Sometimes asking someone to do something for nothing is more powerful than paying them.

In a research paper entitled “Effort for Payment: A Tale of Two Markets,” James Heyman and I that people are willing to help move a couch or perform an experiment just by being asked. Moreover, these individuals feel good about their “gift”. Most interestingly, the experiments show that contrary to standard economic theory, paying a small incremental incentive does not increase effort, but actually lowers it — because meager compensation profanes the gift effect and disincents the giver.

Bringing money into the relationship takes the giver’s work out of “gift” market, and brings it into the “pay-for-effort” market. When it was done for nothing, the protagonist was a “donor.” When small money was on the table, he or she became an underpaid employee. The easiest way to think about this is to imagine if at the end of Thanksgiving dinner you asked your mother-in-law how much you owed her for cooking such a wonderful meal. Would that increase or decrease her effort the next time you came by? (Assuming, of course, she would still invite back you after such an insult.)

In this financial crisis, there has been much discussion about banker’s pay. We think that if President Obama had asked for a group of bankers to take $0, and paid expenses only, it would have brought the discussion back into the gift economy. $500,000 is just low enough to bruise the banker’s egos (after all, they got used to much higher salaries for a long time, higher salaries we can be pretty certain they feel they deserved), but $0 is something to be proud of! In fact, paying these CEOs nothing might remind them about the responsibility they have to the banks they are leading and to the rest of society. The CEO of AIG Ed Liddy is already only taking a one-dollar salary and donating his time to this worthy effort. But his gift is isolated, a drop in the bucket — not part of an overall “corps” of senior financial executives acting in unison to help fix the mess.

Would the best people be willing to work for free? Not all capable bankers could afford it, but many could. We think there would be many willing to pitch in…if asked in the right way. After all, this gift idea was at the core of John F. Kennedy’s brilliant notion, “Ask not what your country can do for you — ask what you can do for your country.” By eliminating pay altogether, these leaders would be giving the nation the donation of their time and skill, improving their level of motivation. Instead of accusing them of being greedy and self interested, people could see them as important actors playing key roles in the stability of our entire economy. This in turn would probably encourage more bankers to see the power of a collective gift and the joy they could feel in donating something so important.

As it stands now, the many good people who are trying to improve things for little or no pay are isolated, their effort drowned out by the outrage over bonuses and salaries. Hence we have the Congress and President involved in legislating the level of executive compensation all the way down to its structure and timing! Congress should not be mired in the details of compensation design. Not only are they bad at it, but the beleaguered public — whose median household income is less than 1/10th of $500,000 — is watching the pay ping pong with collective disgust. The knee-jerk reaction to create a confiscatory 90% tax on the AIG bonuses makes the conservatives among us think we are killing capitalism itself.

When individuals commit acts of personal generosity, it sparks a gift culture that replenishes a store of trust — a resource as multiplicative as any Keynesian monetary policy. This sharing is not done in a communist, carving-up-the-spoils manner, but rather in the tradition of bravery and sacrifice for our collective benefit. When those in power act within a gift culture guided by a spirit of generosity for common cause, it creates a tangible trust asset that supports the flow of credit, money, and markets. By focusing on limiting executive pay, President Obama did the political equivalent of asking his mother-in-law how much he owed her for Thanksgiving dinner — and moved the discussion away from social responsibility, and into the pay-for-effort market, where the negotiations for spoils now dominate the discourse.

We think our bold young President has to improve his request. A gift culture — created at the top — will benefit all of us; and, strangely, will also help strengthen the rapacious markets where self-interest reigns supreme. The good news is, it’s not too late.

By John Sviokla and Dan Ariely

Will Rogers once said that “The income tax has made liars out of more Americans than golf” and I worry that he was correct.

When I came to the US I was very excited with the tax system. I thought that as a matter of civic engagement this was wonderful ritual, where once a year citizens reflected on their contribution to the common pool of taxes — both for good and for bad.  Thinking about the benefits of taxes but also worrying about the waste and protesting against it.  Only later did I realize that the tax code is so complex and annoying that instead of thinking about social issues, taxation, and waste –it is mostly a day of annoyance (in fact more than one day) and rather than promoting civic mindedness it is mostly about tying to find loopholes in the tax code that will decrease our individual payments.  

One reason for this is that the tax code is so confusing and ambiguous (is taking your sister for dinner and talking to her about work a legitimate business expense?  What if she gives you a good idea that you later use?) that we are drawn to the details of how to fit our particular pattern of expenditures within this messy tax code — and while playing this game we also try to minimize our payment.  

