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Like all revolutions in thought, thisone began with anomalies,
strange facts,odd observations that the prevailing wis-dom could
not explain. Casino gamblers,for instance, are willing to keep
bettingeven while expecting to lose. People saythey want to save
for retirement, eat better,start exercising, quit smokingand
theymean itbut they do no such things. Vic-tims who feel theyve
been treated poorlyexact their revenge, though doing so hurtstheir
own interests.
Such perverse facts are a direct aront tothe standard model of
the human actorEconomic Manthat classical and neo-classical
economics have used as a founda-tion for decades, if not centuries.
EconomicMan makes logical, rational, self-interesteddecisions that
weigh costs against benetsand maximize value and prot to
himself.Economic Man is an intelligent, analytic, selsh creature
who hasperfect self-regulation in pursuit of his future goals and
isunswayed by bodily states and feelings. And Economic Man is
amarvelously convenient pawn for building academic theories.
ButEconomic Man has one fatal aw: he does not exist.
When we turn to actual human beings, we nd, instead ofrobot-like
logic, all manner of irrational, self-sabotaging, and even
altruistic behavior. This is such a routine ob-servation that it
has been made for cen-turies; indeed, Adam Smith saw psychologyas a
part of decision-making, says assistantprofessor of business
administration NavaAshraf. He saw a conict between the pas-sions
and the impartial spectator.
Nonetheless, neoclassical economicssidelined such psychological
insights. Asrecently as 15 years ago, the sub-disciplinecalled
behavioral economicsthe studyof how real people actually make
choices,which draws on insights from both psy-chology and
economicswas a marginal,exotic endeavor. Today, behavioral
eco-nomics is a young, robust, burgeoningsector in mainstream
economics, and canclaim a Nobel Prize, a critical mass of
em-pirical research, and a history of upendingthe neoclassical
theories that dominated
the discipline for so long.Although behavioral economists teach
at Stanford, Berkeley,
Chicago, Princeton, MIT, and elsewhere, the subelds
greatestconcentration of scholars is at Harvard. Harvards approach
toeconomics has traditionally been somewhat more worldly
andempirical than that of other universities, says
PresidentLawrence H. Summers, who earned his own economics
doctor-
The Marketplace of
PerceptionsBehavioral
economics explainswhy we
procrastinate, buy,borrow, and
grab chocolate on the spur of the
moment.
by Craig Lambert
Portraits by Stu Rosner
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Harvard Magazine 51
ate at Harvard and identies himselfas a behavioral economist.
And ifyou are worldly and empirical, youare drawn to behavioral
approaches.
Framing a New FieldTwo non-economists have wonNobel Prizes in
economics. As earlyas the 1940s, Herbert Simon ofCarnegie Mellon
University put for-ward the concept of bounded ratio-nality,
arguing that rational thoughtalone did not explain human
deci-sion-making. Traditional economistsdisliked or ignored Simons
research,and when he won the Nobel in 1978,many in the field were
very unhappyabout it.
Then, in 1979, psychologists DanielKahneman, LL.D. 04, of
Princetonand Amos Tversky of Stanford pub-lished Prospect Theory:
An Analysisof Decision under Risk, a break-through paper on how
people handleuncertain rewards and risks. In theensuing decades, it
became one of themost widely cited papers in econom-ics. The
authors argued that the waysin which alternatives are
framednotsimply their relative valueheavilyinuence the decisions
people make.This was a seminal paper in behav-ioral economics; its
rigorous equa-tions pierced a core assumption ofthe standard
modelthat the actualvalue of alternatives was all that mat-tered,
not the mode of their presenta-tion (framing).
Framing alternatives dierentlycan, for example, change
peoplespreferences regarding risk. In a 1981Science paper, The
Framing of Deci-sions and the Psychology of Choice,Tversky and
Kahneman presented anexample. Imagine that the U.S. ispreparing for
the outbreak of an un-usual Asian disease which is ex-pected to kil
l 600 people, theywrote. Two alternative programs tocombat the
disease have been pro-posed. Choose Program A, and aprojected 200
people will be saved.Choose Program B, and there is aone-third
probability that 600 peoplewill be saved, and a two-thirds
probability that no one will besaved. The authors reported that 72
percent of respondents choseProgram A, although the actual outcomes
of the two programsare identical. Most subjects were risk averse,
preferring the cer-
tain saving of 200 lives. The researchers then restated the
prob-lem: this time, with Program C, 400 people will die,
whereaswith Program D, there is a one-third probability that no
onewill die, and a two-thirds probability that 600 people will
die.
Professor of economics David Laibson,whose research explores the
fundamentaltension between seizing available rewardsin the present,
and being patient for rewards in the future
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52 March - April 2006
This time, 78 percent chose Program Dagain, despite
identicaloutcomes. Respondents now preferred the risk-taking
option.The dierence was simply that the rst problem phrased its
op-tions in terms of lives saved, and the second one as lives lost;
peo-ple are more willing, apparently, to take risks to prevent
livesbeing lost than to save lives.
Kahneman and Tversky started this revolution in econom-ics, says
Straus professor of business administration Max Bazer-man, who
studies decision-making and negotiation at HarvardBusiness School.
