University of Chicago economist Richard H. Thaler, probably the most important founder of “behavioral economics,” is a fantastic storyteller. In his latest book, Misbehaving, he tells, roughly chronologically, of his initial doubts about the standard economist’s “rational actor” model and how those doubts led him to set his research agenda for the next 40 years. In chapter after chapter, he tells of anomalies—bits of evidence that are inconsistent, sometimes wildly so—with the various economic models and of his debates with the proponents of those models. In Thaler’s telling, he always won the debates. One would expect him to say that, but as someone who did not start out on his side of the debates, I think he often did win.

One disclosure: In 1975, about the time he was coming up with his list of doubts, I became an assistant professor of economics at the University of Rochester’s business school, where Thaler was also an assistant professor. We overlapped for my first three years at Rochester, until he moved on to Cornell. That disclosure probably does not matter, except for the fact that I saw close‐​up how he developed his ideas in the face of a fair amount of hostility from some of his colleagues. I was skeptical, but not hostile.

In a review of this length, it’s impossible to cover all of the topics Thaler discusses. So I’ll focus on five: the endowment effect, his quest for other scholars who were interested in the same ideas, financial economists’ efficient market hypothesis (EMH), various methods employers use to affect their employees’ saving for retirement, and the question of whether mistakes get small when the stakes get large.

Homo economicus and homo sapiens / At the start of the book, Thaler distinguishes between “Econs” and “Humans.” Econs are the rational economic actors who can easily figure out which deal is better, are never misled by the order in which alternatives are presented, always ignore sunk costs, etc. His Humans are people who make every imaginable mistake and who, he claims, are actually representative of most people. Time and again when discussing various issues, he reminds us what Econs would do and compares that to what actual humans (notice the small “h”) do. The contrast is often large.

Consider what he calls the endowment effect. In laying out the effect, Thaler presents the results of two versions of a question he asks his students. In version A, he tells them that they have been exposed to a rare disease that they have a 1 in 1,000 chance of contracting. If they get the disease, they will die within a week. They can take an antidote now that, with certainty, will prevent death. How much, he asks, are they willing to pay for the antidote? A typical answer is $2,000.

Then he presents the same students with version B, telling them that they can choose whether or not to enter a room in which they will have a 1 in 1,000 chance of getting that same disease. The question: how much do they have to be paid to be willing to enter the room? The answer should be something close to $2,000, possibly a little higher to reflect what economists call the “wealth effect”: if they are paid to accept a small risk, they are slightly wealthier than if they must pay to avoid a small risk. But the typical answer? $500,000. Thaler calls this phenomenon the endowment effect because, he explains, “the stuff you own is part of your endowment” and “people valued things that were already part of their endowment more highly than things that could be part of their endowment.” He gives numerous other examples that, I suspect, will ring true with most readers.

Search for others / In the mid‐​1970s, after coming up with his list of the kinds of human behavior that are at odds with the economic model of rational behavior, Thaler set out to find other people working on the same sort of issues. A large part of his book is about that quest. I remember when he started the quest shortly after I arrived at the University of Rochester, and I remember thinking—and I still think—that he had a lot of courage in marching to the tune of a very different drum.

As mentioned, Thaler is a great storyteller. His tales of how he met some of the other key players in behavioral social science—Daniel Kahneman, who later won the Nobel Memorial Prize in economics for his work, Amos Tversky, who died early but probably would have shared the Nobel, and others—are enjoyable and occasionally inspiring.

EMH / When Thaler and I were both at the University of Rochester, it was one of the top schools in finance. One of the main players there was Michael Jensen, whose hero was the great financial economist Eugene Fama, under whom Jensen had done his dissertation. You couldn’t be around there for long without getting somewhat steeped in the financial literature. The dominant view in finance then was the efficient market hypothesis (EMH), according to which stock prices incorporate all public information because if they didn’t, investors could gain by selling overpriced stocks short or by buying and holding underpriced stocks.

That view made complete sense to me. After all, with millions of dollars of their own wealth on the line, wouldn’t investors be the paragons of rationality? The problem, as Thaler learned over the years, is that there are many anomalies. He discusses the most important ones. One is that stock prices are “too” variable. If prices are based on fundamentals, how could stock prices have fallen an average of 20 percent on “Black Monday,” October 19, 1987, based on no apparent news? Also, if investors are rational, why would they settle for buying shares in firms that pay dividends? The favorable tax treatment of capital gains—capital gains are taxed at a lower rate and only when they are realized—should mean that firms owned by Econs should never pay dividends.

