The Undoing Project

by Michael Lewis

  This was odd, as Thaler’s other pronounced trait was a sense of ineptitude. When he was ten or eleven years old, and a B student, his father, a detail-oriented insurance executive, had grown so frustrated with his sloppy schoolwork that he handed his son The Adventures of Tom Sawyer and told him to copy a few pages exactly as Mark Twain had written them. Thaler tried, seriously. “I did it over and over, kicking and screaming.” Each time, his father found errors—missing words, missing commas. The quotation marks in an exchange between Tom and Aunt Polly confounded him. Looking back on it, he could see that his problem was more than a lack of effort: He was probably mildly dyslexic. But people just assumed he was either careless or lazy, or both.

  And so he began to think of himself this way, too. Economics just then wasn’t perhaps the ideal place for people who were easily bored and had trouble with details. Thaler had gone from college straight to graduate school mainly because his father’s life had persuaded him that business careers were mind-crushingly boring, and that he had no ability to work for someone else. He couldn’t think of what else to do but go to graduate school, and he picked economics because “it seemed kind of practical.” Only then did he discover that the field placed a terrifying premium on both precision and mathematical ability—to the point where it seemed that the only people who were allowed to make jokes in their journal articles were the guys who were best at math. By the time Thaler arrived at the University of Rochester’s Graduate School of Management, he sat at some distance from his own field, and from his fellow graduate students. “I was more interesting than them, and not as good at math,” he said. “What was I good at? It was at finding things that were interesting.”

  He wrote his thesis about why the infant mortality rate in the United States was twice as high for black as for white populations. Controlling for all the obvious variables—education and income of the parents, whether the baby was born in a hospital, and so on—he explained only half the difference. He was left with what seemed an unsolvable puzzle. “I tried and failed to explain it,” he said. “I could have made it more interesting if I had had more confidence.” The economics profession responded by rejecting him for every university job he applied for. He settled for a job with a consulting firm.

  Then, just as he set out on a new path in life, the firm closed an office and let him go. At the age of twenty-seven, broke and unemployed, with a wife and two little kids, Thaler begged the head of the Rochester School of Management for a job, and the man gave him a temporary one-year gig teaching cost-benefit analysis to business school students. Back in school, he set out to write another dissertation. He found another interesting question: How much is a human life worth? He also found a clever way to approach the problem. He compared the salaries for risky jobs—coal miner, logger, skyscraper window-washer—to the life expectancy of the people who did them. From the data, he backed out what Americans needed to be paid to accept an expected reduction in their life span. If you could calculate what people needed to be paid to accept a 1 percent chance of being killed on the job, you could, in theory, work out what you’d need to pay them to accept a 100 percent chance of being killed on the job. (The number he came up with was $1.4 million, in 2016 dollars.) Later he’d think of his methods as a little silly. (“Do we really think people make this decision rationally?”) But older, more successful economists were happy to assume that, say, America’s coal miners made some inner calculation of the value of their lives, and charged accordingly.

  The paper secured Thaler a full-time job, without tenure, at the Rochester Graduate School of Management. But it was while he was trying to calculate the value of a human life that he began to feel uneasy with economic theory. He’d given questionnaires to subjects that asked them a hypothetical question: If they had been exposed to a virus, and knew there was a one-in-a-thousand chance that they had contracted a fatal disease, how much would they pay for the drug to cure it? Because he was an economist, he knew that there was more than one way to ask the question, so he also asked people: How much would you need to be paid to be exposed to a one-in-a-thousand chance of getting the same fatal disease? Economic theory said the two numbers should be the same. Whatever you were willing to pay to rid yourself of a one-in-a-thousand chance of dying, it should be the same as the sum you needed to be paid to expose yourself to a one-in-a-thousand chance of dying: That number was the value you assigned to a one-in-a-thousand chance of losing your life. People whose lives were even hypothetically on the line didn’t feel that way. “The answers people gave were orders of magnitudes apart,” said Thaler. “People would say they would pay ten thousand for the cure but would need to be paid a million to be exposed to the virus.”

  Thaler thought that was really interesting. He told his thesis advisor about his findings. “Stop wasting your time with questionnaires and start doing real economics,” said his advisor.

  Instead, Thaler began to keep a list. On the list were a lot of irrational things people do that economists claim that they don’t do, because economists presume that people are rational. At the top of the list was their willingness to pay 100 times more to avoid a one-in-a-thousand chance of being infected with an incurable disease than they were for the cure for that same disease, after they already had a one-in-a-thousand chance of having it.

