Predictably Irrational (29 page)

T
HERE'S ANOTHER, SINISTER
impression that I took out of our studies. In our experiments, the participants were smart, caring, honorable individuals, who for the most part had a clear limit to the amount of cheating they would undertake, even with nonmonetary currency like the tokens. For almost all of them, there was a point at which their conscience called for them to stop, and they did. Accordingly, the dishonesty that we saw in our experiments was probably the lower boundary of human dishonesty: the level of dishonesty practiced by individuals who want to be ethical and who want to see themselves as ethical—the so-called good people.

The scary thought is that if we did the experiments with nonmonetary currencies that were not as immediately convertible into money as tokens, or with individuals who cared less about their honesty, or with behavior that was not so publicly observable, we would most likely have found even higher levels of dishonesty. In other words, the level of deception we observed here is probably an underestimation of the level of deception we would find across a variety of circumstances and individuals.

Now suppose that you have a company or a division of a company led by a Gordon Gekko character who declares that “greed is good.” And suppose he used nonmonetary means of encouraging dishonesty. Can you see how such a swashbuckler could change the mind-set of people who in principle want to be honest and want to see themselves as honest, but also want to hold on to their jobs and get ahead in the world? It is under just such circumstances that nonmonetary currencies can lead us astray. They let us bypass our conscience and freely explore the benefits of dishonesty.

This view of human nature is worrisome. We can hope to surround ourselves with good, moral people, but we have to be realistic. Even good people are not immune to being partially blinded by their own minds. This blindness allows them to take actions that bypass their own moral standards on the road to financial rewards. In essence, motivation can play tricks on us whether or not we are good, moral people.

As the author and journalist Upton Sinclair once noted, “It is difficult to get a man to understand something when his salary depends upon his not understanding it.” We can now add the following thought: it is even more difficult to get a man to understand something when he is dealing with nonmonetary currencies.

T
HE PROBLEMS OF
dishonesty, by the way, don't apply just to individuals. In recent years we have seen business in general succumb to a lower standard of honesty. I'm not talking about big acts of dishonesty, like those perpetrated by Enron and Worldcom. I mean the small acts of dishonesty that are similar to swiping Cokes out of the refrigerator. There are companies out there, in other words, that aren't stealing cash off our plates, so to speak, but are stealing things one step removed from cash.

There are plenty of examples. Recently, one of my friends, who had carefully saved up his frequent-flyer miles for a vacation, went to the airline who issued all these miles. He was told that all the dates he wanted were blacked out. In other words, although he had saved up 25,000 frequent-flyer miles, he couldn't use them (and he tried many dates). But, the representative said, if he wanted to use 50,000 miles, there might be some seats. She checked. Sure, there were seats everywhere.

To be sure, there was probably some small print in the frequently-flyer brochure explaining that this was OK. But to my friend, the 25,000 miles he had earned represented a lot of money. Let's say it was $450. Would this airline have mugged him for that amount of cash? Would the airline have swiped it from his bank account? No. But because it was one step removed, the airline stole it from him in the form of requiring 25,000 additional miles.

For another example, look at what banks are doing with credit card rates. Consider what is called two-cycle billing. There are several variations of this trick, but the basic idea is that the moment you don't pay your bill in full, the credit issuer will not only charge a high interest rate on new purchases, but will actually reach into the past and charge interest on past purchases as well. When the Senate banking committee looked into this recently, it heard plenty of testimony that certainly made the banks look dishonest. For instance, a man in Ohio who charged $3,200 to his card soon found his debt to be $10,700 because of penalties, fees, and interest.

These were not boiler-room operators charging high interest rates and fees, but some of the biggest and presumably most reputable banks in America—those whose advertising campaigns would make you believe that you and the bank were “family.” Would a family member steal your wallet? No. But these banks, with a transaction somewhat removed from cash, apparently would.

Once you view dishonesty through this lens, it is clear that you can't open a newspaper in the morning without seeing new examples to add.

