Predictably Irrational

Coffee Shops & The Honor System: Would It Work?

Dan Ariely — Fri, 31 Jul 2009 18:05:48 +0000

What if on your next coffee run, you discover that Starbucks has started running on the honor system? All the baristas are gone, and in their place, you find Tupperware filled with coins and bills. Would you pay for your daily soy Latte? Or would you "forget" to shell out the five bucks? Be honest.

This, of course, is only a thought experiment, as I doubt Starbucks will be adopting the honor policy anytime soon. But in another part of the world, it's a real question that residents are facing on a daily basis. As the New York Times recently reported, the attorney general's office in Indonesia has been opening thousands of "honesty cafes" as part of its anticorruption campaign.

The idea is that these cashier-free cafes will teach people to be honest and curb the country's corruption problem (which pervades business, politics, and education) by inducing residents - especially the young - to get into the habit of practicing honesty. As the Times reports, "...the cafes are meant to force people to think constantly about whether they are being honest and, presumably, make them feel guilty if they are not."

It's a laudable plan, and a lovely feel-good idea, but will it work? I have my doubts.

First I think that people will also cheat to a certain extent in these honesty cafes (as they do in our experiments). In fact, according to one Indonesian student, they already do: "Some of my friends don't pay the right amount."

But that's not the worst of it. I worry that these cafes won't just fail to discourage cheating - they will actually lead to more of it. In some of our research, we found that cheating on one occasion makes it easier for people to cheat again on a later task, because it alters their self-concept. (Think of dieting as an analogy: once you break your diet once, it's that much easier to say, "Oh what the hey, cut me a slice of that chocolate cake; I'll count calories again tomorrow.")

With honesty cafés widespread, residents will have more temptations to cheat, more occasion to cheat, and maybe this will make it such that they will find it easier to cheat again in other contexts.

Maybe these cafes are a good idea, maybe it will not have any effect, but I worry that it might make things worse.

The Value of Advice

Dan Ariely — Thu, 30 Jul 2009 17:13:32 +0000

A few days ago Dan wrote about Don Moore's research on how we accept advice from others. A lab experiment showed that subjects adhered to advice from confident, not necessarily accurate, sources. The findings of another research, led by Prof. Gregory Berns of Emory University, show another aspect of our reaction to advice.

Berns recorded his subjects' brain activity with an fMRI machine while they made simulated financial decisions. Each round subjects had to choose between receiving a risk-free payment and trying their chances at a lottery. In some rounds they were presented with an advice from an "expert economist" as to which alternative they consider to be better.

The results are surprising. Expert advice attenuated activity in areas of the brain that correlate with valuation and probability weighting. Simply put, the advice made the brain switch off (at least to a great extent) processes required for financial decision-making. This response, supported by subjects' actual decisions in the task, are troublesome, perhaps even frightening. The expert advice given in the experiment was suboptimal - meaning the subjects could have done better had they weighted their options themselves. But how could they? Their brains were somewhat dormant.

References:
Jan B. Engelmann, C. Monica Capra, Charles Noussair, Gregory S. Berns (2009). Expert Financial Advice Neurobiologically "Offloads" Financial Decision-Making under Risk.

We're More Swayed by Confidence than Expertise

Dan Ariely — Thu, 30 Jul 2009 17:11:59 +0000

"For the great majority of mankind are satisfied with appearances, as though they were realities, and are more often influenced by the things that 'seem' than by those that ‘are.'"
-16th-century Italian politician Niccolo Machiavelli

It's something we come across regularly: presentation trumps content. Often what matters is not what we know, or what we have done, but rather how we spin it. It's why cover letters are so important, and why the peripheral route to persuasion - one of advertising's biggest weapons - works.

Now, Don Moore of Carnegie Mellon University demonstrated yet another way that we are heavily influenced by delivery - We tend to seek advice from experts who exhibit the most confidence - even when we know they haven't been particularly accurate in the past.

