The Marketplace of Perceptions
Behavioral economics explains why we procrastinate, buy, borrow, and grab
chocolate on the spur of the moment.
by Craig Lambert
Like all revolutions in thought, this one began with anomalies, strange
facts, odd observations that the prevailing wisdom could not explain. Casino
gamblers, for instance, are willing to keep betting even while expecting to
lose. People say they want to save for retirement, eat better, start
exercising, quit smoking-and they mean it-but they do no such things.
Victims who feel they've been treated poorly exact their revenge, though
doing so hurts their own interests.
Such perverse facts are a direct affront to the standard model of the human
actor-Economic Man-that classical and neoclassical economics have used as a
foundation for decades, if not centuries. Economic Man makes logical,
rational, self-interested decisions that weigh costs against benefits and
maximize value and profit to himself. Economic Man is an intelligent,
analytic, selfish creature who has perfect self-regulation in pursuit of his
future goals and is unswayed by bodily states and feelings. And Economic Man
is a marvelously convenient pawn for building academic theories. But
Economic Man has one fatal flaw: he does not exist.
When we turn to actual human beings, we find, instead of robot-like logic,
all manner of irrational, self-sabotaging, and even altruistic behavior.
This is such a routine observation that it has been made for centuries;
indeed, Adam Smith "saw psychology as a part of decision-making," says
assistant professor of business administration Nava Ashraf. "He saw a
conflict between the passions and the impartial spectator."
Nonetheless, neoclassical economics sidelined such psychological insights.
As recently as 15 years ago, the sub-discipline called behavioral
economics-the study of how real people actually make choices, which draws on
insights from both psychology and economics-was a marginal, exotic endeavor.
Today, behavioral economics is a young, robust, burgeoning sector in
mainstream economics, and can claim a Nobel Prize, a critical mass of
empirical research, and a history of upending the neoclassical theories that
dominated the discipline for so long.
Although behavioral economists teach at Stanford, Berkeley, Chicago,
Princeton, MIT, and elsewhere, the subfield's greatest concentration of
scholars is at Harvard. "Harvard's approach to economics has traditionally
been somewhat more worldly and empirical than that of other universities,"
says President Lawrence H. Summers, who earned his own economics doctorate
at Harvard and identifies himself as a behavioral economist. "And if you are
worldly and empirical, you are drawn to behavioral approaches."
Framing a New Field
Two non-economists have won Nobel Prizes in economics. As early as the
1940s, Herbert Simon of Carnegie Mellon University put forward the concept
of "bounded rationality," arguing that rational thought alone did not
explain human decision-making. Traditional economists disliked or ignored
Simon's research, and when he won the Nobel in 1978, many in the field were
very unhappy about it.
Then, in 1979, psychologists Daniel Kahneman, LL.D. '04, of Princeton and
Amos Tversky of Stanford published "Prospect Theory: An Analysis of Decision
under Risk," a breakthrough paper on how people handle uncertain rewards and
risks. In the ensuing decades, it became one of the most widely cited papers
in economics. The authors argued that the ways in which alternatives are
framed-not simply their relative value-heavily influence the decisions
people make. This was a seminal paper in behavioral economics; its rigorous
equations pierced a core assumption of the standard model-that the actual
value of alternatives was all that mattered, not the mode of their
presentation ("framing").
Framing alternatives differently can, for example, change people's
preferences regarding risk. In a 1981 Science paper, "The Framing of
Decisions and the Psychology of Choice," Tversky and Kahneman presented an
example. "Imagine that the U.S. is preparing for the outbreak of an unusual
Asian disease which is expected to kill 600 people," they wrote. "Two
alternative programs to combat the disease have been proposed." Choose
Program A, and a projected 200 people will be saved. Choose Program B, and
there is a one-third probability that 600 people will be saved, and a
two-thirds probability that no one will be saved. The authors reported that
72 percent of respondents chose Program A, although the actual outcomes of
the two programs are identical. Most subjects were risk averse, preferring
the certain saving of 200 lives. The researchers then restated the problem:
this time, with Program C, "400 people will die," whereas with Program D,
"there is a one-third probability that no one will die, and a two-thirds
probability that 600 people will die." This time, 78 percent chose Program
D-again, despite identical outcomes. Respondents now preferred the
risk-taking option. The difference was simply that the first problem phrased
its options in terms of lives saved, and the second one as lives lost;
people are more willing, apparently, to take risks to prevent lives being
"lost" than to "save" lives.
