American Psychological Society OBSERVER
Vol. 15, No. 10, December 2002 (pp. 1, 8)

Why a Psychologist Won the
Nobel Prize in Economics

Daniel Kahneman has long been recognized as one of the eminent academic psychologists of the past century. He has already received all the most prestigious awards our profession bestows. He now adds to those honors the distinction of being the first PhD in psychology to receive a Nobel Prize in Economics.

Giving the award to a psychologist is not entirely unprecedented. The 1978 Nobel in Economics went to Herbert Simon, professor of Psychology and Computer Science at Carnegie Mellon, for his groundbreaking work on bounded rationality - an important precursor to Kahneman's own work. But Simon's PhD was in Political Science, not psychology, and his rationality work - unlike his work on artificial intelligence - was much more strongly rooted in economics, political theory and management theory than in academic psychology.

Of course, the main reason so few psychologists have reached Nobel Laureate status is simply that there is no Nobel Prize for psychology. (Nobel also snubbed mathematics, by the way.) That economists would bestow this scarce resource on an outsider is remarkable; that they would award it to Daniel Kahneman is doubly so, because Kahneman has been openly and relentlessly critical of the very foundations of neo-classical economics since the 1970s. Until quite recently many economists have been fiercely resistant and sometimes openly hostile to Kahneman's work with the late Amos Tversky. The typical arguments: People are rational when the stakes matter; people are rational in the aggregate if not individually; people learn from mistakes in ecologically representative situations; our cognitive strategies must be evolutionarily adaptive or we wouldn't have them. A defensible version of the latter argument was endorsed explicitly by Kahneman and Tversky several decades ago, a fact which recent critics continue to ignore. The other arguments are empirical, and the collective evidence against them is now quite impressive.

But that evidence was also impressive a decade ago, with little apparent effect on economists. In a recent article in Journal of Economic Perspectives, Matthew Rabin and Richard Thaler compared their profession's state of denial to the pet shop proprietor in the Monty Python sketch who refused to refund the sale of a dead Norwegian Blue parrot, insisting it was merely "pining for the fjords." It may be difficult for psychologists to empathize with economists' prolonged resistance to several decades of experimental evidence. Contemporary psychologists hold few bedrock theoretical assumptions, and our core principles are sometimes too supple and flexible to permit direct falsification. Arguably, any smugness we feel at Kahneman's victory should be blended with a large dose of admiration for the explicitness and testability of economic theory.

Many other prominent psychologists have documented cognitive and motivational principles at odds with the "economic actor" caricature. Why is it that Kahneman's work stands out in the eyes of economists? There are three distinctive features of his research program with Tversky. First, almost every one of their papers confronts questions framed in the language (often mathematical) of neo-classical economics. Second, though their discussion sections are rich in cognitive theorizing, their core arguments make only sparing use of hypothetical constructs, focusing instead on functional relationships among observed variables in the tradition of psychophysics. Regardless of whether this promotes better psychology, it certainly facilitates better economics. Finally, Kahneman and Tversky's papers rely less on elaborate experimentation and psychometrics than on simple but powerful demonstrations of replicable phenomena that were "right under our noses" but had previously escaped our collective attention. One can imagine Bentham or Bernoulli or Bayes reading the 1974 and 1984 Science papers with surprised engagement.

An early indication of a thaw in economists' views of Kahneman came in 1998, in a tribute to Tversky and Kahneman's work written by Harvard economists David Laibson and Richard Zeckhauser, soon after Tversky's death. Summarizing the 1972 Science paper on heuristics and biases, and the 1979 Econometrica article on prospect theory, they argued that "these two publications altered the intellectual history of economics." They also note that "folk wisdom holds that 'Prospect theory' is the most cited paper ever published in Econometrica," a claim the Nobel committee confirmed.

The momentum continued in 2000 and 2001. In 2001, the Nobel went to George Akerlof, an economist who had long made use of psychological insights in his work. And economist Matthew Rabin, who has collaborated with Kahneman for many years on a biannual Russell Sage Foundation behavioral economics summer camp, received both a MacArthur "genius" grant and the John Bates Clark Medal in Economics, awarded biennially to the most significant American economist under the age of 40 [Editor's Note: Kahneman, Rabin, and MacCoun participated in John Darley's Presidential Symposium at the 2002 APS Convention]. In 2000, Rabin published in Econometrica what many consider to be the final nail in the coffin for the traditional economic utility calculus as a description of human choice. Rabin proved mathematically that the degree of concavity necessary to explain risk-averse choices in low stakes choices necessarily predicts absurd (and unobserved) levels of risk aversion in higher-stake situations. Rabin noted that prospect theory nicely handled this and other anomalies with relative few additional assumptions.

Though economists are learning to accommodate the reality of cognitive heuristics, loss aversion, and framing effects, it is interesting to note that the Prize committee made no mention of some of Kahneman's more recent work, which poses new and provocative challenges for economic theory and institutional design. Kahneman and his collaborators have demonstrated serious limitations in our ability to map important evaluative judgments - willingness to pay for environmental mitigation, or recommended punitive damage awards - onto a dollar metric. And they have documented the often sizeable disjuncture between our abstract preferences, our actual momentary hedonic experiences, and our subsequent mental representations of those experiences.

In his public addresses, Kahneman is always quick to point out his enormous debt to his many collaborators and close colleagues, especially Amos Tversky, who would surely have shared the Nobel were he alive today. Still, there are few if any living social scientists, of any discipline, who have made contributions on a par with the breadth, depth, and sheer magnitude of Kahneman's scholarly output. His selection for the Nobel Prize shows that, for all its foibles, human judgment sometimes gets it right.

ROBERT MACCOUN is Professor of Public Policy, Professor of Law, and Affiliated Professor of Psychology at the University of California, Berkeley. As a visiting professor at Princeton in 1999, he co-taught a course on Psychology and Public Policy with Kahneman at the Woodrow Wilson School.