So, what do we do to fix this problem?  First I think that we need to simplify the tax code to make the process less time consuming, less annoying, and maybe even making it more equitable.  Second, I think that we can ask citizens how they want the government to use their tax money.  This does not have to be 100% of the tax, and instead the tax forms can ask us how we want to allocate 10% of our taxes between education, clean energy, health, etc.  By doing so I think that we can increase the care and scrutiny that should come with tax season and more generally increase civic engagement.

Finally – I cannot post something about taxes without making some comment about how to decrease cheating.  My suggestion is to have the first question on the tax form asking us if we want to contribute $25 to a task force to fight cheating and corruption.  The people who would say “yes” to this question would have committed themselves, and some money, toward honesty — and it is likely that they would continue behaving more ethically while filling in the rest of the tax form.  And for the people who answer “no”?  Maybe they should audited.

Happy tax day

Dan

Imagine that it is the last day of the month and you have $20 in your checking account. Your $2,000 salary will be automatically deposited into your bank later today.  You walk down the street and buy yourself a $2.95 ice cream cone. Later you also buy yourself a copy of Predictably Irrational for $25.95, and an hour later you treat yourself to a $2.50 cup of café latte. You pay for everything with debit card, and you feel good about the day – it is payday, after all.

That night, sometime after midnight, the bank settles your account for the day.  Instead of first depositing your salary and then charging you for the three purchases, they do the opposite – qualifying you for an overdraft fee.  You would think this would be enough punishment, but the banks are even more nefarious. They use an algorithm that charges you for the most expensive item (the book) first.  Boom, you are over your available cash and charged a $35 overdraft fee.  The ice cream and the latte come next, each with its own $35 overdraft fee.  A split second later, your salary is deposited and you are back in the black – only $105 poorer.

Overdraft plans connected to checking accounts are common at most major financial institutions, and the Center for Responsible Lending estimates that this practice costs consumers about $17.5 billion in fees every year. Given these numbers, it is perhaps not very surprising that most financial institutions currently enroll their account holders into this expensive method of covering overdrafts without the customer’s consent or knowledge and that when consumers try to get out of these programs they find it incredibly difficult.  When I called the few banks I have accounts with last week and tried to un-enroll from these programs, the most common response I got was that it was impossible. Similarly, one New Jersey columnist reported that his own daughter was charged a $35 overdraft fee for a debit card purchase of less than $2, even when he had accompanied her to open her account and asked that transactions that would overdraw the account be denied. (Paul Mulshine, ‘Courteous’ bankers in for a rude awakening, The Newark Star-Ledger, June 7, 2007, at 15)

With the current financial challenges, I suspect that the people at the lower Social Economic Status (SES) are carrying a large part of the general financial crisis in terms of jobs and housing, as well as a large part of the overdraft fees related to overdraft protection plans.  Given this, it is a good sign that the Feds are finally looking at this issue.  The first thing that the policymakers are considering is whether to require banks to let their customers opt-out of the default overdraft system.  This sounds like a no-brainer.  A far better version of the rule would require banks to obtain explicit permission from their customers before enrolling them in this program, the “opt-in rule”. So when you sign up for a bank account, you are not enrolled in this program unless you decide that you want the bank to approve debit purchases you make even if you have no money in your account.  Given what we know about defaults and behavioral economics (that most people adapt the default option as their choice, and they see it as an implicit recommendation), I suspect that with the opt-out requirements, the vast majority of consumers will become part of the program and will keep on paying these high penalties, while the opt-in approach would make consumers much less likely to join these programs. Presumably, the banks know this, which is why they are arguing for the right to put all their customers into this expensive system of overdraft coverage without asking.

But of course, this is just the first step. In addition to the pending Federal Reserve regulatory proposal, Representative Carolyn Maloney (D-NY) has introduced legislation that, in addition to requiring that banks get explicit “opt-in” permission, would require warnings at the checkout counters and ATMs to allow customers to cancel a transaction before incurring a fee. It would also stop banks from clearing transactions from the highest to the lowest in order to increase their fees.  These are useful reforms that are much needed to prevent banks from taking advantage of their customers.

The banks of course are very worried about losing this income stream, but I suspect that changing the bankers’ mindset from business as usual to one where they are actually going to start seeking their customers’ trust and products that would actually appeal to their clients is in everyone’s best interest.  Adopting such programs might in fact push the banks to further improve their overdraft protection programs so that they are truly valuable for their consumers.  For example, banks might start giving consumers better access to competitively priced short- term loans, better connections between saving and checking accounts, or at least they can start alerting consumers using SMS when they are in danger of overdrawing their account. In the meantime, the Federal Reserve Board’s “opt-in” rule would be a step in the right direction.

I am teaching today in class about self control problems, and approaches to regain self control.  Here is a story of Buffett and his attempts at self-control:

Even the most analytical thinkers are predictably irrational; the really smart ones acknowledge and address their irrationalities. We find a great example in Alice Schroeder’s “The Snowball: Warren Buffett and the Business of Life.”