"Kahneman and Tversky started this revolution in economics," says Straus
professor of business administration Max Bazerman, who studies
decision-making and negotiation at Harvard Business School. "That 1979 paper
was written on the turf of economics, in the style of economists, and
published in the toughest economic journal, Econometrica. The major points
of prospect theory aren't hard to state in words. The math was added for
acceptance, and that was important." In 2002, Kahneman received the Nobel
Prize in economics along with Vernon Smith, Ph.D. '55, of George Mason
University, who was honored for work in experimental economics. (Tversky,
Kahneman's longtime collaborator, had died in 1996.)
In the 1980s, Richard Thaler (then at Cornell, now of the University of
Chicago Graduate School of Business) began importing such psychological
insights into economics, writing a regular feature called "Anomalies" in the
Journal of Economic Perspectives (later collected in his 1994 book, The
Winner's Curse <www.powells.com/partner/30264/biblio/0691019347>).
"Dick Thaler lived in an intellectual wilderness in the 1980s," says
professor of economicsDavid Laibson, one of Harvard's most prominent
behavioral economists. "He championed these ideas that economists were
deriding. But he stuck to it. Behavioral approaches were anathema in the
1980s, became popular in the 1990s, and now we're a fad, with lots of grad
students coming on board. It's no longer an isolated band of beleaguered
researchers fighting against the mainstream."
As with most movements, there were early adopters. "In the 1980s the best
economists in the world were seeing the evidence and adopting it [behavioral
economics]," Bazerman says. "Mediocre economists follow slowly-they
continued to ignore it so they could continue doing their work undisturbed."
To be fair, the naysayers would have agreed that the rational model only
approximates human cognition-"just as Newtonian physics is an approximation
to Einstein's physics," Laibson explains. "Although there are differences,
when walking along the surface of this planet, you'll never encounter them.
If I want to build a bridge, pass a car, or hit a baseball, Newtonian
physics will suffice. But the psychologists said, 'No, it's not sufficient,
we're not just playing around at the margins, making small change. There are
big behavioral regularities that include things like imperfect self-control
and social preferences, as opposed to pure selfishness. We care about people
outside our families and give up resources to help them-those affected by
Hurricane Katrina, for example."
Much of the early work in behavioral economics was in finance, with many
significant papers written by Jones professor of economics Andrei Shleifer.
In financial markets, "The usual arguments in conventional economics are,
'This [behavioral irrationality] can't be true, because even if there are
stupid, irrational people around, they are met in the marketplace by smart,
rational people, and trading by these arbitrageurs corrects prices to
rational levels,'" Shleifer explains. "For example, if people get unduly
pessimistic about General Motors and dump GM shares on the market, these
smart people will sweep in and buy them up as undervalued, and not much will
happen to the price of GM shares."
But a 1990 paper Shleifer wrote with Summers, "The Noise Trader Approach to
Finance," argues against this "efficient market" model by noting that
certain risk-related factors limit this arbitrage. At that time, for
example, shares of Royal Dutch were selling at a different price in
Amsterdam than shares of Shell in London, even though they were shares of
the same company, Royal Dutch/Shell. Closed-end mutual funds (those with a
fixed number of shares that trade on exchanges) sell at different prices
than the value of their portfolios. "When the same thing sells at two
different prices in different markets, forces of arbitrage and rationality
are necessarily limited," Shleifer says. "The forces of irrationality are
likely to have a big impact on prices, even on a long-term basis. This is a
theoretical attack on the central conventional premise."
