Richard Thaler’s Savings Principles

From The Whimpering of the State: Policy after MMP p.75

Keywords History of Ideas, Methodology & Philosophy

People do not behave with the rationalism of the economic theory on which commercialisation was based, especially over their savings. The standard economic theory of individual behaviour is contradicted by the evidence of irrationality (or ‘quasi-rationality’).(1) In practice, as has been attested by numerous studies, the major predictions of economic rationalism fail.(2)

Richard Thaler’s summary of observed human savings behaviour gives the following rules:

1 Live within your means. Do not borrow to increase consumption except during well-defined emergencies (such as unemployment).
2 During emergencies cut consumption as much as possible.
3 Keep a rainy day account equal to some fraction of income. Do not raid the account except in emergencies.
4 Save for retirement in ways that require little self-control.
5 Borrow only on the security of a real asset.

Each rule, widely practised and generally thought prudent, infringes the economic rationalists’ theory. The fourth point has significant implications for retirement policy. We are not very good at saving unless there is a contractual element. We save by paying off the house mortgage or contributing to an occupational pension or life-assurance scheme. Berating us, as economists and government officials are wont to do, will not markedly raise savings, unless it induces us to contract into a compulsory long-term savings scheme (even though the contracting may be voluntary). Despite our best intentions, putting a little something aside each week for our old age will not generally succeed in providing a decent retirement income, unless we are forced to do so. On current policies it would appear that many New Zealanders are going to have a miserable old age.

The behavioural logic suggests that there is some merit in a compulsory second-tier retirement provision. Such proposals outrage economic rationalists. They have imposed their ideology’s narrow conception of the human condition on the public. Those who do not share it should be punished with an impoverished old age. Despite their claims to be liberals, the economic rationalists are fascists about personal behaviour, demanding ‘behave according to our rules, or our policies will punish you.’

1. Thaler, R.H. The Winner’s Curse: Paradoxes and Anomolies of Economic Life, Princeton University Press, 1992; Quasi Rational Economics, Russell Sage Group, New York, 1994.
2. If two people have identical lifetime earnings profiles, and one has $100,000 of pension wealth and the other has none, then economic rationalism predicts that the latter will have other wealth (such as shares and bank deposits) to offset the pension deficit. Even allowing for personality differences, the empirical evidence is that this prediction fails.