Please enjoy this transcript of my conversation with Richard Thaler and Nick Kokonas. Richard H. Thaler (@r_thaler) is the 2017 recipient of the Nobel Memorial Prize in Economic Sciences for his contributions to behavioral economics and the Charles R. Walgreen Distinguished Service Professor of Behavioral Science and Economics at the University of Chicago Booth School […] The post The Tim Ferriss Show Transcripts: Nick Kokonas and Richard Thaler, Nobel Prize Laureate — Realistic Economics, Avoiding The Winner’s Curse, Using Temptation Bundling, and Going Against the Establishment (#830) appeared first on The Blog of Author Tim Ferriss.
Please enjoy this transcript of my conversation with Richard Thaler and Nick Kokonas.
Richard H. Thaler (@r_thaler) is the 2017 recipient of the Nobel Memorial Prize in Economic Sciences for his contributions to behavioral economics and the Charles R. Walgreen Distinguished Service Professor of Behavioral Science and Economics at the University of Chicago Booth School of Business. He is also a founding principal at FullerThaler Asset Management, which uses behavioral finance to manage over $30 billion in small-cap US equities. He is the New York Times bestselling coauthor of Nudge: Improving Decisions About Health, Wealth, and Happiness (with Cass R. Sunstein) and the author of Misbehaving: The Making of Behavioral Economics. His new book is The Winner’s Curse: Behavioral Economics Anomalies, Then and Now, co-authored with economist Alex O. Imas.
Nick Kokonas (@nickkokonas) is an entrepreneur, investor, and author best known as the co-founder of The Alinea Group (sold, 2024) and the reservation platform Tock (now owned by American Express). After revolutionizing how restaurants and experiences are crafted, booked, and managed, he’s now focused on creative ventures that blend business, technology, and art—from immersive theater projects to Napa Valley winemaking. A philosophy graduate of Colgate University, he is as interested in ideas and first principles as he is in building things that last. He lives in Chicago and Napa Valley with his wife and two sons.
Transcripts may contain a few typos. With many episodes lasting 2+ hours, it can be difficult to catch minor errors. Enjoy!
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Tim Ferriss: Well, I’m excited to dive in, and I thought, Nick, we would let you take the reins because you had this idea of starting from first principles or at least fundamentals, and that is a great place to start, because maybe the things we think we understand, we don’t understand, or the things we think we’ve defined for ourselves we haven’t defined.
Nick Kokonas: When I got to college at a Liberal Arts College and didn’t know what I was going to study, but I knew I enjoyed business, quote-unquote, or might work in business of some sort, you’re left with the study of economics there. You’re not getting an undergrad MBA or something. So, you get to economics class and it’s not that at all. It’s a bunch of models, it’s a bunch of all that. So, I thought what we would start, which is first principles, what is the study of economics? And we’re going to the best source in the world on that, but it’s really basic, yet I think fundamentally misunderstood.
Richard Thaler: So, I think that’s actually a great place to start. And especially, it’s not really possible to talk about what behavioral economics is without understanding what economics is. And economics is really two things. It’s people interacting in markets, and then what are those people doing? And what happened is sometime right after World War II, economists started getting interested in making their models more rigorous and more mathematical. And the easiest model to write down of what somebody’s doing is to write down a model in which they’re doing it perfectly.
So, if you open up any economics textbook, you’ll see the three letters MAX. And that’s short for maximize, and all models start with that. So, we assume that when Nick goes to the grocery store, what he chooses is the best things he could choose. And that’s a simplifying assumption. It’s simplifying for the economist because that’s the easiest model to write down.
Nick Kokonas: And so, what are they modeling, though, even more fundamentally?
Richard Thaler: Well, what they’re modeling is whatever you do. So, what route do you take to drive from home to the golf course? The best route. Which home do you choose to buy? The best one. What mortgage do you choose? The best one.
Look, economists are jealous of physics, and they’re jealous of physicists. Many economists started out in school as a math major or physics major or engineering major, and then decided, “Oh, this is too hard.”
Richard Thaler: But they admire that. So, they want a model that’s as accurate as the model you use to send up a rocket. And the problem is that that problem is solvable. How much stuff do you need to get a rocket to go up there? That’s a solvable problem. And figuring out what people do. If you open a book, an economics textbook, you actually don’t see the word “People,” You see the word, “The agents.”
Richard Thaler: Economics starts with Adam Smith, 1776, and it’s that way about until 1950, then we start having math. Now, we have an equation that says exactly what a smart person is going to do. And so, the agents in these models are getting smarter and smarter because the norm is, “My model is better than your model if my agents are smarter than your agents.”
Nick Kokonas: And so, what does it mean to be rational within those models?
Richard Thaler: Well, it means to solve the problem the way an economist would. And I don’t mean that economists think that they’re the smartest, though they may. But if it’s an economic problem, how to adjust your thermostat so you’re comfortable and spend the least money? That’s a little practical economic problem. And an economist and an engineer might solve it. And knowing you, Nick, you could easily get absorbed with figuring out how to really do it. But most people can’t figure out how to use that easy-using thermostat in their house, much less solve it themselves. So, people will take shortcuts.
And my joke is, instead of writing down “Max,” suppose we wrote down “Meh,” because what people are doing isn’t really max, right? It’s “I’ll do something.” And so, where I come in on that part of the story is, “Okay, if people are not capable or interested in solving and they’re doing something else, taking some shortcut, then what?” So, that’s principle number one.
