Conversation with Dan Ariely, author and behaviorial economist

Dane Stangler interviews Dan Ariely

Dane Stangler: I'm here with Dan Ariely. Dan's a professor at Duke University. He's also the author of Predictably Irrational: The Hidden Forces that Shape our Decisions; and more recently, The Upside to the Irrationality. Dan, welcome to the, welcome to the show.

Dan Ariely: My pleasure, nice to be here.

Stangler: I want to start by asking about your own personal experiences. You spoke eloquently at TED in your TED talks about what got you interested in behavioral finance and behavioral economics and irrationality. I wonder if you could sort of recap that story for us.

Ariely: You know, the fact that you said "eloquent" makes me, makes me worried. So let me, let me say in a non-eloquent way. So, I got badly burned many years ago, and I spent a long time in hospital. And hospitals are a place where you can observe lots and lots of irrational behaviors and actually a lot of them kind of sprung some interest in me. But the thing that was initially the most salient and also the most important was the debate I used to have with the nurses about what's the right way to remove bandages from burn patients. So think about it for yourself and ask, what's, what does intuition tell you? That it's better to rip off bandages quickly, short duration, but every second is very intense, or to take them off slowly, take a long time, and each second is not very intense. And when you ask people this question of what does your intuition tell you, most people think that the ripping approach is the right approach. Actually, I suspect that my nurses got this intuition from how they used to wax their legs. But it turns out that this is not the right intuition. Maybe it's correct for waxing legs because of the structure of the hair and hair follicles, but it's not the right way for to think about removing bandages from burn patients or electrical shocks or other things. Because when I do experiments in which I give people different profiles of pain over time, and I examine what's the relationship between the duration and the profile of pain over time, we find out that the way people trade off duration and intensity is that they focus very much on the intensity and not so much on the duration. So this means that if you take our discussion now and you make it twice as long, you will not make it twice as pleasurable or twice as painful, depending on how you stand. It's the intense moment of either clarity or lack of clarity that will be important for the overall evaluation of the experience.

And what puzzled me about this is that by the time I finish the results, I took already Economics 101, and in Economics 101 people always make the right decisions, particularly if they're carrying, if they have lots of experience, if the decisions are important, and my nurses had all of those conditions, but nevertheless, they would get things wrong. And it's the kind of wrong that not that one nurse got it wrong one way, and the other nurse got it wrong a different way, and if somehow there was just a market for nurses, things would cancel each other out, or they would teach each other what to do. They were all getting it wrong in the same, in the same way, which made me wonder about mistakes more generally. Are there cases in life when we have good intentions, we have lots of experience, but our intuition leads us astray in a systematic and predictable way. And that's when I decided to study not just pain and not just nurses, but all kinds of behaviors.

Stangler: That's terrific. That's a terrific story and I think that really speaks to a lot of people and gives it a real personal dimension for a lot of people reading your work. I wonder if you could sort of follow up on that and summarize or briefly describe in your eyes or in general terms sort of the basic tenets of behavioral economics of behavioral finance. What is it good at? What are sort of its limitations? Things like that?