Meanwhile, the Russell Sage Foundation, which devotes itself to research in
the social sciences, consistently supported behavioral economics, even when
it was in the intellectual wilderness. Current Sage president Eric Wanner,
Ph.D. '69, whose doctorate is in social psychology, was running a program in
cognitive science at the Alfred P. Sloan Foundation in 1984 when Sloan
started a behavioral economics program as an application of cognitive
science to the study of economic decision-making. ("The field is misnamed-it
should have been called cognitive economics," says Wanner. "We weren't brave
enough.") After Wanner became president of Russell Sage in 1986, the two
institutions worked jointly to foster the new subfield. In the last 20
years, Sage has made well over 100 grants to behavioral economists; it also
organizes a biennial summer institute that has drawn younger scholars like
Laibson and professor of economics Sendhil Mullainathan. Princeton
University Press and Russell Sage also co-publish a series of books in the
field.
Behavioral economics, then, is the hybrid offspring of economics and
psychology. "We don't have much to tell psychologists about how individuals
make decisions or process information, but we have a lot to learn from
them," says Glimp professor of economics Edward Glaeser. "We do have a lot
to say about how individuals come together in aggregations-markets, firms,
political parties."
The Seductive Now-Moment
A national chain of hamburger restaurants takes its name from Wimpy,
Popeye's portly friend with a voracious appetite but small exchequer, who
made famous the line, "I'll gladly pay you Tuesday for a hamburger today."
Wimpy nicely exemplifies the problems of "intertemporal choice" that
intrigue behavioral economists like David Laibson. "There's a fundamental
tension, in humans and other animals, between seizing available rewards in
the present, and being patient for rewards in the future," he says. "It's
radically important. People very robustly want instant gratification right
now, and want to be patient in the future. If you ask people, 'Which do you
want right now, fruit or chocolate?' they say, 'Chocolate!' But if you ask,
'Which one a week from now?' they will say, 'Fruit.' Now we want chocolate,
cigarettes, and a trashy movie. In the future, we want to eat fruit, to quit
smoking, and to watch Bergman films."
Laibson can sketch a formal model that describes this dynamic. Consider a
project like starting an exercise program, which entails, say, an immediate
cost of six units of value, but will produce a delayed benefit of eight
units. That's a net gain of two units, "but it ignores the human tendency to
devalue the future," Laibson says. If future events have perhaps half the
value of present ones, then the eight units become only four, and starting
an exercise program today means a net loss of two units (six minus four). So
we don't want to start exercising today. On the other hand, starting
tomorrow devalues both the cost and the benefit by half (to three and four
units, respectively), resulting in a net gain of one unit from exercising.
Hence, everyone is enthusiastic about going to the gym tomorrow.
Broadly speaking, "People act irrationally in that they overly discount the
future," says Bazerman. "We do worse in life because we spend too much for
what we want now at the expense of goodies we want in the future. People buy
things they can't afford on a credit card, and as a result they get to buy
less over the course of their lifetimes." Such problems should not arise,
according to standard economic theory, which holds that "there shouldn't be
any disconnect between what I'm doing and what I want to be doing," says
Nava Ashraf.
Luckily, Odysseus also confronts the problem posed by Wimpy-and Homer's hero
solves the dilemma. The goddess Circe informs Odysseus that his ship will
pass the island of the Sirens, whose irresistible singing can lure sailors
to steer toward them and onto rocks. The Sirens are a marvelous metaphor for
human appetite, both in its seductions and its pitfalls. Circe advises
Odysseus to prepare for temptations to come: he must order his crew to
stopper their ears with wax, so they cannot hear the Sirens' songs, but he
may hear the Sirens' beautiful voices without risk if he has his sailors
lash him to a mast, and commands them to ignore his pleas for release until
they have passed beyond danger. "Odysseus pre-commits himself by doing
this," Laibson explains. "Binding himself to the mast prevents his future
self from countermanding the decision made by his present self."