In his experiment, Don had volunteers guess the weight of people in photographs, and paid them for their correct answers. But before each guess, the volunteers were asked to choose one of four advice-givers (also volunteers) from whom to buy advice. Each advice-giver submitted their weight guess in percentage form, with some advisers spreading out their advice over multiple weight ranges. So, one advisor might have said that there was a 70% chance that the person's weight was 170-179 pounds, a 15% chance that it was 160-169, and a 15% chance that it was 180-189. A more confident advisor, however, would have put all his eggs in one basket and said there was a 100% chance that the weight was within the 170-179 range.

Now here's the really important part: in each round, before they chose their adviser, volunteers got to see each adviser's percentage spread, but not the associated weight ranges. (See this really handy chart for more on the set-up.)

What did Moore find? Volunteers were more likely to buy advice from confident advisers (such as the 100% adviser from above) than those who spread out their percentages. What's more, this tendency led advisors to make their advice more and more precise in subsequent rounds - but not more accurate.

These findings are troublesome. Because though confidence and accuracy sometimes go hand-in-hand, they don't necessarily do so. And when we want confident advisors, some will exaggerate to give us what we want. Maybe this is why so many pundits on TV for example exaggerate their certainty?

The Context Effect in Britain's Got Talent?

Dan Ariely — Thu, 30 Jul 2009 17:00:03 +0000

I got this suggestion from Thomas Aedy in Eton College in the UK:
Dear Dan,

The final for Britain's Got Talent was on Saturday June 30th and this final was very interesting because it involved 3 choices, 2 of which were very similar, and 1 of which was different. In our show, viewers have to vote in by telephone on the night of the show for a winner to be decided, and there was some shock when the favorite (Susan Boyle - a singer) didn't win, and lost out to one of two dance groups (Diversity were the winners, Flawless were the other dance group) - whilst the dance group were very good, most people thought that the singer would edge win.

I think this is a case of relativism:

Option A - Singer - Susan Boyle who was generally regarded (before the final) as the favorite contender for the win

Option B - Dance group - Diverstiy

* Probably the better of the two dance groups - more creativity and flair, and possibly more entertaining
* That is largely my view, although their victory in the competition would suggest that they were the better of the two dance groups

Option B' - Dance group - Flawless

* Also a very talented dance group, but more straightforward dancing - not very many surprises from them
* We could view them as the ‘dud' choice of the two (although this is somewhat harsh)

General points

* Frankly impossible to judge who were the best of all three - all of them were very talented, but it is impossible for most viewers to try and think whether Option B was better than Option A (comparing singing and dancing)
* However, on the night, it is fair to say that Option B was better than Option B'
* Thus whilst most found it impossible to establish who was better of A and B - it was clear that B was better than B', and this made it easier to select an overall winner (which would be Option B)

In my mind this could be seen as an example of relativism

Very best wishes,

Thomas Aedy

PS: YouTube videos of the 3 acts if you're interested.

Option A (singer) : http://www.youtube.com/watch?v=b2xiAQCTy2E

Option B (dance) : http://www.youtube.com/watch?v=KJIz8BgRQc0

Option B' (dance) : http://www.youtube.com/watch?v=NY9I6pxnVpM

-----

I did not watch this show - but I find the idea plausible and interesting.

Beware: Happiness is Contagious

Dan Ariely — Thu, 11 Jun 2009 20:46:47 +0000

Recently I wrote a short summary of Christakis's research for Time magazine 100 people of 2009. Here is my summary of the research:

Social scientists used to have a straightforward, if tongue-in-cheek, answer to the question of how to become happy: Surround yourself with people who are uglier, poorer and shorter than you are - and who are unhappily married and have annoying kids. You will compare yourself with these people, and the contrast will cheer you up.

