Daniel L. McFadden

Nobel 2000 | Why do people make bad decisions?

Young Daniel McFadden met a young lady named Beverlee and married her three months later. The two are happy together to this day. It’s no surprise his studies on behavioral economics teach us about questions such as when to marry, where to work and where to live. His work on discrete choice was only the starting point in analyzing people’s behavior. McFadden’s research predicted everything from the use of public transportation to the state of the elderly in society, housing, financial diversification, and health services. His own biography underlines his economic reputation. He grew up during the Great Depression in a family who grew peanuts despite being deprived of running water. Today, McFadden grows grapevines on his Napa Valley vineyard.

Daniel L. McFadden

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel (shared), 2000

At a glance

Born: 1937, Raleigh, North Carolina, USA

Field: Behavioral economics

Prize-winning work: Theory and methods for analyzing discrete choice

Early engagements: Started a civil rights petition at high school and got suspended

Decision skills: He got married three months after the first date with his future wife

Self-confidence: He thought the call from the Nobel Committee was a prank

Bad at: Dancing

Stalkers: One. His dog, Odi, follows him around everywhere

How can we forecast behavior and decisions?

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How can we foresee people’s decisions?

When we meet McFadden in Napa Valley, he begins by pointing out that people behave in their own self-interest. They have preferences and these preferences can be measured. “People are maximizing utility,” he says. “For some people, the utility of having a red car is high, for others the utility of having a red car is low. When you describe these random preferences, you can characterize how the population will behave. If you trace out the proportion of people that will buy a car and plot it against the price of the car, what you’ll see is some kind of curve. The car is very inexpensive, lots of people buy it. If it gets more expensive, then fewer will buy it.”

How can we prevent people from making harmful decisions?

McFadden’s model gained prominence in many areas of economics, as it successfully predicts behavior. At the same time, he mentions that one of the big lessons of behavioral economics is that people often don’t consider the long term when making financial decisions. He suggests that more instruments are needed to help people spend their money wisely in addition to saving and planning for retirement.

“Building up some assets starting young would put you in a much better position towards the end of your life,” he says. “Balance is needed.”

Living every day as if it were the last

He speaks from experience. During the Great Depression of the 1930s, his parents were forced to move to a farm without running water or electricity. In this environment, McFadden’s social life mainly consisted of the characters he met in books. “If you asked me anything when I was 10 years old, I pretty much knew about everything,” he reminisces with a smile.

Why do people fear trade and investments?

Although McFadden himself is a child of the Great Depression, he still doesn’t understand why people fear trade and investments. Of course, from a psychological and behavioral economics perspective, it makes sense. “You’re being thrown into an interpersonal interaction with someone you’re not sure you can trust and that creates stress,” he says. “A set of questions tends to bother people.”

“If you decide something and it turns out to be a bad choice, you beat yourself up about it,” he continues. “What then happens, psychologically, is that people often say ‘Why bother with it at all? I’m okay where I am.’”

While he does emphasize that it’s important to be cautious about savings, in his mind, avoiding investments and trade isn’t the answer.

Why do people fear trade?

What are systematic mistakes in decision-making?

Anxiety towards risk isn’t the only problematic aspect of making bad decisions that affect our lives. Political events give an even wider perspective. “I think it’s reported that the main two Google searches in the days after the Brexit vote were one, what is Brexit and two, what is the EU?” says McFadden.

“Concentrating too much on what’s going to come right now without looking into the future to see what the consequences will be, or paying too much attention to the things that are so easy to see, all those things are systematic biases in the way people, in general, make decisions.”

 

In McFadden’s opinion, people are driven by fear on many levels when making bad decisions and they don’t consider the long-term benefits. “When you have immigrants coming into a nation, they bring economic activity, which generates income,” he says. “In most cases, these immigrants end up adding to the economy and even employing other people.”

What can be done to solve the refugee crisis and stop populism?

What McFadden has learned from his own research is that people don’t learn as well as they should from their own bad decisions. “There’s a cultural failure to take responsibility for your own actions and to try to learn from your own mistakes,” McFadden thinks we’ll go on making systematic errors unless we recognize them and do our best to correct them in our behavior.

Do people learn from bad decisions?

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“One would hope that in future, young people won’t sit on the sidelines, but rather think seriously about the kind of future they want for themselves, and try to achieve it.”

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