That 1979 paper was written on the turf of eco-nomics, in the style
of economists, and published in the toughesteconomic journal,
Econometrica. The major points of prospect the-
ory arent hard to state in words. The math was added for
accep-tance, and that was important. In 2002, Kahneman received
theNobel Prize in economics along with Vernon Smith, Ph.D. 55,
ofGeorge Mason University, who was honored for work in
experi-mental economics. (Tversky, Kahnemans longtime
collaborator,had died in 1996.)
In the 1980s, Richard Thaler (then at Cornell, now of the
Uni-versity of Chicago Graduate School of Business) began
import-ing such psychological insights into economics, writing a
regu-lar feature called Anomalies in the Journal of Economic
Perspectives(later collected in his 1994 book, The Winners Curse).
Dick Thalerlived in an intellectual wilderness in the 1980s, says
professor ofeconomics David Laibson, one of Har-vards most
prominent behavioraleconomists. He championed theseideas that
economists were deriding.But he stuck to it. Behavioral ap-proaches
were anathema in the 1980s,became popular in the 1990s, andnow were
a fad, with lots of gradstudents coming on board. Its nolonger an
isolated band of belea-guered researchers ghting againstthe
mainstream.
As with most movements, therewere early adopters. In the 1980s
thebest economists in the world wereseeing the evidence and
adopting it[behavioral economics], Bazermansays. Mediocre
economists followslowlythey continued to ignore it sothey could
continue doing their workundisturbed.
To be fair, the naysayers would haveagreed that the rational
model only ap-proximates human cognitionjust asNewtonian physics is
an approxima-tion to Einsteins physics, Laibson ex-
plains. Although there are dierences, when walking along
thesurface of this planet, youll never encounter them. If I want
tobuild a bridge, pass a car, or hit a baseball, Newtonian
physicswill suce. But the psychologists said, No, its not
sucient,were not just playing around at the margins, making
smallchange. There are big behavioral regularities that include
thingslike imperfect self-control and social preferences, as
opposed topure selshness. We care about people outside our families
andgive up resources to help themthose aected by Hurricane
Ka-trina, for example.
Much of the early work in behavioral economics was in nance,with
many signicant papers written by Jones professor of eco-
nomics Andrei Shleifer. In nancialmarkets, The usual arguments
inconventional economics are, This[behavioral irrationality] cant
betrue, because even if there are stu-pid, irrational people
around, theyare met in the marketplace by smart,rational people,
and trading by thesearbitrageurs corrects prices to ratio-
nal levels, Shleifer explains. For example, if people get
undulypessimistic about General Motors and dump GM shares on
themarket, these smart people will sweep in and buy them up as
un-dervalued, and not much will happen to the price of GM
shares.
But a 1990 paper Shleifer wrote with Summers, The NoiseTrader
Approach to Finance, argues against this ecient mar-ket model by
noting that certain risk-related factors limit thisarbitrage. At
that time, for example, shares of Royal Dutch wereselling at a
dierent price in Amsterdam than shares of Shell inLondon, even
though they were shares of the same company,Royal Dutch/Shell.
Closed-end mutual funds (those with a xednumber of shares that
trade on exchanges) sell at dierent prices
than the value of their portfolios. Whenthe same thing sells at
two dierentprices in dierent markets, forces of ar-bitrage and
rationality are necessarilylimited, Shleifer says. The forces of
ir-rationality are likely to have a big im-pact on prices, even on
a long-termbasis. This is a theoretical attack onthe central
conventional premise.
Meanwhile, the Russell Sage Foun-dation, which devotes itself to
researchin the social sciences, consistently sup-ported behavioral
economics, evenwhen it was in the intellectual wilder-ness. Current
Sage president Eric Wan-ner, Ph.D. 69, whose doctorate is in
so-cial psychology, was running a programin cognitive science at
the Alfred P.Sloan Foundation in 1984 when Sloanstarted a
behavioral economics programas an application of cognitive science
tothe study of economic decision-making.(The eld is misnamedit
should havebeen called cognitive economics, saysWanner. We werent
brave enough.)After Wanner became president of Rus-
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.
D a v i d L a i b s o n
ST
U R
OS
NE
R
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Harvard Magazine 53
sell Sage in 1986, the two institutions worked jointly to
fosterthe new subeld. In the last 20 years, Sage has made well
over100 grants to behavioral economists; it also organizes a
biennialsummer institute that has drawn younger scholars like
Laibsonand professor of economics Sendhil Mullainathan.
PrincetonUniversity Press and Russell Sage also co-publish a series
ofbooks in the eld.
Behavioral economics, then, is the hybrid ospring of
economicsand psychology. We dont have much to tell psychologists
abouthow individuals make decisions or process information, but
wehave a lot to learn from them, says Glimp professor of
economicsEdward Glaeser. We do have a lot to say about how
individualscome together in aggregationsmarkets, rms, political
parties.
The Seductive Now-MomentA national chain of hamburger
restaurants takes its namefrom Wimpy, Popeyes portly friend with a
voracious appetitebut small exchequer, who made famous the line,
Ill gladly payyou Tuesday for a hamburger today. Wimpy nicely
exempliesthe problems of intertemporal choice that intrigue
behavioral
economists like David Laibson. Theres a fundamental tension,in
humans and other animals, between seizing available rewardsin the
present, and being patient for rewards in the future, hesays. Its
radically important. People very robustly want instantgratication
right now, and want to be patient in the future. Ifyou ask people,
Which do you want right now, fruit or choco-late? they say,
Chocolate! But if you ask, Which one a weekfrom now? they will say,
Fruit. Now we want chocolate, ciga-rettes, and a trashy movie. In
the future, we want to eat fruit, toquit smoking, and to watch
Bergman lms.