Nicholas Christakis, 47, a physician and sociologist at Harvard University, challenges this idea. Using data from a study that tracked about 5,000 people over 20 years, he suggests that happiness, like the flu, can spread from person to person. When people who are close to us, both in terms of social ties (friends or relatives) and physical proximity, become happier, we do too. For example, when a person who lives within a mile of a good friend becomes happier, the probability that this person's good friend will also become happier increases 15%. More surprising is that the effect can transcend direct links and reach a third degree of separation: when a friend of a friend becomes happier, we become happier, even when we don't know that third person directly.

This means that surrounding ourselves with happier people will make us happier, make the people close to us happier - and make the people close to them happier. But social networks don't transmit only the good things in life.

Christakis found that smoking and obesity can be socially infectious too. If his thesis proves out, then the saying that you can judge a person by his or her friends might carry more weight than we thought.

How Pigs Replaced Economics

Dan Ariely — Tue, 19 May 2009 16:36:30 +0000

It’s hard to displace a global economic crisis from headlining the news, but the pigs did it. A variant of the H1N1 flu virus, associated in our lore with the 1918 flu pandemic, has jumped species and infected humans. There are reported deaths (though numbers and details vary wildly) and cases appear to have spread globally.

The media jumped on this new new new crisis, the politicians around the world thanked Providence for something to distract voters from their ethical lapses and the opportunity to pad their budgets, pharmaceutical stocks rallied, airline stocks tanked, and the conspiracy theories are running wild. The Russians stopped importing pork, even though you don’t get the flu from eating pork.

On the positive side, a few more people started washing their hands. This is a rational response; hygiene is an innovation that works. (Purell and other hand disinfectants work in a pinch, but washing your hands for at least one minute, with a long rinse in running warm water is better.)

Three of our predictable irrationalities give the swine flu story much more impact than it should have — and in this case, it would be better if we were more rational.

One: Unlike the agents in economic models, we have limited memory and limited thinking capacity; to manage it we shift our attention depending on outside information. Or, in non-academese, we pay attention to what’s happening now: things that are recent and things that are repeated often get more attention, even if they are not that important. Because the news focus on the negative (it’s their business model) we keep hearing about the cases discovered, and not about the millions of people who were exposed and didn’t get sick. Which gets us to point two:

Two: We overweigh new risks relative to comparable risks we are accustomed to. Around 100 people per day died in US roads in 2008, an enormous improvement over previous years but still. People obsessing about spending 5 minutes in elevators with others (an infinitesimal chance of contagion) will blithely cross the street against the light to have a artery-clogging triple cheeseburger with fries and then smoke a pack of cigarettes. These things have much higher risks, but because we have grown accustomed to them, we don’t think of the risks. They are not, in the technical term, salient; but they are much more dangerous. Still, their dangers are dry statistics and people are not good with statistics, which gets us to point three:

Three: Brains are wired to work well with stories. And there are many stories one can make from the news reports: pandemics amplified by airport air recycling and global travel; mass extinction followed by anarchy and mayhem; terrorism taking advantage of the burden on the health system; the flu as prelude to alien invasion from Alpha Centauri. Ok, the last one only works around the MIT Media Lab. But we love stories, and forget that the plural of anecdote is not data. Statistics, dry as they may be, give a lot more information than stories.

It is not that this problem is not real and important, I just don’t think that relative to our other problems, it is as big as we are making it to be.

What can we do: as the British said during the Blitz, keep calm and carry on. Take appropriate precautions, wash your hands, and if you’re sick get help and keep out of crowds.

CDC page on this flu

Is Business Education Valuable?

Dan Ariely — Mon, 18 May 2009 15:27:01 +0000

Derek Bok, the 25th President of Harvard, famously said: “If you think education is expensive, try ignorance.” What we need is more business education, not less!