Ariely: Okay. So I would say that behavioral economics and behavioral finance are inherently agnostic. So standard economic theory starts with some very strong assumption about human behavior, what people can and can't do, what we're capable of, and the basic assumption is that we're capable of everything, that our computation abilities unlimited, that we can consider all the options, that we know exactly what we want, that we can always pick the right option that would maximize our wellbeing or our financial outcome. Behavioral economics basically, doesn't make any assumptions to start with. We just say, we just don't know. Let's be empirical. Let's be a bit more like biology or physics, and then let's just see how people behave. Now, people's behavior is a bit more complex than atoms or molecules, which are also complex of course. But we start from a perspective of we just don't make any preconceived notions and assumptions about people behaviors. And because of that, we come up to different conclusions. And often we find out that people are not rational. So that's the first point. The second point is if you take the irrational behavior into account, you would make very different prescriptions about what the government or companies or policy makers should be doing. So, for example, think about something like obesity. If you're a rational economist that believes that people always make the rational correct decisions, and I ask you why are people obese, you would say people are making a trade off. They're saying, how much do I enjoy this fatty delicious food right now, and how much do I want to be healthier in the future, and they decide rationally and correctly that it's better to live well right now than to live longer or healthier in the future. If you start from the assumption that people always make the right decision, the question is not why people make this decision, they're making the right decision, you can ask yourself, you know, what is causing them to do it. And you can say, well, people just really like fatty food a lot, which is of course correct. If you start from the behavioral economics perspective, when you say people are not necessarily rational, you would say, sure people love fatty food, but they might not consider their long term goals as vividly as they're considering their short term goals. People might have some bias, of difficulty of understanding, what are the consequences of their actions. Emotions compel us to act immediately, even when we want to resist temptation in principle. And you can actually see some interesting evidence. Recently, there was basically a rollout of a new program in New York City where they asked all the fast food places to start posting calorie information on their menu. So they basically provided all the information. And again, the cognitive, rational economic approach is saying as long as you give people all the information, they will make the right decision. What do you think happened the moment that they put more calorie information on the menus? Nothing. You know, there's some studies showing slight decrease in consumption, some are showing a slight increase in consumption, but overall it doesn't seem like much is happening because the truth is, it's not about information. When you go to Dunkin' Donuts or to Panda Express or to McDonald's, you're not in a rational tradeoff mindset in which you're thinking about cost and benefit. You're in a mindset of thinking about greasy, fantastic, tasty, tasty food. So all this, I think, is about the benefit. Now, we can ask what are some of the shortcomings and disadvantages of behavior economics and I think the main one which economists complain about correctly is that there's not a single theory. So economics is basically a single theoretical framework in which everything fits in, where behavior economics is more like a collection of fact and ideas that are combined together. So we say people are myopic. They don't think about their future, easily confused, don't know what their preferences are, they rely on their own past behavior as a starting point for the next behavior, and they don't examine all the options, they only look at some of the options that are available to them. We're trying to justify and rationalize the actions that we've taken. I mean, we have lots and lots of those descriptions of things that people do badly, but we don't have a simple, single theory for that. Now, I should say two things. One is that I wish we had a single theory, but the fact that we don't have doesn't mean that it's less accurate. No, think about something relative simple in human behavior like vision. If you look at the way that the eye operates, the eye operates by multiple mechanisms. There's not one mechanism that the eye operates by. There's vision in the middle of the eye, and there's vision in the periphery of the eye. These are different mechanisms. There's vision for color, which is different than vision for black and white, and there's different for motion than is different for motio-, move, and vision for stationary stuff. So even something simple, relatively simple, like the eye works in different ways. So why would we expect that something complex like decisions about stock market and health and kids and education and eating and drinking and self control and so on will always be driven by one theory and one mechanism? So I wish it was the case, but I don't think it necessarily has to be the case. It could be that the more accurate description of reality is one in which we have this brain mechanism that has evolved over a long time, and we call all different parts of it to do different jobs. And because of that, we have many different ways to try and solve a problem, many of them are wrong.

Stangler: That's a terrific, a terrifically comprehensive, yet brief, overview. I love the examples of calories on the menu. I remember some of the news stories that came out and think some of the cases had actually found that people intentionally consumed more calories after seeing the amount listed on the various food items.

Ariely: No, but wait. You know, you're giving me all these compliments. This is fantastic. This is great. You know the reasons by Paul Rosand [sp] that shows that when you give people compliments, even when they know that you don't mean it, they still think higher of you and they enjoy the compliment?

Stangler: You want me to stop giving you compliments?

Ariely: Oh no, it's great. I'm saying go ahead, it's fantastic. And I also want to say that we recently did the little app called "Attaboy" in which we, it's an app that every time you open it, you get the random compliment. And we're trying to study what compliments people enjoy getting in which time of the day and so on, and the app also asks people to propose different compliments. So we really, it's a very interesting thing, compliments, and we're trying to understand it a bit better.

Stangler: Wow, that's very interesting.

Ariely: You're asking fantastic questions.