Laibson can sketch a formal model that describes this dy-namic.
Consider a project like starting an exercise program,which entails,
say, an immediate cost of six units of value, butwill produce a
delayed benet of eight units. Thats a net gain oftwo units, but it
ignores the human tendency to devalue the fu-ture, Laibson says. If
future events have perhaps half the value ofpresent ones, then the
eight units become only four, and startingan exercise program today
means a net loss of two units (sixminus four). So we dont want to
start exercising today. On theother hand, starting tomorrow
devalues both the cost and the
Assistant professor of business administration Nava Ashraf
helpedadapt a home-grown savings techniqueshe saw in West Africa to
the Philippines, where the cute SEED(Save, Earn, Enjoy Deposits)
bank (opposite) helped ordinary citizens save money.
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54 March - April 2006
benet by half (to three and four units, respectively), resulting
ina net gain of one unit from exercising. Hence, everyone is
enthusi-astic about going to the gym tomorrow.
Broadly speaking, People act irrationally in that they
overlydiscount the future, says Bazerman. We do worse in life
be-cause we spend too much for what we want now at the expenseof
goodies we want in the future. People buy things they cantaord on a
credit card, and as a result they get to buy less overthe course of
their lifetimes. Such problems should not arise, ac-cording to
standard economic theory, which holds that thereshouldnt be any
disconnect between what Im doing and what Iwant to be doing, says
Nava Ashraf.
Luckily, Odysseus also confronts the problem posed byWimpyand
Homers hero solves the dilemma. The goddessCirce informs Odysseus
that his ship will pass the island of theSirens, whose irresistible
singing can lure sailors to steer towardthem and onto rocks. The
Sirens are a marvelous metaphor forhuman appetite, both in its
seductions and its pitfalls. Circe ad-vises Odysseus to prepare for
temptations to come: he must orderhis crew to stopper their ears
with wax, so they cannot hear the
Sirens songs, but he may hear the Sirens beautiful voices
withoutrisk if he has his sailors lash him to a mast, and commands
themto ignore his pleas for release until they have passed beyond
dan-ger. Odysseus pre-commits himself by doing this, Laibson
ex-plains. Binding himself to the mast prevents his future self
fromcountermanding the decision made by his present self.
Pre-commitments of this sort are one way of getting aroundnot
only the lure of temptation, but our tendency to procrasti-nate on
matters that have an immediate cost but a future payo,like dieting,
exercise, and cleaning your oce. Take 401(k) retire-ment plans,
which not only let workers save and invest for retire-ment on a
tax-deferred basis, but in many cases amount to a bo-nanza of free
money: the equivalent of nding $100 Bills on theSidewalk (the title
of one of Laibsons papers, with James Choiand Brigitte Madrian).
Thats because many rms will match employees contributions to such
plans, so one dollar becomestwo dollars. Its a lot of free money,
says Laibson, who has pub-lished many papers on 401(k)s and may be
the worlds foremostauthority on enrollment in such plans. Someone
making$50,000 a year who has a company that matches up to 6
percent
Certain patterns of response torewards seem to be biologically
embedded in the human brain. Abranch of behavioral economicscalled
neuroeconomics looks inside thebrain with scanning tools like
mag-netic resonance imaging (MRI) to investigate patterns of
mo-tivation. Neuroeconomics is controversial, as the link
betweencerebral blood ow and decision-making is less
straightfor-ward than, say, playing slot machines and losing money.
Yet itis one of the most fascinating and provocative aspects of
theyoung eld.
Economists specialize in taking really complex things andboiling
them down to simple principles, says David Laibson.So, rather than
treat the brain as billions of neurons, or trillionsof
neurotransmitters, we want to ask, what is the right level
ofanalysis? It turns out that the brain has two key subsystems.One,
the limbic and paralimbic system, rules theintuitive and aective
parts of our psyches.Its shared by all mammals and seems todo a lot
of emotional cognitionhowwe feel emotionally, how we re-spond to
other humans, or tobeing treated unfairly. This sys-tem seems to
function uncon-sciously; we dont have accessto it and maybe cant
even con-trol it. Its experiential andrapid in function.
Contrast that with the ana-lytic system, centered in thefrontal
and parietal cortexes, Laib-son continues. It controls a lot of
thethought processes we learn to do: cal-culated, conscious,
future-oriented
thinking. Its not based on past expe-rience; you could have the
rules of abrand-new game explained and theanalytic system would be
able togure out how to play.
Brain researchers have shown thatan interaction of the limbic
and analytic systems governshuman decision-making. The limbic
system seems to radicallydiscount the future. While the analytic
systems role remainsconstant from the present moment onward, the
limbic systemassumes overriding importance in the present moment,
butrapidly recedes as rewards move into the future and the
emo-tional brain reduces its activation. This explains
impulsive-ness: the slice of pizza thats available right now trumps
the di-etary plan that the analytic brain has formulated.