Principle number two is economists, again, for simplicity, have assumed that people are selfish. And we do — most of us care more about ourselves than anybody else. Maybe our family, some family members, but we give money to charity. NPR collects money. Churches collect money.
Nick Kokonas: We might care about fairness.
Richard Thaler: We might care about fairness, right? I’m sure we’re going to have a discussion about fairness, and we might care about being treated fairly. And so, that was left out of the model again because it seemed like a simplifying assumption to just start out —
Nick Kokonas: You’re making the rocket equation, and you don’t really care about the astronauts at this point. You’ve just got to get the rocket.
Richard Thaler: You’ve got to get the rocket up. Then I’ll mention a third thing, which is these agents don’t have any self-control problems. So, they eat just the right amount, they exercise just the right amount, amount. We wouldn’t need these new fat drugs because people would already —
Nick Kokonas: Be optimizing for their health. Yeah, of course.
Richard Thaler: It would be perfectly fit. And you wouldn’t have sold half as many books, Tim. If people were those agents, then that par— And even the other kinds of things you’re interested in. Implicitly, in this idea that the agents are maximizing, means they don’t need any advice. They’re doing it right. They’re getting the labor leisure trade-off, right. They don’t need any help in getting along with their spouse because they’re —
Nick Kokonas: No, I’ve optimized my marriage. It’s perfect.
Richard Thaler: And in fact, our wives would be happy to testify.
Nick Kokonas: Yes, they’ve done a wonderful job.
Richard Thaler: We’re both perfect, really. We couldn’t be better husbands.
Tim Ferriss: So, I’ve been looking forward to this conversation that I’ve always furrowed my brow at the agents all as rational and selfish because I just don’t see that behavior if you look at your neighbor or your friend or someone else. So, my question though, is not so much to dive into that we could, and the story of your friend who got hay fever, Richard, when he mowed his lawn is a pretty funny one from New York Times. Maybe we’ll bring that up. But suffice to say, people self-sabotage, they care about fairness, there are all these things that seem to invalidate getting the rocket to the moon or that approach to economics.
And I’m wondering, were they just force-fitting precision to something in order to defend it as more rigorous, and it was a waste of time? Or was it more like Newtonian physics versus quantum mechanics, where it’s like, “Well, you can actually use Newtonian physics for a lot of good things.” Is there anything productive that came of these incorrect assumptions about all agents being rational and selfish as a bedrock assumption?
Richard Thaler: Yeah, I would say, sure, supply and demand still works, right? All the economic starts with supply and demand. If you raise the price, you’re going to sell less, almost always. And when you write down these more formal models and make more precise predictions, then the question is, “Are you adding predictive power through that?” And what happened is as this norm we’re starting in the 50s, and I would say rationality peaked in the 90s, maybe, where this norm that a model with really, really, really smart people is the best possible model. Eventually, people start to realize, “Well, maybe there’s some drawbacks to that.”
But you can argue, and of course, I’ve spent my career arguing about how wrong this is. The great Chicago economist, Milton Friedman, had this defense, is he would say, “Look, I just want a model that people are behaving as if they were maximizing.” So, he would say, “It doesn’t matter if they literally know how to do it, if their behavior is close enough.” The real debate over my career has been about that question.
Nick Kokonas: Well, let’s go back to the start then, I think, of your origin story and thus the origin story of behavioral economics itself. Because at some point, psychologists start getting involved, and they start looking at these models, and they start saying, “Yeah, but people don’t really act this way.” And so, this could be great in a laboratory or on a piece of paper in a spreadsheet, but it might not work in the real world, and there’s real consequences to those things. So, let’s go back to when you were a young academic and started coming across those ideas.
Richard Thaler: This is in grad school. So, there’s a story I tell about a dinner party with some other economics graduate students, and there’s some roast in the oven, it smells great, and there’s some adult beverages. And I bring out a bowl of cashew nuts, and people started nibbling as they do, and at some point, I realized that their appetite was in danger. And so, I grabbed the bowl of cashew nuts and went and hid them in the kitchen. And then I came back into the living room, and people thanked me, “Oh, thank God you got rid of those nuts. We were going to eat them.”
Nick Kokonas: So, you removed choice.
Richard Thaler: I removed choice. And then, because this is a group of economists, they start analyzing it. There’s a rule of thumb—you don’t want too many economists at any dinner party. And this is a good example of it. So, somebody mentions that “Well, we’re actually not allowed to be happy about that because more options is always better. And we used to have the option of eating nuts, and now we don’t.” Well, you can imagine. But the principle, the discussion wasn’t that interesting. But the principle is interesting that sometimes we prefer not to have options. And so, I started with this list of stuff like that, and then the work comes into, “All right, well, how can you go beyond a story?” “So, yeah, that’s an amusing story, but so what?”
Nick Kokonas: You want to change the framework of economic theory without throwing out the rigor, but now you’re introducing something super messy, which is humans and psychology and irrationality and all of those things. So, how do you do that without getting rid of the rigor?
Tim Ferriss: Yeah. Just to make sure I’m tracking, it seems like, so you’ve created this list of sacred cows that you had put on trial, but the question was how to do it quantitatively or in some way, like Nick said, rigorously without just leaving it as an anecdote?