  Thaler may not have felt all that sure of himself, but he was quick to see that others shouldn’t feel so sure of themselves, either. And he noticed that when he had his fellow economists to dinner, they filled up on cashews, which meant they had less appetite for the meal. More to the point, he noticed that they tended to be relieved when he removed the cashew nuts, so they didn’t ruin their dinners. “The idea that it could make you better off to reduce your choices—that idea was alien to economics,” he said. After he and a friend were given tickets to a basketball game in Buffalo, then decided it wasn’t worth driving through a snowstorm to watch it, his friend said, “But if we’d paid for those tickets, we’d be going.” An economist would see the tickets as “sunk cost.” You don’t go to a game you don’t want to go to just because you paid for the tickets. Why add to your misery? “I said, ‘C’mon, don’t you know about sunk cost?’” recalled Thaler. His friend was a computer scientist and didn’t know about sunk cost. After Thaler explained the concept, his friend just looked at him and said, “Oh, that’s just a bunch of bullshit.”

  Thaler’s list grew quickly. A lot of the items on it fell into a bucket that he eventually would label “The Endowment Effect.” The endowment effect was a psychological idea with economic consequences. People attached some strange extra value to whatever they happened to own, simply because they owned it, and so proved surprisingly reluctant to part with their possessions, or endowments, even when trading them made economic sense. But in the beginning, Thaler wasn’t thinking in categories. “At the time, I’m just collecting a list of stupid things people do,” he said. Why were people so slow to sell vacation homes that, if they hadn’t bought them in the first place and were offered them now, they would never buy? Why were NFL teams so reluctant to trade their draft picks when it was obvious that they could often get more than the players were worth in exchange? Why were investors so reluctant to sell stocks that had fallen in value, even when they admitted that they would never buy those stocks at their current market prices? There was no end of things people did that economic theory had trouble explaining. “When you start looking for the endowment effect,” Thaler said, “you see it everywhere.” His feelings about his own field were not so very different from his feelings for Monopoly as a kid: It was boring, and unnecessarily so. Economics was meant to be the study of an aspect of human nature, but it had ceased to pay attention to human nature. “Thinking about this stuff was way more interesting than doing economics,” he said.

  When he called his observations to the attention of his fellow economists, they weren’t interested. “The first thing they’d always say was, ‘Of course we know people
make mistakes every now and then, but the mistakes are random, and they’ll wash out in the market,’” recalled Thaler. Thaler no longer believed that. His list, and the impulse to create it, did not win him friends in the University of Rochester’s Department of Economics, or its business school. “He had enemies and he’s not awfully good at mollifying enemies,” said Tom Russell, a fellow economics professor at Rochester. “If you tell an academic to his face, ‘You’ve just said something really stupid’—okay, the big ones might say, ‘How is it stupid?,’ but the little ones just store it.”

  The University of Rochester denied Thaler tenure. His future was hazy when, in 1976, he attended a conference on how to value a human life. When he heard of Thaler’s curious interests, another conference attendee suggested that Thaler read Kahneman and Tversky’s article in Science that sought to explain why people did stupid things. Thaler went home and found “Judgment Under Uncertainty” in an old copy of Science. He couldn’t believe his own excitement as he read it. He went and pulled all the other articles in other publications written by Kahneman and Tversky. “I have vivid memories of running from one article to another,” says Thaler. “As if I have discovered the secret pot of gold. For a while I wasn’t sure why I was so excited. Then I realized: They had one idea. Which was systematic bias.” If people could be systematically wrong, their mistakes couldn’t be ignored. The irrational behavior of the few would not be offset by the rational behavior of the many. People could be systematically wrong, and so markets could be systematically wrong, too.

  Thaler got someone to send him a draft of “Value Theory.” He instantly saw it for what it was, a truck packed with psychology that might be driven into inner sanctums of economics and exploded. The logic in the paper was awesome, overpowering. What soon would be known as prospect theory explained most of the items on Thaler’s list, in a language economists could understand. There were items on Thaler’s list that prospect theory did not address—self-control was the big one—but that didn’t matter. The paper blew a hole in economic theory for psychology to enter. “That really is the magic of the paper,” said Thaler, “showing you could do it. Math with psychology in it. That paper was what an economist would call proof of existence. It captured so much of human nature.”

  Till then, Thaler had felt his place in economics to be as uncertain as his ability to copy Tom Sawyer. “If they didn’t exist, I don’t know if I would have stayed in the field,” he said. After finishing the collected works of the Israeli psychologists, he had a new feeling. “The way it feels to me,” he said, “is that there were certain ideas that I was put on this earth to think. And now I can think them.” He would begin, he decided, by turning his list into an article. But even before he did, he found a mailing address for the Department of Psychology at Hebrew University and wrote a letter to Amos Tversky.

  * * *

  It was almost always to Amos that the economists wrote. They understood him. Amos’s insistently logical mind was much like their own but somehow better: They could see his genius. To most economists, Danny’s mind was a mystery. Richard Zeckhauser, an economist at Harvard who became friends with Amos, spoke for his entire field when he said, “My impression of the way they worked on a paper is that they walked around and let Danny do a variety of things. ‘Guess what, Amos, I went to buy a car and I offered 38 grand and the salesman said 38.9 and I said yes! Did I do a good job?’ And Amos would say, ‘Let’s write that up.’” The economists’ view of the collaboration was that Amos Tversky had set out, like an anthropologist, to study an alien tribe of beings less rational than himself, and his tribe was Danny. “I share your feeling that such behavior is, in some sense, unwise or erroneous, but this does not mean that it does not occur,” Amos wrote, to an American economist who complained about the description of human nature implied by “Value Theory.” “A theory of vision cannot be faulted for predicting optical illusions. Similarly, a descriptive theory of choice cannot be rejected on the grounds that it predicts ‘irrational behavior’ if the behavior in question is, in fact, observed.”

