Naked Economics, Wheelan, Charles [open ebook .txt] 📗

be better off if we curtailed international trade, thereby closing down the sweatshops that churn out shoes and handbags for those of us in the developed world. But how exactly does that make workers in poor countries better off? It does not create any new opportunities. The only way it could possibly improve social welfare is if fired sweatshop workers take new, better jobs—opportunities they presumably ignored when they went to work in a sweatshop. When was the last time a plant closing in the United States was hailed as good news for its workers?

Sweatshops are nasty places by Western standards. And yes, one might argue that Nike should pay its foreign workers better wages out of sheer altruism. But they are a symptom of poverty, not a cause. Nike pays a typical worker in one of its Vietnamese factories roughly $600 a year. That is a pathetic amount of money. It also happens to be twice an average Vietnamese worker’s annual income.11 Indeed, sweatshops played an important role in the development of countries like South Korea and Taiwan, as we will explore in Chapter 12.

Given that economics is built upon the assumption that humans act consistently in ways that make themselves better off, one might reasonably ask: Are we really that rational? Not always, it turns out. One of the fiercest assaults on the notion of “strict rationality” comes from a seemingly silly observation. Economist Richard Thaler hosted a dinner party years ago at which he served a bowl of cashews before the meal. He noticed that his guests were wolfing down the nuts at such a pace that they would likely spoil their appetite for dinner. So Thaler took the bowl of nuts away, at which point his guests thanked him.12

Believe it or not, this little vignette exposes a fault in the basic tenets of microeconomics: In theory, it should never be possible to make rational individuals better off by denying them some option. People who don’t want to eat too many cashews should just stop eating cashews. But they don’t. And that finding turns out to have implications far beyond salted nuts. For example, if humans lack the self-discipline to do things that they know will make themselves better off in the long run (e.g., lose weight, stop smoking, or save for retirement), then society could conceivably make them better off by helping (or coercing) them to do things they otherwise would not or could not do—the public policy equivalent of taking the cashew bowl away.

The field of behavioral economics has evolved as a marriage between psychology and economics that offers sophisticated insight into how humans really make decisions. Daniel Kahneman, a professor in both psychology and public affairs at Princeton, was awarded the Nobel Prize in Economics in 2002 for his studies of decision making under uncertainty, and, in particular, “how human decisions may systematically depart from those predicted by standard economic theory.”13

Kahneman and others have advanced the concept of “bounded rationality,” which suggests that most of us make decisions using intuition or rules of thumb, kind of like looking at the sky to determine if it will rain, rather than spending hours poring over weather forecasts. Most of the time, this works just fine. Sometimes it doesn’t. The behavioral economists study ways in which these rules of thumb may lead us to do things that diminish our utility in the long run.

For example, individuals don’t always have a particularly refined sense of risk and probability. This point was brought home to me recently as I admired a large Harley Davidson motorcycle parked on a sidewalk in New Hampshire (a state that does not require motorcycle helmets). The owner ambled up and said, “Do you want to buy it?” I replied that motorcycles are a little too dangerous for me, to which he exclaimed, “You’re willing to fly on a plane, aren’t you!”

In fact, riding a motorcycle is 2,000 times more dangerous than flying for every kilometer traveled. That’s not an entirely fair comparison since motorcycle trips tend to be much shorter. Still, any given motorcycle journey, regardless of length, is 14 times more likely to end in death than any trip by plane. Conventional economics makes clear that some people will ride motorcycles (with or without helmets) because the utility they get from going fast on a two wheeler outweighs the risks they incur in the process. That’s perfectly rational. But if the person making that decision doesn’t understand the true risk involved, then it may not be a rational trade-off after all.

Behavorial economics has developed a catalog of these kinds of potential errors, many of which are an obvious part of everyday life. Many of us don’t have all the self-control that we would like. Eighty percent of American smokers say they want to quit; most of them don’t. (Reports from inside the White House suggested that President Obama was still trying to kick the habit even after moving into the Oval Office.) Some very prominent economists, including one Nobel Prize winner, have argued for decades that there is such a thing as “rational addiction,” meaning that individuals will take into account the likelihood of addiction and all its future costs when buying that first pack of Camels. MIT economist Jonathan Gruber, who has studied smoking behavior extensively, thinks that is nonsense. He argues that consumers don’t rationally weigh the benefits of smoking enjoyment against future health risks and other costs, as the standard economic model assumes. Gruber writes, “The model is predicated on a description of the smoking decision that is at odds with laboratory evidence, the behavior of smokers, econometric [statistical] analysis, and common sense.”14

We may also lack the basic knowledge necessary to make sensible decisions in some situations. Annamaria Lusardi of Dartmouth College and Olivia Mitchell of the Wharton School at the University of Pennsylvania surveyed a large sample of Americans over the age of fifty to gauge their financial literacy. Only a third could do simple interest rate calculations; most