A
ND SO WE
return to our original observation: isn't cash strange? When we deal with money, we are primed to think about our actions as if we had just signed an honor code. If you look at a dollar bill, in fact, it seems to have been designed to conjure up a contract:
THE UNITED STATES OF AMERICA,
it says in prominent type, with a shadow beneath that makes it seem three-dimensional. And there is George Washington himself (and we all know that he could never tell a lie). And then, on the back, it gets even more serious:
IN GOD WE TRUST,
it says. And then we've got that weird pyramid, and on top, that unblinking eye! And it's looking right at us! In addition to all this symbolism, the sanctity of money could also be aided by the fact that money is a clear unit of exchange. It's hard to say that a dime is not a dime, or a buck isn't a buck.

But look at the latitude we have with nonmonetary exchanges. There's always a convenient rationale. We can take a pencil from work, a Coke from the fridge—we can even backdate our stock options—and find a story to explain it all. We can be dishonest without thinking of ourselves as dishonest. We can steal while our conscience is apparently fast asleep.

How can we fix this? We could label each item in the supply cabinet with a price, for instance, or use wording that explains stocks and stock options clearly in terms of their monetary value. But in the larger context, we need to wake up to the connection between nonmonetary currency and our tendency to cheat. We need to recognize that once cash is a step away, we will cheat by a factor bigger than we could ever imagine. We need to wake up to this—individually and as a nation, and do it soon.

Why? For one thing, the days of cash are coming to a close. Cash is a drag on the profits of banks—they want to get rid of it. On the other hand, electronic instruments are very profitable. Profits from credit cards in the United States rose from $9 billion in 1996 to a record $27 billion in 2004. By 2010, banking analysts say, there will be $50 billion in new electronic transactions, nearly twice the number processed under the Visa and MasterCard brands in 2004.
³⁰
The question, therefore, is how we can control our tendency to cheat when we are brought to our senses only by the sight of cash—and what we can do now that cash is going away.

Willie Sutton allegedly said that he robbed banks because that's where the money was. By that logic he might be writing the fine print for a credit card company today or penciling in blackout dates for an airline. It might not be where the cash is, but it's certainly where you will find the money.

CHAPTER
15
Beer and Free Lunches

What Is Behavioral Economics, and Where
Are the Free Lunches?

T
he Carolina Brewery is a hip bar on Franklin Street, the main street outside the University of North Carolina at Chapel Hill. A beautiful street with brick buildings and old trees, it has many restaurants, bars, and coffee shops—more than one would expect to find in a small town.

As you open the doors to the Carolina Brewery, you see an old building with high ceilings and exposed beams, and a few large stainless steel beer containers that promise a good time. There are semiprivate tables scattered around. This is a favorite place for students as well as for an older crowd to enjoy good beer and food.

Soon after I joined MIT, Jonathan Levav (a professor at Columbia) and I were mulling over the kinds of questions one might conjure up in such a pleasant pub. First, does the sequential process of taking orders (asking each person in turn to state his or her order) influence the choices that the people sitting around the table ultimately make? In other words, are the patrons influenced by the selections of the others around them? Second, if this is the case, does it encourage conformity or nonconformity? In other words, would the patrons sitting around a table intentionally choose beers that were different from or the same as the choices of those ordering before them? Finally, we wanted to know whether being influenced by others' choices would make people better or worse off, in terms of how much they enjoyed their beer.

T
HROUGHOUT THIS BOOK,
I have described experiments that I hoped would be surprising and illuminating. If they were, it was largely because they refuted the common assumption that we are all fundamentally rational. Time and again I have provided examples that are contrary to Shakespeare's depiction of us in “What a piece of work is a man.” In fact, these examples show that we are not noble in reason, not infinite in faculty, and rather weak in apprehension. (Frankly, I think Shakespeare knew that very well, and this speech of Hamlet's is not without irony.)

In this final chapter, I will present an experiment that offers one more example of our predictable irrationality. Then I will further describe the general economic perspective on human behavior, contrast it with behavioral economics, and draw some conclusions. Let me begin with the experiment.

T
O GET TO
the bottom of the sudsy barrel of questions that we thought of at the Carolina Brewery, Jonathan and I decided to plunge in—metaphorically, of course. We started by asking the manager of the Carolina Brewery to let us serve free samples of beer to the customers—as long as we paid for the beer ourselves. (Imagine how difficult it was, later, to convince the MIT accountants that a $1,400 bill for beer is a legitimate research expense.) The manager of the bar was happy to comply. After all, he would sell us the beer and his customers would receive a free sample, which would presumably increase their desire to return to the brewery.