  Danny, for his part, claimed that it wasn’t until 1976 that he woke up to the effects their theory might have on a field he knew nothing about. His awakening came when Amos handed him a paper written by an economist. The paper opened, “The agent of economic theory is rational, selfish, and his tastes do not change.” The economists at Hebrew University were in the building next door, but Danny hadn’t paid any attention to their assumptions about human nature. “To me, the idea that they really believed in it—that this is really their worldview—was incredible,” he said. “It’s the worldview in which if people tip in a restaurant to which they will never return it counts as a puzzle.” It was a worldview that took it as given that the only way to change people’s behavior was to change their financial incentives. The idea of it struck him as so bizarre that he could scarcely bring himself to engage with it directly. To Danny the whole idea of proving that people weren’t rational felt a bit like proving that people didn’t have fur. Obviously people were not rational, in any meaningful sense of that term.

  He and Amos wanted to avoid getting into an argument about the rationality of man. That argument would only distract people from the phenomenon they were uncovering. They preferred to reveal man’s nature, and let man decide what he was. Their next task, they saw, was to buff and polish “Value Theory” for publication. They both worried that someone would find an obvious contradiction—some Allais paradox–like observation that would render their theory dead on arrival. They’d spend three years doing very little else but searching the theory for internal contradictions. “In those three years we did not discuss anything of genuine interest,” said Danny. Danny’s interest ended with the psychological insights; Amos was obsessed with the business of using the insights to create a structure. What Amos saw, perhaps more clearly than Danny, was that the only way to force the world to grapple with their insights into human nature was to embed them in a theory. That theory needed to explain and predict behavior better than existing theory, but it also needed to be expressed in symbolic logic. “What made the theory important and what made it viable were completely different,” said Danny, years later. “Science is a conversation and you have to compete for the right to be heard. And the competition has its rules. And the rules, oddly enough, are that you are tested on formal theory.” After they finally sent a draft of their paper to the economics journal Econometrica, Danny was perplexed by the editor’s response. “I was kind of hoping he’d say, ‘Loss aversion is a really cool idea.’ He said, ‘No, I like the math.’ I was sort of shattered.”

  By 1976, purely for marketing purposes, they changed their title to “Prospect Theory.” “The idea was to give the theory a completely distinct name that would have no associations whatsoever,” said Danny. “When you say ‘prospect theory,’ no one knows what you’re talking about. We thought: Who knows? It may turn out to be influential. And if it is we don’t want it to be confused with anything else.”

  In all of this they were slowed, dramatically, by the turmoil in Danny’s life. By 1974 he’d moved out of his house and was living apart from his wife and children. A year later he left the marriage, and flew to London to meet the psychologist Anne Treisman to formally “declare my love.” She reciprocated. By the fall of 1975 Amos was clearly weary of the inevitable fallout. “It is hard to overestimate the amount of time and the amount of emotional and mental energy that is consumed with such affairs,” he wrote to his friend Paul Slovic.

  In October 1975 Danny flew to England again, this time to see Anne in Cambridge and to travel with her to Paris. He was at once in a totally uncharacteristic state of elation and worried about the effect of his new relationship with Anne on his old one with Amos. In Paris he found waiting what appeared to be a letter from Amos—but, opening it, he at first found only a draft of what would become “Prospect Theory.” Danny took the absence of any personal note as a subtle message from
Amos. Sitting with his new love in the world’s capital of romance, Danny sat down and wrote what amounted to a love letter: to Amos. “Dear Amos,” it began. “When I came to Paris I found an envelope from you. I pulled out your manuscript but there was no letter with it. And I told myself that Amos is very angry with me, and not without reason. After dinner, I was looking for a used envelope to send this back to you and I found your envelope, and then saw your letter inside. We were late for dinner and I just glanced to see how you finish it. And I saw the words ‘Yours, as ever’ and I had goose bumps from emotion.” He went on to write that he’d explained to Anne that he could never have achieved on his own what he had achieved with Amos, and that the new paper they were working on was yet another step. “This is for me the greatest moment in a relationship which I see as one of the peaks of my life,” he wrote. Then he added: “I was yesterday at Cambridge. And I spoke to them about our work on Value Theory. The enthusiasm is almost embarrassing. I concluded with a discussion of the early stages of the isolation effect. And they responded to that especially. In general, they gave me the feeling that I’m one of the world’s greats. They were trying so hard to impress me that I reached the conclusion that maybe the time has come for me to be free of the need to impress others.”