Seizingavailable rewards now might be a response pattern with
evo-lutionary advantages, as future benets are always
uncertain.
Consider an experiment that scans thebrains of research subjects
oered a
choice between present and future re-wards: $20 now, or $23 a
month from
now. Both limbic and analytic sys-tems show activity. Then
changethe oer to two future prospects:$20 two weeks from now, or
$23 ina month. In this case, the limbicsystem pretty much drops
out.The analytic system, in contrast,shows the same activation
pat-
terns regardless of the delay, be ithours or months. When the
ana-
lytic system is more active, peoplechoose the patient reward;
whenboth systems are active, temptation
usually trumps prudence.
Neuroeconomics
GE
TT
Y I
MA
GE
S
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Harvard Magazine 55
of his contributions could receive an additional $3,000 per
year.The rational model unequivocally predicts that people will
cer-
tainly snap up such an opportunity. But they dontnot evenworkers
aged 59 or older, who can withdraw sums from their401(k) plans
without penalty. (Younger people are even more un-likely to
contribute, but they face apenalty for early withdrawal.) Itturns
out that about half of U.S.workers in this [above 59 ] agegroup,
who have this good dealavailable, are not contributing,says
Laibson. Theres no down-side and a huge upside. Still, indi-viduals
are procrastinatingtheyplan to enroll soon, year after year,but
dont do it. In a typical Ameri-can rm, it takes a new employee
amedian time of two to three yearsto enroll. But because
Americanschange jobs frequentlysay, everyve yearsthat delay could
meanlosing half of ones career opportu-nity for these retirement
savings.
Laibson has run educational in-terventions with employees
atcompanies, walking them throughthe calculations, showing themwhat
they are doing wrong. Al-most all of them still dont invest,Laibson
says. People nd thesekinds of nancial transactions un-pleasant and
confusing, and theyare happier with the idea of doingit tomorrow.
It demonstrates howpoorly the standard rational-actormodel predicts
behavior.
Its not that we are utterly help-less against procrastination.
Laib-son worked with a rm thatforced its employees to make
activedecisions about 401(k) plans, insist-ing on a yes or no
answer within30 days. This is far dierent fromgiving people a
toll-free phonenumber to call whenever they de-cide to enroll.
During the 30-dayperiod, the company also sent fre-quent e-mail
reminders, pressur-ing the sta to make their deci-sions. Under the
active-decisionplan, enrollment jumped from 40to 70 percent. People
want to beprudent, they just dont want todo it right now, Laibson
says.Youve got to compel action. Orenroll people automatically.
When he was U.S. Treasury Sec-retary, Lawrence Summers
appliedthis insight. We pushed very hard
for companies to choose opt-out [automatic enrollment]
401(k)srather than opt-in [self-enrollment] 401(k)s, he says. In
classicaleconomics, it doesnt matter. But large amounts of
empirical evi-dence show that defaults do matter, that people are
inertial, andwhatever the baseline settings are, they tend to
persist.
Associate professor of public policy Iris Bohnet, who has played
games thatmeasure aversion to betrayal with subjects from Brazil to
Switzerland to Kuwait
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56 March - April 2006
Marketing PrudenceThese insights can also be writ large.
Laibsons former studentNava Ashraf, who has worked extensively with
non-governmen-tal organizations, is now applying behavioral
economics to inter-ventions in developing countries. She lived for
a year in IvoryCoast and Cameroon, where she noticed that farmers
andsmall-business owners were often not doing the things that a
de-velopment policymaker or economist thinks they should do,
shesays. They wouldnt take up technologies that would
increaseagricultural yield, for example. They wouldnt get vaccines,
eventhough they were free! They also had a lot of trouble saving.
InJanuary they had a lot of money and would spend it on feasts
andspecial clothes, but in June their children would be
starving.
Still, some found ways to oset their less-than-prudent
ten-dencies. One woman had a cashbox in her home, where shesaved
money regularlyand gave her neighbor the only key.Another timed the
planting of her sweet-potato crop so thatthe harvest would come in
when school fees were due. Herfarm became an underground bank
account that allowed with-drawal only at the proper moment.
Ashraf worked with a bank in the Philippines to design a
sav-ings plan that took o from the African womans cashbox. The
bank created a savings account, called SEED (Save, Earn,
EnjoyDeposits), with two features: a locked box (for which the
bankhad the key) and a contractual agreement that clients could
notwithdraw money before reaching a certain date or sum. Theclients
determined the goal, but relied on the bank to enforce
thecommitment. The bank marketed the SEED product to
literateworkers and micro-entrepreneurs: teachers, taxi drivers,
peoplewith pushcart businesses.
The SEED box, designed to appeal to the banks clients (Inthe
Philippines, they like cute stuff, Ashraf explains ),
helpedmobilize deposits. Its similar to automatic payroll
deduction,but not enough of the customers had direct deposit to
makethat work, she says. To further encourage deposits,
Ashrafworked with the bank on an additional program of deposit
col-lectors who, for a nominal fee, would go to the customers
homeon a designated day and collect the savings from the SEED
box.The withdrawal restrictions on the account helped clients
avoidthe temptation of spending their savings. The SEED savings
ac-count made a designed choice available in the marketplace
that,so far, has helped a growing number of microfinance clients
inthe Philippines reach their savings goals.
