How cold?

(featured image: Ross Dunn CC BY)

 

When we say something leaves us cold, we don’t always mean absolute zero

Last Sunday, the Christmas lights were switched on in my town. This is an annual event, not just here, but up and down the country. The weather was nice and dry, but even when it is less clement, the switch-on seems to excite lots of people, children and grown-ups alike. But me? I am indifferent.

It leaves me about as cold as the Christmas market that takes place in our high street every Sunday from the first weekend of October, and as the Christmas displays in the shops that are ubiquitous this time every year.  Not that I am complaining, even though moaning about premature Christmas decorations is a popular pastime in the UK. it is the country in which the phrase ‘Bah humbug!’ originated after all.

The no man’s land of indifference

Yuletide fans like to wheel out evidence that Christmas decorations signal a friendly nature, of course. (They have little regard for the fact that the research is now nearly 30 years old, and is rather more tentative in its conclusion than is sometimes implied.) The Scrooges, in turn, can point to articles like this, with a headline like “Why playing Christmas songs early is actually bad for your health”. Clearly it is not just Brexit that is dividing the British nation.

But just like I cannot get excited about tinsel and fairy lights, I cannot get agitated by them being applied early either. The whole affair simply leaves me indifferent.

Of course, nobody can possibly get excited about everything, and tastes differ. One person may be passionate about opera while they have a strong dislike of football, while for their neighbour it may be the exact opposite. But for many people, there seems to be a no man’s land in between like and dislike, where we simply don’t give a damn either way.

From an economic perspective, the subject of such feelings (or better, absence of feelings) provides us with neither benefits or costs – this is indeed a way of defining indifference as an economics concept. And there are actually quite a few such things when you start looking for them. For people without small children, for example, the provision of playgrounds in their vicinity is of no consequence. Yes, you may have something of a societal conscience, and feel that it would be good if there were playgrounds for families with young children – or you may have grandchildren, or nieces and nephews who would benefit from them when they visit, or with whom you identify.

playground

It does not leave them cold (image: spilltojill CC BY)

But if everyone in your household is well beyond the age of being excited by a roundabout, a see-saw or a swing, playgrounds probably leave you cold. And if it’s not that, then there may be sports events (that you never attend), parks (that you never visit) or shops (where you never buy anything).

For things that involve public money, you could perhaps argue that their elimination would make you better off as you’d pay less tax. Or you could argue that playgrounds are an investment in public order, helping keep children occupied who might otherwise engage in mischief, causing an even higher cost than the upkeep of a play area. But unless you are so disposed, we are really talking about proper indifference.

Or so it seems, at least.

Not so cold?

Let’s look at other situations where we should be indifferent – say someone else will pay for something for you. They invite you for a meal, for example, or your uncle or grandma will pay for a new suitcase as a Christmas present, but she wants you to buy it.

The normal cost benefit analysis that we tend to use when we are footing the bill doesn’t really apply here.

Or imagine this situation, inspired by a discussion I had with a colleague last week, on what price we’d find acceptable for a hotel room “when the client pays”. You’ve booked a room at £150 per night, which is not out of the ordinary for the location, and you know that this will be entirely acceptable to the client. You then notice that this price includes breakfast – and that the price without breakfast is £25 less. A couple of croissants, a glass of juice and a coffee would cost about £7 in the café next door to the client.

If you had to pay out of our own pocket, you would most likely get breakfast in the café: £25 for breakfast feels rather overpriced. But if the client pays, and you know you can claim the cost, including breakfast, in full without problems, a rational you should really be indifferent to the price: you would not be better or worse off either way.

And yet, would you not feel a bit reluctant to allow the hotel to rip off your client, even if they would reimburse you without blinking, unaware of the overpriced breakfast? And you would probably not go for the most expensive dish on the menu, and still look for a good price for that suitcase, even if someone else is paying. It seems that indifference is not quite so indifferent.

breakfast

Is this breakfast worth £25… if someone else pays for it? (image: Kathryn Wright CC BY)

Something similar may be happening with playgrounds, parks and the annual Christmas lights switch on. Imagine you had no junior relatives, and you could move into your dream house which would either be built in an area with a playground nearby, or in one without. Your choice. Would you pay more for one option than for the other? Probably not – so you’re indifferent!

The question whether we’d pay for something is a good way to establish whether we’re indifferent. But it may not paint the full picture. Let’s turn things around: what if the local council were to decide to take down all playgrounds, or sell off the park we never visit to a property developer? What if the cute, quirky shops that we never frequent were to close? Would we still feel indifferent, or would we actually experience this as a loss? If, by contributing say just £10, we could prevent the playgrounds disappearing, or the park being turned into a housing estate, or the shops shutting down – would we do so?

I am pretty sure I would, and probably more than £10. I would miss the playgrounds even if I never use them, and the park that I never go to. And I’d miss the quirky high street shops where I never buy anything. Even if all I was prepared to spend to stop their disappearance is a tenner, that is enough for anyone, including myself, to question my claim that all that stuff leaves me cold. That’s the endowment effect for you: once you have something, it’s hard to be indifferent about it.