Handing us our aprons, he established his one and only condition: that we approach the people and get their orders for samples within one minute of the time they sat down. If we couldn't make it in time, we would indicate this to the regular waiters and they would approach the table and take the orders. This was reasonable. The manager didn't know how efficient we could be as waiters, and he didn't want to delay the service by too much. We started working.

I approached a group as soon as they sat down. They seemed to be undergraduate couples on a double date. Both guys were wearing what looked like their best slacks, and the girls had on enough makeup to make Elizabeth Taylor look unadorned in comparison. I greeted them, announced that the brewery was offering free beer samples, and then proceeded to describe the four beers:

Which would you choose?

□ Copperline Amber Ale

□ Franklin Street Lager

□ India Pale Ale

□ Summer Wheat Ale

After describing the beers, I nodded at one of the guys—the blond-haired guy—and asked for his selection; he chose the India Pale Ale. The girl with the more elaborate hairdo was next; she chose the Franklin Street Lager. Then I turned to the other girl. She opted for the Copperline Amber Ale. Her boyfriend, who was last, selected the Summer Wheat Ale. With their orders in hand, I rushed to the bar, where Bob—the tall, handsome bartender, a senior in computer science—stood smiling. Aware that we were in a hurry, he filled my order before any of the others. I then took the tray with the four two-ounce samples back to the double-daters' table and placed their beers in front of them.

Along with their samples, I handed each of them a short survey, printed on the brewery's stationery. In this survey we asked the respondents how much they liked their beer and whether they had regretted choosing that particular brew. After I collected their surveys, I continued to observe the four people from a distance to see whether any of them took a sip of anyone else's beer. As it turned out, none of them shared a sample.

Jonathan and I repeated this procedure with 49 more tables. Then we continued, but for the next 50 tables we changed the procedure. This time, after we read the descriptions of the beers, we handed the participants a small menu with the names of the four beers and asked each of them to write down their preferred beer, rather than simply say it out loud. In so doing, we transformed ordering from a public event into a private one. This meant that each participant would not hear what the others—including, perhaps, someone they were trying hard to impress—ordered and so could not be influenced by it.

What happened? We found that when people order out loud in sequence, they choose differently from when they order in private. When ordering sequentially (publicly), they order more types of beer per table—in essence opting for variety. A basic way to understand this is by thinking about the Summer Wheat Ale. This brew was not very attractive to most people. But when the other beers were “taken,” our participants felt that they had to choose something different—perhaps to show that they had a mind of their own and weren't trying to copy the others—and so they chose a different beer, one that they may not have initially wanted, but one that conveyed their individuality.

What about their enjoyment of the beer? It stands to reason that if people choose beer that nobody has chosen just to convey uniqueness, they will probably end up with a beer that they don't really want or like. And indeed this was the case. Overall, those who made their choices out loud, in the standard way that food is ordered at restaurants, were not as happy with their selections as those who made their choices privately, without taking others' opinions into consideration. There was, however, one very important exception: the first person to order beer in the group that made its decisions out loud was de facto in the same condition as the people who expressed their opinion privately, since he or she was unencumbered, in choosing, by other people's choices. Accordingly, we found that the first person to order beer in the sequential group was the happiest of his or her group and just as happy as those who chose their beers in private.

B
Y THE WAY,
a funny thing happened when we ran the experiment in the Carolina Brewery: Dressed in my waiter's outfit, I approached one of the tables and began to read the menu to the couple there. Suddenly, I realized that the man was Rich, a graduate student in computer science, someone with whom I had worked on a project related to computational vision three or four years earlier. Because the experiment had to be conducted in the same way each time, this was not a good time for me to chat with him, so I put on a poker face and launched into a matter-of-fact description of the beers. After I finished, I nodded to Rich and asked, “What can I get you?” Instead of giving me his order, he asked how I was doing.

“Very well, thank you,” I said. “Which of the beers can I get you?”

