DAN ARIELY TALKS WITH KATE FILLION ABOUT WHY SO MANY ECONOMISTS UNDERSTAND SO LITTLE, AND HOW A BURN UNIT CHANGED HIS LIFEQ: What exactly is a behavioural economist?

A: Much of standard economic analysisassumes rationality. If you ask a standard economist why people don’t saveenough money, they’d say it’s a meaningless statement; people are reasonable,they know what they’re doing–they might not be saving a lot because maybe theydon’t have enough resources right now, maybe they want to check out how itwould feel to live with their kids at retirement, maybe they really want totest out the bounds of social security. Behavioural economists, though, believethat people make all kinds of irrational mistakes, and we try to analyze themin order to create opportunities to help people out. For instance, have youever gone to a restaurant wanting to watch your diet, but when the waiter camewith a tray of desserts, you succumbed to temptation?

Q: That’s just because I’m weak.

A: Well, a standard economics perspectivewould say, “If you eat a cheesecake, at the end of the day, it means youare not really concerned with your weight.” Behavioural economists say,”No, people are really concerned with their weight, they just can’t handlethe emotion that comes over them from getting so close to the chocolatesoufflé, and as a consequence, they make a mistake and regret it later.”You have a different long-term goal than the short-term goal, and in manycases, short-term goals have an emotional component that overtakes us and makesus forget our long-term goals. Think about health care. Nobody wakes up andsays, “Today’s a good day for a colonoscopy!” Because of the fear anddisgust that takes over when we think about it, we procrastinate and eventuallydon’t end up doing it.

Q: Speaking of irrationality, do you find people havenegative expectations of you based on the fact that you have visible scars onyour face and hands?

A: Yes, very much. When I meet people, I’mvery sensitive to whether they shake my hand or not, and I very much categorizepeople by the type of handshake they give me. There are these people who kindof hold [my hand] between their thumb and their index finger.

Q: Like it’s a bug or something.

A: Yeah! I can understand that it’s notcomfortable and you don’t know exactly what to do, but on my side, it’s difficult.

Q: How were you injured?

A: I was 18, at the beginning of mandatorymilitary training in Israel. I was in a place that had someammunition, and among the things they had were flares, these bombs that aresupposed to light up the whole battlefield. One of them exploded next to me.There’s nothing glorifying about that injury, it was just a stupid accident.

Q: How did you get from lying in a hospital bed with 70 percent of your body burned to reaching the top of your field and teaching at MIT?

A: The hospital is a completely differentuniverse, and I was there for a long time. For months I couldn’t eat, I was fedthrough a tube, I couldn’t walk, I couldn’t even move. I started looking at thepeople around me and feeling more and more like a neutral observer because Iwasn’t a part of that life anymore. I really started working on [the idea of]human irrationality through the bath treatment, which is the horror of everyburn patient. Every day, sometimes twice a day, burn patients are lowered intoa big metal bath filled with water and iodine to soak a little bit, and thenthe nurses start tearing the bandages off. Everybody’s had a Band-Aid removed,and it’s always a question of do you do it slowly, or fast? But when it’s 70per cent of your body, and occurs every day, and takes more than one hour, andthere’s absolutely no skin so the bandages have adhered to flesh, it’s reallyvery intense. The nurses in my unit believed the best way to get the bandagesoff was by tearing them very fast, one after the other, and trying to finishquickly.

Q: To minimize the torture.

A: Right. But I thought it would be betterto make it slower and more steady for a longer duration, with less pain everysecond. When I got out of the hospital, I wanted to test out my theory. So Icreated experiments [at university] in which I would hurt people in differentways. Sometimes you would get a high intensity pain for a short time, sometimeslow intensity but longer duration, sometimes pain that increased, sometimespain that decreased–all kinds of versions, and I hurt people in all kinds ofways: with heat, with a carpenter’s vise I would crunch their finger, and soon. It turns out that the nurses were wrong: it’s much better to have a longerduration of pain with lower intensity than a shorter duration with higherintensity It also turns out that it’s much better to start with the mostpainful part and end up with the least painful, to create a decreased patternof pain over the treatment. The nurses didn’t know that. I was bothered by thefact that here were these really good people who had tons of experience–theydid many of these baths every day for many years. How could they not know theright approach? And I started wondering: what are other cases in which we havea lot of experience and data but very little real knowledge?

Q: So in a very real sense, your injury shaped your careerpath.

