Strange dictators

An old game is turned upside down, and the results are surprising

An old favourite in behavioural science, often wheeled out to show that we are not ‘rational’, is the Dictator Game. According to standard economic theory, people should be acting to maximize their own economic gain. This is not the behaviour observed, and so the game can be seen as an indicator of our ‘irrational’ altruism or generosity.

The game, first introduced in 1994 by Robert Forsythe and colleagues at the University of Iowa, goes as follows. There are two participants, one of whom (the dictator) is given a sum of money. Initially, the second person (the receiver) gets nothing, but the dictator can decide to give away any proportion of the sum received, literally between 0% and 100%. The receiver must accept this amount and cannot intervene in any way.

It was a development of the Ultimatum game, first described in 1982, in which the receiver can reject the amount offered by the other player, the proposer. If that happens, the whole sum is forfeited, and no one gains anything. The big difference is that here the receiver has control over the outcome, but of course at her own expense. If the amount on offer is deemed too low, both parties lose.

Not a homo economicus

A rational, self-interested, utility-maximizing person would act predictably in all roles in a one-off game. (If the game is repeated, things get more complicated.) In the Dictator game, the dictator would simply keep all the money. In the Ultimatum game, the receiver is better off with even the smallest amount, so that is what  a rational proposer would offer.

Dictatordistribution

This is what dictators do – source: Dictator Games, A Meta Study

Yet in practice, people rarely act in that way. Dictators turn out to be a lot more generous than expected. A metastudy by Christoph Engel of the Max Planck Institute analysed the data from more than 20,000 observations in 83 papers on the subject. While in six of the reported 616 treatments Dictators actually do give an average of nothing, over the whole range of observations the average is no less than 28.35%.

Another metastudy by Jean-Christian Tisserand and colleagues at the Université de Franche-Comté looked at both the Dictator and the Ultimatum game. They found that on average the dictators offered 25.6%. The proposers in the Ultimatum game gave on average 41.04% away.

ultimatumdistribution

The effect of fear of retaliation – source: A meta-analysis on the ultimatum and dictator games

For firm believers in homo economicus, the Dictator game’s results are the most baffling. While having nothing to lose, dictators give up more than a quarter of their endowment. The significant difference with the Ultimatum game can be explained by the threat of punishment by the receiver. But that, in turn, is no less mystifying on the part of the receiver, since rejecting any non-zero offer the receiver makes is, of course, an ‘irrational’ sacrifice.

One explanation for this behaviour is that people value other things than simply economic gain, in return for which we are prepared to make economic sacrifices. We appear to have an innate sense of fairness and an aversion for (excessive) inequality, which inspire us both as a dictator or a proposer, and as a receiver. In other words, we are prepared to pay for fairness.

At least, that is the case when a monetary gain is to be split between two people. But what if it concerned a non-monetary harm instead? This is the question Alexander Davis and colleagues at Carnegie Mellon University asked themselves.

Sharing gain and sharing pain – two forms of altruism?

And a rather intriguing question it is. The debate around altruism does indeed seem to focus mostly on the sacrifices (generally of money) made for the benefit of others. They very rarely look at a form of altruism that involves taking over a burden from another person, or suffering some form of harm to reduce the harm to someone else. Yet that is, as Davis and co describe, a very common form of altruism. In most families, members share relatively unpleasant chores like washing up or taking out the rubbish. Many people donate blood, and some of us put their lives at risk for the benefit of others in the emergency services or in the armed forces.

Now it is true that most instances of such altruism involve direct or indirect reciprocity. If we do a chore to reduce the burden on someone else, they might return the favour. One day we may need a blood transfusion, and then we’ll be glad someone else donated blood, so that might inspire us to do so ourselves.

What makes the research by Davis et al particularly interesting is the absence of such a reciprocity context to motivate altruistic behaviour. For their experiment they used tokens, each of which represented an obligation to submerge a hand into a container with ice water for a given number of seconds. The dictators were asked to divide a number of tokens between themselves and an anonymous receiver. Like in a conventional Dictator game, where they were able to keep all the money, they were at liberty to allocate all the tokens to the receiver and thus escape the unpleasant ice water experience.

The findings are remarkable. On average, the dictators kept more than 40% of the tokens, and thus took more than 40% of the harm. Overall, the dictators allocated more of the harm to the receiver in 47% of the cases. But they shared the harm equally in 44% of the cases, and in 9% they took more of the harm than they allocated to the receiver.