Richard Thaler: Well, there are two parts to it. One is can you show that people are really doing that? And then second, can you create rigorous models that describe that behavior? And we might as well stick to the demonstration part. So, we can go from that, the cashew story, and say, “Well, what does that have to do with the real world?” and we can talk about retirement saving. As a first principle, Americans don’t save unless the money is taken from their paycheck and put into a retirement plan. Now, economic theory would say “It doesn’t matter. People are going to save the right amount.”
There have been two Nobel Prizes for theories that basically say, “People save the right amount.” So, they take their income, and they decide, “Okay, I’d like this consumption path over my lifetime, and now how much do I have to save to get that? And then I keep re-optimizing, market goes up, I can save a little less,” and so forth.
Nick Kokonas: That seems so obviously wrong. So, were you frustrated at this point? I read some of your old papers in preparation for this, and I saw these little backhanded little mentions that were snide. It’s funny reading 40-year-old academic papers and reading the snark in them, right? There’s actual snark in young Thaler, long before any of this.
Richard Thaler: It never escaped.
Nick Kokonas: It never escaped. So, tell me a little bit about that, because it seems to me in hindsight, the first time we met, we played golf together after a Twitter exchange. And I remember thinking to myself as you were saying this, I would go like, “Yeah, well obviously.” And then you’d look at me like, “No, no, no, you don’t understand. For 150 years, that wasn’t obvious.” And so, within the context of this academic world, why was any of applying what seems to be pretty logical stuff, why was it resisted so much? Why is that system built like that?
Richard Thaler: I can tell you, while I was living through that, The Emperor Has No Clothes was a recurring thought that, “Why am I seeing that and no one else does?” And the “no one else” was just economists. So, I remember giving a talk in the Psychology department at Cornell, where I was teaching, and I was talking about this theory of how people save, and the audience just starts laughing.
Nick Kokonas: Yeah, that’s what I did. I was like, “This is pretty easy stuff.”
Richard Thaler: They’re laughing and one of my economist friends was there, and he had to assure them that I wasn’t making this up and that this wasn’t a caricature of economic theory. No, there are economists, one floor up from here, who actually believe this is the way people behave.
Nick Kokonas: But they didn’t even think of it as an abstraction in the model? They actually thought like, “Hey, this is how humans go through life.”
Richard Thaler: Or, “as if,” remember those magic—?
Nick Kokonas: Yes.
Richard Thaler: They don’t have to know how to do a present value, but they’re acting as if they knew.
Nick Kokonas: That’s right.
Tim Ferriss: That has a bit of a “maxing works in mysterious ways” type of ring to it. Is that defensible as an argument, the “as if”? Or is that just a wiggle?
Richard Thaler: Look, it was the winning argument when I started on this. And in fact, in my first paper, which was published in 1980, my first behavioral economics paper, it ends with a long response to Milton Friedman’s “as if.” He talks about a billiards player, and he says, “Look, the billiards player may not…” It’s an expert billiards player. I should point out that he talks about, he says, “He may not know physics or trigonometry, but he acts as if he did.”
Nick Kokonas: But is it really inferring that the law of large numbers or crowd intelligence, or whatever you want to call it, where you go, “Well, it doesn’t matter what the individual does,” as an aggregate? When we look at a model, it will average out that the smart people and the idiots all get to the midline, which is the model.
Richard Thaler: So, there are two things here. One is when he talks about this expert billiards player, I pointed out in this article, we actually study regular people, not experts. So, you are a pretty good golfer. I’m a mediocre golfer. Neither of us play like Tiger Woods. So, even though you’re a pretty good golfer, we wouldn’t want to predict the way you’re going to hit a shot by saying, “What would Tiger do?”
Nick Kokonas: 1000 percent, yeah.
Richard Thaler: And so, that was my first point about the billiards player is let’s just go to a bar and try to predict what this guy is going to do. Is the model going to be the one that is optimizing, or is it the model of the regular guy at a bar? And if we’re studying investors, they’re not Warren Buffett, they’re pretty far from Warren Buffett. So, the second thing is, and it’s another version of the same thing, which is if we’re trying to describe behavior, whose behavior is it? So, there’s a lot of discussion in, say, monetary policy about expectations.
So, the Fed will say, “We have to change interest rates because we are worried that if prices go up, people will expect them to go up further.” I’m always asking my friends who are in that field, whose expectations are they talking about? If it’s the guy walking down Michigan Avenue, they have no expectations about inflation. They may have impressions of what’s going on now. Like, “Oh, meat’s high now.”
Nick Kokonas: The eggs.
Richard Thaler: Eggs are high, right? Gasoline, I have an electric car, even I’m aware of the price of gas because it’s posted in those big signs that you walk by. So, we know the level, do we have real forecasts about the future? No.
Nick Kokonas: Then how did you, going back a little bit now, how did you then go about designing thought experiments, actual lab experiments, experiments out in the public to take these erratic, if you will, or non-optimal behaviors, and go back to the models that you questioned and improve them, alter them, change them? If you could give a couple examples, because I think they’re fun too.
