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Behavioral Economics Pioneer Thaler Wins Nobel Prize for Economics

American economist Richard Thaler, a pioneer in behavioral economics, has been awarded the 2017 Nobel prize for Economic Science.

Thaler, currently with the University of Chicago, was a force behind the automatic default options in the Pension Protection Act of 2006. As early as 1994, he proposed changing the default in DC plans to an automatic enrollment arrangement with a default savings rate and default investment strategy.

Thaler was awarded the prize for his contributions to behavioral economics in which insights from psychological research are applied to economic decision-making. The Royal Swedish Academy of Sciences noted that Thaler, in his applied work, demonstrated how nudging may help people exercise better self-control when saving for retirement, as well as in other contexts.

“By exploring the consequences of limited rationality, social preferences, and lack of self-control, he has shown how these human traits systematically affect individual decisions as well as market outcomes,” the Academy said.

‘Save More Tomorrow’

In 2001, Thaler along with Shlomo Benartzi of the UCLA Anderson School of Management, addressed the issue of using behavioral economics to increase employee saving. They demonstrated, among other things, that when individuals are faced with a number of possible funds to which they can allocate their retirement savings, they tend to follow a naïve diversification strategy, leading to unintended economic effects.

To address these shortcomings, Thaler and Benartzi pioneered their “Save More Tomorrow” (SMarT) program designed to help employees increase their savings rates gradually over time by overcoming self-control problems and other behavioral biases. In essence, the automatic enrollment, automatic escalation, opt-out and default options outlined in the SMarT program were key components of the PPA and are largely credited with increasing retirement participation levels and savings rates as companies implemented the provisions in their DC plans.

Choice Architecture

The academy also cited Thaler’s work with Cass Sunstein and their 2008 book, Nudge: Improving Decisions about Health, Wealth, and Happiness, which the idea of “libertarian paternalism” where beneficial changes in behavior can be achieved by “minimally invasive policies” that nudge people to make the right decisions for themselves. Following publication of the book, policymaking in several countries apparently has been influenced by this approach, not only in the area of retirement savings, but also in health care, education and other areas where current choices have long-term consequences.

Thaler’s theory of mental accounting, explaining how people simplify financial decision-making by focusing on the narrow impact of each individual decision rather than its overall effect, and his work on the so-called “endowment effect,” showing how aversion to losses can explain why people value the same item more highly when they own it than when they don’t, were also cited by the Academy.

Demonstrating his sense of humor, when asked at the Nobel news conference what he planned to do with his prize money (about $1.1 million), Thaler said he planned to spend it “as irrationally as possible.”