The experiment suggests that we are considerably more generous in the context of non-monetary harm than regarding monetary gain – even when there is no external motivation to do so. (Remember that in a conventional game the dictators kept 75-80% of the money.)

This is not easily explained. Is the discrepancy due to that between the gain and harm frame, or between the monetary and non-monetary frame? Do we have a different set of moral rules when we are concerned with the harm we choose to inflict on others, and when we are concerned with sharing our wealth? Perhaps further research will shed more light on exactly what is behind this asymmetry.

But that shouldn’t stop us from reflecting on the actual behaviour itself, irrespective of its motivation. We humans seem to have a deep desire to reduce the harm to others, even if this is to our own detriment. That makes us strange, even incompetent, dictators.

And that is a hopeful and uplifting thought, no matter why or how.

 

 

Posted in Uncategorized | Leave a comment

The Big Yellow Taxi Fallacy

(featured image: FHG Photo cc2.0)

Could there be such a thing as the sunk benefit fallacy alongside the sunk cost one?

Wednesday 29 March 2017 was a day of celebration for some, and a day of deep sadness for others. For it was the day that Sir Tim Barrow, the UK’s Permanent Representative to the European Union, arrived at the European Council to hand-deliver the letter in which Prime Minister Theresa May officially gave notification of the UK’s intention to withdraw from the EU.

The process so far has provided a rich catalogue of quirks in human behaviour, and the next couple of years, as the negotiation gets under way, promise to be no less fascinating. Perhaps the most prominent and visible one is the emergence of the Leaver and Remainer tribes, fuelled by groupthink. Sometimes it looks as if the nation has completely lost its sense of nuance. The halo effect  (about which I wrote before) makes Leavers dismiss whatever a Remainer says as nonsense, and vice versa.

The availability heuristic reinforces black-and-white thinking on either side. Whenever a company announces an investment in the UK, Leavers hail it as a success, often tauntingly adding “despite Brexit”:

 

And whenever a city firm moves staff from London to a continental location, Remainers present it as yet another sign of the looming disaster of Brexit. Lloyds of London, an insurer dating back to the 17th century, “moving to” Brussels the day after Brexit day (even if it concerned just setting up a small subsidiary with a few dozen staff) was the latest example:

SebDance tweet

There has been anchoring  by the EU side around the magnitude of the exit bill the UK would need to pay. And could confirmation bias have driven Mrs May’s to suggest in her letter that “it is necessary to agree the terms of our future partnership alongside those of our withdrawal from the EU”? The BBC’s political editor would seem to think she saw what she wanted to see rather than what there was:

 

The response from the other side was swift (and the same it has been in the last nine months): first the divorce settlement, then the future. Maybe we’ve also seen an attempt at a precommitment strategy: Theresa May has repeatedly been saying “no deal is better than a bad deal”.

But the most momentous of them all might still be looming in the shadows, ready to pounce during the negotiations: the sunk cost fallacy. When you have heavily invested in an initiative, not just money, but political and emotional capital, blood, sweat and tears, it becomes exceedingly difficult to abandon it. Even if continuing is sure to lead to a worse outcome, the thought that all the effort has been for nothing is hard to bear.

What about the benefit?

Yet among all these biases and fallacies, there is one that has been overlooked. It is not even found in the literature. Remarkably, a google search for “sunk benefit fallacy” returns just two hits. Nevertheless this appears to be a cognitive quirk afflicting the government and the Brexit adherents.

This first occurred to me when, even before last year’s referendum, I heard someone ask a very fair question: “If we weren’t a member of the EU now, would we join?” Even among Remainers, there are many areas of criticism of the EU, from the way it has handled the euro crisis and the refugee problem to its relentless drive towards more political integration.

But the question itself is misleading because it assumes that the present situation is unrelated to EU-membership. In other words, it assumes the benefits arose independently of that membership, and will persist even after it is relinquished.

wreck

Are these my sunk costs, or my sunk benefits? (Photo: Jonathan E.Shaw cc2.0)

In many ways, the sunk benefit fallacy is the mirror image of the sunk cost fallacy. The latter makes us focus on the costs already incurred, even if the gains we hope to make are elusive. The former makes us ignore the benefits of the status quo we stand to lose, and only have eyes for the gains we stand to make.