He and his companion both selected beers, and then Rich took another stab at conversation: “Dan, did you ever finish your PhD?”

“Yes,” I said, “I finished about a year ago. Excuse me; I will be right back with your beers.” As I walked to the bar to fill their order, I realized that Rich must have thought that this was my profession and that a degree in social science would only get someone a job as a beer server. When I got back to the table with the samples, Rich and his companion—who was his wife—tasted the beers and answered the short questionnaire. Then Rich tried again. He told me that he had recently read one of my papers and liked it a lot. It was a good paper, and I liked it, too, but I think he was just trying to make me feel better about my job as a beer server.

A
NOTHER STUDY, CONDUCTED
later at Duke with wine samples and MBA students, allowed us to measure some of the participants' personality traits—something the manager of the Carolina Brewery had not been thrilled about. That opened the door for us to find out what might be contributing to this interesting phenomenon. What we found was a correlation between the tendency to order alcoholic beverages that were different from what other people at the table had chosen and a personality trait called “need for uniqueness.” In essence, individuals more concerned with portraying their own uniqueness were more likely to select an alcoholic beverage not yet ordered at their table in an effort to demonstrate that they were in fact one of a kind.

What these results show is that people are sometimes willing to sacrifice the pleasure they get from a particular consumption experience in order to project a certain image to others. When people order food and drinks, they seem to have two goals: to order what they will enjoy most and to portray themselves in a positive light in the eyes of their friends. The problem is that once they order, say, the food, they may be stuck with a dish they don't like—a situation they often regret. In essence, people, particularly those with a high need for uniqueness, may sacrifice personal utility in order to gain reputational utility.

Although these results were clear, we suspected that in other cultures—where the need for uniqueness is not considered a positive trait—people who ordered aloud in public would try to portray a sense of belonging to the group and express more conformity in their choices. In a study we conducted in Hong Kong, we found that this was indeed the case. In Hong Kong, individuals also selected food that they did not like as much when they selected it in public rather than in private, but these participants were more likely to select the same item as the people ordering before them—again making a regrettable mistake, though a different type of mistake, when ordering food.

F
ROM WHAT I
have told you so far about this experiment, you can see that a bit of simple life advice—a free lunch—comes out of this research. First, when you go to a restaurant, it's a good idea to plan your order before the waiter approaches you, and stick to it. Being swayed by what other people choose might lead you to choose a worse alternative. If you're afraid that you might be swayed anyway, a useful strategy is to announce your order to the table before the waiter comes. This way, you have staked a claim to your order, and it's less likely that the other people around the table will think you are not unique, even if someone else orders the same dish before you get your chance. But of course the best option is to order first.

Perhaps restaurant owners should ask their customers to write out orders privately (or quietly give their orders to the waiters), so that no customer will be influenced by the orders of his or her companions. We pay a lot of money for the pleasure of dining out. Getting people to order anonymously is most likely the cheapest and simplest way to increase the enjoyment derived from these experiences.

But there's a bigger lesson that I would like to draw from this experiment—and in fact from all that I have said in the preceding chapters. Standard economics assumes that we are rational—that we know all the pertinent information about our decisions, that we can calculate the value of the different options we face, and that we are cognitively unhindered in weighing the ramifications of each potential choice.

The result is that we are presumed to be making logical and sensible decisions. And even if we make a wrong decision from time to time, the standard economics perspective suggests that we will quickly learn from our mistakes either on our own or with the help of “market forces.” On the basis of these assumptions, economists draw far-reaching conclusions about everything from shopping trends to law to public policy.

But, as the results presented in this book (and others) show, we are all far less rational in our decision making than standard economic theory assumes. Our irrational behaviors are neither random nor senseless—they are systematic and predictable. We all make the same types of mistakes over and over, because of the basic wiring of our brains. So wouldn't it make sense to modify standard economics and move away from naive psychology, which often fails the tests of reason, introspection, and—most important—empirical scrutiny?

Wouldn't economics make a lot more sense if it were based on how people actually behave, instead of how they should behave? As I said in the Introduction, that simple idea is the basis of behavioral economics, an emerging field focused on the (quite intuitive) idea that people do not always behave rationally and that they often make mistakes in their decisions.