Richard Thaler: Let’s talk about loss aversion. And here’s the first survey I ever — my thesis, which was a very traditional bit of economics, although on a exotic topic, it was on the value of saving lives. So, if we make a highway safer and we save 10 lives a year, how much should we be willing to pay for that? And I decided it might be interesting to ask people a question. So, I asked people, “Suppose by attending this lecture today, you’ve been exposed to a one in a thousand risk of dying, you have this disease and there’s a one in a thousand chance you’re going to die a quick and painless death next week but I have a cure here that I can sell. How much would you pay for it?” That was one question. Another question was, “Over at the med school, we’re studying that same disease. We’d like to know how much you would have to pay you to expose yourself to a one in a thousand chance of getting that disease and there’s no cure here.” Now, economic theory says the answers to those two questions have to be the same. So, the amount I’m willing to pay to get rid of it or the amount I have to be paid to do it should be approximately the same. They are nowhere near the same.
Richard Thaler: So, people would say, “Oh, I’d pay $1,000 to get that cure, but youI wouldn’t do that experiment for $1 million.” Now, they’re lying because they drive, they —
Nick Kokonas: Yeah, they do all sorts of things, yes.
Richard Thaler: But they wouldn’t choose to be in that experiment for a million. So, okay. So, that’s buying and selling prices are wildly different. Now, how do we get that down to something more real? You asked about an experiment, there’s a famous experiment I did with my friend and mentor, Danny Kahneman and our friend Jack Knetsch. And the way it works is very simple. We go into a classroom and—we did some of these at Cornell—we would go and put a Cornell coffee mug of the sort you can get at any campus bookstore.
We put it on every other desk and then we say, “All right, if you have a mug, we ask you, of each of the following prices, are you willing to sell?” Start at $10 and go down. And if you don’t have a mug, you get the same form and say at each of the following prices are you willing to buy. Now, the mugs are assigned at random, people have had this mug for 30 seconds. It’s not their grandma’s mug, it’s been in their possession for 30 seconds. And what do you find? Well, the people who have a mug demand twice as much to give it up than the ones who don’t have a mug are willing to pay to get it.
Nick Kokonas: Why is that, do you think?
Richard Thaler: Well, if I’ve got it, I don’t want to give it up.
Nick Kokonas: That’s it.
Richard Thaler: But I wouldn’t pay much to get it.
Nick Kokonas: Right. So, the variance between retaining something and acquiring it are really wide.
Richard Thaler: Yeah.
Nick Kokonas: What are the consequences of that?
Richard Thaler: It means there’s much less trading and much less change than we would expect because we hold on to the stuff that we have because we don’t like giving it up. But when there’s a big fire like they had in LA last year, people are going to have to decide. All right, now they don’t have the option of moving into the old house, what are they going to do?
Nick Kokonas: The interesting thing about these is that the way that we met is that I was running experiments of loss aversion with a restaurant. So, I had these restaurants and I had people making reservations and, if they had absolutely not a single penny in, they didn’t care about anything. But you could take the richest person in the world and, once they had $5 in for their reservation as a deposit, it took the no-show rate from 14 percent to under three percent. And I wrote about that and published it, and these economists from Northwestern published an article saying that I was an idiot and I should just run an auction. And I replied to them suggesting that maybe there’s a little bit of human behavior and psychology involved in this and I think that I’ve got it right and I have hundreds of thousands of examples as to why this is working for my business. And Thaler read this and tweeted at me, but at the time I didn’t know who he was.
And so, finally people said, “Hey, you’ve got one of the best economics professors in the world who really wants to talk to you about this.” And so, I was just doing it out of intuition and experimentation, but they’re the same sorts of experiments in a practical way that you are abstracting into these traditional models.
Richard Thaler: So, Kahneman and I wrote another paper where we tried to find out what people think is fair.
Nick Kokonas: Yeah. Fairness is a really interesting concept.
Richard Thaler: And the Northwestern economists that were dumping on Nick thought that what he really should do is just auction off the tables at 7:30 on Saturday night for whatever price he could get.
Nick Kokonas: Because I’d be maximizing my utility.
Richard Thaler: Well, no, you’d be maximizing your profits.
Nick Kokonas: And profits, yeah.
Richard Thaler: Right, right. And there is some rich guy who will pay $2,000.
Nick Kokonas: For sure. Especially then, yeah.
Richard Thaler: Yeah. And you wrote back and said, “Yeah, but they might not come back.” And the questions that we asked in this paper were scenarios like there’s a hardware store that’s been selling snow shovels for $20 and there’s a blizzard and they raise the price to $30. Is that fair? And people say no, but there’s one exception. There’s a group that say absolutely yes, and that’s business school students. So, I teach a class in decision-making, and each week I show them, look, here’s the data from some experiment and you think these people are idiots but, look, you do it the same. So, they may be idiots but so are you.
Nick Kokonas: What’s the example?
Richard Thaler: Any of them. Any of any these other experiments except this one on fairness, the business school students are different from the idiots because they think, of course, you should raise the price of snow shovels after a blizzard, we learned that in micro.
Nick Kokonas: Yeah. Well, that’s the Uber surge pricing. Tim, you know something about that.
Tim Ferriss: Yeah. Surge pricing, I know it well.
Richard Thaler: Yeah. So, surge pricing, I thought at the time that there’s nothing wrong with surge pricing, but you have to put a limit on it. And the example I gave, I tried to convince the owner of Uber of this. I said suppose Uber existed on 9/11 and you had Ubers charge $5,000 to drive people back to Greenwich. How many days would Uber still be in business? Minutes. You can’t do that.