We are all liable to fall prey to this fallacy as much as the Brexiteers. It is easy to take for granted what we have. If we are moving house, the attractive features of the new place may figure prominently, but we pay a lot less attention to the many nice things of our current place – because we’ve become so used to them. The easy path from kitchen to dining room, or the short walk to the butcher’s are replaced with an awkward doorway and the need to drive for 15 minutes to get fresh meat.

Changing jobs is similar. A new title on your business card and a higher salary have great appeal, but do we realize how much we appreciated the wonderful coffee in the old job, or the smile every morning of the security guard?

This doesn’t mean, of course, that we should hold on to what we have at any cost. But it does mean that when we are contemplating a new direction, we should make sure we properly recognize the self-evident benefits of the present that we might lose. It is precisely the loss of the stuff we had taken for granted that may make us regret our decision.

“You don’t know what you’ve got ’till it’s gone”, Joni Mitchell sang. Perhaps we ought to reflect on the good things we’ve come to take for granted, even if we don’t plan to make big change. And perhaps we should name the sunk benefit fallacy the Big Yellow Taxi fallacy.

 

Posted in Behavioural economics, Cognitive biases and fallacies, politics, Uncategorized | Tagged | 1 Comment

Uber and the four trade-offs of disruption

(featured image adapted from winnifredxoxo cc 2.0)

The effects of disruptive innovation are more multifarious than they may seem at first sight

On Wednesday evening 23 March, a few hours after the Westminster terrorist attack, a friend of mine wanted to take an Uber taxi home from central London. Normally, even during rush hour, there would have been an Uber within a few minutes from any location, but this time the wait was more than 20 minutes. What was going on? Four interesting trade-offs explain this unusual situation, each of them related to Uber’s disruptive business model.

Time vs money

One of Uber’s central features is its use of dynamic pricing – aka surge pricing. When demand from customers rises while the supply of drivers remains constant, the waiting time inevitably increases. This triggers Uber to increase its prices, which is an incentive for more drivers to come on stream. As capacity is brought in line with the demand the price stabilises and drops again.

Uberphone

Wondering what my time is worth (cc0)

This is standard economic theory, and generally works well. Economists love this approach, as it offers customers a choice between time and money. Price-sensitive users can wait, or use a slower means of transport, while those who value their time more can choose to take the financial hit.

Such price discrimination is sometimes regarded as unfair, not just with Uber, but elsewhere too, for example with fast-track tickets in theme parks. Yet all this does is recognize that whenever a good or service is scarce, the users pay a price – if not in money, then in time.

Efficiency vs reputation

So did the system fail to work on Wednesday evening? Not really: there was another trade-off at play. When, in December 2014, Man Haron Monis took several people hostage in the Lindt Chocolat Café in Sydney, Uber hiked its prices for rides in the area by up by a factor four. They received a barrage of criticism, in spite of their protestations they did so for people’s own good.

So instead of letting the law of supply and demand do its thing, Uber took the view, last Wednesday, that their reputation is more important. Sydney taught them a lesson they could have learned from a 1986 paper by Daniel Kahnemann, Jack Knetsch and Richard Thaler. In it they explore the trade-off between fairness and profit. An often quoted question from their research is this one: “A hardware store has been selling snow shovels for $15. The morning after a large snowstorm, the store raises the price to $20. Please rate this action as: Completely Fair, Acceptable, Unfair, Very Unfair”.  82% of the respondents thought the store’s actions as unfair or very unfair.

Work vs leisure

hammock

More money, or I stay in my hammock (picture: Paw Paw cc2.0)

The irony is that Uber was actually right in Sydney (and would have been right in London) that surge pricing would have helped more people get away more quickly. Another key characteristic of Uber’s model is that the drivers work when they like. Surge pricing is meant to alter the balance between the attraction of free time and the appeal of working and earning money (as well as, perhaps, putting oneself in danger) for drivers.

During normal rush times, the prospect of higher earnings entices more drivers to work in more unpleasant conditions – in exactly the same way that extra pay is needed to get employees to put in overtime. But that incentive was missing now, and clearly the sense of civic duty was not sufficient to increase the number of drivers to meet the increase in demand.

Control vs less responsibility

One of the controversies surrounding Uber is that of the status of its drivers. Are they employees or self-employed? This is the subject of an on-going legal dispute. The implications on things like holiday and sickness pay are very important for the drivers, and these are something which Uber clearly does not want to take responsibility for.