Interestingly, Fama and his University of Chicago co‐​author Ken French altered their model of stock prices in response to the evidence, bringing in two other factors—company size and value. They claimed that those factors would make both “value stocks”—those whose share prices appear low relative to their earnings—and small‐​company stocks riskier and, thus, earn higher returns. But, notes Thaler, “Fama and French were forthright in conceding that they did not have any theory to explain why size and value should be risk factors.” Moreover, notes Thaler, a paper by financial economists Josef Lakonishok, Andrei Shleifer, and Robert Vishny found that value stocks are not riskier.

If everyone were an “Econ,” it wouldn’t matter what the employer’s default option is for signing up employees to a tax‐​advantaged retirement plan.

Retirement saving / Thaler has also been a leader on the issue of saving for retirement, based on his taking account of humans as they are and not as economists usually model them. He points out that if everyone were an Econ, it wouldn’t matter whether employers’ default option was not to sign up their employees for tax‐​advantaged retirement accounts or to sign them all up and let employees opt out. Because signing up and signing to get out are both so low‐​cost relative to the stakes involved, either option should lead to the same percentage of employees taking advantage of the program. But that’s not what happens. Thaler cites research by Brigitte Madrian of Harvard’s Kennedy School of Government showing that before a company she studied had tried automatic enrollment, 49 percent of employees joined the plan. When enrollment became the default, 84 percent of employees stayed enrolled.

High‐​stakes mistakes / One of the arguments that economists often make against Thaler’s view of humans is that most of his evidence comes from low‐​stakes situations in which the gains from being rational are not large. However, they assert, when the gains are large, humans tend to be much more careful. But, using evidence from the National Football League’s entry draft, Thaler makes a strong argument against this view.

NFL teams are multi‐​multi‐​million‐​dollar enterprises, and their draft picks represent multi‐​million‐​dollar decisions. Surely, if there is strong evidence of rationality, it would be in the NFL. But Thaler shows that NFL owners and managers seem to make poor draft decisions.

For instance, he discusses the considerable evidence that teams are better off “trading down”—that is, swapping a single early‐​round draft pick for multiple later picks—and trading away a draft pick this year for multiple picks in future drafts. Yet, few teams employ those strategies. He even tells of a conversation he had about these issues with Dan Snyder, owner of the Washington Redskins, which led Snyder to send two of his top managers to talk to Thaler and his colleague Cade Massey. Their subsequent draft picks showed that they ignored Thaler’s advice. And, as anyone who follows the Redskins knows, they paid dearly, highlighted by the bonanza of high‐​round draft choices they traded away for a single pick in 2012, which they used to draft Robert Griffin III.

There is one major discordant note in this otherwise solid book: Thaler’s evaluation of the work of economist John Lott, who once offered a critique of Thaler’s work at a University of Chicago workshop. (I’m not claiming that Lott’s critique was sound.) Thaler writes of Lott’s book, More Guns, Less Crime: “As the title suggests, the thesis of the book is that if we just made sure every American was armed at all times, no one would dare commit a crime.” That is not the thesis of Lott’s book, which is much more nuanced. (See “Torturing the Data?” Winter 2010–2011.) Although Thaler is generally good at presenting the ideas of economists who disagree with him, he did a poor job with Lott’s views.

Conclusion / Assuming that we are persuaded of many of Thaler’s claims, what are their implications for government policy? He sees many. He and his then–University of Chicago colleague Cass Sunstein co‐​authored their 2008 book, Nudge, about such implications. Unlike many critics, as I explained in my review of the book (“A Less Oppressive Paternalism,” Summer 2008), I do find merit in some of their proposals grounded in “libertarian paternalism,” a term they coined. Given the latest Supreme Court decision on same‐​sex marriage, one of their proposals—getting the government out of marriage altogether—has become even more relevant.

But Thaler and Sunstein drastically understate the problems that arise because the people in government doing the nudging are also Humans, not Econs. And bureaucrats have generally bad incentives to nudge in the “right” direction. On this point, I laid out my criticisms in more detail in my review of Sunstein’s 2013 book, Simpler (“Simpler? Really?” Fall 2013.)

Thaler answers that he and Sunstein “went out of our way to say that if the government bureaucrat is the person trying to help, it must be recognized that the bureaucrat is also a Human, subject to biases.” He expresses his frustration that “no matter how many times we repeat this refrain we continue to be accused of ignoring it.” But the accusation is understandable, as they keep advocating government intervention.

The best way to show that they do not ignore this problem is for them to advocate taking large amounts of power out of the government’s hands. As I’ve written elsewhere, one way to reduce government power and make people more aware of its activities—after all, many of the problems Thaler cites are due to people’s being unaware—is to get rid of tax withholding. That way, people can be more aware of their tax bill, which is one of the major costs of government. He has not yet advocated that idea.

Maybe we should nudge him.