2008 was a very interesting and important year for Behavioral Economics.

For many years, the common reaction to the experimental evidence showing different types of irrationality was that these irrationalities will “go away” when dealing with professional people, dealing with a lot of money, and of course acting within the competitive environment of the market.

While I never understood the intensity of beliefs in these arguments, it was not really possible to test these assertions — so this remained an academic debate.

In 2008 when the markets failed is such a miserable way, it became clear that rationality was not just playing a role in “regular” peoples’ lives, and that it was also a part of professional sector and our institutions.  Now irrationality became much more interesting to the general audience, business, and even policy makers.

Predictably Irrational was first published in February 2008, and given the relative ease of modifying books these days, I decided to add some of my reflections on the stock market crisis — and create an expanded edition of Predictably Irrational.  Once I decided to add some material, I also realized that I have learned some new things in the last two years about some of the original chapters in Predictably Irrational, so I added some material about these topics as well.

The expanded edition will come out on May 19th, with a somewhat different cover (see below), more material, and also with a more aggressive stand against rational economics.

I am looking forward to the reactions to this version, and in particular to the criticisms from rational economists.

Order from Amazon

Recently I wrote a short summary of Christakis’s research for Time magazine 100 people of 2009.  Here is my summary of the research:

Social scientists used to have a straightforward, if tongue-in-cheek, answer to the question of how to become happy: Surround yourself with people who are uglier, poorer and shorter than you are – and who are unhappily married and have annoying kids. You will compare yourself with these people, and the contrast will cheer you up.

Nicholas Christakis, 47, a physician and sociologist at Harvard University, challenges this idea. Using data from a study that tracked about 5,000 people over 20 years, he suggests that happiness, like the flu, can spread from person to person. When people who are close to us, both in terms of social ties (friends or relatives) and physical proximity, become happier, we do too. For example, when a person who lives within a mile of a good friend becomes happier, the probability that this person’s good friend will also become happier increases 15%. More surprising is that the effect can transcend direct links and reach a third degree of separation: when a friend of a friend becomes happier, we become happier, even when we don’t know that third person directly.

This means that surrounding ourselves with happier people will make us happier, make the people close to us happier – and make the people close to them happier. But social networks don’t transmit only the good things in life.

Christakis found that smoking and obesity can be socially infectious too. If his thesis proves out, then the saying that you can judge a person by his or her friends might carry more weight than we thought.

A few people have been asking me if there is a good way to self diagnose the swine flu.

Luckily there is a highly accurate test (with accuracy above 99.9%).

Step 1: ask yourself: do I have the swine flu?

Step 2: scroll to the bottom of this screen

Congratulations!  You don’t have the swine flu

An interesting argument between Bob Frank and Fox news about the role of luck (and some about taxes as well)

What is amazing to me is how little evidence we have to support any side of this debate and yet how certain each person is in his position.

Maybe what we need is research directed at the beliefs that drive our political system and convictions.

A few weeks ago at TED I met John Hodgman, and he agreed to watch my version of his mac vs pc videos (he is the guy playing the PC on the apple ads).  He approved.

This is the last one in the set

Here are the first two question of the exam I just gave:

1) My parents and grandparents would be most proud of me if:
a. I did not cheat on this exam and got the score I deserve
b. I cheated on this exam and got a score higher than the score I deserve

2) While taking this exam, I intend to:
a. cheat (e.g., by looking at other people’s answers, or showing my answers to others)
b. not cheat

I think it was effective..

It’s hard to displace a global economic crisis from headlining the news, but the pigs did it. A n variant of the H1N1 flu virus, associated in our lore with the 1918 flu pandemic, has jumped species and infected humans. There are reported deaths (though numbers and details vary wildly) and cases appear to have spread globally.

The media jumped on this new new new crisis, the politicians around the world thanked Providence for something to distract voters from their ethical lapses and the opportunity to pad their budgets, pharmaceutical stocks rallied, airline stocks tanked, and the conspiracy theories are running wild. The Russians stopped importing pork, even though you don’t get the flu from eating pork.

On the positive side, a few more people started washing their hands. This is a rational response; hygiene is an innovation that works. (Purell and other hand disinfectants work in a pinch, but washing your hands for at least one minute, with a long rinse in running warm water is better.)

Three of our predictable irrationalities give the swine flu story much more impact than it should have — and in this case, it would be better if we were more rational.