I would even be prepared to contribute to ensure that each year, there’d be Christmas decorations in the town, and even to have the annual event of switching the lights on.

It could be the Christmas spirit taking hold of me. But really, I think this stuff may not be leaving me as cold as I first thought…

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Posted in Behavioural economics, Cognitive biases and fallacies, Economics, Psychology | Tagged , | Leave a comment

How difficult can it be?

(featured image credit: Torbein Rønning CC BY)

We all need a little faith, once in a while, when we’re faced with a difficult problem and we don’t know what is the best solution. But it’s best not to use it as a substitute for curiosity

Are you curious? I bet you are. The fact itself that you are reading this suggests that you are interested in finding out what this article is about. Maybe you even expect to learn something (I hope you do!). But even if you’re just reading this to while away a few idle moments, there are most likely other areas where what you do is motivated by curiosity.

A good thing on balance

Checking your social media feeds, watching or listening to the news, reading a book, viewing a documentary or even a soap opera or a reality show – if you were not curious what the next page, the next minute or the next episode would bring, you would already have ceased checking, watching, listening etc.

Curiosity doesn’t get the unequivocal thumbs up, though. The English proverb curiosity killed the cat ascribes lethal capacities to it. And in a famous Kipling story a little elephant with “’satiable curtiosity” initially gets beaten up for asking too many questions, but eventually its curiosity is vital in providing all elephants ever since with a most handy appendage.

So it is in practice for us too: curiosity is a valuable trait. Arguably, the success of our species so far, as well as the prospects of its future are closely tied to this trait. Maybe that is symbolized by the most important punctuation sign by far: the question mark. We owe a debt of gratitude to our ancestors for their why, how, when, and what questions which have led to all the good stuff we have today, from agriculture and electric cars to cancer treatment and Netflix.

So, curiosity is a key driver for acquiring knowledge, insight. This can serve us personally – if we are more educated or skilled our work can be more financially and emotionally rewarding. And it can serve others: when we put to use what we learn thanks to being curious, our family and friends, our colleagues, our clients (and indeed our readers, I should add) can also benefit.

Costly curiosity

But responding to curiosity is costly. When it comes to choosing things – whether it’s breakfast cereal, a car, a sofa or even a house or a life partner, most people are by and large satisficers, rather than optimizers. This means that we tend to go for answers, solutions or choices that are “good enough”, rather than figuring out what is the very best one. As long as we avoid a major catastrophe, we seem to be reasonably content.

loads of money

Is satisfying your curiosity worth this much? (image: reynermedia CC BY)

There are several possible reasons for this. A recent paper by Larbi Alaoui and Antonio Penta, two economists at the university of Barcelona, explores why we stop reasoning before we have found the best answer. Being economists, they hypothesize a trade-off between the (expected) benefit of a better solution, and the (cognitive effort) cost of discovering it. However, such a cost-benefit analysis may not always be the only or the dominant factor in the decision whether or not to continue reasoning.

We often don’t know for certain whether there is a better solution to be discovered, whether we will actually find it, and how much effort it will take. How we deal with this uncertainty may depend on who we are, and on the context. Some people may derive intrinsic joy out of exploring possibilities – thus lowering the cost of satisfying their curiosity. But others may, in contrast, have an aversion to thinking, or fail to systematically pursue all the options because they are under time pressure and the fear of failure is large. (This can sometimes be spotted in TV game shows.)

But even establishing whether ‘a’ solution to a problem or ‘a’ choice is ‘good enough’ may require some measure of cognitive effort. Ultimately, we need confidence that it will indeed be good enough – i.e. it will not be disastrously wrong. Maybe we need to work something out, imagine different futures, or do some calculation and check that the result is above or below a certain threshold. Maybe we need to estimate a number or likelihood. Or perhaps we can rely on previous experience, or on heuristics.

A bad trump card

But there is one thing that can trump all that: faith. Faith can give us confidence, without requiring evidence.

That can be quite helpful. If it is too effortful to work out which of two satisfactory options will be better, and we are uncomfortable with tossing a coin, then a sprinkle of faith can add to the confidence we already had in one of them and seal our choice. But faith is such a powerful element in our decision-making process, that it can overshadow all other aspects.

In an article in the Guardian last week, Rafael Behr described a striking illustration of how this can happen. It featured the then-Brexit Secretary, Dominic Raab (who has since resigned from the British government over the draft EU withdrawal agreement that prime minister Theresa May is – as I write this – still valiantly defending in the House of Commons).

Raab had, to use a phrase that was inadvertently coined by George W Bush, ‘misunderestimated’ the importance of cross-channel trade for the UK economy, notably the Dover-Calais crossing. In doing so, he joined his predecessor David Davis and other leading figures on the Leave side of the Brexit divide, whose assumptions and predictions had likewise often turned out to be at odds with reality (see this Twitter thread for some choice examples).

