy, just like all the people you know.

Lynne Malcolm: Richard Thaler's latest book is called Misbehaving: The Making of Behavioural Economics.

Richard Thaler: The title really has two meanings, first the fact that people misbehave according to economists. Economists model creatures that are hyper rational, have no self-control problems, no emotions, are extremely selfish, they would never leave a tip at a restaurant they didn't intend to go back to. And violating that isn't really misbehaviour, unless you are an economist. The other meaning of the title is that the fact that I've been pointing this out for the last 40 years or so meant that professionally I was also misbehaving.

Lynne Malcolm: So if we could go back a bit, there was an influence from your time at university when you read a paper on psychology which you say changed your life forever.

Richard Thaler: Well, the paper was written by two psychologists who became very well-known, Daniel Kahneman and Amos Tversky. I was reading this in about 1976. And Kahneman has since gone on to win the Nobel Prize in Economics, even though he is a psychologist. He would have shared it with Tversky had Tversky been alive at the time.

And in the paper they describe how people make judgements, so how they estimate probabilities or quantities. They make two points, one is that we use simple rules of thumb to make those judgements. We can't calculate everything. But the second is that using those simple rules of thumb leads to systematic error, systematic bias. So an example is anchoring. Suppose I ask you whether the population of Chicago is more or less than 5 million people, and then I say, okay, what is the population of Chicago? You're likely to give a higher answer than if my first question had been, 'Is the population of Chicago more or less than 1 million?' Because you will anchor on that first number and then adjust, and then we don't adjust enough.

So this idea was important to me because economists would admit, at least privately, that people weren't quite as smart as the creatures they describe in their models. But they thought, okay, they make mistakes but they average out. And what Kahneman and Tversky's research showed is, no, they don't wash out, the mistakes are all in the

same direction. And that was like a big idea for me, and suggested that I could incorporate that idea into economics. Then I was in business.

Lynne Malcolm: And then you further developed the idea and it was all around a bowl of cashews I think at a dinner party. Tell us the story about how that concept dawned on you.Richard Thaler: Yes, well, Newton had his apple, I had a bowl of cashews. Yes, I had some friends over for a dinner party when I was in graduate school and put out a big bowl of cashew nuts, along with cocktails, and people started eating this bowl of cashews like they would never have anything to eat again in their lives, although they could smell dinner cooking in the oven.And after a few minutes I realised that we would soon finish this bowl and lose our appetites. So I picked the bowl up and, eating a few more while I went, hid it in the kitchen. And when I came back, since we were a bunch of economics graduate students, we immediately started analysing this. It illustrates why you don't want to invite too many economists to a dinner party. And the analysis was that we were happy that I had hidden the bowl, and that according to economic theory we were not allowed to be happy because having more choices always makes you better off than having fewer choices. And previously we could eat nuts or not, now we couldn't. So that was a puzzle. And I started making this list of funny behaviour, like removing

the bowl of cashews and then being happy and wondering what to do with it.

Lynne Malcolm: So tell me more about that list, because it was a list really of human inconsistencies. Can you give me a couple of examples of that and about how it applies to behavioural economics?Richard Thaler: Many of them were just things that I would observe. So I had a professor who was a wine collector and had been collecting wine for a long time, and he had bottles that he had paid say $5 for and were now worth $100. And he said he would occasionally drink one of those bottles, but he would never dream of spending that much money to buy such a bottle. This is misbehaving, according to economic theory, because either the wine is worth $100 to him to drink or it isn't. If it is worth $100 and he drinks a bottle then he should be willing to pay $100 to buy such a bottle.And you can see this at major sporting events. Suppose there's a big cricket match in Australia and somebody is given two tickets and you ask them, 'Well, how much would you demand to give up those tickets?' And they'll say, 'Oh, $300.' And then you say, 'Well, how much would you be willing to pay to get those tickets?' 'Oh, $150.' And again, this is misbehaviour. And I ended up calling this the endowment effect, that's because in economics we refer to things you own as part of your endowment, and we value the things we own more than the things we don't own. And this creates a lot of status

quo. We all have stuff lying around the house that we'd never think of paying any money to buy it but nevertheless we don't get rid of it.

