If you look up the list for the Winners of the Nobel Memorial Prize in Economics, you’re bound to come across Mathematicians, Economists, and most importantly, Psychologists. The behavioral side of economics has become more and more pertinent in the 21st century as people realize that the economy shifts when people’s sentiments do.
Dan Ariely is the James B. Duke Professor of Psychology and Behavioral Economics at Duke University and he was there at Money 20/20, Europe 2018 to enlighten the audience as to why people choose the economy they do.
He began in jest, by asking the audience to admit to themselves that they misbehave in general. It was no revelation that people don’t exercise regularly, stay up late at night, eat junk food and even text while driving. They even pass on washing their hands after going to the bathroom at times. The reason is simple, we place the short term satisfaction of our actions over our long term objectives.
But it’s much more than that. According to Dan, we are influenced by our environments much more than we know. This is a principle in behavioral economics. He gave the example of Express, an online pharmacy in the UK, to illustrate this.
Express wanted their customers to change their preference of medicines from branded to generic. The deal they offered to their customers was, if they would switch to generic, the medicines would be free for the whole year. However, less than 10% of them switched. Express then went to Dan and asked him for advice. He suggested mailing the customers letters that said, if they wanted to keep their subscription, they had to come to the physical location to return the letter; additionally they would get to choose between generic and branded medicines. The result: 80-90% of customers switched.
To Dan, this revealed that friction in the economy mattered because it pushed people to reveal their preferences. What stops them from doing that is ease. It took work to switch from branded to generic medicines but it was a choice. When Express took away that choice and handed their customers an ultimatum, the ease of inaction went away.
Another example of environments influencing choice is the freezer. Most of us buy vegetables and fruits and stuff them in the drawer below our main groceries. As a result, we see everything that we want to eat when we open the freezer, at eye level. By the time we bend down for the vegetables and fruits, it’s too late, they’re rotten. That’s bad design.
The insight gleaned from these examples is that when desired behavior equals ease, the best outcome arises.
Then Dan shifted the conversation to the invisibility of money and its impact on spending. He argued that digital currency had made spending visible and saving invisible, so that the former was rampant and the latter almost non-existent. Thousands of years ago, the first people used to raise livestock; each animal was a part of their savings. Neighbors used to compare each other’s livestock and this allowed them to compete with each other to raise more. Today, with digital currency, we only see what we spend.
He pointed to an interesting study which showed that the neighbors of lottery winners began spending more, even to the point of bankruptcy. He pointed to two interesting examples to drive his point home.
The first was teaming up with M-PESA in Kenya where people live on $10/week. This makes it almost impossible for them to save. M-PESA allowed them to send money into an account easily, but made withdrawal hard. They made it so that their savings were transferred into an investment bank and into the Kenyan stock market. Withdrawal would entail taking a bus to the city, filling out a form, waiting for an hour for the money and then taking the bus back. So obviously, this incentivized saving. The environment made it harder for the customer NOT to save.
Next, M-PESA added incentives to repeat this process. The first were weekly reminders, some from the company and others made to look like they were from the customer’s children, “Try and save 100 shillings this week for the future of our family.” This capitalized on the guilt that parents feel if they’re not saving for their children. However, all of these measures paled in comparison to “The Coin”. M-PESA gave its customers a coin with 24 numbers on it to place in their home. And for each week, they were supposed to scratch that number with a negative or positive sign. The customers with the coin doubled their savings in a year.
The second example was South Africa. Funerals are very expensive there. It takes around 1-2 years of income to arrange one. So there’s actually funeral insurance in South Africa, which allows people to insure themselves for a week, or a month. There are no other options. Yet, that insurance is very popular, even amongst the poor. The reason is, it is an investment into something immediate and very real. So even if a poor family is eating less food one day, they know their money has been set aside for an important economic activity.
Even in America, it’s been shown that if an employee shares his employment package of a 401(k) with his spouse or family, it provides extra visibility to that investment and it’s more likely to be approved.
Dan concluded his talk with the thought that the nature of money is not compatible with how people make good decisions. He conducted a thought experiment with the audience to demonstrate this. He said if there was a restaurant that charged people one dollar per bite and one day, it switched that policy to half a dollar per bite, people would inevitably try to take bigger bites of whatever portions they were served. This would make the meal less pleasurable, however “efficient”, the process of eating may be.
It seemed, according to Dan, that the nature of money truly did make people do stupid things.