Warren Buffett is a numbers-driven investor whose life choices and business decisions would make the vulcan Mr. Spock seem over-emotional. A teenage horse handicapper who grew up into a deep reader of Moody’s and Standard and Poor’s reports, Buffett is the archetypal quant: a data-processing, information-consuming, hard-thinking, analytical machine. His ability to outperform the market by basing his decisions on hard data and on an uncanny understanding of business fundamentals earned him the moniker “Oracle of Omaha.”

Buffett’s success as an investor required not only deep analysis of financial documents but also a large measure of self-control to avoid getting caught in market bubbles and panics. Buffett’s rule “buy when everyone else is selling, sell when everyone else is buying” requires enormous self-assurance to execute.

And yet, even the Oracle of Omaha is not immune to the allure of irrational behavior. He is what Behavioral Economists call a sophisticate: someone who understands his irrationality and builds systems to cope with it. (The other types of people are the “rational,” who never deviates from optimal behavior, and the “naif,” who is unaware of his irrationality and therefore doesn’t do anything to address it.)

Uncommon a person as he was, Buffett had a very common concern: he feared gaining too much weight. Rational agents don’t gain weight because they always consider all the possible consequences of all actions. Naifs plan to start their diet tomorrow.

But Buffett — who breakfasted on spoonfuls of Ovaltine — understood his predictable irrationality: people eat without consideration for the long-term effects; that’s why they gain unwanted weight. Being a pragmatic person, he decided to curtail overeating with a commitment device.

He gave unsigned checks for $10,000 to his children, promising to sign them if he was over target weight by a certain date. Many people use commitment devices to try to keep their weight down, but Buffett’s idea had a big flaw: his children, spotting a rare opportunity to get money from the notoriously frugal billionaire, resorted to sabotage. Doughnuts, pizza, and fried food mysteriously appeared whenever Buffett was home.

In the end the incentives worked: even with his children’s sabotage, the Oracle kept his weight down, and his checks went unsigned. But had he been purely rational, no commitment device would have been needed.

February 19th was the one-year anniversary for the publication of Predictably Irrational.

To celebrate I called the chef at Rue Cler — Jason Bissey — and asked him to make an irrational dinner for us.

Here is what he came up with:
As soon as we sat at the table they gave us the check and thanked us for coming — asking us to come again soon.

Next, we each got a randomly chosen dessert accompanied by cappuccino & espresso served in wine glasses.

Jason stopped by a few minutes later, spilled some wood chips on the floor, handed me a broom & dustpan and asked me to sweep the floor (which I did, and I did a good job at it).

For the entrée: they asked who didn’t eat seafood and who didn’t eat pork and made sure to give the person who didn’t eat seafood the scallops and the person who didn’t eat pork the pork dish.

The appetizer was next.  It was delicious but a few seconds after I started eating Jason came out of the kitchen and as he walked by, he helped himself to a few of the shoestring onions from my plate and just keept on walking.

Soup and salad were next. We were given large serving spoons to eat the soup with and very, very small forks for the salad.  The server stopped by a few times to make sure that everything tasted horrible and that we were having a miserable time.

At the end, she asked who had the scallops and then said “Well you’ll be needing these” as she handed those who had the scallops an Imodium AD pill in a tiny plastic cup (an Antidiarrheal medicine).

Jason – Thanks a lot. I don’t think we will forget this meal for a long time.

Given Valentine’s Day and the state of the market, let’s consider which approach to finding love is better: 1) the free market system where everyone can find their own date and figure out who and what is best for themselves; or 2) a regulated market where your parents, family, or perhaps some kind of matchmaker have a say. This may be an impractical question these days (how many people let their mothers set them up?), but this is still a complex problem that’s been discussed for millennia, without any apparent solution. But here’s a boon for anyone who is starting to lose hope of finding love: a study that shows the importance of commitment to happiness.

The world of dating has grown increasingly complex, we have online dating, speed dating, casual dating, traditional dating (I think it’s still around anyway), and so on. The problem is, that with so many options, commitment to a relationship becomes difficult—you never know if there’s someone more perfect for you just around the corner. In a world where switching partners is difficult, people are likely to hang on and attempt to work things out. But in a world where it’s easy, or seems easy, to switch partners, people are likely to give up when things first go wrong. And yet, the ever-present temptation that there is someone out there who is better can be incredibly devastating to our personal happiness.

