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From NPR News, this is ALL THINGS CONSIDERED. I'm Melissa Block.

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And I'm Michele Norris.

The Obama administration came to power promising change. One of the things that's changing is the way economists and the government think about individuals. There's a whole group of people appointed by President Obama that believes the human brain is hardwired to make serious errors in judgment. And that means people need to be helped to make decisions in their own best interest. That's not the way economists have traditionally viewed human behavior.

NPR's Alix Spiegel has our story about the origins of these new economic ideas and what they might mean for policy.

ALIX SPIEGEL: In the city of Greensboro, North Carolina, there's a program designed for teenage mothers; girls who already have one baby. To prevent these women from having another child, the city offers them $1 a day for every day they're not pregnant. Apparently the psychological power of that small daily payment is huge. A single dollar a day is somehow enough to push the rate of teen pregnancy down, and with it, all the incredible costs - human and financial that go with teen parenting. [POST-BROADCAST CORRECTION: Greensboro in the past experimented with such a program, but no such program is currently in effect.]

Now, this program has been promoted by Cass Sunstein, President Obama's pick to head the Office of Information and Regulatory Affairs. Sunstein likes it because it's an economic policy that shapes itself around human psychology. You see, Sunstein, like a number of other high-level appointees now working in the administration, is a devotee of behavioral economics; a school of economic thought greatly influenced by psychological research that took a good hard look at the human animal and found that people have a lot of trouble making decisions.

Daniel Kahneman, one of the psychologists credited with creating behavioral economics, explains.

Dr. DANIEL KAHNEMAN (Psychologist; Nobel Laureate): People are highly suggestible. It's very easy to put things in their mind. They're certainly not coherent. They're certainly very lazy. And those are discoveries that were made by psychologists and were later put to work by behavior economists.

SPIEGEL: Kahneman came to his work in decision making pretty much by accident in 1955, when he was working as a psychologist in the Israeli army. You see, Kahneman's primary job in the army, the thing he did day in and day out, was to try to figure out which of his fellow soldiers might make good officers.

To do this, Kahneman ran the men through a really unusual exercise. He'd organize them into groups of eight, then tell them to lift an enormous telephone pole over a six-foot wall.

Dr. KAHNEMAN: We could see who was a leader, who was taking charge, and we could see who was a quitter, who gave up. And we thought that what we saw before us is how they would behave in combat.

SPIEGEL: Kahneman and his fellow psychologists, certain of their wisdom, would then make recommendations. The chosen would go off to officer school, and Kahneman would move to the next batch. There was only one tiny problem.

Dr. KAHNEMAN: Turned out that there was absolutely no relationship between what we saw and what people saw who examined them for six months in officer training school.

SPIEGEL: But here's the very remarkable thing: despite negative feedback from the school, Kahneman's faith in his own ability was unshaken.

Dr. KAHNEMAN: The next day after getting those statistics, we put them there in front of the wall, gave them a telephone pole, and we were just as convinced as ever that we knew what kind of officer they were going to be.

SPIEGEL: It's a problem, says Kahneman, that afflicts us all: people have a huge amount of confidence in their own judgment, even in the face of evidence that their judgment is wrong. That mistake is just one of the many cognitive errors identified by Kahneman and his frequent collaborator, the psychologist Amos Tversky.

For over a decade, the two worked together cataloging the ways that the human mind systematically misjudges the world around it.

Turns out that we're not very good at processing information or making calculations, and as a consequence, they found the decisions we make often don't serve our best interests.

Now, in the realm of academic psychology this isn't much of a revelation. Psychologists see people as flawed in all kinds of ways. So had the ideas of Kahneman and Tversky simply stayed in psychology, there wouldn't be much of a story to tell, but the ideas of Kahneman and Tversky didn't just stay in the realm of academic psychology; they jumped; jumped to economics.

Here's the economist Richard Thaler.

Professor RICHARD THALER (Behavioral Science and Economics, University of Chicago): I met a psychologist who introduced me to the work of Kahneman and Tversky, and once I read their work, I got very excited.

