When a psychologist won economics Nobel

Aunindyo Chakravarty

There was something odd about the Nobel Prize in Economics in 2002. It was given to the psychologist, Daniel Kahneman. Perhaps, this would never have happened had Kahneman and his comrade-in-arms, Amos Tversky, chosen to publish their most significant theory on how people take decisions — they called it ‘prospect theory’ — in Psychological Review, the most respected journal for psychologists. Instead, they chose to send it to Econometrica, perhaps the most name-drop-worthy journal for economists to be published in. It is now considered to be the most cited paper ever in the history of economics.

What Kahneman and Tversky showed in their theory was that when human beings make choices, they do it on the basis of how these choices are represented to them, not how they actually exist in the objective, external world. For example, imagine there’s a deadly virus ravaging your town, which could kill 60,000 people. You are the mayor and you have to choose between two vaccines — one which is guaranteed to save only 20,000 people, and another which has a one-third chance of saving everybody, but a two-thirds chance of not saving anyone. Most people choose the first option, even though it would kill 40,000. On the other hand, if the same choice is reversed and they are told that the first choice is guaranteed to kill 40,000 people, and the second has a 1/3rd chance of saving everyone, they are likely to choose the second. The two choices are exactly the same, but they have been represented differently.

Kahneman gave another example of how human beings are driven more by their aversion to avoiding losses, than by rational calculations of how much things would actually cost them. It goes something like this — imagine a situation in which you have bought movie tickets for Rs 300 and when you reach the theatre, you find you have lost them. Chances are, you will simply go home because you don’t want to pay twice for the same thing. On the other hand, imagine that you didn’t have tickets when you reached the cinema, but realised that Rs 300 had fallen out of your pocket. There is a high likelihood that you will buy the movie ticket and watch it, even though the monetary loss is exactly the same. The rational consumer should have recognised that it would make no difference to their overall consumption to buy the tickets again, but the real consumer would only buy when the loss of Rs 300 has been “charged to general revenue”.

Economists, who had been dissatisfied with the complete absurdity of rational choice, embraced Kahneman’s insights into how consumers actually make choices. On the other hand, the orthodoxy, which wanted to protect the theoretical validity of Homo Economicus, attacked and rejected Kahneman. One young economist who took to Kahneman’s ideas was Richard Thaler, who would later go on to win the Nobel in economics for his contributions to ‘behavioural economics’. Thaler had been pointing to ‘anomalies’ in the supposedly ‘rational’ behaviour of economic agents, in his popular series in the Journal of Economic Perspectives. Collaborating with Thaler helped Kahneman dig deeper into the discipline of economics and also helped further establish his credentials amongst economists.

Kahneman’s contribution to the theory of decision-making has had many more applications outside the discipline of economics, most importantly in public policy. It gave rise to the concept of ‘nudges’ (popularised by Thaler) to push people to make the choices that policymakers want, without depriving them of the freedom of choice. For instance, it was found that consumers can be ‘nudged’ into choosing to buy more fruits if these were displayed close to the payment counter. Similarly, people can be oriented towards choosing environment-friendly options if that is the default option. This is based on the work of behavioural economists, like Kahneman, that people often tend to use their intuition and habitual ways of thinking when they make decisions, instead of thinking things through. Nudge theory attempts to utilise this tendency to offer ‘good’ options that people will intuitively choose.

Kahneman popularised this concept in his bestselling book, ‘Thinking, Fast and Slow’. Fast thinking, or System 1 thinking, involves heuristics, or mental shortcuts, that people use to make decisions. Kahneman showed that these are based on past experiences, the availability of past examples, the framing of choices, and our tendency to avoid losses. Slow thinking, or System 2 thinking, is more deliberate, dispassionate and logical. While fast thinking is useful in taking quick decisions, slow thinking helps in avoiding the biases associated with the former.

The question that might be asked is, why did mainstream economics accept Kahneman’s disruptive ideas, which, if taken to the extreme, could entirely derail the project of neoclassical economics? The answer to that is probably that Kahneman’s critique of the rational ‘subject’ of economics lent itself to being defanged and incorporated into the wider model of free-market economics. Kahneman based his theses on statistical studies of real-life consumers, which could be understood as the basics of ‘human nature’.

Stronger challenges to the idea of the human subject, leave alone a rational one, that came from European post-structuralist theories were entirely incompatible with the project of neoliberalism. Those would perforce question the fundamental validity of the ‘invisible hand’ of the market, and any economic arguments that are based on the idea of free markets.

Kahneman wrote that we make decisions based on how we remember experiences, and not the real experiences themselves. Indeed, we are ‘our remembered selves’. One would be tempted to say that Daniel Kahneman’s legacy is equally how it is remembered after his death. Not how his ideas have actually been experienced by people, whose lives have been changed by four decades of neoliberal economic policies.

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