Lynne Malcolm: So the idea is that if you own it and somehow you've invested in having it, then we attribute more value to it.Richard Thaler: Right. We see the same kind of behaviour in the stock market, by the way. I always tell people, if you have some stock in your portfolio and you wouldn't buy it at the current price, then you should sell it. And the same goes with some exercise machine you have lying around the house that you haven't used for a year, you could probably get at least a few hundred dollars if you sold it. If you don't use it, why don't you sell it? But people wouldn't want to sell it because they'd sell it for much less than what they paid for it, so it just sits there.Lynne Malcolm: And another observation you've made is that we seem to be more challenged by losing something than gaining something of the same value.Richard Thaler: Well, in some ways the example we were just talking about illustrates that because we act like giving something up hurts more than acquiring it. So I'll give you an illustration of an experiment we did to test this idea. We went into a classroom and gave every other student in the class a coffee mug with the university insignia on it. And then we conducted a market in these mugs. And what we found was the people who had the mugs

tended to keep them, and the people who didn't have the mugs didn't have much interest in buying them. So if I have the mug I don't want to give it up because that would be a loss, but if you ask me to pay for it, well, I'm not that attracted to it. So we would see that the asking price to sell a mug would be about twice the buying price to acquire one.Lynne Malcolm: Also there are couple of terms that you use when you are describing people. There's the econs as opposed to the humans.Richard Thaler: Well, econs are these fictional creatures we've been talking about,Homo economicus, as the Latin term goes, and humans are just real people. So I study humans and other economists study econs. And if we really want to understand how the world works then we have to shift our attention to humans, and that's true for virtually any problem. Just think about what's been going on in the stock market. It's pretty hard to think that this is a bunch of highly rational, unemotional people that are trading in these markets.Lynne Malcolm: Economists saw us as rational beings before this concept of behavioural economists came about. Why then were we considered rational in, say, the 1970s?Richard Thaler: Until about 1940, I would say most economists were behavioural economists in some way. Even Adam Smith, the founder of modern economics, if you go back and read his first book, The Theory of Moral Sentiments, he talks

about people having passions and having to control the passions. And after World War II, economics started to become much more mathematical. Economists started writing down mathematical models in an attempt to be more scientific. And the problem is that the easiest models to write down are ones in which people are behaving rationally. Describing the way a real person wanders through a supermarket and is attracted by some display or by the fact that some item is described as selling below its suggested retail price. The things they buy depend on the order in which they are displayed on the shelves. None of this would be very easy to describe in a mathematical model.So as economics became more and more mathematical, it became less and less realistic. The behavioural economics revolution is really to say, okay, we can do maths but it's going to be harder maths because we have to incorporate these human features as well as the automaton behaviour that economists usually study.

Lynne Malcolm: Richard Thaler, from the University of Chicago.You're with All in the Mind on RN Radio Australia, online and on your ABC Radio mobile app, I'm Lynne Malcolm.Richard Thaler's earlier book on behavioural economics is called Nudge: Improving Decisions About Health, Wealth and Happiness. This concept of nudging began to be used as a technique to steer people's choices and help them make better

decisions. In behavioural insights departments, known colloquially as Nudge units, Richard Thaler has advised the US and British governments on how to use behavioural economics to inform policy. So what is nudging?Richard Thaler: A nudge is any small feature in the environment that attracts our attention and influences our behaviour. Maybe the most famous example of a nudge is to be found in the Amsterdam International Airport where some genius etched the image of a house fly near the drain in the men's urinals. And the airport claims that spillage was reduced by 80%. It seems if you give men a target, they will aim at it.Lynne Malcolm: In more ways than one.Richard Thaler: Yes. So, moving to more serious problems, one of the ways we can nudge people to help make better decisions is just to make the good decision easier. And often that can be done just by setting whatever the default options are. I was having a problem today with my computer, that whenever my cell phone would ring, the computer would start ringing, and that's because it's a new laptop and the settings that came with the computer turned that feature on. And all the features that are automatically turned on you are likely to use. And if you have to go out of your way to change them, then you are less likely to do it.So we've been able to use this in the design of retirement savings plans. In the US there are defined contribution retirement savings plans that

are voluntary. It used to be that employees used to fill out a bunch of forms if they wanted to join, and then employers got smart and started switching to default and said 'you're eligible for this plan now and you don't have to join, if you don't want to join you have to fill out this form saying you don't want to join'. Well, if you do it that way, enrolments go up to about 90%.