Pre-commitments of this sort are one way of getting around not only the lure
of temptation, but our tendency to procrastinate on matters that have an
immediate cost but a future payoff, like dieting, exercise, and cleaning
your office. Take 401(k) retirement plans, which not only let workers save
and invest for retirement on a tax-deferred basis, but in many cases amount
to a bonanza of free money: the equivalent of finding "$100 Bills on the
Sidewalk" (the title of one of Laibson's papers, with James Choi and
Brigitte Madrian). That's because many firms will match employees'
contributions to such plans, so one dollar becomes two dollars. "It's a lot
of free money," says Laibson, who has published many papers on 401(k)s and
may be the world's foremost authority on enrollment in such plans. "Someone
making $50,000 a year who has a company that matches up to 6 percent of his
contributions could receive an additional $3,000 per year."
The rational model unequivocally predicts that people will certainly snap up
such an opportunity. But they don't-not even workers aged 59 1/2 or older,
who can withdraw sums from their 401(k) plans without penalty. (Younger
people are even more unlikely to contribute, but they face a penalty for
early withdrawal.) "It turns out that about half of U.S. workers in this
[above 59 1/2] age group, who have this good deal available, are not
contributing," says Laibson. "There's no downside and a huge upside. Still,
individuals are procrastinating-they plan to enroll soon, year after year,
but don't do it." In a typical American firm, it takes a new employee a
median time of two to three years to enroll. But because Americans change
jobs frequently-say, every five years-that delay could mean losing half of
one's career opportunity for these retirement savings.
Laibson has run educational interventions with employees at companies,
walking them through the calculations, showing them what they are doing
wrong. "Almost all of them still don't invest," Laibson says. "People find
these kinds of financial transactions unpleasant and confusing, and they are
happier with the idea of doing it tomorrow. It demonstrates how poorly the
standard rational-actor model predicts behavior."
It's not that we are utterly helpless against procrastination. Laibson
worked with a firm that forced its employees to make active decisions about
401(k) plans, insisting on a yes or no answer within 30 days. This is far
different from giving people a toll-free phone number to call whenever they
decide to enroll. During the 30-day period, the company also sent frequent
e-mail reminders, pressuring the staff to make their decisions. Under the
active-decision plan, enrollment jumped from 40 to 70 percent. "People want
to be prudent, they just don't want to do it right now," Laibson says.
"You've got to compel action. Or enroll people automatically."
When he was U.S. Treasury Secretary, Lawrence Summers applied this insight.
"We pushed very hard for companies to choose opt-out [automatic enrollment]
401(k)s rather than opt-in [self-enrollment] 401(k)s," he says. "In
classical economics, it doesn't matter. But large amounts of empirical
evidence show that defaults do matter, that people are inertial, and
whatever the baseline settings are, they tend to persist."
Marketing Prudence
These insights can also be writ large. Laibson's former student Nava Ashraf,
who has worked extensively with non-governmental organizations, is now
applying behavioral economics to interventions in developing countries. She
lived for a year in Ivory Coast and Cameroon, where she "noticed that
farmers and small-business owners were often not doing the things that a
development policymaker or economist thinks they should do," she says. "They
wouldn't take up technologies that would increase agricultural yield, for
example. They wouldn't get vaccines, even though they were free! They also
had a lot of trouble saving. In January they had a lot of money and would
spend it on feasts and special clothes, but in June their children would be
starving."
Still, some found ways to offset their less-than-prudent tendencies. One
woman had a cashbox in her home, where she saved money regularly-and gave
her neighbor the only key. Another timed the planting of her sweet-potato
crop so that the harvest would come in when school fees were due. Her farm
became an underground bank account that allowed withdrawal only at the
proper moment.