Nick Kokonas: You can’t do that. And that’s the fairness principle.
Richard Thaler: That’s — right, right.
Tim Ferriss: And that proves the rule that we are psychological, everyone is a psychological creature when it comes to markets and interaction.
Richard Thaler: Right. It might be the guys that are in that Uber for five grand, but even they are going to be a little pissed.
Tim Ferriss: Yeah, yeah.
Richard Thaler: But more importantly to Uber, if they did that — the thing is, at the time, when they would have these surges of 10X, they were not making any money off of that, it would be fleeting. So, they’d make a little bit of money just like if Nick had sold one dinner reservation for 10 grand. Yeah, he’d make 10 grand but he’d have thousands of people writing articles.
Nick Kokonas: 1,000 percent, yeah.
Richard Thaler: So, Uber was making a little bit of money and pissing off millions of people and that was dumb in a business where they had to fight city by city to get permission to take people to the airport. And so, I think the important lesson is that, if you’re doing business in the real world and you have customers and employees that are people, not agents, then you have to do things a bit differently. And that’s the one-sentence summary of behavioral economics.
Tim Ferriss: So, Richard, could you, for people listening in, for me, give an example or two of how you take the research and then apply it in the real world? You mentioned, effectively, forced savings earlier, maybe that’s a domain we could explore.
Richard Thaler: When my father worked, he was an actuary, he worked at a big insurance company. He had the pension that was prevalent at that time, defined benefit pension plan, the old-fashioned kind, where how much you got in your pension just depended on how long you worked and what your final salary was, no decisions. And we gradually started shifting over to the new 401(k) type that’s called defined contribution meaning you put money in and invest it and then you get what you have at the end.
Now, when I started working in this area, one problem we noticed was lots of people weren’t joining this savings plan even though their employer was matching contributions dollar for dollar up to, say, 6 percent of their salary. So, that’s the stupidest thing you could ever do. You’re making $100,000, they’ll say, “I’m going to give you $6,000 as long as you put —
Nick Kokonas: You save 6,000, yeah.
Richard Thaler: Yeah. In a tax deferred —
Nick Kokonas: Yes, right.
Tim Ferriss: Yeah.
Richard Thaler: So, an economist would say, “Well…”
Tim Ferriss: 100 percent of the people are going to do that.
Richard Thaler: “…everybody will do it.” And what we noticed is, in a lot of companies, only half of new workers would sign up within the first year. So, how can we fix that? Well, remember we talked about status quo bias. So, here’s a simple way. The way it worked at that time was, in order to join, you have to fill out a form and choose some investments and then sign and this was a piece of paper at the time. I said how about if we just change the form and say there’s this plan, we’re going to put you in unless you fill out a form saying you don’t want it. Now, again, economic theory says that won’t make any difference, everybody’s going to join and, certainly, just filling out a piece of paper, that’s —
Tim Ferriss: It’s not enough friction to change things. Right, yeah.
Richard Thaler: We’re giving you $6,000 so no one will — but the first company that did that, new employees now joined 90 percent instead of 50 percent. So, that’s an example. I wrote a book called Nudge and that’s an example of a nudge.
Tim Ferriss: I am fascinated by nudges and tell me if I’m defining this correctly but “some feature of the environment that improves decisions but doesn’t force anyone to do anything.” Is that a fair —
Richard Thaler: Yes.
Tim Ferriss: I think I’m trying to quote directly, hopefully it’s accurate.
Richard Thaler: I’m pretty sure I wrote those words.
Tim Ferriss: Yeah, I think you did. So, one of the examples that I’ve heard you discuss, I think this started in the Netherlands, but it is the fly etched or otherwise put inside of urinals to reduce spillage because a lot of guys are on autopilot, turns out they like to aim at things. My question is —
Nick Kokonas: I love that that’s what you — of everything that you read, that’s what you chose to pick.
Tim Ferriss: Well, I picked it because at least most guys listening have seen this. And my question is is there a certain half-life to the effectiveness of nudges? Because I remember the first time I saw one of these, I was like, “Oh, I’m definitely going to get that fly.” I remember it. And then, after a while, I was like, “Okay, I realize this is just painted on enamel or etched into the enamel, it’s no longer that interesting.” And not to extrapolate from myself to everyone but I’m wondering if you need to refresh nudges as you might refresh many other things that maybe Nick has experimented with in the realm of business. How do you think about the durability of these types of nudges?
Richard Thaler: So, there’s a good example of a nudge of that sort here in Chicago. When Nick and I drive back home, we’re going to go on Lakeshore Drive and there’s a bendy part, and it’s beautiful road, and a lot of people wipe out around these bends. You really can’t go more than about 30 and it’s a six-lane road so people think they can go fast. So, what somebody did, around the time we wrote that book, a little before, is they painted lines on the road that get closer and closer together that gives the illusion that you’re speeding up.
Tim Ferriss: That’s clever.
Richard Thaler: And so, you’re just instinctively tap the brake and then don’t wipe out your car. That’s good. Now, those lines, they keep repainting them.
Nick Kokonas: No one pays attention anymore, yeah.
Richard Thaler: Well, I don’t know.
Nick Kokonas: I don’t know either.