So here's an interesting example. I believe in Australia your national retirement saving plan is mandatory. In the UK they've just adopted a similar plan and it's not mandatory, but there's automatic enrolment. And enrolment is about 90% or a little over 90%. So you are able to achieve almost as high an enrolment without forcing anybody to do anything. That was really the idea of 'nudge', how much can we achieve without requiring anyone to do anything? Because some of the people might have very good reasons for not wanting to save for retirement right now. Maybe they have student loans that they have to pay off or other debts, or maybe they are expecting to receive some inheritance or what have you. And if we can get 90% of the people doing it without requiring it, that I think that's better than making everybody do it.

Lynne Malcolm: So you've advised both the US and the British governments on behavioural economics, and you set up the Nudge unit, part of a behavioural insights team. Tell me a couple of ways

in which you've been able to change policy to improve the outcome?Richard Thaler: Well, that has become its nickname. Its official name is the Behavioural Insights Team, and the US version is the Social and Behavioural Sciences Team. But you're right that everybody just calls them Nudge units. One of the first things that we did with the British Nudge unit, we met a guy in Treasury whose job it was to collect taxes from people who owed money. And we said, 'Well, what do you do?' And he said, 'Well, we send them a letter.' And we said, 'Maybe we can write a better letter.'And then we started running experiments, sending people letters that would have one or two sentences added, otherwise the letter was identical. And it turns out if you tell people truthfully, 90% of the citizens of Melbourne pay their taxes on time, that increases the number of people who respond to that letter quickly by about five percentage points. So the winning letter turned out to be a combination, you'd tell them 'the vast majority of people pay their taxes on time and you are in the minority of those who don't'. So that's the version of the letter that is being used now, and it's bringing millions of pounds into the treasury more quickly than it would have otherwise, and this is an intervention that essentially costs nothing.

Lynne Malcolm: So in a way these applications, they are a way of helping use people's weaknesses to help them achieve their goals.

Richard Thaler: Yes, although I kind of resist that terminology a little bit because I don't want people to think that we are taking advantage of people or exploiting them. We are recognising that people are lazy and that they take the easy way. So we make the easy way better. Think of it as GPS. If you have GPS on your car or on your phone, no one is telling you you have to use it, but if your sense of direction is anything like mine, you get lost a lot less often if you follow those directions. So we are trying to give people tools like GPS or alarm clocks. And if you want to get up on time for an early appointment, it's good to have an alarm clock.Lynne Malcolm: It's potentially a very powerful concept. So is there a moral dimension to the concept?Richard Thaler: Well, when anyone asks me to sign a copy of that book I always sign it 'nudge for good'. That's a plea, not a claim. You can certainly nudge for good or nudge for evil. You know, the private sector nudges us all the time, and not always for good. If you fill out any form there are going to be pre-check boxes, and a good question to ask is is the firm checking the boxes that are best for the customer or best for the firm? And all too often we see that the preselected boxes are the ones that are good for the firm. You know, you buy an airline ticket and they try very hard to sell you an insurance policy in case you are going to have to miss your flight, and you have to read through the fine print that says that you only collect on this if

you are sick and you get a letter from your doctor. You know, this insurance costs about 5% of the ticket. Do people really get sick one out of 20 trips? I doubt it.So yes, there is a moral dimension, we can nudge for good or for bad. And certainly in my work with governments I try to help nudge for good. Of course it's reasonable to ask do we always know what's best for people? No, we don't. It would be good if everything was like GPS, that the user plugs in their intentions and then you just give them instructions.