Ashraf is now working with Population Services Interna-
Policymakers think that if they get the abstractions right, that
willdrive behavior in the desired direction, says professor of
economicsSendhil Mullainathan. But the world happens in real
time.
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Harvard Magazine 57
tionala nonprot organization that seeks to focus private-sec-tor
resources on the health problems of developing nationsona project
in Zambia to motivate people to use a water puri-cation solution
known as Clorin. We can use what marketingpeople have known all
along, Ashraf says. There are ways ofmanipulating peoples
psychological frameworks to get them tobuy things. How do you use
this knowledge to get them to adoptsocially useful products or
services? Its so practical, and very im-portant in development, for
anybody who wants to help peoplereach their goals.
Carefully designed programs like the SEED bank are examplesof
what Richard Thaler called prescriptive economics, whichaims not
only to describe the world but to change it. Behavioraleconomics
really shines when you talk about the specics ofwhat the policy
should look like, says Sendhil Mullainathan, whoreceived a
MacArthur Fellowshipin 2002. The dierence in impactbetween two
broad policies maynot be as great as dierences inhow each policy is
frameditsdeadlines, implementation, and thedesign of its physical
appearance.
For example, in Social Security privatization,
Mullainathancontinues, the dierence between private accounts and
the sta-tus quo may be less than that between two dierent ways of
im-plementing private accounts. What is the default option? Areyou
allowed to make changes? Whats the deadline for makingchanges? How
are the monthly statements presentedjust yourreturns, or are the
market returns printed alongside your own?In terms of impact, the
devil really is in the details of how theprogram is designed. We
know that people have a tough timemaking these choices. So how are
the choices framed? Whatmetrics do they focus on?
We tend to think people are driven by purposeful choices,
heexplains. We think big things drive big behaviors: if people
dontgo to school, we think they dont like school. Instead, most
behav-iors are driven by the moment. They arent purposeful,
thought-out choices. Thats an illusion we have about others.
Policymak-ers think that if they get the abstractions right, that
will drivebehavior in the desired direction. But the world happens
in realtime. We can talk abstractions of risk and return, but when
theperson is physically checking o the box on that investment
form,all the things going on at that moment will
disproportionatelyinuence the decision they make. Thats the
temptation ele-mentin real time, the moment can be very tempting.
The mainthing is to dene what is in your mind at the moment of
choice.Suppose a company wants to sell more soap. Traditional
econo-mists would advise things like making a soap that people
likemore, or charging less for a bar of soap. A behavioral
economistmight suggest convincing supermarkets to display your soap
ateye levelpeople will see your brand rst and grab it.
Mullainathan worked with a bank in South Africa thatwanted to
make more loans. A neoclassical economist wouldhave oered simple
counsel: lower the interest rate, and peoplewill borrow more.
Instead, the bank chose to investigate somecontextual factors in
the process of making its oer. It mailedletters to 70,000 previous
borrowers saying, Congratulations!Youre eligible for a special
interest rate on a new loan. But theinterest rate was randomized on
the letters: some got a low rate,
others a high one. It was done like a randomized clinical trial
ofa drug, Mullainathan explains.
The bank also randomized several aspects of the letter. In
onecorner there was a photovaried by gender and raceof a
bankemployee. Dierent types of tables, some simple, others
complex,showed examples of loans. Some letters oered a chance to
win acell phone in a lottery if the customer came in to inquire
about aloan. Some had deadlines. Randomizing these elements
allowedMullainathan to evaluate the eect of psychological factors
as op-posed to the things that economists care abouti.e.,
interestratesand to quantify their eect on response in basis
points.
What we found stunned me, he says. We found that anyone of these
things had an eect equal to one to ve percentagepoints of interest!
A womans photo instead of a mans increaseddemand among men by as
much as dropping the interest rate ve
points! These things are not small. And this is very much an
eco-nomic problem. We are talking about big loans here;
customerswould end up with monthly loan payments of around 10
percentof their annual income. Youd think that if you really needed
themoney enough to pay this interest rate, youre not going to
beaected by a photo. The photo, cell phone lottery, simple or
com-plicated table, and deadline all had eects on loan
applicationscomparable to interest. Interest rate may not even be
the thirdmost important factor. As an economist, even when you
thinkpsychology is important, you dont think its this important.
Andchanging interest rates is expensive, but these psychological
ele-ments cost nothing.
Mullainathan is helping design programs in developing
coun-tries, doing things like getting farmers to adopt better feed
forcows to increase their milk production by as much as 50
percent.Back in the United States, behavioral economics might be
able toraise compliance rates of diabetes patients, who dont
alwaystake prescribed drugs, he says. Poor families are often
deterredfrom applying to colleges for nancial aid because the forms
aretoo complicated. An economist would say, With $50,000 atstake,
the forms cant be the obstacle, he says. But they can.
(Atraditional explanation would say that the payo clearly
out-weighs the cost in time and eort, so people wont be deterred
bycomplex forms.)
Economists and others who engage in policy debates like
towrangle about big issues on the macroscopic level. The
nitty-grittydetails of executionwhat do the forms look like? what
is in thebrochures? how is it communicated?are left to the support
sta.But that work is central, Mullainathan explains. There shouldbe
as much intellectual energy devoted to these design choices asto
the choice of a policy in the rst place. Behavioral economicscan
help us design these choices in sensible ways. This is a big
holethat needs to be lled, both in policy and in science.