There are recent debates about the value of MBA education and I have to say that I find the notions of scrapping management education somewhat odd. It is not that I think that management education is perfect, far from it, but its importance in my mind has only increased due to this financial crisis. Does anyone really want to suggest that the people who are running our institutions and companies do not need to learn more? That they don’t need to have specific knowledge to better guide their companies and our economy? For example, is there anyone who doesn’t think these days that executives need to have a much better understanding of accounting, and that they need to know how to read accounting statements?

From my perspective, the main lesson from this economic meltdown is that despite our confidence - we actually know very little about the operation of the financial world around us. Moreover, it is clear that such lack of understanding, together with high confidence and reliance on the opinions of others (presumably experts) can have devastating consequences. If anything I suspect that this meltdown shows exactly how important it is for executives to have a better understanding of the world in which they operate.

Of course, like many others, I believe that it will be very useful to change the curriculum of the MBA program so that it is more useful — but if anything I would make it mandatory for executives to keep on learning throughout their careers in the same way that we require physicians to keep on improving and learning.

In terms of the actual curriculum for management education, my own view is very simple-minded: The world is incredibly complex, it changes all the time, and we should not even hope that we could create a general model that accurately describes the world in all its possible states. Instead I proposed that management education and practice should become much more experimental and data-driven in nature — and I can tell you that it is amazing to realize how little business know and understand how to create and run experiments or even how to look at their own data!

We should teach the students, as well as executives, how to conduct experiments, how to examine data, and how to use these tools to make better decisions. For example, over the past five years or so we have learned from experimental evidence a lot about the tricks that conflicts of interests can play on us, and these findings help us understand financial catastrophes from Enron to the recent market failures (for my take on this see TED). Given this new understanding, and we lean more and more all the time, I think it is crucial to transfer this knowledge to business executives so that they can take this new understanding into account.

Disasters are usually a good time to re-examine what we’ve done so far, what mistakes we’ve made, and what improvements should come next. If the lesson from all of this will be to blame the MBA programs than I think we would have not gained much. However if we will seriously consider how to keep on exploring and understanding the complex world we live in, and make this an inherent part of management education, perhaps the future version of our world would look better.

Irrationality is the real invisible hand

Dan Ariely — Fri, 08 May 2009 16:31:17 +0000

Adam Smith first coined the term "The Invisible Hand" in his important book "The Wealth of Nations." With this term he was trying to capture the idea that the marketplace would be self-regulating. The basic principle of the invisible hand is that though we may be unaware of it, an unseen hand is constantly prodding us along to act in line with what's best for the whole economy. This means that when this invisible hand exists, when we all pursue our own interest, we end up promoting the public good, and often more effectively than if we had actually and directly intended to do so. This is a beautiful idea, but the question of course is how closely it represents reality.

In 2008, a massive earthquake reduced the financial world to rubble. Standing in the smoke and ash, Alan Greenspan, the former chairman of the Federal Reserve Bank once hailed as "the greatest banker who ever lived," confessed to Congress that he was "shocked" that the markets did not operate according to his lifelong expectations. He had "made a mistake in presuming that the self-interest of organizations, specifically banks and others, was such that they were best capable of protecting their own shareholders."

We are now paying a terrible price for our unblinking faith in the power of the invisible hand.

In my mind this experience has taught us that Adam Smith ‘s version of invisible hand does not exist, but that a different version of the invisible hand that is very real, very active, and very dangerous if we don't learn to recognize it. Perhaps a more accurate description of the invisible hand is that it represents human irrationality. In terms of irrationality the hand that guides our behavior is clearly invisible - after all recent events have demonstrated that we are largely blinded to the ways rationality plays in our lives and our institutions. Moreover it is also clear that irrationality does shape our behavior in many ways, pushing and prodding us along a path can lead to destruction. Whether we're procrastinating on our medical check-ups, letting our emotions get the best of us, or letting conflicts of interest and short term time horizon ruin the financial market, irrationality is certainly involved.