There is of course nothing wrong with being ignorant, even though it is not always bliss. We are born ignorant, but also with the capacity to ask questions and learn. As Behr points out, however, the key flaw in Mr Raab’s attitude and that of his naïvely optimistic colleagues was that they did not ask. Their faith in the righteousness of the cause, and in the ability of determination to overcome every and any obstacle disengaged their curiosity. And when there is no curiosity, there is no awareness of ignorance.

This would appear to be a peculiar instance of a cognitive phenomenon known as motivated reasoning, peculiar in the sense that there is hardly any reasoning involved. Normally, those who engage in it will emphasize the facts and data that support the conclusion that they prefer (or that they believe is most likely). Like a lawyer for the defence or the prosecution in an adversarial case, they are highly selective to build and strengthen their argument.

blindfold

Blindfolded by faith – yay ignorance! (image: Kirill Balobanov)

What we see here, however, is the justification of a choice based entirely on faith, which makes facts and data unnecessary. Genuine curiosity tends to generate question upon question in the search for understanding.

But if faith is all there is, there is just one rhetorical question: “How difficult can it be?” The only value of this question is that it is a rather good tell-tale sign for the problem.

Faith, next to curiosity, can play a useful role in decision-making, in particular to combat indecisiveness, and to provide enthusiasm for a satisfactory, rather than an optimum choice. But it can be very dangerous when it is used on its own. Before you know it, it can have fooled you into thinking that there is no need for facts or data, and shut down your curiosity.

Isn’t that curious?

Posted in Behavioural economics, Cognitive biases and fallacies, Emotions, politics, Psychology | Tagged | Leave a comment

A new life or an old life?

(featured image credits: Jenny Mealing CC BY and Dr KontogianniIVF)

One of the fundamentals of economics is also a fundamental of life. It involves cake and eating.

Most people know pretty well what actions are needed to make babies. But these technicalities are a necessary condition, rather than a sufficient one to actually produce a new life. For some couples with a desire to have children of their own, that first step is not a straightforward process.

About 1 in 7 couples may have difficulty conceiving. 16% of couples will fail to become pregnant naturally within a year if they have regular unprotected sex, and those who have unsuccessfully tried to do so for more than three years have only a ¼ chance of succeeding in the next year. Many such couples turn to in vitro fertilization (IVF).

Science to the rescue

Thankfully, for British women this intervention is available free of charge through the UK’s National Health Service. But IVF is not a done deal. The chance of a successful treatment falls rapidly with the age of the would-be mother, from 29% for women aged under 35, to just 2% for women over 44.

The age of the first pregnancy for women has been steadily rising (e.g. in the UK from about 26 years in 1974 to 30 years in 2015). This means that more women discover relatively late that they may need to resort to IVF, and hence the number of them seeking the treatment when they’re 35 or older is growing. The average age of a woman receiving IVF treatment in 2016 was 35.5, up one year since 2000.

louisebrown

40 years ago – the first of many

But recently the treatment has been refused to women over 34 in twelve areas of the UK (and is no longer offered to anyone in a further seven). Not surprisingly, this has been met with protestations. What is going on?

The NHS, the UK’s flagship (at least in the eyes of a sizeable part of the British population) health service, does not have unlimited resources, and funding has been under pressure for years. In one area’s own words, it has “taken into account the relative cost-effectiveness [of IVF] compared to other treatments that could be funded with the resources we have available.” In the UK, the cost of IVF is around £5,000 ($6,500) for one cycle. Of the 68,000 IVF treatment cycles in 2016, 41% were funded by the NHS – a total cost of about £139 million.

That looks like a sizeable amount, but if you compare it with the bill for cancer diagnosis and treatment, it is relatively small: the NHS spends about £8 billion ($10.5 billion) on this. Look at the individual patient expenditure, though, and the picture changes. A woman under 40 is entitled to up to three IVF cycles funded by the NHS. 29% of those under 35 will be lucky and become pregnant in the first cycle. Yet others won’t, and a woman under 35 will, on average, receive 2.2 IVF treatment cycles, with an overall probability of around 65% of getting pregnant.  The average number of cycles increases, and the probability of a successful pregnancy decreases as the age of the woman at the time of the treatment is higher, as the table shows.

IVFtable

The key number to look at is the he cost of producing an IVF-baby. This increases rapidly from just over £17,000 for women under 35 to £250,000 for women over 44. For women aged 38 or 39, the cost is already a little more than that of diagnosing and treating a cancer patient, which is £30,000.

The healthcare cake

This is the choice the people in the NHS face: should they spend £30,000 of their scarce resources to fund the treatment of a cancer patient or for producing a pregnancy in a woman aged 38 or 39? Should they prioritize the old life, or the new life?

They can only spend every pound once. They can, as the hackneyed phrase has it, either have their cake, or eat it – but not both.