Ashraf worked with a bank in the Philippines to design a savings plan that
took off from the African woman's cashbox. The bank created a savings
account, called SEED ("Save, Earn, Enjoy Deposits"), with two features: a
locked box (for which the bank had the key) and a contractual agreement that
clients could not withdraw money before reaching a certain date or sum. The
clients determined the goal, but relied on the bank to enforce the
commitment. The bank marketed the SEED product to literate workers and
micro-entrepreneurs: teachers, taxi drivers, people with pushcart
businesses.
The SEED box, designed to appeal to the bank's clients ("In the Philippines,
they like 'cute' stuff," Ashraf explains), helped mobilize deposits. "It's
similar to automatic payroll deduction, but not enough of the customers had
direct deposit to make that work," she says. To further encourage deposits,
Ashraf worked with the bank on an additional program of deposit collectors
who, for a nominal fee, would go to the customer's home on a designated day
and collect the savings from the SEED box. The withdrawal restrictions on
the account helped clients avoid the temptation of spending their savings.
The SEED savings account made a designed choice available in the marketplace
that, so far, has helped a growing number of microfinance clients in the
Philippines reach their savings goals.
Ashraf is now working with Population Services International-a nonprofit
organization that seeks to focus private-sector resources on the health
problems of developing nations-on a project in Zambia to motivate people to
use a water purification solution known as Clorin. "We can use what
marketing people have known all along," Ashraf says. "There are ways of
manipulating people's psychological frameworks to get them to buy things.
How do you use this knowledge to get them to adopt socially useful products
or services? It's so practical, and very important in development, for
anybody who wants to help people reach their goals."
Carefully designed programs like the SEED bank are examples of what Richard
Thaler called "prescriptive economics," which aims not only to describe the
world but to change it. "Behavioral economics really shines when you talk
about the specifics of what the policy should look like," says Sendhil
Mullainathan, who received a MacArthur Fellowship in 2002. "The difference
in impact between two broad policies may not be as great as differences in
how each policy is framed-its deadlines, implementation, and the design of
its physical appearance.
"For example, in Social Security privatization," Mullainathan continues,
"the difference between private accounts and the status quo may be less than
that between two different ways of implementing private accounts. What is
the default option? Are you allowed to make changes? What's the deadline for
making changes? How are the monthly statements presented-just your returns,
or are the market returns printed alongside your own? In terms of impact,
the devil really is in the details of how the program is designed. We know
that people have a tough time making these choices. So how are the choices
framed? What metrics do they focus on?"
"We tend to think people are driven by purposeful choices," he explains. "We
think big things drive big behaviors: if people don't go to school, we think
they don't like school. Instead, most behaviors are driven by the moment.
They aren't purposeful, thought-out choices. That's an illusion we have
about others. Policymakers think that if they get the abstractions right,
that will drive behavior in the desired direction. But the world happens in
real time. We can talk abstractions of risk and return, but when the person
is physically checking off the box on that investment form, all the things
going on at that moment will disproportionately influence the decision they
make. That's the temptation element-in real time, the moment can be very
tempting. The main thing is to define what is in your mind at the moment of
choice. Suppose a company wants to sell more soap. Traditional economists
would advise things like making a soap that people like more, or charging
less for a bar of soap. A behavioral economist might suggest convincing
supermarkets to display your soap at eye level-people will see your brand
first and grab it."
Mullainathan worked with a bank in South Africa that wanted to make more
loans. A neoclassical economist would have offered simple counsel: lower the
interest rate, and people will borrow more. Instead, the bank chose to
investigate some contextual factors in the process of making its offer. It
mailed letters to 70,000 previous borrowers saying, "Congratulations! You're
eligible for a special interest rate on a new loan." But the interest rate
was randomized on the letters: some got a low rate, others a high one. "It
was done like a randomized clinical trial of a drug," Mullainathan explains.