In Adam Smith's world the invisible hand was a wonderful force, and the fact it was invisible made no difference whatsoever. The irrational invisible hand is a different story altogether - here we must identify the ways in which irrationality plays tricks on us and make the invisible hand visible!

Why bankers would rather work for $0 than $500k

Dan Ariely — Mon, 04 May 2009 19:33:13 +0000

Sometimes asking someone to do something for nothing is more powerful than paying them.

In a research paper entitled "Effort for Payment: A Tale of Two Markets," James Heyman and I that people are willing to help move a couch or perform an experiment just by being asked. Moreover, these individuals feel good about their "gift". Most interestingly, the experiments show that contrary to standard economic theory, paying a small incremental incentive does not increase effort, but actually lowers it - because meager compensation profanes the gift effect and disincents the giver.

Bringing money into the relationship takes the giver's work out of "gift" market, and brings it into the "pay-for-effort" market. When it was done for nothing, the protagonist was a "donor." When small money was on the table, he or she became an underpaid employee. The easiest way to think about this is to imagine if at the end of Thanksgiving dinner you asked your mother-in-law how much you owed her for cooking such a wonderful meal. Would that increase or decrease her effort the next time you came by? (Assuming, of course, she would still invite back you after such an insult.)

In this financial crisis, there has been much discussion about banker's pay. We think that if President Obama had asked for a group of bankers to take $0, and paid expenses only, it would have brought the discussion back into the gift economy. $500,000 is just low enough to bruise the banker's egos (after all, they got used to much higher salaries for a long time, higher salaries we can be pretty certain they feel they deserved), but $0 is something to be proud of! In fact, paying these CEOs nothing might remind them about the responsibility they have to the banks they are leading and to the rest of society. The CEO of AIG Ed Liddy is already only taking a one-dollar salary and donating his time to this worthy effort. But his gift is isolated, a drop in the bucket - not part of an overall "corps" of senior financial executives acting in unison to help fix the mess.

Would the best people be willing to work for free? Not all capable bankers could afford it, but many could. We think there would be many willing to pitch in...if asked in the right way. After all, this gift idea was at the core of John F. Kennedy's brilliant notion, "Ask not what your country can do for you - ask what you can do for your country." By eliminating pay altogether, these leaders would be giving the nation the donation of their time and skill, improving their level of motivation. Instead of accusing them of being greedy and self interested, people could see them as important actors playing key roles in the stability of our entire economy. This in turn would probably encourage more bankers to see the power of a collective gift and the joy they could feel in donating something so important.

As it stands now, the many good people who are trying to improve things for little or no pay are isolated, their effort drowned out by the outrage over bonuses and salaries. Hence we have the Congress and President involved in legislating the level of executive compensation all the way down to its structure and timing! Congress should not be mired in the details of compensation design. Not only are they bad at it, but the beleaguered public - whose median household income is less than 1/10th of $500,000 - is watching the pay ping pong with collective disgust. The knee-jerk reaction to create a confiscatory 90% tax on the AIG bonuses makes the conservatives among us think we are killing capitalism itself.

When individuals commit acts of personal generosity, it sparks a gift culture that replenishes a store of trust - a resource as multiplicative as any Keynesian monetary policy. This sharing is not done in a communist, carving-up-the-spoils manner, but rather in the tradition of bravery and sacrifice for our collective benefit. When those in power act within a gift culture guided by a spirit of generosity for common cause, it creates a tangible trust asset that supports the flow of credit, money, and markets. By focusing on limiting executive pay, President Obama did the political equivalent of asking his mother-in-law how much he owed her for Thanksgiving dinner - and moved the discussion away from social responsibility, and into the pay-for-effort market, where the negotiations for spoils now dominate the discourse.

We think our bold young President has to improve his request. A gift culture - created at the top - will benefit all of us; and, strangely, will also help strengthen the rapacious markets where self-interest reigns supreme. The good news is, it's not too late.