Stangler: Thanks. I wanted to ask you one more question sort of in the vein of irrationality and behavioral economics before talking about more specific applications entrepreneurship, you know, areas of interest go the Kauffman Foundation. One thing I was wondering in reading some of your work and listening to some of your talks is, you know, when we talk about irrationality or people being irrational, it's defined as something that's not right, it's not rational. So its referential anchor is rational behavior. I wonder sort of two things. First, is there always – and you sort of touched on this when you talked about behavioral economics approaching things without a preconceived bias, approaching it only from an empirical perspective. I wonder, are we always sort of fated to see things in this binary perspective of rational or irrational, to always have this anchor of here would be the rational or ideal behavior, or is there a way we can not approach it in those terms, that there is no rational course, or no right course of action? Does that make sense?

Ariely: Yes. So I think that there are cases in which rationality just doesn't apply. For example, taste. It's not clear that I can say that if you like blue more than red, you're more correct than if you like red more than blue. So in some cases of taste, we have nothing normative to say about it. Now, there are some cases in which we can say something normative about your taste. For example, if you prefer to do something that has a very high likelihood of killing you. We can talk about that. You know, if you have a preference for texting while driving at the moment you get a text, but then later on you don't have the preferences, we can say something about that. But there are classes of things that is very hard to argue about what is rational and not rational. But I think there are two kind of more points to your issue. One is that sometimes we actually want people to behave irrationally, and the title of my second book is The Upside of Irrationality because I think that sometimes irrationality is actually quite, quite wonderful. And I'll give you two examples. The first one is think about how many people would give money to charity, and how much would they give if people were perfectly rational? And the answer is not very much because if rationality is only to care about your own, your own wellbeing, your own wallet in some sense, why would you give money to a charity that is far away from you? Now, if it's charity that is close to you, and you can benefit from it, of course. But if it's something that you don't get any benefit from it, why would you ever give money to charity? So that's one thing. Is people show tremendous care for other people, perhaps not as much as we would want, but we show tremendous care to other people relative to the economic benchmark. The second thing is I do lots of research on cheating and dishonesty and when people do it more or less. And while it's a very sad view when we discover how many people can cheat a little bit and still think of themselves as good people, at the same time, people don't cheat enough from a rational economic perspective. Imagine, imagine how much people would steal if everybody was just doing the cost/benefit analysis. Think about your day up to now, and think about all the opportunities you had to steal something where nobody could observe or catch you. And ask yourself whether you would have had many opportunities to get away with lots of dishonesty that would financially benefit you. And I'm guessing the answer is yes. You probably passed by an office of somebody, and it was not locked, and there was a laptop there, and you could have swiped it and nobody would have noticed. You could have probably found some other things you could have taken. So the reality is that people also are more honest than economic theory would have us believe. We're not just calculating machines in which we just do the cost/benefit analysis.

The other way I think relates to entrepreneurs, which is, ask yourself how rational is it for people to become entrepreneurs? Right? How rational is it for people to sacrifice dramatically a big chunk of their time, sometimes a big part of their wealth, and to go on an adventure that has a very low probability of success? And the answer is not very, not very high. If we take, for example, restaurants, you know, we know that lots and lots of the restaurants that open lose lots and lots of money and then they close. And, but at the same time, while it's irrational for the individuals, from a cost/benefit perspective, it's very useful for society. Think about where society would have been without entrepreneurs. Or, where society would have been without new restaurants. So there are classes of things that are irrational from an economic perspective, when we just consider the cost/benefit of an individual, but it's worthwhile for society to sacrifice a few people on, you know, a wild goose chase because there's some probability that what they're doing will be successful. And by the way, I think the same thing about science. In science, there's lots of projects that are useless, a lot of projects that don't really yield much, and in retrospect you could say, "Oh, why did we ever spend taxpayer's money on this project?" But, and you don't always know it. And sometimes it is very useful to try lots and lots of things, and perhaps some of them will work out, and they would have a tremendously big benefit. It's good for society, not so good for the individuals always.

Stangler: Right. That's a great point. And you know, it occurred to me reading some of your work, we've actually been thinking about rationality all this time, you know, for decades and centuries in a much too narrow, almost purely monetary perspective that, you know, going back to the example of charity, that while from a strictly economic or cost/benefit analysis, it's irrational for me to give to charity, in terms of a sort of a psychic utility or the story, I tell myself it's actually quite rational because it supports the story that I tell myself of who I am and things like that. I wonder if your work, in sort of a perverse way, actually can lead to a more beneficially, broader sense of what rationality means or something like that?