The bank also randomized several aspects of the letter. In one corner there
was a photo-varied by gender and race-of a bank employee. Different types of
tables, some simple, others complex, showed examples of loans. Some letters
offered a chance to win a cell phone in a lottery if the customer came in to
inquire about a loan. Some had deadlines. Randomizing these elements allowed
Mullainathan to evaluate the effect of psychological factors as opposed to
the things that economists care about-i.e., interest rates-and to quantify
their effect on response in basis points.
"What we found stunned me," he says. "We found that any one of these things
had an effect equal to one to five percentage points of interest! A woman's
photo instead of a man's increased demand among men by as much as dropping
the interest rate five points! These things are not small. And this is very
much an economic problem. We are talking about big loans here; customers
would end up with monthly loan payments of around 10 percent of their annual
income. You'd think that if you really needed the money enough to pay this
interest rate, you're not going to be affected by a photo. The photo, cell
phone lottery, simple or complicated table, and deadline all had effects on
loan applications comparable to interest. Interest rate may not even be the
third most important factor. As an economist, even when you think psychology
is important, you don't think it's this important. And changing interest
rates is expensive, but these psychological elements cost nothing."
Mullainathan is helping design programs in developing countries, doing
things like getting farmers to adopt better feed for cows to increase their
milk production by as much as 50 percent. Back in the United States,
behavioral economics might be able to raise compliance rates of diabetes
patients, who don't always take prescribed drugs, he says. Poor families are
often deterred from applying to colleges for financial aid because the forms
are too complicated. "An economist would say, 'With $50,000 at stake, the
forms can't be the obstacle,'" he says. "But they can." (A traditional
explanation would say that the payoff clearly outweighs the cost in time and
effort, so people won't be deterred by complex forms.)
Economists and others who engage in policy debates like to wrangle about big
issues on the macroscopic level. The nitty-gritty details of execution-what
do the forms look like? what is in the brochures? how is it
communicated?-are left to the support staff. "But that work is central,"
Mullainathan explains. "There should be as much intellectual energy devoted
to these design choices as to the choice of a policy in the first place.
Behavioral economics can help us design these choices in sensible ways. This
is a big hole that needs to be filled, both in policy and in science."
The Supply of Hatred
While some try to surmount or cope with irrationality, others feed upon it.
In the wake of the 9/11 attacks, Edward Glaeser began using behavioral
economic approaches to research the causes of group hatred that could
motivate murderous acts of that type. "An economist's definition of hatred,"
he says, "is the willingness to pay a price to inflict harm on others." In
laboratory settings, social scientists have observed subjects playing the
"ultimatum game," in which, say, with a total kitty of $10, Player A offers
to split the cash with player B. If B accepts A's offer, they divide the
money accordingly, but if B rejects A's offer, both players get nothing. "In
thousands of trials around the world, with different stakes, people reject
offers of 30 percent [$3 in our example] or less," says Glaeser. "So
typically, people offer 40 or 50 percent. But a conventional economic model
would say that B should accept a split of even one cent versus $9.99, since
you are still better off with a penny than nothing." (If a computer, rather
than a human, does the initial split, player B is much more likely to accept
an unfair split-a confirmation of research conducted by professors at the
Kennedy School of Government; see "Games of Trust and Betrayal," page 94.)
Clearly, the B player is willing to suffer financial loss in order to take
revenge on an A player who is acting unfairly. "You don't poke around in the
dark recesses of human behavior and not find vengeance," Glaeser says. "It's
pretty hard to find a case of murder and not find vengeance at the root of
it."
The psychological literature, he found, defines hatred as an emotional
response we have to threats to our survival or reproduction. "It's related
to the belief that the object of hatred has been guilty of atrocities in the
past and will be guilty of them in the future," he says. "Economists have
nothing to tell psychologists about why individuals hate. But group-level
hatred has its own logic that always involves stories about atrocities.