Those stark trade-offs confronting health decision makers are not always apparent to the rest of us. We are only superficially aware of how healthcare is funded. Our tax and social security contributions are deducted automatically from our income, and we don’t really know what they actually buy. On the other hand, we are used to healthcare being available on demand – without ever having to make a trade-off between having a filling in our wisdom tooth, and having physiotherapy for our sprained ankle. We can have both. So it is not entirely surprising that we wonder why we can’t have IVF and cancer treatment.

Trade-offs – like this one – are a core concept in economics, but not just in economics. The economist Robert Frank argues that in the future Charles Darwin (rather than Adam Smith) may well be seen as the father of economics. Evolution itself is indeed characterized by trade-offs, notably between the benefit of a trait for the individual, and the benefit (or cost) of that same trait for a larger population. He gives the example of the antlers of the male elk. To secure a mate, a bull elk must dominate, and if necessary fight off, a bunch of rivals. The bigger his antlers, the bigger his advantage in stand-offs and combats – and the more likely he will be able to pass on his genes.

But keeping pushy suitors away from his is not male elks’ only concern. They must also be able to outrun wolves. And then the construction on their head, weighing nearly 20 kg, is rather inconvenient, making escaping a hungry pack much harder. So a better chance to procreate for the individual comes at the cost of an increased likelihood of being eaten by wolves – for all bull elks.

elks

“Mine is the biggest” (image: Murry Dalton CC BY)

Imagine the elks could agree to reduce the size of their antlers by 50%. The relative advantage of the toughest bulls would persist, but they would all be much better positioned to escape a wolf attack.

Of course, elks don’t have that capacity. Most animals don’t even consider multiple simultaneous options, don’t weigh up immediate advantage with benefits in the longer term and so on. They just follow their instincts, fine-tuned over many generations to favour whatever option is optimum for the continued success of the species. Their very existence today is testament to this.

For us humans it is a bit different. Evolution has endowed us with the ability to evaluate costs and benefits of multiple competing options. We can reason about which is the better of a range of possibilities… and we can ponder the question whether we prefer to have our cake, or to eat it.

Unfortunately, that doesn’t give us a quick and easy shortcut to choosing between spending money on IVF treatment, and spending money on cancer treatment – between favouring a new life and favouring an old life. If we had to make that kind of decision in our personal life, it would be a tough call.

And yet so it is for the NHS (or any health insurer). It is not different from the hypothetical dilemma in which you would have a daughter struggling to conceive, and a spouse who is suspected to have cancer, and you have only £30,000 available. You would be able to help one or the other, but not both.

The call is no less tough for the people who need to allocate the scarce, limited resources available for the health of the nation. There are no easy answers.

It is good to remember this, before we start criticizing them for making the wrong choice.

Posted in Behavioural economics, Economics, Ethics, Health, Morality, Psychology, Society | Tagged , , | Leave a comment

Our skin in their game

(featured image credit: Pilots of Swiss CC BY)

An economic term for the wrongs of the world

One Friday, a long time ago, I was fortunate enough to travel in the jump seat on the flight deck of a Boeing 737 from Brussels to London. It was a bright early Summer morning, and all through the flight I had a superb forward view through the cockpit windows – not least thanks to several gyrations in the stack over London (even in those days, the airspace was congested). But aside from the sights, one other thing has stuck in my memory.

Before we set off, I had seen the pilots go through a checklist, meticulously verifying that everything of vital importance in the plane was working as required. This is a critical procedure to ensure the safe operation of the aircraft, which is systematically executed before every single flight, without exception.

Aligned interests

One reason why the pilots adhere to this requirement so consistently is undoubtedly their training. But another one is that, quite literally, their life, along with that of their crew and passengers, may depend on it. They have ‘skin in the game’ – a phrase with uncertain origins, but popular in business and finance, certainly since Nassim Taleb used it as the title of his eponymous book.

It is an evocative way to express that a decision-maker will suffer the consequences of a poor decision. As far as the pilots who flew me that day, along with every pilot of every flight are concerned, there is no doubt that they have a direct motivation to ensure that their aircraft is safe.

We need to be careful, though, not to attach too much importance to this one facet of a relationship (as here between pilots and passengers, who engage them implicitly to transport them safely). On the one hand, we must not assume that someone who has skin in the game necessarily has objectives that align with our own. The tragedy of Germanwings 9525 in March 2015, when the co-pilot deliberately flew the plane en route from Barcelona to Düsseldorf into a mountain, killing all 150 people on board serves as a grim reminder. On the other hand, skin in the game is not the same as skill in the game, as a New Yorker cartoon illustrates.

But by and large, if someone you rely on has skin in your game, that is a good heuristic indicating that they are more likely to act in your interest. For example, there appears to be evidence that funds run by managers who themselves invest in the funds they manage, perform better overall. In any case, it is not hard to see how those who simply charge an annual percentage of the value of a client’s holding, irrespective of how it performed, have much less of an incentive to ensure the fund grows: if their client makes a loss, they gain less but they still gain.