Richard Thaler: I don’t know. I think the fly in the urinal probably won’t have any effect in the toilet you use at your place of work where you see it several times a day or whatever. For the pension thing, if we only have to get — you to sign up once, that’s enough. So, yes, attention, it may be that we have to do something different to get your attention this time. But there’s a rule which is if you want people to do something, make it easy. That’s a rule. That’s always true. And if the more complicated you make things, the less people are going to do it. So, I think that’s pretty much automatic. In terms of capturing attention, that’s what the business of advertising is constantly trying to do and clickbait on ads on social media.
Nick Kokonas: I mean, social media itself is in the business of that?
Richard Thaler: Right.
Richard Thaler: Keep it simple is a formula that always works. And getting your attention always works, but it won’t be the same thing that will keep getting your attention.
Nick Kokonas: So, this turned into a whole field from relatively simple concepts like that called choice architecture. And you’ve done consulting with various companies, the NFL, all sorts of people. I don’t even know which ones I’m allowed to talk about or not, so I have to be careful. But tell us a little bit about when does that become a bad thing? So, can you turn the nudge or can someone that’s malicious turn the nudge into something that takes advantage of the lack of self-control in these models?
Richard Thaler: We always say we didn’t invent Nudging. Adam and Eve, right? There was the serpent. There was the apple. So, human nature has been there all along. Hucksters have existed forever. Charles Ponzi didn’t read our book, didn’t read any of my papers, neither did Bernie Madoff. And when we wrote Nudge, it was saying, “Look, here are some basic principles of human behavior. Can we use those to help people make better decisions?”
Nick Kokonas: So, practically speaking, how do you then go into one of the businesses that you’ve consulted for and come up with through your framework what they have overlooked?
Richard Thaler: Well, you want to ask, you want people to do more of that. Why are you making it hard for them to do it? That’s the answer. But where I was going with that was the same principles can be used to harm people. So, if you go into a casino, the whole casino has been designed to get people to bet as much as possible and to bet on things that —
Nick Kokonas: Have the worst possible outcomes.
Richard Thaler: Right.
Nick Kokonas: Yeah.
Richard Thaler: And now, we have online gambling. And we have places like Robinhood that have made investing feel a lot like casino gambling.
Nick Kokonas: Yeah. They gamified it.
Richard Thaler: Yeah. So, they’re making it easy. They’ve made it easy to bet. It used to be you had to go find a bookie. Now, you open your phone and you can bet on the game that you’re watching. And that’s very tempting. So, the principles of understanding the customer and then designing the product can be used for good or evil. I take no responsibility for somebody optimizing an online gambling app to make it as attractive as possible for people to lose all their money. Don’t blame me. But that’s what’s going to happen in a competitive market with consumers who are humans.
Tim Ferriss: Richard, a question for you. How long have you been teaching your, or how long did you teach? It sounded like it was current day, the decision-making class.
Richard Thaler: 40 years.
Tim Ferriss: Okay. So, you’ve had time to work on your material.
Richard Thaler: Yeah. I should be better at it. Right?
Tim Ferriss: Well, I wasn’t going to go that far. I was going to ask you what seems to be the stickiest of what students repeat back to you from that class as concepts, frameworks, stories, could be anything at all. I suppose the precursor question is what are they hoping to gain from the class in the first place? What’s the promise of the class? But I’d be curious to know what sticks.
Richard Thaler: That’s a great question. So, first thing I will say is nobody thinks they need a class in decision-making because they’re great at decision-making. Why would they need a class in that? And do I need a class of breathing? So, although you’re going to tell me, actually, you don’t know how to breathe in, right? Then, yeah, yeah, yeah.
Tim Ferriss: I’ve got a frictionless e-course for you with lots of in-app purchases.
Richard Thaler: I do hear from people who took a class from me at Cornell 40 years ago, which is very gratifying. I’m glad that they even remember that they had such a class. What do they remember? They remember stories. That is the only thing people remember. They do not remember a formula. They don’t remember some abstract concept. They remember a story or they remember a demonstration.
Take the concept of the winner’s curse. This is an obvious move on my part since I have a new book that’s called The Winner’s Curse. But let’s talk about the winner’s curse, because it’s a great example. Winner’s curse, the way you do this in a class is you bring in a jar of coins and you say, “I’m going to auction this off.” You get the money in the jar, and —
Nick Kokonas: You mean the high bidder guy —
Tim Ferriss: Gets the money.
Richard Thaler: High bidder gets the money. So, there’s $75 worth of coins in there, and the high bidder gets 75 bucks and they pay me —
Nick Kokonas: Something.
Richard Thaler: — something.
Nick Kokonas: That’s what we’re getting to.
Tim Ferriss: Do they know that it contains 75 or it’s an unknown.
Richard Thaler: No. They just see —
Nick Kokonas: It’s like a jelly bean estimation or something.
Richard Thaler: Exactly.
Tim Ferriss: I got it.
Richard Thaler: In fact, right, you can use jelly beans or whatever, paperclips. So, what do you find in that? You always make money on this.
Nick Kokonas: The creator of the jar makes money.
Richard Thaler: Yeah. The professor always makes money because you have this jar, it’s worth $75. There’ll be somebody that’ll be 100 or 150.
Nick Kokonas: And they win. They’re the winner.