The Supply of HatredWhile some try to surmount or cope with
irrationality, oth-ers feed upon it. In the wake of
An economist would say, With $50,000 at stake, the forms cant be
the obstacle.But they can.
(please turn to page 93)
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the 9/11 attacks, Edward Glaeser began using behavioral
eco-nomic approaches to research the causes of group hatred
thatcould motivate murderous acts of that type. An
economistsdenition of hatred, he says, is the willingness to pay a
priceto inict harm on others. In laboratory settings, social
scien-tists have observed subjects playing the ultimatum game,
inwhich, say, with a total kitty of $10, Player A oers to split
thecash with player B. If B accepts As oer, they divide the
moneyaccordingly, but if B rejects As oer, both players get
nothing.In thousands of trials around the world, with dierent
stakes,people reject oers of 30 percent [$3 in our example] or
less,says Glaeser. So typically, people oer 40 or 50 percent. But
aconventional economic model would say that B should accept asplit
of even one cent versus $9.99, since you are still better owith a
penny than nothing. (If a computer, rather than ahuman, does the
initial split, player B is much more likely to ac-cept an unfair
splita conrmation of research conducted byprofessors at the Kennedy
School of Government; see Games ofTrust and Betrayal, page 94.)
Clearly, the B player is willing to suer nancial loss in orderto
take revenge on an A player who is acting unfairly. You dontpoke
around in the dark recesses of human behavior and not ndvengeance,
Glaeser says. Its pretty hard to nd a case of mur-der and not nd
vengeance at the root of it.
The psychological literature, he found, denes hatred as
anemotional response we have to threats to our survival or
repro-duction. Its related to the belief that the object of hatred
hasbeen guilty of atrocities in the past and will be guilty of
themin the future, he says. Economists have nothing to tell
psy-chologists about why individuals hate. But group-level
hatredhas its own logic that always involves stories about
atrocities.These stories are frequently false. As [Nazi
propagandistJoseph] Goebbels said, hatred requires repetition, not
truth, tobe eective.
You have to investigate the supply of hatred, Glaeser
contin-ues. Who has the incentive and the ability to induce group
ha-tred? This pushes us toward the crux of the model: politicians
oranyone else will supply hatred when hatred is a complement
totheir policies. Glaeser searched back issues of the Atlanta
Consti-tution from 1875 to 1925, counting stories that contained
the key-words Negro + rape or Negro + murder. He found a
time-se-ries that closely matched that for lynchings described
byhistorian C. Vann Woodward: rising from 1875 until 1890,
reach-ing 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
tothe poor, and got substantial support from African
Americans.Wealthier Southern conservatives struck back, using race
hatredand spreading untrue stories about atrocities perpetrated
byblacks, Glaeser says. Populists are friends of blacks, and
blacksare dangerous and hateful, was the messageinstead of
beingsupported, [blacks] should be sequestered and have their
re-sources reduced. [Rich whites] sold this to poor white
voters,winning votes and elections. Eventually the Populists gave
in anddecided they were better o switching their appeal to poor,
racistwhites. They felt it was better to switch policies than try
tochange voters opinions. The storiesall about rape and murderwere
coming from suppliers who were external to poor whites.
Glaeser applies this model to anti-American hatred, which,
indegree, is not particularly correlated with places that the
UnitedStates has helped or done harm to, he says. France hates
Americamore than Vietnam does. Instead, he explains, it has much to
dowith political entrepreneurs who spread stories about past
andfuture American crimes. Some place may have a leader who has
aworking relationship with the United States. Enemies of the
leaderoer an alternative policy: completely break with the United
Statesand Israel, and attack them. We saw it in the religious
enemies ofthe shah [of Iran]. The ayatollah sought to discredit the
secularmodernists through the use of anti-American hatred.
For Glaeser, behavioral economics can take something we havefrom
psychologyhatred as a hormonal response to threatsandput this in a
market setting. What are the incentives that will in-
crease the supply of hatred in aspecic setting? Economists,
hefeels, can take human tendenciesrooted in hormones, evolution,
andthe stable features of social psychol-ogy, and analyze how they
will playout in large collectivities. Much ofpsychology shows the
enormoussensitivity of humans to socialinuence, Glaeser says. The
Mil-gram and Zimbardo experiments
[on obedience to authority and adaptation to the role of
prisonguard] show that humans can behave brutally. But that doesnt
ex-plain why Nazism happened in Germany and not England.
Zero-Sum PersuasionAndrei shleifer has already made
path-breaking contribu-tions to the literatures of behavioral nance
(as noted above),political economy, and law and economics. His
latest obsession ispersuasionHow people absorb information and how
they aremanipulated, he says. At the American Economic
Associationmeetings in January, Shleifer described cognitive
persuasion,exploring how advertisers, politicians, and others
attach theirmessages to pre-existing maps of associations in order
to movethe public in a desired direction.