These stories are frequently false. As [Nazi propagandist Joseph] Goebbels
said, hatred requires repetition, not truth, to be effective.
"You have to investigate the supply of hatred," Glaeser continues. "Who has
the incentive and the ability to induce group hatred? This pushes us toward
the crux of the model: politicians or anyone else will supply hatred when
hatred is a complement to their policies." Glaeser searched back issues of
the Atlanta Constitution from 1875 to 1925, counting stories that contained
the keywords "Negro + rape" or "Negro + murder." He found a time-series that
closely matched that for lynchings described by historian C. Vann Woodward:
rising from 1875 until 1890, reaching a plateau from 1890 until 1910, then
declining after 1910.
In the 1880s and 1890s, Glaeser explains, the southern Populist Party
favored large-scale redistribution of wealth from the rich to the poor, and
got substantial support from African Americans. "Wealthier Southern
conservatives struck back, using race hatred" and spreading untrue stories
about atrocities perpetrated by blacks, Glaeser says. "'Populists are
friends of blacks, and blacks are dangerous and hateful,' was the
message-instead of being supported, [blacks] should be sequestered and have
their resources reduced. [Rich whites] sold this to poor white voters,
winning votes and elections. Eventually the Populists gave in and decided
they were better off switching their appeal to poor, racist whites. They
felt it was better to switch policies than try to change voters' opinions.
The stories-all about rape and murder-were coming from suppliers who were
external to poor whites."
Glaeser applies this model to anti-American hatred, which, in degree, "is
not particularly correlated with places that the United States has helped or
done harm to," he says. "France hates America more than Vietnam does."
Instead, he explains, it has much to do with "political entrepreneurs who
spread stories about past and future American crimes. Some place may have a
leader who has a working relationship with the United States. Enemies of the
leader offer an alternative policy: completely break with the United States
and Israel, and attack them. We saw it in the religious enemies of the shah
[of Iran]. The ayatollah sought to discredit the secular modernists through
the use of anti-American hatred."
For Glaeser, behavioral economics can take "something we have from
psychology-hatred as a hormonal response to threats-and put this in a market
setting. What are the incentives that will increase the supply of hatred in
a specific setting?" Economists, he feels, can take human tendencies rooted
in hormones, evolution, and the stable features of social psychology, and
analyze how they will play out in large collectivities. "Much of psychology
shows the enormous sensitivity of humans to social influence," Glaeser says.
"The Milgram and Zimbardo experiments [on obedience to authority and
adaptation to the role of prison guard] show that humans can behave
brutally. But that doesn't explain why Nazism happened in Germany and not
England."
Zero-Sum Persuasion
Andrei Shleifer has already made path-breaking contributions to the
literatures of behavioral finance (as noted above), political economy, and
law and economics. His latest obsession is persuasion-"How people absorb
information and how they are manipulated," he says. At the American Economic
Association meetings in January, Shleifer described "cognitive persuasion,"
exploring how advertisers, politicians, and others attach their messages to
pre-existing maps of associations in order to move the public in a desired
direction.
The Marlboro Man, for example, sold filtered cigarettes by mobilizing the
public's associations of cowboys and the West with masculinity,
independence, and the great outdoors. "There is a 'confirmation bias,'"
Shleifer explained, which favors persuasive messages that confirm beliefs
and connections already in the audience's mind (see "The Market for News,"
January-February, page 11, on work by Shleifer and Mullainathan that applies
a similar analysis to the news media). For example, George W. Bush wearing a
$3,000 cowboy hat was not a problem, because it matched his image, but John
Kerry riding a $6,000 bicycle was a problem-that luxury item appeared
hypocritical for a candidate claiming to side with the downtrodden.