Ariely: Yeah, so here's kind of a interesting dilemma. So the question is, it's clearly beneficial. The question is, do we want to call it rational?

Stangler: Right.

Ariely: And the problem is that the more and more things we put in the utility function, and we say, oh you can care about other people, and it's okay for you to care about your own well, psychological wellbeing, and it's okay to care about all kinds of other things. While doing this will make economics more and more descriptive, but we're also making it less and less useful.

Stangler: Right.

Ariely: Actually, like standard economics. I think it's a beautiful framework that captures some of human behavior and it's actually very useful. And I worry that if we try to put too much into economics, if we take economics and say, okay, this is going to capture all of social science, we're actually going to empty economics from content. What I would like to see is, I would like to see economists keep on doing what they were doing, hopefully with more humility, but keep on doing what they were doing, and study economics as it is, and only do something different when it comes to implementing something in the world. So when you study theory, study theory. Economists will study economics, psychologists will study psychology, sociologists will study sociology. But when we come to implement something, we come to create a policy for education, we come to increase taxation, we come to create a software to help people adhere to drugs more, now I want people to not just listen to economics, but take a more broad perspective that includes more stuff, and actually captures human motivation to a better degree.

Stangler: Yeah, that's a great point. Sort of the sense that economic imperialism will end up sort of guiding discipline itself. You talked about entrepreneurs, and you sort of immediately anticipated our next question, which was, while self awareness is key as is understanding one's own, or more generally human cognitive biases, there's this argument that you touched on that entrepreneurs need cognitive biases and delusions to succeed both in two ways: One, as you mentioned, to take the leap in the first place; but also, as some of your work touches on, to capitalize on those biases and delusions for their business model to succeed. So this sort of leads to the question, when does knowing about one's own cognitive biases cross over into being unhelpful?

Ariely: Yeah. That's a great question. I don't have a good answer for this. But I'll give you one example. So I've done all kinds of research on the "not invented here" idea. Which is basically a bias, a not invented here bias, which is basically a bias in which we fall in love with our own ideas. And I think entrepreneurs have this bias in spades. You know, I get lots of calls from lots of people who said, "Hey, I want your feedback on something," and the reality is that they think they want feedback, but they don't, because they love their idea so much that they often don't, are not really open for feedback. And again, it could be good and bad. The good thing is people are incredibly dedicated and motivated and want to see their idea flourish. The negative side, of course, is that people can get stuck on not the perfect implementation or the perfect version and implement something that is not ideal. So it's exactly the case where over confidence and overzealous in your own idea is both good and potentially devastating at the same time.

Stangler: Right. You have had your own personal experience in terms of entrepreneurial ventures, and business, companies, and ideas. What have you learned yourself about being an entrepreneur, and what have you learned about yourself in the context of being an entrepreneur as it relates to some of your work and research?

Ariely: So, so I would say that the biggest thing that amazed me was how bad big companies are in terms of embracing any changes. So, in the early days, what I tried to do was to develop some kind of product to an idea and take it to a big market player that could actually do something. For example, we developed this idea called self control credit card. The problem is, of course, people have good intentions often, they have these good intentions where they sit in their homes and then they go to the supermarket or to the shopping mall and these good intentions stayed home and they end up buying too much stuff. And we said a credit card could bridge, could act like a time machine between your good intentions at home and your execution because when you come to pay, the card could do things for you. By the way, the phone is even better than the card in that regard. We said, what if when you were home, you would specify what categories you want to spend on and to what degree. So, for example, you could say no more than $30 on chocolate, no more than $50 on coffee, and no more than $100 in clothes. And if you pass those limits, there would be something that would happen and you would define it. You could say, send an email to my wife or to my mother, tax me at 100 percent and move it to a charity I like or to a charity I don't like. I mean, there's lots of versions you can do. And I went to quite a few big banks and said, "Why don't we do something like this?" And the interesting thing was how much resistance I got. So initially, you know, some of the resistance was, why is this good for us? We want people to spend too much money. But I think we got over that, because I showed them that it's actually beneficial because the average American has seven credit cards. It could be good for a company to be the only credit card. And one of the features of this approach is that if you have it, you really want to use just one main credit card. But then nobody ever picked it up, even when they agreed it was a good idea and we did all kinds of research to show that people loved this idea, and what kind of categories they would do and how much we thought they would be able to save and so on. And companies just don't try to innovate and this has been very depressing because as an academic, for a long time, I thought that lots of innovation happens there and now I'm convinced that almost no innovation relatively speaking is happening in big companies. And I think it's because people worry about their jobs more than the company. That's one thing, which of course we saw in the financial crisis. But I think it's everywhere. And the second thing is that people are very myopic. They only think about the immediate term. And finally, it's because people are really busy. People have a tendency to take their calendar and fill it with meetings and meetings and meetings, and if you ask them why don't you do something that will take you a few hours to figure out or a few days or a few weeks, nobody has the time. Everybody has too many, too many requests and meetings and time consumption.