Economics is often a good lens through which observe human behaviour, and not surprisingly it has a term for this kind of situation. If A conducts a transaction with B, and the choices this involves have a consequence for a third party C which is not involved in this transaction, we have a so-called externality. When a plane is late in taking off because of a problem on the ground, air traffic control may grant the pilot (A) the possibility to fly faster than normal to reduce the delay. However, B has a contract with the airline (B) which incorporates targets on fuel usage to keep running costs of the airline low. So the pilot declines the possibility and the plane arrives late – thus inconveniencing the passenger (C) who had no influence over the decision. The pilot (and the airline) may have skin in the passenger’s game where the safety of the plane is concerned, but they do not have much skin in other aspects of the passenger’s concerns. They prioritize their fuel cost over the convenience of the passenger, who suffers a negative externality.

Shameful externalities

Such externalities are quite common, and not only in conventional economic transactions. Environmental pollution is a prominent example, but there are many more, including roadworks and traffic congestion, smoking in the presence of others and smoking bans, and mowing the lawn or practising the violin.  In all cases the decisions made by one party are imposing a burden on another party that is not involved.

Once you start looking for externalities, you see them everywhere. Last weekend I read a heart-breaking blogpost by Andrew Morrish, a former head teacher who currently runs a trust comprising multiple publicly funded independent schools. It is worth reading it in its entirety but, writing with a lump in my throat, I will summarize it here:

Daisy is an 8-year old girl. It is her last day at school before the half term break. She has been in foster care with local foster parents for two years, but this afternoon, after school, she will be taken by a social worker, to a town 30 miles away. She will be taken away from the school with the teachers and support staff she got to know, and from the fragile chain of friends she has built up over the last two years. She will be all alone again, having to build a new chain of friends. And she does not know. She does not know that today is the last day she will see her friends, the teachers, and the staff, that she will not see them again once they leave as she stays on, waiting for the social worker to pick her up. She cannot say goodbye, because the move must remain confidential until she is taken away. She is 8 years old.

daisychain

A broken daisy chain (image: Amy Goodman CC BY)

This is happening to her because others, far away and long ago, have made certain choices. Daisy was not involved (how could she have been?), yet she will definitely suffer. When you suffer a negative externality because your neighbour mows his lawn while you want to enjoy the peace of your back garden, you have a voice. You can reason with him, negotiate with him, yell at him, even. You can stand up for yourself and seek redress. Daisy is alone with her negative externality.

There is nobody with skin in her game. Some procedure determines that this is what must happen to her now, and to countless other children at some point. The social worker is only following instructions, powerless, numb perhaps from the many times she has been confronted with similar distressing situations. All she can do is try her best to comfort Daisy.

These are the shameful externalities that are unworthy of a civilized society. What happens to Daisy is the consequence of trade-offs made by undoubtedly well-meaning experts, has been approved by undoubtedly well-meaning politicians, and is being executed by undoubtedly well-meaning social workers. And still, Daisy is abruptly taken away to a strange place where she will know nobody.

Being well-meaning is not enough. We all sometimes make trade-offs that may directly or indirectly affect other people down, sometimes way down, the line. It is easy to be well-meaning and think about the consequences of our choices to these people in the abstract. But they are real people, just like Daisy. We can choose to make different trade-offs, trade-offs that really take those others, whether they be close or distant in time and space, into account.

We owe it to them to put a little bit of our skin into their game.

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When the material meets the immaterial

(featured image credit: Mr Blue MauMau CC BY)

With incentives, things are not always what they seem

“Most of economics can be summarized in four words: ‘People respond to incentives.’ The rest is commentary,” Steven Landsburg writes on the very first page of The Armchair Economist (perhaps not without a hint of provocation).

He has a point. In fact, the observation stretches well beyond economics as we generally understand it: much of biology and even evolution can be explained on the basis of incentives and disincentives. It is because organisms tend to repeat behaviour that provides them with a benefit, and to avoid behaviour that is disadvantageous that they survive, prosper, procreate, evolve and persist.

But the term ‘commentary’ does a lot of the work in that quote. ‘Incentives’ are often – certainly implicitly – interpreted as material incentives, i.e. money, or the things that are typically bought with money. It is, in a sense, at the heart of the assumption of rationality: if we get more money by doing something, we’ll do more of it (work harder, for example), and if we get less (or need to pay) if we do certain things, we’ll do less of them (committing crime, say).

