In a piece published earlier this year in the Financial Times, columnist Tim Hartford observed that "behavioral economics has never been hotter." The field, once considered a marginal intellectual enterprise, has gone mainstream thanks partly to the publication of books like Nudge and work by economists like Sendhil Mullainathan, now the head of research at the Consumer Finance Protection Bureau. But where did behavioral economics come from? How did the idea to integrate psychology and economics gain such traction?
Students of intellectual history will find excellent material in Daniel Kahneman's new book, Thinking, Fast and Slow, which revisits the Nobel Prize-winning psychologist's seminal work on decision-making, prospect theory and hedonics. Together with Amos Tversky and Richard Thaler (now a RSF Trustee), Kahneman played a crucial role in the founding of behavioral economics in the 1980s. As Evan Goldstein notes in this month's Chronicle of Higher Education, the collaboration had much to do with the Russell Sage Foundation and its president Eric Wanner:
Part of the answer can be traced to Wanner. Back in the mid-1970s, he edited Harvard University Press's series on cognitive science. Kahneman and Tversky were on the advisory board, and Wanner heard the buzz about prospect theory. In 1982 he left the press to join the Alfred P. Sloan Foundation, where he tried to bring economists and psychologists together to research the market implications of nonrational decision making. Kahneman and Tversky were at first skeptical, convinced that interdisciplinary work couldn't be coerced. They suggested instead that Wanner get behind the few economists then willing to listen. Sloan's first grant in that area, in 1983, paid for [Richard] Thaler to spend a sabbatical year with Kahneman, who was then at the University of British Columbia. "That's when behavioral economics really crystallized in my mind," Thaler says.
A few years later, Wanner became president of the Russell Sage Foundation, which since 1986 has put $8.3-million into behavioral economics. "These are not princely sums," Wanner says, but the money has been well spent. In 1994 the foundation established a biannual summer camp for budding behavioral economists. The two-week workshop for some 30 advanced graduate students and junior faculty was Kahneman's idea. Among the graduates are several leading lights of the field, including David Laibson and Sendhil Mullainathan, of Harvard, and Terrance Odean, of the University of California at Berkeley. (Mullainathan, who received a MacArthur Foundation "genius award" in 2002, was recently appointed to lead the new Consumer Financial Protection Bureau's Office of Research.) "Dollar for dollar, says Colin Camerer, a professor of economics at the California Institute of Technology, "it's the best social-science investment any foundation has ever made."
In a 2008 conversation with Edge.org, Kahneman described the first encounter that had "quite a bit to do with the birth of behavioral economics":
Amos Tversky and I met Eric at a conference on Cognitive Science in Rochester, where he invited us to have a beer and discuss his idea of bringing together psychology and economics. He asked how a foundation could help. We both remember my answer. I told him that this was not a project on which it was possible to spend a lot of money honestly. More importantly, I told him that it was futile to support psychologists who wanted to influence economics. The people who needed support were economists who were willing to be influenced. Indeed, the first grant that the Russell Sage Foundation made in that area allowed Dick Thaler to spend a year with me in Vancouver. This was 1983-1984, which was a very good year for behavioral economics.
This line of research did encounter resistance and criticism. In an excellent working paper on the history of behavioral economics, Floris Heukelom cites Wanner's recollections of an early conference:
The first real test of the new behavioral economics program was a conference on “The Behavioral Foundations of Economic Theory,” 10-15 June, 1986, organized by Robyn Hogarth and Melvin Reder at the University of Chicago. The conference did not go very well for the members of the Sloan behavioral economics program:
[Eric Wanner:] In the old days people tried to kill [behavioral economics]. You talked about behavioral finance… I remember a conference that we ran in probably 1985 at the University of Chicago.
[Floris Heukelom:] That’s 1986. It’s the…
[EW:] Good, you know all about it. Really the finance economists were out to kill them. People like Merton Miller… I’m trying to think… [..] some of those papers are brutal. They’re basically just efforts to ridicule behavioral finance, and to kind of laugh it out of existence. So in those days it really was a hard thing to do.
For a more detailed account of this period, read Heukelom's working paper, "A Sense of Mission: The Alfred P. Sloan and Russell Sage Foundations’ Behavioral Economics Program, 1984-1992." For more information on RSF's current behavioral economics work, see its Behavioral Economics Research page.