Yet, as so often there is a trade-off involved in choosing to decline that responsibility. A taxi firm whose drivers are employees can use the conventional powers of hierarchy to ensure they get on the road. The trade-off for reluctant drivers would be a tough one: comply with their employer’s demand or resign. But Uber’s conditions explicitly state drivers can set their own schedule, which means the company has traded away much of the control they would otherwise have over them.

 

There is much debate over whether Uberification is a good thing or not. Among both proponents and opponents you find a good deal of ideologically inspired argumentation, and such principled perspectives can sound appealing.

But these four new trade-offs, which did not really exist in the same way before, reveal the complexity that can result from disruptive innovation. Is time worth more than money? Does reputation outweigh efficiency? Is having more choice between work and leisure a good thing? Is it worth giving up control in return for less responsibility?

The Uber question is not an easy one to answer.

 

Posted in Behavioural economics, Economics | Tagged , | Leave a comment

Keeping behavioural science on the straight and narrow

As we see behavioural science being applied all around us, we are left with more questions than answers

Behavioural science has well and truly left obscurity and entered the mainstream. Governments – if they haven’t already done so – are following in the footsteps of the UK and setting up nudge units, and companies are using all the behavioural tricks in the box to market their wares to consumers. But is all that done responsibly? And if not, what should we do to make sure it is?

Those questions formed the backdrop of the March meeting of the London Behavioural Economics Network (LBEN). To celebrate its fifth anniversary, they had a panel of seasoned practitioners pondering the ethics and the responsible application of behavioural science.

Behavioural economics and its close cousin, behavioural science, have of course been in existence for much longer than five years. Amos Tversky and Daniel Kahneman published their famous Econometrica paper on the Prospect Theory more than 35 years ago. But for much of the time since then it all remained well outside the mainstream.

Even ten years ago, as people began to apply concepts from behavioural science, it was pretty obscure – you needed to convince your boss that you were not a lunatic, as Greg Davies, one of the panellists, remarked. But things are very different now. The popularity of the domain is rising, and with it, the suspicion that it is being abused.

Richard Thaler, another pioneer of behavioural economics and co-author of Nudge, is well aware of that:

 

Some people are distrustful of any nudges – good or bad – because nudges are by definition manipulative. And they have a point: nudges change people’s behaviour without their being aware of this. Yet ‘libertarian paternalists *’ maintain that as long as nudges are not sneaky, don’t restrict the choices of the people being nudged and are in their interest, things are OK.

The behaviouralists’ angst

Nonetheless the ongoing suspicion and criticism causes behavioural economists a fair amount of angst. Cass Sunstein has taken up the defence of nudges, and Pelle Guldborg Hansen has explored the criticism of nudges and attempted to nail down the definition of a nudge.

But as Leigh Caldwell, another panellist observed, one of the questions that this debate sidesteps is of course: “what do people really want?” Of course, you can ask people directly. For instance, people who struggle to manage their finances may state quite explicitly that they need help. Nudges to help them keep their spending under control could hardly be viewed as unethical.

Still, many assumptions are made that don’t stand up all that well to scrutiny. “Is it in someone’s interest to be nudged to save for their retirement rather than buy a new pair of shoes?” wondered panellist Emily Haisley. Usually the choice we would make in a ‘cold’ state of mind, free from immediate temptation, is regarded as the right one. Decisions made in the ‘hot’ state, when our impulsive System 1 is in control, are generally assumed to be the ones that we’ll regret later on. But is that really so? After several minutes of debate, the panel didn’t manage to come to a conclusion.

panelchairs

…and soon the chairs would be engulfed in engrossing debate!

What about the criticism that behavioural science is all about manipulation? Panellist Oli Payne dug into his own experience and responded by pointing at an inconvenient truth. Manipulation may not be in the eye of the beholder, but we certainly don’t consider all instances as equal, it seems. A prime example of consumer manipulation was the launch of Procter & Gamble’s soft drink, Sunny Delight. That was actually a distinctly downmarket product, with just 5% citrus juice in a concoction of water, sugar, vegetable oil, thickeners and additives. Nonetheless, P&G’s marketers ensured it was sold in the chiller cabinets, next to the bona fide fruit juices. It worked: consumers paid the premium price, in the belief that they were buying something healthy and worthwhile. (It didn’t last: three years later, the subterfuge had been well and truly revealed and Sunny D had fallen from grace…)

 

But when similar tricks are used to manipulate people to recycle more, there is hardly any moral indignation. That makes objective evaluation of what is (and is not) responsible use of behavioural ploys really quite hard, if not impossible.