Immaterial drivers

In practice, we are often motivated or discouraged by other drivers than material (dis)incentives, of course, and that is certainly part of the commentary. A sense of duty may stimulate us to volunteer or donate to charity, friendship may make us help a friend move house, and guilt aversion, rather than the fear of punishment, may prevent us taking advantage of a colleague’s purse being unattended on her desk. We may buy products of a ‘trusted’ brand, one that we are ‘loyal’ too rather than buy a much cheaper, but otherwise mostly equivalent, alternative from a German discounter. All this is really comprised in Landsburg’s commentary.

late arrival

Damn, 25 minutes late again (image: Melissa Maples CC BY)

Yet it can be interesting to distinguish between material incentives and immaterial influences on our choices. A famous and often quoted example of the remarkable interaction between the two is found in a paper by the economists Uri Gneezy and Aldo Rustichini, A fine is a price. They performed a field study in 10 day-care centres, where on average about 6% of pickups were up to 30 minutes late. There was no cost to being late, so the 94% timely pickups were obviously not motivated by a material incentive. The authors then introduced a fine in some of the locations, and found that in those centres the number of late pickups did not diminish, but instead roughly doubled. One explanation is that any original guilt of being responsible for a carer to stay late was crowded out by the payment of a fine. For some of the parents this was clearly a superior deal.

Some employers looking for staff offer incentives to their employees, encouraging people from their social networks to apply for jobs. This approach is motivated by the belief that such candidates tend to fit better, are of higher quality, and stay longer. An important side effect is that the cost of recruiting in this way is lower too. Overall this appears to be a win-win-win arrangement. Aside from the benefits to the employer, the existing employee gets a cool bonus – which can be as high as a few thousands of dollars, euros or pounds – and the new recruit gets a great job.

Could a similar incentive work the other way around – i.e. if you’re looking for a job, would it make sense to incentivize the people in your network to introduce you to their own employers (or potential employers in their network)? At first sight, commentary-less incentives would seem to make it, at least in principle, a workable proposition. A quick word with HR, or with the recruiting manager of a suitable department on behalf of your friend is such a small effort, that even the smallest compensation would vastly outweigh it, even the chance of success is low. (And anyone lucky enough to have an employer with an employee referral scheme may even benefit twice.)

But when we also look at the commentary, a different picture might emerge. Referring a friend or an acquaintance to a prospective employer is in the first place a favour, inspired by immaterial, social motives rather than material ones.

Material dominance?

That does not necessarily mean an additional material incentive might not boost that motivation, especially in the area of employment. Most of us choose to work where we work, and do what we do, as a result of both kinds of motives. We always face a trade-off, even if we are not entirely conscious of it: often we could earn more, but that would mean doing a job that is not as pleasant or rewarding as our current one. Likewise, we can envisage more appealing work, but it would not pay as much as we earn now. And still, between two jobs that are similar in all other respects, most of us would choose the one that pays more.

bigbonus

A case of incentive (image: Maklay)

 

It is not obvious how that material element would translate to the favour of helping someone find a new job, though. Imagine the amount on offer is small but not insignificant, say £50 or $50 – a nice extra for the referrer. But compared to the referral bonuses employers pay it is pitiful. It would be like asking a friend to spend a weekend helping you move house in return for £50. There are things we would do for free as a favour, or at a proper market rate, but not for something in between. Yet even an incentive comparable to an employer’s bonus might backfire. Leaving aside whether it would make economic sense to pay a friend £2,000 if their referral led to your finding a new job, they might question your friendship: do you really believe they would need that kind of incentive for what is really a favour between friends?

Interestingly, even in conventional employee referral schemes the bonus on offer is probably not the principal motivator, Laszlo Bock, Google’s former Senior VP of People Operations, says. People refer their friends because they like working for their company, not because they’re after a bonus.

Steven Landsburg’s observation is a fine heuristic for understanding and influencing people’s behaviour. But when you wonder whether material incentives are the best way to make people respond, don’t forget to check the commentary.

Posted in Behavioural economics, Economics, Management, Psychology, Society | Tagged | Leave a comment

The value of a discount

(featured image credit: Miguel Tejada-Flores)

When money off is worth more than money alone

 

What is the last item you bought? Maybe a coffee, a pack of bin bags during your weekly shop, or a vacuum cleaner. What was it worth to you?

That is a question which is hard, if not impossible to answer. But one thing we can fairly safely assume is that its value in your eyes was at least the amount you paid for it. Otherwise you would simply not have bought it, would you?

When traders buy goods for a certain price, they are not interested in keeping these items. To them, the so-called surplus is entirely represented by the margin they expect to make when they come to resell the items. But end users like you and me are not intending to sell on our coffee, our bin bags or our vacuum cleaner at a profit. To us it is not the direct economic value, but other aspects of what we buy that represent our surplus.

What the price tells us

If – as is sometimes the case – we don’t buy the cheapest item in a particular category, there has to be some extra utility about the item we acquire that justifies the higher price. The enhanced enjoyment of a shot of flavoured syrup in your latte might outweigh the extra cost, for example. Maybe we’ve had a bad experience with a bin bag tearing, and the more expensive, branded variant has turned out to be a bit more robust. And perhaps the vacuum cleaner carried a best buy label from the consumer organization, which gives us some confidence that a higher price means that it performs better or will not break down one day after the warranty expires.