Richard Thaler: They win. So, that experience, you can tell people this abstract concept of something called the winner’s curse. They won’t even remember what it means. It’s got a weird name. It doesn’t have anything to do with cursing or witches. But they remember, “Oh, yeah. That guy who bid a lot bid too much. Now, this concept was not discovered by psychologists. It was discovered by engineers at ARCO, an oil company. They were bidding for leases in what I’m going to insist on continuing to call the Gulf of Mexico. And what they discovered was the leases that they won had less oil than the engineers and geologists had told them would be there. And they said, “Geez. That’s weird because we thought we had great geologists. And what’s the problem?” And the problem, they figured out, which very subtle, which is that the auctions you win are not a random sample of the auctions you bid in. They’re the ones where you’re the highest bidder. And if you’re the highest bidder, there’s a good chance that —
Nick Kokonas: You bid too much.
Richard Thaler: You bid too much.
Nick Kokonas: So, that leads to an interesting conundrum, or it’s almost like war games where the only way to win the game is not to play if you’re ARCO, which means you should just go out of business. So, how do you win that if you are in that market where you have to bid on these things?
Richard Thaler: That’s a great question. So, all right, it’s 1970 or something, whenever they published that paper, they get this finding, “What should they do?” One would be to not… to go into some other line of business. Another would be to bid less, but then they’re not going to win very many auctions. They came up with a pretty clever solution, I think.
Tim Ferriss: Was it collusion?
Richard Thaler: No.
Nick Kokonas: That would work. I bid on something like that.
Richard Thaler: Major League Baseball.
Nick Kokonas: Major League Baseball does that.
Richard Thaler: That was their solution. And they were outed on that. No. Their solution was to write a paper. Think about it.
Nick Kokonas: So, they made everyone aware of it?
Richard Thaler: Right. So, instead of going to all the other team owners and say, “Hey, guys, when Catfish Hunter becomes a free agent, don’t bid.” That’s illegal. But publishing a paper saying people are bidding too much and the more bidders there are, the less you should bid. That’s perfectly legal and useful. Now, it turns out that there’s a funny story about this, which is the version of this book, The Winner’s Curse, that I published in 1992, the editor who bought that went to Princeton University Press. And then when Nudge came along, there was an auction for the rights to bid it.
Nick Kokonas: Did they pay too much?
Richard Thaler: No. He didn’t bid. And I said, “Peter, how come you didn’t bid on this book? I think it’s going to sell.” He said, “No. I read The Winner’s Curse.” I knew —
Nick Kokonas: I can’t bid on your book.
Richard Thaler: Yeah. And no, don’t bid in auctions. So, I said, “Well, maybe this one should have been an exception.” So, that concept — I haven’t forgotten your question. I don’t know whether people will learn that theoretical lesson, but they’ll remember the jar of coins and they’ll remember stories.
I had two psychologist mentors, Amos Tversky and Danny Kahneman, now both dead. But Amos sadly died at 59. But at his funeral, his son read a little note that Amos had given him that said something like, I’m not going to get this exactly right. But he had cancer and he had a few months where he knew he was dying and was spending time talking to his family about it. And he wrote a note saying that he thinks the time they’ve been spending talking has been useful and that he thinks people learn through stories.
And I’ve put that little note in my first class ever since then. And I say to people, “Look, people will tell you don’t take this class. All he does is tell stories.” And I said, “That’s true. And talk about sports, that’s also true.” But “Look, here’s this line from Amos, smartest man on earth. That’s the way you learn. You’re going to learn through the stories.” And so, I think we show people that they’re overconfident and —
Nick Kokonas: In their decision-making and —
Richard Thaler: Yeah. Or in judgments. I mean, you ask people, what’s the length of the Amazon River and give 90 percent confidence limits, meaning give a high and low estimate so that you’re 90 percent sure that the correct answer lies —
Nick Kokonas: Is somewhere in.
Richard Thaler: — between.
Nick Kokonas: Yeah.
Richard Thaler: And the right answer will be within it — not 90 percent, but like 60 percent.
Nick Kokonas: Yeah. I would not wager on that. I have no idea.
Richard Thaler: Yeah. So, you know you have no idea. But still the limits are too narrow.
Nick Kokonas: Too narrow.
Richard Thaler: By the way, the same is true for CFOs of Fortune 500 companies. I have two friends at Duke who do a survey twice a year of CFOs. And they’re asked what’s going to be the return on the S&P 500 over the next year. And they’re asked for a high and low estimate. And the correct answer comes out between those. I think they asked for 80 percent limits. And it’s like —
Nick Kokonas: Yeah. No one knows.
Richard Thaler: — a third of the time.
Nick Kokonas: Yeah. No one knows.
Richard Thaler: Now, it’s true that that’s an impossible task, meaning nobody can predict the market. But you should know that you can’t predict the market. So, a correct answer for 80 percent is, “Well, it’s going to be somewhere between up 20 percent and down 10 percent.” That’s a reasonable forecast.
Nick Kokonas: Yes.
Richard Thaler: But instead, they say up 10 percent minus two percent, minus two percent.
Nick Kokonas: Or something there. Yeah.
Richard Thaler: There was a whole decade where the average downside scenario was zero.
Nick Kokonas: Well, it’s a recency bias, right? It’s like whatever happened the last couple years, people tend to extrapolate into the future.
Richard Thaler: They were doing that right up until the financial crisis, right?
Nick Kokonas: Yeah, yeah, yeah.