So, so the first thing that I am confident about more than I used to be is that the importance of entrepreneurial activities is dramatic partly because of the structure of companies and the way they have created basically tremendous barriers to innovation. So that has been one thing. The second thing that has happened to me is that I was in a meeting with a very high level executive in an insurance company and I just couldn't believe how everybody in the room was just saying yes to this stupid individual who was just making comments that were, you know, completely detached from reality or from data. But the hierarchical structure of companies just kind of, in that particular case, just killed me. And that made me realize that I'm very, very lucky I don't really have to work for a big company. It was a huge lesson for myself. I was just frustrated that whole day. I couldn't believe what was going on around me. So I think those are kind of the big two lessons for me.

Stangler: I think those are terrific points. And the issue with big companies and innovation or lack of innovation, is certainly something that we in our work on entrepreneurship and education think about a lot and come up against a lot. You know, we ask ourselves this question. Can you somehow reinvent or reorient big companies to innovate, and you certainly I think put that question into doubt.

Ariely: Actually, I'll say one more thing. I think one of the culprits is the calendar application. So we all have calendar application and everybody else can look at our calendar and everybody can do, put meetings on a time. And I think in big companies, people have very little time to think and do something, and actually focus on their job. Every time somebody sees an empty hour, they jump on it and create, and create another meeting.

Stangler: That's correct. Maybe we should strip all the software applications of calendar apps.

Ariely: Actually, you know, I think the right approach would be to say, let's think how we would want a calendar application to look like if the goal was to get people to be more productive. For example, why don't calendar applications learn when in the day people are more productive, and when in the day are they less productive? Both in general, like over time, and specifically on every day, and make us do things that demand high capacity when we're productive, and get us to do things that don't really matter so much when we're not productive? You know, why don't the calendar applications think about it, rather than letting a schedule think. Think about our priorities of what we actually need to achieve and accomplish, and what kind of mistakes we might do. So I love software because I think that software is the way to overcome some of our financial and thinking bugs.

I'll give you one simple example. We recently did a set of studies that asked when people have multiple loans, which loans do they decide to pay faster? And we basically find that people pay the small loans first. They don't pay the with the highest interest rate, which is what they should be doing. They pay the small loans first. And by the way, from maybe three or four thousand people we've tested so far, maybe 3,400, and so far nobody has done the perfect strategy. I mean, some people do closer and further, but nobody has done that. And while it seems ridiculous, think about your own behavior with e-mail. How many times do you answer the quick e-mails that you know you can answer quickly, rather than important e-mails, just so you can feel the satisfaction of cleaning up your desk, your desktop or your e-mail box a little bit? And we do it all along. And now you can say, okay, if we identify this mistake, how would we change it? How would we change loans so that people can't make this mistake? How would we change e-mail if we understand what mistakes people do? How would we change calendars if we understand what mistakes people do? So I love this idea of using behavioral economics for software development.

Stangler: All right. Dan, unfortunately, we have run up against the limits of our time, but I want to thank you for a terrifically stimulating conversation and for agreeing to be a part of this talk series.

Ariely: My pleasure.

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