Perhaps educating people better, so they are more aware of our cognitive biases, and the techniques used by others, well-meaning or not, to influence us might help? Unfortunately there is little or no evidence that this works. Even Daniel Kahneman admits to being just as prone to biases as the next person.

More questions than answers

The concern about unethical use of instruments that affect our choices and our behaviour without us realizing is real and justified. And the desire to set and enforce new ethical standards for behavioural practitioners is understandable.

Is that possible? Could we come up with solid definitions of what is, and what is not acceptable? Could we establish a body whose judgement would guard us from evil nudges? Who would guard these guards themselves?

snakeoil

Vintage manipulation

The panel discussion at the LBEN left the audience with more questions than answers. Yet, enforceable standards and rules rely on clear-cut, unambiguous definitions, and a pile of difficult questions is not a good starting point. With a bad regulatory framework, we risk throwing out the good nudges with the evil bathwater.

Perhaps new regulations are not really needed, anyway.

Attempts to manipulate and mislead people are not new. Yet society has managed to curtail the most egregious excesses. Yes, we have laws to tackle outright fraud, but for the fuzzy stuff we rely on a system of much more informal checks and balances – consumer organizations, the media, the social media. If we could deal with the snake oil of the late 19th century, and with the pretend orange juice of the late 20th, we should be able to deal with the ‘evil’ nudges that the 21st century will throw at us.

For the time being at least, it seems the best we can (and should) do is to remain vigilant and critical of what we see, and shout out when we observe something dubious – whatever side we are on, practitioners or simple nudgees.

All we need now is a clever nudge to help us do so.

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

Nudging people on the escalator

(featured image: Gabriel Jorby)

How to make people stand still to go faster

My very first visit to London left such a big impression on me that I can still recall it decades later. By far the most evocative memories are those of the London Underground: the scent of ozone and lubricant, the sounds of the sliding doors, the labyrinthine access tunnels and, of course, the escalators. The stoic discipline of the Londoners, standing on the right, walking on the left – as the signs everywhere urged travellers to do – was almost as baffling to a continental kid as the neat queues at every bus stop.

That segregation goes back nearly a century. In 1921, ten years after they were first introduced, passengers were first instructed by a recorded voice to stand on the right on escalators. Since then, stand on the right has become embedded in the collective psyche. It has guided generations of passengers smoothly through the underground system.

This is a great example of how a modest heuristic is able to provide both societal and individual value. If you’re in a hurry, you’re free to rush up on the left hand side and get to the top (or the bottom) a few seconds earlier. If not, just relax on the right and let the steps take the strain.

standontheright

Will this soon be history? (Photo: citytransport.info)

Except it seems it’s not that simple. The separation between walkers and standers may be on its last legs, so to speak. Earlier this week, an article on the gadget website Gizmodo reported on a study by public transport operator Transport for London (TfL). For six months, they had been monitoring the traffic flow on the escalators of Holborn tube station – one of London’s busiest – with passengers instructed to stand on both sides. This followed a 3-week experiment in November 2015.

In both cases, the evidence suggests that there are situations where it is actually better to stand still on both sides. The Independent’s headline read “It *is* faster to stand on the escalator rather than walk”, and in a slightly tongue-in-cheek way, they were right. The data showed that, when 40-60% of the people were walking, the escalator could handle maximum of 115 passengers per minute. But when everyone was standing, that went up to 151 passengers per minute.

More space

It is not hard to see why this is the case. The amount of space a walker needs is bigger than the requirement of a stander, so the capacity is lower when people are walking. You see this also on congested motorways: the safe distance between vehicles (and so the amount of road space each vehicle needs) is larger when the speed is higher. In many countries there are signs above each lane to restrict the speed when congestion looms. When everybody moves at the same, lower speed, more vehicles get through every minute.

In addition, keeping everyone driving at the same speed means there is little point in changing lanes. And that is good too, because lane-hopping has what economists would call a significant transaction cost. If someone squeezes in front of you, that forces you to brake, and the same for the car behind you, and so on. The resulting concertina effect causes everyone else to slow down – in economics this is called an externality.

Such externalities are one reason why markets are rarely perfect – including the markets for roadspace or for transportation by escalator. Lane hoppers impose a delay on the other road users, and very similarly, people who choose to walk on a congested escalator impose a delay on everyone else.

