Misbehaving by Richard Thaler, book review: The science behind behavioural economics

Thaler explains how economists can nudge people towards actions that are in their best interests

Economists have had a few bad years: failing to see the financial crisis, squabbling as to how to get out of it, and most recently suggesting that nothing can be done to avoid "secular stagnation" – a state of affairs where we will see no increase in living standards in the developed world. A dismal science indeed.

There is, however, one particular branch of the subject that is flourishing, called behavioural economics. It is an off-putting label but anyone who has read Freakonomics will grasp what it is about: explaining how people really behave when confronted with economic choices. This has implications for policy, because you can use what you know about behaviour to nudge people towards actions that are in their best interests.

These ideas were first developed in the book Nudge, by Richard Thaler and Cass Sunstein (2008) and have been adopted by both the Obama administration in the US and the Cameron Government in the UK. In Britain we set up the Nudge Unit, officially the Behavioural Insights Team, now spun off as an independent social purpose company, which has tackled such diverse issues as encouraging people to give more money to charity or to use less energy in the home.

Until now, however, there has been no account of how the subject developed. Professor Thaler was one of its founders, and with Misbehaving has set this right.

Until 30 years ago economists regarded people as rational beings. You could see from the choices they made what they really wanted to do. But actually we are not rational at all: for example, while most of us would be happy to win an extra £100 and upset if we lost it, we feel the loss more strongly than the gain. Car companies use the lure of a zero interest loan, rather than a cheaper price, because we would rather have the cheap loan, even if the car costs more in the long run. Ask people how big a pension they think they will need in retirement, then tell them how much of their income they will need to save in a pension plan to get it, and very few people are prepared to put in enough to do so.

Professor Thaler takes us through the early days of the discipline, when it was derided by mainstream economists, through a debate about what people think is fair pricing and what is unfair (should Uber charge more at peak periods?), to attitudes towards investment and saving, and the debate as to whether people should have to opt in or opt out of organ donation.

He also shows how behavioural economics has been applied to practical policy, for example by UK schools sending text messages to parents, reminding them that their children have a maths exam in a week's time. Children nudged in that way did much better than those whose parents had not been sent the text.

That is a tiny example. But if governments, companies and individuals all make better decisions then our futures need not be so dismal, and economics will be a driver of optimism rather than the reverse.