Richard Thaler: So, they were most overconfident right before —
Nick Kokonas: Right before the shit hit the fan.
Richard Thaler: Exactly. So, that was Kokonas saying the shit hit the fan, not —
Nick Kokonas: I’m allowed to swear on this podcast.
Richard Thaler: Oh, okay.
Tim Ferriss: You can swear. You are free to fire away.
Richard Thaler: So, the winner’s curse sounds like an abstract concept, but Nick knows I wrote a paper about the NFL draft that applies exactly that concept. The teams really think it’s valuable to have the first pick or one of the top 10 picks.
Nick Kokonas: And then you just cited the Chicago Bears and their quarterback picks, and that’s all you needed to do.
Richard Thaler: Yeah. I mean, and I think the Bears traded up twice to pick quarterbacks, at least —
Nick Kokonas: I mean, this is always — it’s not just the Bears though.
Richard Thaler: It’s not just the Bears. No. This is availability bias.
Nick Kokonas: Yeah.
Richard Thaler: We live in Chicago. But they’re not the only team that does this. And my co-author and I, that paper and somebody else, have been, again, updating that and nothing has changed.
Nick Kokonas: But then people actually then hire you to tell them this because for some reason they can’t believe it.
Richard Thaler: Yeah. But then the problem is that there’s an owner.
Tim Ferriss: Well, let me ask you, Richard, about the hiring just for a second, because the example with ARCO involved writing a paper that draws attention to the fact that if you bid the most, you’re likely going to be overpaying, which is a very interesting stratagem. I’m wondering, in the case of, say, an NFL team, what is it that they can do? How can they change their behavior or bidding behavior based on you describing the winner’s curse and all the connective tissue around it?
Richard Thaler: If they have a top pick, they can trade down. So, if you have the first pick, you can trade it for the 7th and 8th picks, or five, count them, five second round picks. And those five players will cost you about the same as —
Nick Kokonas: In dollars, in contracts.
Richard Thaler: In dollars.
Nick Kokonas: Yeah.
Richard Thaler: Right. And if you look, I mean, any sports fan can rattle off the number of very high picks, quarterbacks and others that have been complete busts. So, here’s the one statistic from that paper that I think is most compelling. Take the players at any one position, let’s say running backs and rank them in the order in which they were picked. So, we have the first down to whatever. Now, we ask, “What’s the chance the higher one picked is better than the next one?” My co-author, Cade, and I used to — we call this the better than the next guy stats.
Nick Kokonas: Yeah, yeah, yeah. So, it’s like a tennis ladder.
Richard Thaler: Right. Right? So, yeah. And if teams are perfect at predicting, it’ll be 100 percent. If we rank them —
Nick Kokonas: Number three guy is —
Richard Thaler: — tallest to shortest, that’ll be 100 percent. And if they’re flipping coins, it’s 50 percent.
Nick Kokonas: Sure.
Richard Thaler: It was 53 percent.
Tim Ferriss: All that work, all of the prediction, all of the people, all of the scouting, all the combine, and it’s pretty much coin flip.
Richard Thaler: Yeah. It’s pretty much coin flips. So, that means more picks are better.
Nick Kokonas: So, Tim’s podcast is really about taking, as he always says at the beginning of everyone, the high-performers and the people who see things differently and trying to take the nuggets that people can apply to their lives. And so, I know that some of what you’ve studied and done, you’ve looked at people’s habits like we were saying at the very beginning, where everyone makes perfect — we live in this wonderful world where people make perfect decisions. And of course, that’s not the case.
That’s really what the whole podcast is about, how to change those bad habits into positive habits. And so, what kind of frictions can we create in our lives where we can improve our decision-making? We can be more like that ideal agent that actually cares about our economic utility without going nuts and sitting in a room with spreadsheets. But how do you take these things that you’ve studied in human nature for 40 years and apply them to my life normally?
Richard Thaler: Well, let’s go back to the cashews. This is stuff everybody knows. Your mother told you that if you’re trying to quit smoking, you don’t have cigarettes around. If you are drinking too much —
Nick Kokonas: Lock the wine cellar.
Richard Thaler: Yeah. Lock the wine cellar. And so, make it harder to do the stuff you want to do less of and make it easier to do the stuff you want to do more of.
Nick Kokonas: Yeah. I mean, that seems obvious.
Richard Thaler: Well —
Nick Kokonas: Not so much for economist.
Richard Thaler: Basically, everything I’ve done has seemed obvious after the fact. Selling reservations at a restaurant, instead of, as you used to say, having five people you pay to say “no” on the phone, that seems like an obvious thing to do.
Nick Kokonas: It does. But I will say that since I have sold the company, we’ll talk about the law of one price. Like this pen, if it’s identical should cost the same all over the place, and that’s where arbitrage opportunities come from and all of that. And classical economics would say, “Well, those get scrubbed out because of perfect information and all of that.” But as it turns out, you have to then convince business owners that, “Hey, this is not a controversial idea, and you can indeed charge a deposit and change the economics of your business.” And I spent over a decade doing that. And it was very difficult, actually.
Richard Thaler: Yeah.
Nick Kokonas: And no matter how easy we made that choice architecture for them as business owners, their psychology was that, “Well, this is a controversial topic.” And then since I’ve left the company, what I’ve watched is that one of the big competitors is now sim