The problem for TfL and its users is that it is only in certain situations that it’s better for everyone to stand. Not only is the old stand on the right heuristic still perfectly fine outside the peak hours, things also change according to the height of the escalator. An earlier trial at Canary Wharf station, where the height of the escalator was just 10m, found that with everybody standing capacity was reduced by 10%. (The Holborn escalator has a height of 24m.)

Heuristic versus nudge

Replacing a century-old heuristic with a new one would be quite a challenge. But even a new heuristic wouldn’t help here: a rule of thumb couldn’t really capture the complexity.

Is there another way to guide people guided towards the behaviour that is right for the location, and for the situation? How can passengers in a hurry be prevented from mindlessly pursuing the old heuristic, or from following their counterproductive instincts that cause others (and indeed themselves) delay?

The approach used to control traffic flow on motorways is not really suitable. It depends on enforcement, and fining passengers for walking when they shouldn’t would surely meet with protest. Would just telling people help?

Simply advertising what you want people to do is easy and straightforward, but it’s unlikely to have much effect here. Imagine posters explaining the conditions when walking is allowed, and when standing is de rigueur. Regular passengers would ignore the signs because they already know what they say. Occasional travellers might be intrigued by them, but both would still need to judge the height of the escalator and the congestion level to know whether they should stand on the left or are allowed to walk. Nope, the old heuristic won’t be beaten by something like that.

dontwalkwalk

Not so suitable for escalators (Photo: Simon Murphy)

A dynamic eye-catching Walk/Don’t Walk sign at the start of the escalator would require a bit of technology to control it, but it might be more effective. At least it gives a visual cue when it matters. Or maybe the original technology could be reused? A looped spoken announcement saying “Walk on the left”, or “Don’t walk on the left” according to the situation would probably become annoying very quickly, however. And in both cases it would still be tempting for anyone on the left hand side, seeing half a dozen empty steps ahead, to start walking again to close the gap, of course immediately followed by everyone behind.

Seeing the light

Perhaps road traffic can provide inspiration after all. Environmental cues can influence how we behave, and traffic engineers in Japan (and elsewhere) have used this to great effect. Grooves in the so-called Melody Road produce a well-known tune you drive over them at a particular speed. And while sound might not be a good choice to influence pedestrians on an escalator, light might be a better cue.

A mechanism developed by three sports scientists, Liang Huang, Jie Zhuang and Yanxin Zhang, offers intriguing possibilities. Using a system of running lights they were able to control a subject’s walking speed in order to analyse their gait. So imagine a strip of lights on either side of an escalator. If the lights move at the same speed as the steps, people would be nudged to stand. When the situation allows for it, the lights on the left hand side could be made to move at a faster pace, thus encouraging them to walk (and help distracted passengers keep out of the way of their hurried fellow travellers).

The tube network becomes ever busier. TfL will need to come up with ways to maximize throughput in the stations during peak times, and avoid having to temporarily close them for safety reasons when they become congested.

Literally nudging people on escalators would probably be a violation of safety regulations, but a metaphorical nudge might just make travellers see the light and let go of the old heuristic.

 

Posted in Behavioural economics, Economics | Tagged , | Leave a comment

The largest anchor ever

(Featured image: clmper)

How do we know what is a reasonable amount of money to pay?

How much would a rational person be prepared to pay for, say, a cauliflower? They’d go down the ranking of all possible purchases, and for each one compare the utility it provides with that offered by the vegetable, until the utilities are equal. Whatever price they’d pay for these equivalent goods, they’d hand over for the cauliflower.

But we ordinary humans don’t possess the power to determine the price independently. Our willingness to pay – whether for a cauliflower, a used car, a sofa, a haircut or a holiday in the Mediterranean – is strongly influenced by what others are happy to pay. And that information comes to us via the market.

In the supermarket, it is advertised on the shelves. Conventional purchases in shops, certainly in the West, involve little negotiation. In practice, it is generally a binary decision: are we willing to pay the asking price or not? Either something is too expensive (but by how much?) or it is cheap enough (but how much more could it cost before we bail out?). So we’re generally not really aware of the maximum price we’d be willing to pay.  Perhaps surprisingly, that means we don’t know how much we truly value the things we buy.

A now classic experiment by Dan Ariely, George Loewenstein and Drazen Prelec, then at Harvard University, illustrates this very clearly. They showed 55 students six products with an average retail price of $70, without mentioning the price. The students were then asked whether or not they would be prepared to buy each good for a dollar amount equal to the last two digits of their social security number. After this response, they stated their maximum willingness-to-pay (WTP) for each item. Despite being wholly irrelevant, the last two digits of the social security number turned out to be very influential on the WTP. The table shows that, on average, people whose number ended in 80-99 were prepared to pay $37.55 for the rare wine, over three times more than those with a number ending in 00-19.