How to charge $37.50 for a cup of cafe latte

Dan Ariely — Mon, 13 Apr 2009 15:17:37 +0000

Imagine that it is the last day of the month and you have $20 in your checking account. Your $2,000 salary will be automatically deposited into your bank later today. You walk down the street and buy yourself a $2.95 ice cream cone. Later you also buy yourself a copy of Predictably Irrational for $25.95, and an hour later you treat yourself to a $2.50 cup of café latte. You pay for everything with debit card, and you feel good about the day - it is payday, after all.

That night, sometime after midnight, the bank settles your account for the day. Instead of first depositing your salary and then charging you for the three purchases, they do the opposite - qualifying you for an overdraft fee. You would think this would be enough punishment, but the banks are even more nefarious. They use an algorithm that charges you for the most expensive item (the book) first. Boom, you are over your available cash and charged a $35 overdraft fee. The ice cream and the latte come next, each with its own $35 overdraft fee. A split second later, your salary is deposited and you are back in the black - only $105 poorer.

Overdraft plans connected to checking accounts are common at most major financial institutions, and the Center for Responsible Lending estimates that this practice costs consumers about $17.5 billion in fees every year. Given these numbers, it is perhaps not very surprising that most financial institutions currently enroll their account holders into this expensive method of covering overdrafts without the customer's consent or knowledge and that when consumers try to get out of these programs they find it incredibly difficult. When I called the few banks I have accounts with last week and tried to un-enroll from these programs, the most common response I got was that it was impossible. Similarly, one New Jersey columnist reported that his own daughter was charged a $35 overdraft fee for a debit card purchase of less than $2, even when he had accompanied her to open her account and asked that transactions that would overdraw the account be denied. (Paul Mulshine, ‘Courteous' bankers in for a rude awakening, The Newark Star-Ledger, June 7, 2007, at 15)

With the current financial challenges, I suspect that the people at the lower Social Economic Status (SES) are carrying a large part of the general financial crisis in terms of jobs and housing, as well as a large part of the overdraft fees related to overdraft protection plans. Given this, it is a good sign that the Feds are finally looking at this issue. The first thing that the policymakers are considering is whether to require banks to let their customers opt-out of the default overdraft system. This sounds like a no-brainer. A far better version of the rule would require banks to obtain explicit permission from their customers before enrolling them in this program, the "opt-in rule". So when you sign up for a bank account, you are not enrolled in this program unless you decide that you want the bank to approve debit purchases you make even if you have no money in your account. Given what we know about defaults and behavioral economics (that most people adapt the default option as their choice, and they see it as an implicit recommendation), I suspect that with the opt-out requirements, the vast majority of consumers will become part of the program and will keep on paying these high penalties, while the opt-in approach would make consumers much less likely to join these programs. Presumably, the banks know this, which is why they are arguing for the right to put all their customers into this expensive system of overdraft coverage without asking.

But of course, this is just the first step. In addition to the pending Federal Reserve regulatory proposal, Representative Carolyn Maloney (D-NY) has introduced legislation that, in addition to requiring that banks get explicit "opt-in" permission, would require warnings at the checkout counters and ATMs to allow customers to cancel a transaction before incurring a fee. It would also stop banks from clearing transactions from the highest to the lowest in order to increase their fees. These are useful reforms that are much needed to prevent banks from taking advantage of their customers.

The banks of course are very worried about losing this income stream, but I suspect that changing the bankers' mindset from business as usual to one where they are actually going to start seeking their customers' trust and products that would actually appeal to their clients is in everyone's best interest. Adopting such programs might in fact push the banks to further improve their overdraft protection programs so that they are truly valuable for their consumers. For example, banks might start giving consumers better access to competitively priced short- term loans, better connections between saving and checking accounts, or at least they can start alerting consumers using SMS when they are in danger of overdrawing their account. In the meantime, the Federal Reserve Board's "opt-in" rule would be a step in the right direction.