The Undoing Project: A Friendship that Changed the World(82)

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.