Citing Republican pollster and communications consultant Frank Luntz,
Shleifer noted how the estate tax was renamed the "death tax" (although
there is no tax on death) in order to successfully sell its repeal. The
relabeling linked the tax to the unpleasant associations of the word
"death," and the campaign asked questions like, "How can you burden people
even more at this most difficult time in their lives?" "Messages, not hard
attributes, shape competition," Shleifer said; he noted that the fear of
terrorism is a bigger issue in probable non-target states like Wyoming,
Utah, and Nevada than in New York and New Jersey.
Because successful persuasive messages are consistent with prevailing
worldviews, one corollary of Shleifer's analysis is that persuasion is
definitely not education, which involves adding new information or
correcting previous perceptions. "Don't tell people, 'You are stupid, and
here is what to think,'" Shleifer said. During presidential debates, he
asserted, voters tune out or forget things that are inconsistent with their
beliefs. "Educational messages may be doomed," he added. "They do not
resonate." In economic and political markets, he said, there is no tendency
toward a median taste; divergence, not convergence, is the trend. Therefore,
the successful persuader will find a niche and pander to it.
When making choices in the marketplace, "People are not responding to the
actual objects they are choosing between," says Eric Wanner of the Russell
Sage Foundation. "There is no direct relation of stimulus and response.
Neoclassical economics posits a direct relationship between the object and
the choice made. But in behavioral economics, the choice depends on how the
decision-maker describes the objects to himself. Any psychologist knows
this, but it is revolutionary when imported into economics.
"We are vulnerable to how choices are described," Wanner explains.
"Advertising is a business that tries to shape how people think about their
choices. Neoclassical economics can explain ads only as providing
information. But if the seller can invest in advertising that frames the
choice, that frame will skew the buyer's decision. The older economic
theories depend on the idea that the successful seller will produce a better
product, the market will price the product correctly, and the buyer will buy
it at a price that maximizes everyone's interest-the market is simply where
the buyer and seller come together. But once you introduce framing, you can
argue that the buyer may no longer be acting entirely in his own
self-interest if the seller has invented a frame for the buyer, skewing the
choice in favor of the seller.
"Then, the model of the market is not simply buyers and sellers coming
together for mutually beneficial exchange," Wanner continues. "Instead, the
exchange between buyers and sellers has aspects of a zero-sum game. The
seller can do even better if he sells you something you don't need, or gets
you to buy more than you need, and pay a higher price for it." The classical
welfare theorem of Vilfredo Pareto was that markets will make everyone as
well off as they can be, that the market distribution will be an efficient
distribution that maximizes welfare. "But once you introduce framing, all
bets are off," Wanner says. A zero-sum game between buyer and seller clearly
does not maximize everyone's welfare, and hence suggests a different model
of the marketplace.
There are many political implications. We have had 30 years of deregulation
in the United States, freeing up markets to work their magic. "Is that
generally welfare-enhancing, or not?" Wanner asks. "Framing can call that
into question. Everyone agrees that there's informational asymmetry-so we
have laws that ensure drugs are tested, and truth-in-advertising laws.
Still, there are subtle things about framing choices that are deceptive,
though not inaccurate. We have the power of markets, but they are places
where naive participants lose money. How do we manage markets so that the
framing problem can be acknowledged and controlled? It's an essential
question in a time of rising inequality, when the well-educated are doing
better and the poorly educated doing worse."
It's a question that behavioral economics raises, and, with luck, may also
be able to address. The eclipse of hyper-rational Economic Man opens the way
for a richer and more realistic model of the human being in the marketplace,
where the brain, with all its ancient instincts and vulnerabilities, can be
both predator and prey. Our irrationalities, our emotional hot-buttons, are
likely to persist, but knowing what they are may allow us to account for
them and even, like Odysseus, outwit temptation. The models of behavioral
economics could help design a society with more compassion for creatures
whose strengths and weaknesses evolved in much simpler conditions. After
all, "The world we live in," Laibson says, "is an institutional response to
our biology."
Craig A. Lambert '69, Ph.D. '78, is deputy editor of this magazine.
source: www.harvardmagazine.com/print/030640.html