For things like saving for retirement or helping people quit smoking, you have a pretty good idea that most people think they should be saving more or smoking less or somebody who is obese, if you help them lose weight, again, you have pretty good ideas. In other cases you are not so sure and you'd have to be more careful about what you are going to do and maybe try to elicit some preferences from the consumer, although that's not as straightforward as it sounds.

Lynne Malcolm: Let's take that example of helping people with obesity, for example, and controlling their diets and exercise. What are some ways that nudging could help?Richard Thaler: By far the best solution is to control portion size. Certainly in America, if you go into a restaurant, the portions they serve you are gigantic. So here's a simple trick that has been used in school cafeterias, in fact it's used at the

university where I'm sitting today in San Diego, and that's just to use smaller plates in the cafeteria lines, and no trays. That reduces consumption. People are entitled to go back as often as they want. But if you give people a big plate, they are going to fill it up, if you give them a smaller plate, they'll take less and then they will end up eating less.Lynne Malcolm: So still in the medical area, let's take a situation in which people are faced with a difficult decision to make with their doctors. So they are told that they have a condition which has a particular survival rate associated with it and the doctor is told that what the survival rate is, both with and without having treatment. This is a very difficult situation for people to be in, to make that decision about which way to go. How can these nudging techniques or framing techniques help people in a situation like that?Richard Thaler: Well, just to show you how difficult a problem this is, the problem you described, we know that people will make different decisions if we describe the outcomes in terms of survival rates or mortality rates, even though of course one is just one minus the other, there's a 20% mortality rate, there is an 80% survival rate. So these are very difficult problems, and the way that the problem is described or framed can help.Part of the problem is that physicians are often not very sophisticated about statistics themselves. Just a regular general practitioner doesn't have a lot of statistics training. So I think we have a lot of room

to move in this direction. I must say that the empowering patients idea requires careful thought if the patient isn't really capable of making the decision. For example, there are lots of tests that we should probably stop using or use less because the rate of false positives is so high that lots of people get treatment that they don't need.

Lynne Malcolm: I wonder now if we could look at behavioural economics and about how it will play out in the future, both at a government policy level and also at an individual level.Richard Thaler: Certainly there are lots of brilliant young economists that are taking up behavioural economics and doing exciting things with it, and I think we've just scratched the surface of topics that could be studied. One topic that has not received enough attention in my opinion is macroeconomics, you know, the study of recessions and depressions and financial crises. I think we could learn how to do it better if we understood the psychology involved of the people affected.But if you think of any of the world's big problems, almost all of them are behavioural at the heart of it. So climate change is a behavioural problem. Rising healthcare costs are a behavioural problem because many healthcare problems are self-inflicted. Terrorism is a behavioural problem. How do we discourage people from becoming suicide bombers? That's a behavioural problem. Don't get me wrong, I don't think I have the solution to any of these problems, but the first step is to realise that they

are at their essence behavioural problems, and we need to employ the best minds in all of social science to try and figure out what the best steps to take are.

Lynne Malcolm: Do you see a real value in perhaps increasing the research in the behavioural and psychological fields to feed into this?Richard Thaler: Absolutely, and one of the campaigns I've been on for over a decade, maybe more, is to get other social scientists more interested in thinking about public policy problems. And the creation of these so-called Nudge units, Behavioural Insights Teams, I think has raised interest among psychologists and sociologists and other social scientists to say, hey, not only economists can advise governments. And if they start doing research on some of these important problems, then there is a way that they can be listened to.Lynne Malcolm: Richard Thaler, Professor of Behavioural Science and Economics at the University of Chicago.Details of his books Nudge and Misbehaving are on our website. Go to the RN home page abc.net.au/rn and choose All in the Mind in the list. While you're there, leave a comment on any of our programs, we'd love you hear from you, and you can catch up on episodes you've missed from there too.Thanks to the team: Muditha Dias, Diane Dean and Joe Wallace.

I'm Lynne Malcolm. Thanks for your company, catch you next time.