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Behavioral economics is catching on
Dan Ariely, author of "Predictably Irrational"
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TEXT OF INTERVIEW
Kai Ryssdal: We sit down to chat with Dan Ariely about once a month or so. He's a behavioral economist at Duke University. And when he's not teaching, he's thinking about how humans, and markets, and entire economies sometimes, do things that don't make much sense. And then he tries to explain why. About a year ago he wrote a book about that, called "Predictably Irrational." And since then we have collectively given him so much more to talk about that there's an expanded version out this week. Dan, it's great to have you back.
DAN ARIELY: Same here, as always.
Ryssdal: So it's been a little bit more than a year since the first version of this book came out. And it's been quite the tumultuous year in the economy, obviously. Do you find that behavioral economics is a little bit more, I don't know, respectable now?
ARIELY: Oh, yeah. Very much so. This has been a great year for me.
Ryssdal: Well, that's good, Dan.
ARIELY: Yeah, if you're looking for a satellite in this whole thing, it's behavioral economists, we're all celebrating. And the real issue is that for a long time we would do these experiments showing all kinds of irrationalities, and people would say, OK, it's very cute, it's very entertaining, it's amusing, but surely when it will come to people making large decisions in a repeated who are experts, all of these irrationalities will go away and people would behave perfectly rational. In 2008, Greenspan's testimony, that basically you can summarize as, oops, I thought the markets were irrational and would take care of themselves but they don't. I think there's a new realization of how important an endemic irrationality is, and that we really need to understand it better if we ever want to get out of not just this crisis, but we want to prevent the next ones who are just waiting around the corner.
Ryssdal: It occurs to me that behavioral economics is pretty easy to figure out in hindsight, right? We can look back over the past year, year and a half, since your original book came out, and say, well, look at the irrationalities. The mortgage market, so many smart people on Wall Street doing so many dumb things. Let me put the test to you then, and ask you what we might see in the next year in terms of irrational economic behavior. Is there a way to figure that out?
ARIELY: So if you think about the problem from a behavioral economists' perspective, then what you would say is the following: we might get over the housing problem, we might help people, we might bail out some of the banks, but the real problem, the thing that was causing this whole issue, is actually the conflict of interest that the bankers had. And unless you solve that deeper problem, you haven't solved anything. So in fact what we're doing is we're looking at the causes for these behaviors. And this actually helps you to think very much about regulation. So we can say what are people naturally good at? And in those cases all we need to do is the government to step out of our business and let us do whatever we can because we would optimize. Versus what kind of things do people fail in and fail in them routinely, in predictable and repeatable ways, and those are the places that we would need to actually step in and regulate, and don't let people create damage for themselves and for the economy.
Ryssdal: When you go to a cocktail party, and somebody says, so Dan, lovely to meet you, what do you to do for a living, what do you say?
ARIELY: I say I examine human irrationality, and then what they say, oh, you must know my wife.
Ryssdal: And then your wife says what?
ARIELY: And then I say, yes, I can see you saying it, but, of course, your wife is not next to you.
Ryssdal: That's right, that's right.
ARIELY: But you know, I think there's actually a recent interest from the public in this irrationality. There's a general mistrust, I think, in economics. I mean, think about what happened to us. We trusted the economics to a very high degree. The metaphor of the market and freedom has permeated every aspect of society and of beliefs. And it's kinda driven us down to a very serous black hole. Even people who were schooled in rational economics, but deal with the real world everyday, all of the sudden are looking at their own behavior and saying, I'm now recognizing all kinds of things I didn't see before. That's kinda the first step for improvement.
Ryssdal: Dan Ariely is a professor of behavioral economics at Duke University. His book, revised and expanded, is called "Predictably Irrational." Dan, thanks a lot.
ARIELY: My pleasure.
If one hasn't read his book, it would be easy to misjudge his statements on this interview as naive and simple. Maybe everyone has read his book, but it appears from the comments that some are reacting to the simplicity of the interview and not the whole realm of his research.
Mr. Ariely assumes that bank executives acted irrationally. This is not true. They acted in their own, rational self interest. They knew that by taking big risks, they would make big short term profits for their bank, and therefore get big bonuses for themselves. They also knew that FDIC guaranteed their customers' deposits, thus mitigating damage should the risks go bad. They further reasoned that, should their risks go terribly wrong, they stood the chance of being bailed out by the FDIC, Treasury, and Federal Reserve. This hunch proved, in large part, to be accurate, as we have seen.
Again, the bankers acted in their own, rational self interest. What they did could be called immoral, and it was not in the interest of the bank as a corporation or to the overall economy and society. But corporations and societies do not make decisions; people do.
Mr. Ariely starts with a false premise, that bankers acted irrationally, then uses it to draw a false conclusion: That banks must therefore be further regulated. Though the bankers were rational in this case, people certainly can act irrationally, as evidenced by the board committees that structure compensation to encourage such imprudent risk taking and the investors who poured money into obscure financial instruments. So irrationality is an accepted fact of human behavior.
How, then, should we expect regulatory agencies to somehow be free of irrationality that inflicts business and investors? Government and agencies do not make decisions; people do, so people working for the government are at least as likely to act irrationally as those in private industry. The crucial difference is, when private individuals make irrational decisions, they, in absence of bailouts, suffer the consequences, so there is a natural incentive to avoid such irrationality (there's also a survival-of-the-fittest weeding out of irrational actors). When people in government make irrational decisions, the taxpayers are the ones who lose while the agency is rewarded with a bigger budget.
Mr. Ariely's wrong diagnosis (which he is not alone in making) has lead to the wrong prescription, which will only worsen our economic ailment.
I believe Dr. Ariely's contention that because people fail in repeatable and predictable ways the government needs to intervien is wrong. People need to make mistakes to grow and understand themselves and others. If you look you will find many of our greatest accomplishments come because we have had the chance to goof up and see live the consequences.
ok so he says what? besides " we would do these experiments showing all kinds of irrationalities, and people would say, OK, it's very cute, it's very entertaining, it's amusing,"
just like the interview!!!!!!!!!!!
The bankers had "a conflict of interest" is not an irrationality.
How about some examples of the irrational behavior?