A

The accident was aterrible thing, but it also changed my life in some important ways. All throughhigh school, I was in the last row of the class, making jokes, never reallybeing involved in school. But after my injury, after getting out of thehospital, I started university, and for two years I had these bandages all overmy body, to keep pressure on the scars. Everyone around me was young andhealthy, and they would look at me and see this limping, brown-bandaged,Spider-Man-type image. People expect some correlation between the way you lookand your intelligence–I’m not sure I would go as far as to say they expectedretardation, but definitely they expected lower intelligence. I still feel alittle bit of the same today. So I started participating in classes and askingquestions for the first time, partly because I felt this was all I had. I wassort of invisible, the only thing you could see was my eyes, and the only way Icould portray something about myself was through speaking in class.

Q: Now you portray yourself as acontrarian. In your new book, Predictably Irrational: The Hidden ForcesThat Shape Our Decisions, you state the centrepiece of standard economictheory, that supply and demand determine markets, is a fallacy. How so?

A: It’s not a simple, straightforwardanswer. Let me describe an experiment first. We went into a classroom and solddifferent products: keyboards, books, chocolate and so on. We asked people toinspect the products, then write down the last two digits of their socialsecurity numbers. Let’s say your last two numbers are 44. We then asked whetheryou’d buy each product for $44. Next, we said, “Now we’re going to have a[silent] auction, a real one where the highest bidder will pay cash for anitem–please submit your bids.” Well, there was a .5 correlation betweenpeople’s social security numbers and how much they were bidding. So your firstdecision [regarding a purchase] can be rather arbitrary, but once you’ve madeit, other decisions can be based on it. Here’s the thing: decisions about aproduct or service should, according to standard economics, involve acost-benefit analysis. But it turns out, we don’t really know how toevaluate something in terms of its value. Think about something as simple as apiece of chocolate: it’s melting in your mouth, it’s oozing sweetness–how muchis this experience worth? How easy is it for you to say, “Exactly 85cents, but I will not pay 86”? It’s very hard to take an experience andtranslate it into monetary value. So what people do is to think about theirpast decisions as a starting point for their next behaviours.

Q: A lot of the experiments in your book are very cleverlydesigned. Is there one you left out that you really like?

A: A study that I find very interesting,that was very difficult to do but potentially quite important, asked the question,do people always perform better when you offer them more money? This is what’sdriving the incredible salaries of CEOs: let’s just offer these people a ton ofmoney based on their performance and stock performance, and they will really bedriven to do well. But does being driven to do well actually help you do yourbest? We came up with a couple of tasks that demanded creativity, thought, concentrationand memory and so on, took them to India, and got people to do them and paidthem based on their performance. Some people we paid a small amount: if you dothis well, you get an hourly wage, if you do it very well, you get two hours’wages. Some people we paid a month’s wages; some people we paid six months’wages. What we found was that when more money was at stake, people really triedharder, but actually performed worse.

Q: Was it simply anxiety about not getting the money?

A: Money is a double-edged sword. Itmotivates you, but beyond a certain level, it actually backfires. Imagine Isaid, I’ll give you $50,000 if you’re creative in the next five minutes. Howmuch of that five minutes would you spend thinking about the money versusthinking about the task? Or think about the even worse version: in theexperiment, we gave some of the people the money upfront, then said, “Ifyou don’t do well, you’ll have to give it back.”

Q: Were they even less creative then?

A: Oh my goodness, they hated it! Twopeople ran off with the money. We had to stop doing it.

Q: Does recognition work better as a motivator than cash?

A: Sometimes. We live all the time in twomarkets: one is social, and one monetary. We apply different rules in each, andwe decide to work to a different intensity in each, based on rewards. Imaginethat I ask you to help change the tire of my car; next, imagine that I ask youdo the same thing and tell you I’ll give you $2. Instead of thinking,”Hey, I get to help Dan, plus I get $2,” you’re actually lessinclined to do it–the social value of helping is eliminated, so you only thinkabout the money, and it seems insulting. When we move from zero to any amount,we move from a social to a financial norm. We did an experiment where we didn’tgive people money but gifts. We gave people nothing, or a tiny gift of a candybar, or a box of Godiva chocolates, and we saw that people were not offended bythe small gift, they worked hard all the time. So next we created a mixedmarket, where we gave the same gift but told you how much it cost us. Well,when people learned they were getting a 50-cent candy bar, they were suddenlyupset and not willing to work very hard. What this says for society andbusinesses is, I think, quite important.