This phenomenon is known as anchoring. The first piece of information (in this case totally unrelated and arbitrary) weighs heavily on the subsequent decision-making. In practice, you can see this effect being used in situations where it is customary to negotiate.

It is telling that sellers on car boot sales or flea markets almost never advertise prices on their stall. This forces the buyer, who is used to seeing prices displayed, to ask for it. And that gives the seller the upper hand, as their ‘asking price’ will then be the anchor in the negotiation. Of course they’ll aim high, so they can concede a little to the buyer, who will immediately get the feeling they’re getting a bargain.

First mover advantage

Intuitively you would assume that being the first to put your cards on the table undermines your negotiating position. But this is not borne out by the research, as Leigh Thompson, a psychologist at Northwestern University’s Kellogg School of Management, explains. On the contrary, several investigations show a powerful first mover effect, especially if both parties are equally well prepared and have similar leverage points.

kadett

A steal at 5,000 DM!

The uncertainty around the ‘right’ price is not just on the side of the naïve party in a negotiation either. In a 1997 study by Thomas Mussweiler  and others at Würzburg University, a 10-year old car with numerous defects was shown to 60 mechanics and car dealers. They could inspect it and were then asked to estimate the selling price, but not before the researcher gave his opinion. In half the cases he told the expert “I thought the car should sell for about DM 2,800”; the other half were told the selling price was “about DM 5,000”. The average estimates of the second group turned out to be DM 1,000 higher than those of the first group.

Even jokingly demanding a ridiculously high salary ($1million) was found to influence the eventual offer in a study by Todd Thorsteinson at the University of Idaho. Certainly worth bearing in mind during your next job interview!

A huge anchor

It is hard not to see last week’s media attention for the UK’s “Brexit bill” in this light. This is the amount that the UK will need to hand over to cover outstanding liabilities when it finally leaves. And in mid-November of last year the EU was first in putting forward the amount of €60 billion ($63 billion, £51 billion at the time of writing).

It then went quiet for a while. Yet the British government didn’t take advantage of this lull to try and regain the initiative: last week the figure was back in the headlines with a vengeance.

Just like in a divorce, this will be the subject of negotiations. The €60 billion is well underpinned and defensible. But there are numerous components to the calculation, many of which are ambiguous. The UK had a chance to develop its own version yet it failed to take the initiative, not once, but twice.

Perhaps the poor preparation of Brexit in the first few months is to blame. It is not surprising that a Brexit ministry without proper accommodation, so that it reportedly had to hold meetings in the local Starbucks, doesn’t have the resources to develop its own calculations.

But maybe there is more to this than meets the eye, and the lack of counteroffer is deliberate. Arguably this scenario plays into the hands of the British government. Just like the naïve buyer on a flea market will walk away with the idea they’ve bargained well if they knock a few pounds of the seller’s anchor price, any reduction to the €60 billion can be sold at home as a victory in the negotiation.

Yet just like it is the flea market seller that has the last laugh, so it is likely to be for chief EU negotiator Michel Barnier – thanks to a €60 billion anchor, the largest anchor ever.

 

Posted in Behavioural economics, Cognitive biases and fallacies, Economics | Tagged , , | 1 Comment

A new challenge for behavioural economics

Can behavioural economics play a role in the process of policy-making, as well as in its implementation?

(Featured image: Unsplash)

Many of the best known examples of everyday Behavioural Economics are about health, wealth and wellbeing. Not surprisingly, these three central aspects of our life feature in the subtitle of Thaler and Sunstein’s popular book on the discipline, Nudge.

As they explain, we have many conflicting aspirations, and we’re not very good at weighing them up. We want to lose weight, but we also prefer snacking on a chocolate bar or crisps, rather than on a banana. We want to keep fit, but we also like to lie in in the morning rather than to go jogging. We look forward to a comfortable retirement and know we should save for it, but we also like spending money here and now.

A rational person would simply attribute weights to these conflicting options, and work out what, on the whole, is the optimum combination. Thaler and Sunstein call such a mythical person an ‘econ’, short for “homo economicus”. But we are not econs – we are humans, subject to all kinds of biases and temptations that trip us up and make us regret our choices, over and over again.