One: Unlike the agents in economic models, we have limited memory and limited thinking capacity; to manage it we shift our attention depending on outside information. Or, in non-academese, we pay attention to what’s happening now: things that are recent and things that are repeated often get more attention, even if they are not that important. Because the news focus on the negative (it’s their business model) we keep hearing about the cases discovered, and not about the millions of people who were exposed and didn’t get sick. Which gets us to point two:

Two: We overweigh new risks relative to comparable risks we are accustomed to. Around 100 people per day died in US roads in 2008, an enormous improvement over previous years but still. People obsessing about spending 5 minutes in elevators with others (an infinitesimal chance of contagion) will blithely cross the street against the light to have a artery-clogging triple cheeseburger with fries and then smoke a pack of cigarettes. These things have much higher risks, but because we have grown accustomed to them, we don’t think of the risks. They are not, in the technical term, salient; but they are much more dangerous. Still, their dangers are dry statistics and people are not good with statistics, which gets us to point three:

Three: Brains are wired to work well with stories. And there are many stories one can make from the news reports: pandemics amplified by airport air recycling and global travel; mass extinction followed by anarchy and mayhem; terrorism taking advantage of the burden on the health system; the flu as prelude to alien invasion from Alpha Centauri. Ok, the last one only works around the MIT Media Lab. But we love stories, and forget that the plural of anecdote is not data. Statistics, dry as they may be, give a lot more information than stories.

It is not that this problem is not real and important, I just don’t think that relative to our other problems, it is as big as we are making it to be.

What can we do: as the British said during the Blitz, keep calm and carry on. Take appropriate precautions, wash your hands, and if you’re sick get help and keep out of crowds.

CDC page on this flu

2 years ago on April 29th 2007 I turned 40 and at the same day submitted the final draft of Predictably Irrational to my editor.

It has been an incredible journey, very unexpected, and much more exciting than I imagined.

A few weeks ago I finished writing the expanded version of Predictably Irrational, and today I should get the first copy from the printer.

Irrationally yours

Dan

Paul Krugman published an op-ed yesterday about exec salaries.

The very sad conclusion he comes to is that because the financial markets seem to be on an improving trajectory (although it is hard to know if this reflects a real improvements in the economy yet) the push to reform the banks could die off.  As Krugman puts it: “In 2008, overpaid bankers taking big risks with other people’s money
brought the world economy to its knees. The last thing we need is to
give them a chance to do it all over again.”

We are now in a unique point in time where we just realized the mess we got ourselves into by assuming that the markets will be perfectly rational — and I sure hope we are not going to forget this painful lesson just because the market seem to be slightly higher these days.  In fact, I suspect that what we need to do is take this lesson to heart and expand our search for other markets that are just waiting for similar disasters (and the health market looks to me to be heading is similar direction..)

Derek Bok, the 25th President of Harvard, famously said: “If you think education is expensive, try ignorance.” What we need is more business education, not less!

There are recent debates about the value of MBA education and I have to say that I find the notions of scrapping management education somewhat odd.  It is not that I think that management education is perfect, far from it, but its importance in my mind has only increased due to this financial crisis. Does anyone really want to suggest that the people who are running our institutions and companies do not need to learn more? That they don’t need to have specific knowledge to better guide their companies and our economy? For example, is there anyone who doesn’t think these days that executives need to have a much better understanding of accounting, and that they need to know how to read accounting statements?

From my perspective, the main lesson from this economic meltdown is that despite our confidence – we actually know very little about the operation of the financial world around us.  Moreover, it is clear that such lack of understanding, together with high confidence and reliance on the opinions of others (presumably experts) can have devastating consequences. If anything I suspect that this meltdown shows exactly how important it is for executives to have a better understanding of the world in which they operate.

Of course, like many others, I believe that it will be very useful to change the curriculum of the MBA program so that it is more useful — but if anything I would make it mandatory for executives to keep on learning throughout their careers in the same way that we require physicians to keep on improving and learning.

In terms of the actual curriculum for management education, my own view is very simple-minded: The world is incredibly complex, it changes all the time, and we should not even hope that we could create a general model that accurately describes the world in all its possible states. Instead I proposed that management education and practice should become much more experimental and data-driven in nature — and I can tell you that it is amazing to realize how little business know and understand how to create and run experiments or even how to look at their own data!

We should teach the students, as well as executives, how to conduct experiments, how to examine data, and how to use these tools to make better decisions.  For example, over the past five years or so we have learned from experimental evidence a lot about the tricks that conflicts of interests can play on us, and these findings help us understand financial catastrophes from Enron to the recent market failures (for my take on this see TED).  Given this new understanding, and we lean more and more all the time, I think it is crucial to transfer this knowledge to business executives so that they can take this new understanding into account.

Disasters are usually a good time to re-examine what we’ve done so far, what mistakes we’ve made, and what improvements should come next. If the lesson from all of this will be to blame the MBA programs than I think we would have not gained much. However if we will seriously consider how to keep on exploring and understanding the complex world we live in, and make this an inherent part of management education, perhaps the future version of our world would look better.