The economic term utility, however, suggests a utilitarian approach that is not always accurate. Perhaps we just believe that the branded bin bags are better, because they are more expensive (this is known as the price-quality heuristic). The economist Oswald Knauth, in an article published as long ago as 1949, describes a retailer who, after a few weeks of lacklustre sales of stockings priced at $1.00 per pair, decided to raise the price by 14% – to an “enormous response”. The explanation was that a higher price was strongly suggestive of better quality

stella-artois.jpg

Thankfully it is really expensive! (via YouTube)

This is an approach that is associated with, in particular, German brands of cars and white goods (I am sure you can think of the brand names). But none of them have used this heuristic as blatantly as the Belgian lager, Stella Artois. In its home country, this beer is as ordinary as it gets. In the UK, however, it was advertised, for 25 years until 2007, as “reassuringly expensive” (for example in this TV spot).

If we buy highly-priced goods because they are more expensive (and we think this makes them qualitatively superior), is there a similar phenomenon with discounted goods?

Valuable bargains

Some people are attracted by bargains, but perhaps they are being misled. Merle van den Akker is a PhD student in behavioural science at Warwick university, who writes fine posts about money on her blog. She tweeted something interesting recently: “If something cost $1,000, and it is on sale for $750, and then you decide to buy it, you did not save $250. You spent $750.”

At first sight it’s hard to argue with her conclusion. It exposes the popular advertising invitation “The more you spend, the more you save”, about which Randall Munroe (author of the popular XKCD comic) once wrote that it would be difficult to be more wrong. If you check your bank balance after the transaction that is described, you will easily verify that it contains $750 less than before, and not $250 more.

And yet… This depends on your point of reference. You do indeed have less money in your bank account, but you also possess an item that, before, cost $1,000.  Provided it is, to you, worth more than $750, it is undeniably a good deal. If it is worth more than $1,000 to you, you are $250 better off having bought it at a discount, and even if you would have paid no more than say $900, you’re still $150 up.

There is nothing particularly mysterious about it: if you are willing to pay X for something, and it is on offer with a discount of Y, then your advantage is Y. Merle’s warning seems of little relevance here. But as so often, the story is not quite over yet.

jacket

Worth its price for the discount alone! (via Atomretro)

Perhaps there exists such a thing as the mirror image of the price-quality heuristic, let’s call it the discount-bargain heuristic. Do people buy something simply because it is cheaper, in the same way that they prefer something precisely because it is more expensive? The answer appears to be yes. A paper by Mark Armstrong and Yongmin Chen, economists at respectively the universities of Oxford and Colorado at Boulder, proposes two reasons why a rational consumer may be more willing to buy an item at a price when that is presented as a discount, than when it is simply offered at the (same) low price. One is that the higher (now discounted) price is, as we saw before, strongly suggestive of better quality. The other is that the discount suggests that the price is unusually low, so that there is no point looking for lower prices still.

There is a third reason that could be considered, though. Some people derive specific enjoyment from the purchase of a bargain. I can say this with certainty, because I am such a person.

The rational me does of course verify that I would have bought this jacket at its current price in any case – sale or not. As long I do that, and I am careful not to focus exclusively on the discounted price, buying something because it is a bargain is a perfectly rational thing to do. The knowledge that it cost me 40% less than the ticket price in the sale gives me pleasure every time I wear the jacket. That enjoyment is higher, much higher than that of the actual money I ‘saved’.

That can be the real value of a discount.

 

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Coloured reality

(image via Youtube/PBS)

Is reality, as we see it, anywhere near the mark?

Have a look around you, listen (and feel free to use your other senses too). That should give you a good sense of the reality of your current environment, shouldn’t it? Yet the picture we get of that reality is inevitably limited by what our senses can detect. Our eyes can only ‘see’ light with wavelengths between infrared and ultraviolet, and our ears can only ‘hear’ sounds with a frequency between roughly 30 Hz and 19,000 Hz (this range reduces dramatically as we get older).

These limits are peculiar to us: bees have no receptors for the colour red, but they have one for ultraviolet (as shown in the banner picture); dogs can detect sounds with a frequency more than an octave higher than the highest-pitched sounds we can hear. But they too have limits to their perception. Whatever reality anyone observes, it’s only a fraction of what is really out there.

Perilous perceptions

Our senses are not the only limit on how we construct reality. We do the same at a higher, cognitive level, combining existing beliefs with our perception. The polling organization Ipsos conducts an annual survey in dozens of countries, gauging people’s perception of a range of societal matters, and compare it with the actual facts. I mentioned this project in an earlier essay, but since then Bobby Duffy (until September 2018 the Global Director of the Ipsos Social Research Institute) has bundled several years of insights in a new book, The Perils of Perception.