Thankfully, behavioural economics offers an arsenal of tricks to help us to make better choices. Nudges can make the option we think we ought to take easier than the tempting alternatives.

But it is important to realize that this is not about one choice winning and the other losing. It is not because we save more for our retirement that we stop spending money today on things we like. Neither do we give up chocolate altogether because we start eating more fruit. Behavioural Economics is not about replacing surrender to immediate temptation by surrender to austerity. It helps us find a compromise between the tempting and the reasonable that is good enough.

It is almost as if deep inside there are two separate single-minded, simplistic entities with opposing aims. Each has complete disregard for their counterpart: “I like chocolate!” versus “I want to be healthy and fit!”. And behavioural economics speaks to a third, impartial entity. This kind of inner benevolent dictator uses  tricks like putting an apple on the counter the night before to reduce the temptation to grab a bar of chocolate for our lunch bag. This seems to model how we function much better than Thaler and Sunstein’s mythical econ, in which everything is integrated in one, rational entity.

A larger scale

So we appear to be capable of recognizing the conflict between two aspirations within ourselves, and use behavioural economics to help us take a more beneficial course of action. Can this be done on a larger scale?

Setting and implementing public policy shows some interesting parallels. In public life it’s not various aspects of a single individual that needs to be reconciled, but the diverse demands and expectations of a single population. Policy related to the regulation of road traffic is a good example. None other than Cass Sunstein wrote a Bloomberg view column this week with the provocative title “No One Needs to Die on America’s Highways”. And a last week a member of the Green Party in Belgium wrote an opinion piece (in Dutch – Google Translate) pleading for cities that make it possible for young children safely to cycle to school.

Both articles take a one-sided view in which road traffic safety dominates. Such single-minded views are characteristic for campaigners, who, pretty much by definition, don’t have to worry about ‘the other hand’.

crashtest

This crumple zone comes with a price tag (picture: Pixel-Mixer)

But of course there are other hands. Not only are there the petrolheads who would resist, out of principle, lowering the speed limits or indeed imposing any speed limits at all. There is also the economic reality of the burden of regulation. The safety-related features of our cars, from seat belts and crumple zones to anti-lock brakes and air bags, cost a lot of money. So does building bridges and underpasses to reduce the chance of collisions at junctions, and so on. And of course reducing the speed limit means it takes longer to get from A to B – and that too has an economic cost.

There is nothing wrong with campaigning in a single-minded way. Just like it’s fine for part of us to insist on having more chocolate, so it is fine for people to argue in favour of taking road space away from cars and giving it to cycle lanes. That is, as long as there is a mechanism to balance these one-sided demands with the ones with which they are in conflict.

The checks and balances of policy-making usually work well in modern western society. Policy is generally developed through debate, often involves the input of impartial experts, and eventually ends up being a compromise that is ‘good enough’ for almost all parties.

But what if it isn’t? What if single-minded campaigners actually gain the power to push through their single-minded cause, disregarding opposite views? Or what if a binary vote, like in a referendum, becomes the dictatorship of a slim numerical majority?

Such situations may have seemed a remote, perhaps only theoretical, possibility just a year ago. But now, there is much evidence that the checks and balances that are intended to protect liberal democracy are under pressure. We see an authoritarian president with a rather cavalier attitude towards his country’s constitution and to the separation of powers. In the British parliament, we see the most ineffective opposition for generations, and a depressing abdication of its scrutinizing role, thus bolstering the unchecked power of the government.

Behavioural economics is being used in public life. More and more governments are setting up teams to use behavioural insights to support the implementation of policies and to influencing the behaviour of their citizens.

But perhaps a much bigger public life challenge for behavioural economics is the safeguarding of a liberal democracy from domination by single-minded views, and that ensures a sensible compromise between the conflicting demands of the population. When it concerns nudging us individuals into healthier, greener or safer behaviours, behavioural economics can appeal to our inner benevolent dictator. Unfortunately, in the domain of policy-making and government there is no such benevolent dictator.

I am not normally attracted by campaigning, precisely because of its single-minded nature. It is hard not to invoke the ‘other hand’ as soon as I see even a hint of a campaign. But a campaign to encourage behavioural economics practitioners to find ways to curb authoritarian policy-making certainly has some appeal.

That’s the kind of campaign that I can wholeheartedly get behind.

Posted in Behavioural economics, Economics, politics | Tagged , | Leave a comment