The Marlboro Man, for example, sold ltered cigarettes
bymobilizing the publics associations of cowboys and the Westwith
masculinity, independence, and the great outdoors. Thereis a
conrmation bias, Shleifer explained, which favors persua-sive
messages that conrm beliefs and connections already in theaudiences
mind (see The Market for News, January-February,page 11, on work by
Shleifer and Mullainathan that applies a sim-
You have to investigate the supply of hatred. Who has the
incentive and ability to induce group hatred? Politicians or anyone
else will supply hatred when hatred complements their policies.
THE MARKETPLACE OF PERCEPTIONS(continued from page 57)
E d w a r d G l a e s e r
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94 March - April 2006
ilar analysis to the news media). For example, George W.
Bushwearing a $3,000 cowboy hat was not a problem, because
itmatched his image, but John Kerry riding a $6,000 bicycle was
aproblemthat luxury item appeared hypocritical for a candi-date
claiming to side with the downtrodden.
Citing Republican pollster and communications consultantFrank
Luntz, Shleifer noted how the estate tax was renamed thedeath tax
(although there is no tax on death) in order to suc-cessfully sell
its repeal. The relabeling linked the tax to the un-pleasant
associations of the word death, and the campaignasked questions
like, How can you burden people even more atthis most dicult time
in their lives? Messages, not hard at-tributes, shape competition,
Shleifer said; he noted that the fearof terrorism is a bigger issue
in probable non-target states likeWyoming, Utah, and Nevada than in
New York and New Jersey.
Because successful persuasive messages are consistent
withprevailing worldviews, one corollary of Shleifers analysis is
thatpersuasion is denitely not education, which involves addingnew
information or correcting previous perceptions. Dont tellpeople,
You are stupid, and here is what to think, Shleifersaid. During
presidential debates, he asserted, voters tune out orforget things
that are inconsistent with their beliefs. Educa-tional messages may
be doomed, he added. They do not res-onate. In economic and
political markets, he said, there is notendency toward a median
taste; divergence, not convergence, isthe trend. Therefore, the
successful persuader will nd a nicheand pander to it.
When making choices in the marketplace, People are not
re-sponding to the actual objects they are choosing between, says
EricWanner of the Russell Sage Foundation. There is no direct
rela-
People care not only about outcomes,but about how outcomes came
to be, says as-sociate professor of public policy Iris Bohnetof the
Kennedy School of Government. Thatdoesnt strike anyone but an
economistlikemeas a surprise. Game theory, as concep-tualized by
conventional economics, suggeststhat players care only about
substantive re-sults. With Ramsey professor of politicaleconomy
Richard Zeckhauser, Bohnet devel-oped a concept of betrayal
aversion, build-ing on the well-established psychologicalprinciple
of risk aversionby and large, hu-mans simply dont like to take
risks.
It turns out they dont like to trust, either, because trust is
aform of risk that makes one vulnerable to betrayal. To buy anitem
on eBay, one must trust the seller. We also trust
attorneys,doctors, and politicians to tell us the truth and to
represent ourinterests. These are principal-agent relationships,
Bohnet says.An agent does something on your behalf. But principals
andagents incentives are not always completely aligned, and
theresasymmetric information.
Traditionally, academics have linked trust to risk
tolerance,since it involves taking a risk. Instead, Were saying
that risk-taking when the agent of uncertainty is nature is very
dierentfrom when the agent is another person, Bohnet asserts.
Afarmer, for example, faces natural risks like weather and soil
conditions. But there are also social risksspeculativebubbles,
HIV infection, terrorismwhere other
people produce the uncertainty.Bohnet and Zeckhauser have been
run-
ning two games, now with about a thou-sand subjects around the
world, playingin groups of 30 at a time. They are two-person games,
a variant of the classicPrisoners Dilemma. In the rst game,Player A
can choose a safe alternativeor choose to trust Player B, who can
in
turn choose an option that rewards bothof them more than the
safe alternative, or
a second option that brings even greater win-nings for Bbut less
than the safe optionwould have given A. In other words, thegood
(i.e., trustworthy) B player will takethe win-win alternative,
while the selsh Bwill maximize his own outcome at As ex-pense. When
the researchers ask subjectsplaying A, What percentage of good
peoplewould there have to be in the room [of 15 po-tential B
players] before you would be willingto trust this stranger [the B
player]? the an-swer has consistently been 50 to 80 percent.
The second game has the same rules as therst, except that an urn
containing 100 blue
and green marbles takes the role of Player B. The urn is a
proxyfor an impersonal force, such as nature. If a blue ball is
randomlychosen, B selects the trustworthy win-win alternative; if
agreen ball, the selsh one. The researchers then asked A
players,What percentage of blue balls would the urn have to contain
foryou to be willing to take this risk? A rational
money-maximizingpersonone who cares only about outcomeswould give
thesame answer to this question as to the analogous one in the
rstgame. But when playing with nature, respondents generallypeg the
gure at 30 to 40 percent, far lower than in the rst game.People are
less willing to take risks when confronted with an-other person
than when confronted by nature, Bohnet explains.Trust is not only
about willingness to take risks, but about thewillingness to be
betrayed.