In most cases when we get things wrong, like the percentage of teenage girls that become pregnant, or the proportion of Muslims in the population, we overestimate reality rather than underestimate it. One of the main reasons, Duffy says, is that we have an in-built bias for negative information. And of course, the media feed us plenty of that – a case of selection bias on their part (they report mostly bad news), and of the saliency effect on ours (we see this bad news as representative).

non-pregnant teenager

An unlikely headline in the media – (image: Ipsos via Twitter)

We see bad stuff more easily, and we remember it better. This is not so extraordinary from an evolutionary perspective – in face of limited data, we are more likely to survive if we are pessimistic and cautious than if we dismiss what worries us. Bobby Duffy calls this emotional innumeracy: we may try to be accurate in our estimates, but if we are concerned about something, we will project this and inflate the corresponding number. This is not a one-way process: our overestimate can feed our worry, just as much as our worry can cause us to overestimate the numbers. For this reason, overestimations are a good indicator of what worries a population. Add other cognitive tendencies like confirmation bias (we have more eye for that which supports what we already believe) and motivated reasoning (we seek to explain things based on what we believe), and you’d almost be surprised we can function at all with such a distorted world view.

Yet it is not just in our opinions and beliefs about our wider society that we get things badly wrong. Sometimes it can affect us directly, for example when we disagree with a certain behavioural norm, and mistakenly assume it is common among our peers. This phenomenon, known as pluralistic ignorance, captures how we adjust our behaviour in accordance with that misperceived reality. In a 1993 paper, Deborah Prentice and Dale Miller, two psychologists at Princeton University, described how students believe their peers drink more alcohol than they themselves do (and than they consider healthy). They found that male students then tended to not only adjust their attitude towards this perceived norm and become more tolerant, but also adjust their behaviour and drink more and more as the year progresses.

The behaviour can be detrimental in the other direction, too. A recent paper by Steven Buzinski (a psychologist at the university of North Carolina at Chapel Hill) and colleagues explores perception of the amount of time spent studying. Students were, on average, found to underestimate how much their peers studied for an upcoming exam. Interestingly, it was the students who overestimated the effort of their colleagues who went on to underperform on the exam. The authors speculate this is because, instead of being encouraged to study more, they suffered from anxiety and self-doubt as they felt deeply unprepared.

And even when we hypothesize about alternative realities, we seem to be subject to biases.

We often imagine counterfactuals to compare our current situation, past actions or future possibilities with alternatives. A quick search across my earlier posts suggest I have invited readers to “imagine” something more than 80 (!) times. But do we treat these imagined realities the same as the actual reality? Jens Andreas Terum, a psychologist at the Arctic University of Norway (the name alone makes me want to go there) investigated this question as part of his PhD Thesis.

Terum found the subjects in his studies treated counterfactuals with considerable bias in comparison with how they handled actual facts. Alternative realities were almost always imagined as opposite to actual realities, and extremely so (i.e. if in a scenario, things went well in reality, the imagined counterfactual was not a bit better or a bit worse, but very badly indeed). They also evaluated the consequences of a negative event (e.g. arriving late at a job interview) as worse when it was presented as a counterfactual, than as an actual event.

You might imagine (!) that this tendency helps us by bringing to the fore the dire consequences of ill-considered future actions. But this was not the case: the emotional intensity felt with counterfactuals was lower than with actual events. We see the outcome as worse, but we care less about it. This aligns with what he found in another study: near-accidents (where the counterfactual is of course a bad accident) were far less likely to inspire more caution in future than actual accidents. All this seems to fit with the idea that, even in imagined realities, we tend to be self-serving, first and foremost seeking to justify or absolve our actual behaviour.

Larger than you think

Perhaps the most graphic illustration of how distorted our reality is, is the way we map the world. Looking at the familiar picture below, would you say Europe is larger or smaller than Africa?

mercatorprojection

Living in a distorted world. Image: Wikimedia CC BY

The area of Africa is just over 30 million km2, that of Europe 10 million km2 – not quite what the map suggests: so Europe fits three times into Africa. The Gall-Peters projection does a much better job of showing relative sizes, but we hang on to the inaccurate, heavily distorted Mercator projection. Perhaps the reason is that it exaggerates the importance of Europe and North-America? You might very well think that, but of course I could not possibly comment…

We may not be able to swap the ubiquitous distorted world maps, but can we do something about our own misperceptions? Easier said than done, but we could try, for example, in our personal sphere, not to make too many untested assumptions about the norms others hold and apply. We could also bear in mind that imagined realities are, if anything, even more biased than our perception of the actual reality. With respect to our perception of the world at large, Bobby Duffy’s advice is to actively unfilter our world, to be critical and check facts – especially facts that chime with our values and those presented by members of our ingroup. We can counterbalance our natural pessimism by cultivating a basic assumption that things are not getting worse, but getting better (Max Roser’s work, and that of the late, great Hans Rosling – continued by his son Ola and daughter-in-law Anna – are an excellent antidote for excessive negativism).

That will leave us more than enough pessimism to help us survive… if all goes well of course.

Posted in Behavioural economics, Cognitive biases and fallacies, Emotions, Psychology, Society | Tagged | Leave a comment