SPIEGEL: Thaler is a professor at the University of Chicago. And together with Kahneman and Tversky, he's credited with creating behavioral economics. When Thaler first came across the work of Kahneman and Tversky, he was just barely out of graduate school, a new professor. But Thaler wanted to work with them and so the young economist contrived a way to put himself in their path.

Prof. THALER: I heard they were planning to spend a year at Stanford, so I made it my business to go and spend a year at Stanford at the same time.

Dr. KAHNEMAN: I remember Dick showing up to my office, and he presented himself. And our friendship, I think, started immediately and has gone on to this day.

SPIEGEL: For a year, Kahneman, Thaler and Tversky walked the hills of Stanford. Kahneman and Tversky taught Thaler about psychology. Thaler, in turn, taught them about economics. In the early '80s, they began to publish their ideas: an integration of psychological research and economics. The reception from mainstream economists: not so good.

Dr. KAHNEMAN: Oh, it wasn't very friendly. You know, the economists are not known for humility, so they didn't feel they needed much psychology.

SPIEGEL: The main point of contention, says Thaler, was the suggestion that humans are less than perfectly rational when it comes to decision making. For the majority of the 20th century, and for the most part even today, the human beings imagined by economists and placed at the center of their economic models have always had a Mr. Spock-like rationality.

Prof. THALER: Economists literally assume that the agents in the economy are as smart as the smartest economist.

SPIEGEL: And not just smart, but also paragons of self-control.

Prof. THALER: We're not overweight, we never over drink, and we save just the right amount for retirement. And, of course, the people we know aren't like that.

SPIEGEL: So why would economists take this view of the human animal? Because using rational humans in their mathematical models worked. Also, says Ed Glaeser, a professor of economics at Harvard University...

Professor ED GLAESER (Economics, Harvard University): Behavioral economics has identified a dizzying array of human foibles. We clearly can't incorporate all of them. And because of that, people often feel that incorporating one error into your model may be just as unrealistic as incorporating none.

SPIEGEL: But there's probably another reason for this resistance from economists. An imperfectly rational human being challenges in a pretty fundamental way a really important idea: the notion that markets work well because individuals can be counted on to make the best choice for themselves.

Here's Kahneman.

Dr. KAHNEMAN: Merely accepting the fact that people do not necessarily make the best decision for themselves is politically very explosive. The moment you admit that, you have to start protecting people.

SPIEGEL: In other words, if it is the case that the human brain, as a piece of machinery, is hard-wired to make serious errors, that implies all kinds of things about the need for regulation and protection. Last year, Thaler actually wrote a book about this called "Nudge," with Cass Sunstein, the man recently appointed by President Obama.

The book proposed that, for example, if you want people to save for retirement, it's important to take account of the fact that people are easily overwhelmed by information, and so are likely to simply opt for the status quo. The lesson for policymakers, says Thaler, is...

Prof. THALER: If you want people to enroll in the pension plan, then automatically enroll them and let them opt out if they want to.

SPIEGEL: But critics like Ed Glaeser of Harvard are worried. Glaeser and many Republican critics believe that our current economic predicament is the product of government intervening in the markets, intervening in a way that distorted incentives. And he says that, if anything, the current crisis is proof that the Obama administration has drawn just the wrong conclusions from Kahneman and Thaler's work.

Prof. GLAESER: Just understanding that human beings don't make perfect decisions does not make the case for government by any stretch of the imagination because, after all, governments are made up of people too.

SPIEGEL: But Thaler argues government policymakers don't need to be hyper-rational to help people make better choices. He offers this example.

Prof. THALER: Any American goes to London realizes that they are endangering their lives every time they cross the street, because the traffic comes from the wrong direction. Someone in the government in London had the clever idea of writing on the sidewalk, in busy intersections full of tourists from America and Europe, a sign that says: Look right.

So British bureaucrats are no smarter than American bureaucrats, but they know that tourists tend to look the wrong way, and they could use a helpful nudge to avoid getting hit by a truck.

SPIEGEL: The Obama administration believes it is shaping policy in a way that will keep us all from getting hit by trucks: health care trucks, financial trucks, trucks that come from every direction and affect every aspect of our lives.

Alix Spiegel, NPR News, Washington.

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