By comparing the dierence between Minimal
AcceptableProbabilities in the rst and second games, the
researchershave been able to distinguish risk aversion from
betrayal aver-sion. The nature game establishes a baseline level of
risk aver-sion, but the game with a human Player B introduces the
addi-tional possibility of betrayal. Thus, the gap
betweenpercentages on the two games gives a rough index of
betrayalaversion. In the United States, Switzerland, and Brazil,
the be-trayal aversion dierential is 10 to 20 percent. Zeckhauser
andBohnet have also played the games in the Persian Gulf
region,with subjects in Kuwait, Oman, and the United Arab
Emirates.(They are the rst social scientists to run economic
experi-
Games of Trust and Betrayal
GE
TT
Y I
MA
GE
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Harvard Magazine 95
tion of stimulus and response. Neo-classical economics posits a
directrelationship between the object andthe choice made. But in
behavioraleconomics, the choice depends onhow the decision-maker
describes the ob-jects to himself. Any psychologistknows this, but
it is revolutionarywhen imported into economics.
We are vulnerable to how choices are described, Wanner
ex-plains. Advertising is a business that tries to shape how
peoplethink about their choices. Neoclassical economics can
explainads only as providing information. But if the seller can
invest inadvertising that frames the choice, that frame will skew
thebuyers decision. The older economic theories depend on the
idea
that the successful seller will produce a better product, the
mar-ket will price the product correctly, and the buyer will buy it
at aprice that maximizes everyones interestthe market is
simplywhere the buyer and seller come together. But once you
intro-duce framing, you can argue that the buyer may no longer be
act-ing 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 buyersand
sellers coming together for mutually benecial
exchange, Wanner continues. Instead, the ex-change between
buyers and sellers has aspects of azero-sum game. The seller can do
even better if hesells you something you dont need, or gets you
tobuy more than you need, and pay a higher price forit. The
classical welfare theorem of VilfredoPareto was that markets will
make everyone as
well o as they can be, that the market distribu-tion will be an
ecient distribution that maximizes
welfare. But once you introduce framing, all bets areo, Wanner
says. A zero-sum game between buyer and
seller clearly does not maximize everyones welfare, andhence
suggests a dierent model of the marketplace.
There are many political implications. We have had 30 years
ofderegulation in the United States, freeing up markets to
worktheir magic. Is that generally welfare-enhancing, or not?
Wan-ner asks. Framing can call that into question. Everyone
agreesthat theres informational asymmetryso we have laws that
en-sure drugs are tested, and truth-in-advertising laws. Still,
thereare subtle things about framing choices that are
deceptive,though not inaccurate. We have the power of markets, but
theyare places where naive participants lose money. How do we
man-age markets so that the framing problem can be acknowledgedand
controlled? Its an essential question in a time of rising
in-equality, when the well-educated are doing better and the
poorlyeducated doing worse.
Its a question that behavioral economics raises, and, withluck,
may also be able to address. The eclipse of hyper-rationalEconomic
Man opens the way for a richer and more realisticmodel of the human
being in the marketplace, where the brain,with all its ancient
instincts and vulnerabilities, can be bothpredator and prey. Our
irrationalities, our emotional hot-but-tons, are likely to persist,
but knowing what they are may allowus to account for them and even,
like Odysseus, outwit tempta-tion. The models of behavioral
economics could help design a so-ciety with more compassion for
creatures whose strengths andweaknesses evolved in much simpler
conditions. After all, Theworld we live in, Laibson says, is an
institutional response toour biology.
Craig A. Lambert 69, Ph.D. 78, is deputy editor of this
magazine.
ments in the Gulf region, and will go toSaudi Arabia in March.)
In these coun-tries, betrayal aversion is markedlyhigher, with a
dierential in the 30 to 40percent range. Many in this area saythey
are willing to trust only if 100 per-cent of the people are
trustworthy,Bohnet reports.
She had an enlightening experiencewhen teaching negotiation and
decisionanalysis to a group of government ministersfrom the Persian
Gulf region in a Kennedy Schoolexecutive-education program. I
started the class byasking them to recall a time when they lost
trust in someone,Bohnet recalls. One minister said, Trust is not an
issue for us. Wenever trust. What a beginning! It opened up a very
interesting dis-cussion. A minister said, We cannot dare to trust
because we maylose face. I would never come to a meeting and put
something onthe table that other people could decline. The
meeting-before-the-meeting is absolutely critical in the Gulf,
because being let down isterribly humiliating.
Trust has other policy implications. Social capital, per
capitaincome, economic growth, and political stability all have
positivecorrelations with trust in a society. Trust is a generally
goodthing, says Bohnet. And nations deal with breakdowns of trust
indierent ways. In the Western world, especially the UnitedStates,
contract law builds on the notion of damages or ecientbreach,
Bohnet says, meaning that someone who breaches acontract must
compensate their counterpart. But if people are re-ally betrayal
averse, damages wont satisfy them, because whatthey are concerned
with is the fact of betrayal. U.S. contract lawfocuses on
decreasing the material cost of betrayal, but what be-trayal
aversion asks for is to decrease the likelihood of betrayal,which
causes emotional hurt. In Islamic law, which seems to en-courage
building trust by personal relationships rather than legalmeans,
damages play a much smaller role than in the West. In ad-dition to
differences in law, there obviously are other contributingfactors.
For example, group-based social organization, typical inthe Gulf
but not in Western countries, is based on
long-standingrelationships. This substantially reduces the
likelihood of betrayaland thus, the social uncertainty involved in
trust.
Educational messages may be doomed. They do not resonate. Voters
tune out or forget things that are inconsistent with their
beliefs.
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