So we have to wonder then, how important is commitment? Dan Gilbert and Jane Ebert conducted a study with this question in mind using photography. In their experiment, they gave students a short course in taking black and white photos and taught them how to develop their pictures in the darkroom. Half the people were told that they could pick one of their pictures to be professionally enlarged and developed, which they could then keep. The other half were told to pick two pictures to keep, and that they could change their minds until the minute that the film was sent off. These people had a continual temptation to change their choices, so they had time to consider and reconsider which of their prints were the best.
Later, each participant was asked to rate their level of happiness with their prints. Guess who was happier, those who chose a photo and stuck with it, or those who had flexibility and time to make the perfect selection? As it turned out, the people who could alter their choices were much less happy than the first group. The principle behind this is that when we have to deal with a certain reality, we get used to it and often come to prefer it. But if we think we can change it, we don’t force ourselves to cope, so inevitable imperfections—whether in people or in pictures—can drive us to distraction. And the same thing happens with marriage. If we think of marriage as an open market and always have half an eye on other options, we’ll be less likely to be happy.

There’s a phrase we hear all the time, and one that suggests something about our psychological makeup: we’re not just concerned with actions, but with their attendant mens rea – or lack thereof – as well. If it wasn’t intentional, then it’s not as painful.

And, as it turns out, that is quite literally true: Harvard researchers Kurt Gray and Daniel Wegner recently found that we experience greater pain when we perceive it to be deliberately inflicted, rather than by accident.

In their clever experiment, they had volunteers perform a variety of tasks, including an assessment of discomfort. This involved receiving electric shocks and then rating them on a 1 to 7 scale. When participants thought their “study partner” (who was actually a research accomplice) had selected the task for them to complete, they rated their perceived pain as higher (Mean ratings = 3.62) than when they were told the selection was computer-generated the pain was lower (Mean ratings = 3.00).

What’s more, deliberate pain was not just more acute, it also lasted longer: whereas participants rated the unintentional shocks less and less unpleasant as the experiment progressed, the intentional shocks remained just as painful.

So next time you are at the doctor try to think that he or she really cares about you.

HBR just came out with their Breakthrough Ideas for 2009.

One of my projects was selected to this list in 2008, and another was selected this year.

Here is the writeup of the project ….

Labor is not just a meaningful experience – it’s also a marketable one. When instant cake mixes were introduced, in the 1950s, housewives were initially resistant: The mixes were too easy, suggesting that their labor was undervalued. When manufacturers changed the recipe to require the addition of an egg, adoption rose dramatically. Ironically, increasing the labor involved – making the task more arduous – led to greater liking.

Our research shows that labor enhances affection for its results. When people construct products themselves, from bookshelves to Build-a-Bears, they come to overvalue their (often poorly made) creations. We call this phenomenon the IKEA effect, in honor of the wildly successful Swedish manufacturer whose products typically arrive with some assembly required.

In one of our studies, we asked people to fold origami and then to bid on their own creations along with other people’s. They were consistently willing to pay more for their own origami. In fact, they were so enamored with their amateurish creations that they valued them as highly as origami made by experts.

We also investigated the limits of the IKEA effect, showing that labor leads to higher valuation only when the labor is fruitful: When participants failed to complete an effortful task, the IKEA effect dissipated. Our research suggests that consumers may be willing to pay a premium for do-it-yourself projects, but there’s an important caveat: Companies hoping to persuade their customers to assume labor costs – for example, by nudging them toward self-service through internet channels – should be careful to create tasks difficult enough to lead to higher valuation but not so difficult that customers can’t complete them.

Finally, the IKEA effect has broader implications for organizational dynamics: It contributes to the sunk cost effect, whereby managers continue to devote resources to (sometimes failing) projects in which they have invested their labor, and to the not-invented-here syndrome, whereby they discount good ideas developed elsewhere in favor of their (sometimes inferior) internally developed ideas. Managers should keep in mind that the ideas they have come to love, because they invested their own labor in them, may not be as highly valued by their coworkers – or their customers.

Here’s a very interesting piece from the New York Times’ Review of Books: “Drug Companies & Doctors: A Story of Corruption.”

The basic story is that whereas only a few decades ago physicians generally lacked any lucrative ties to pharmaceutical companies, these days such conflicts of interest permeate the field, and debase it.

Take the example of Dr. Charles B. Nemeroff, the psychiatry department chair at Emory University. He received a NIMH grant to study drugs made by GlaxoSmithKline AND at the same time he also got $500,000 in fees from GlaxoSmithKline. Talk about a conflict of interest!

That’s not the only egregious case – there are many.  As it turns out a recent survey found that about two thirds of academic medical centers hold equity interest in companies that sponsor research within the same institution… And here is another one:  Of the 170 contributors to the most recent edition of the American Psychiatric Association’s Diagnostic and Statistical Manual of Mental Disorders (DSM), ninety-five had financial ties to drug companies.  The top dogs aside, many physicians accept hefty salaries to consult for drug companies, and most accept pharmaceutical gifts like pens and free lunches.

So the medical profession is teeming with conflicts of interest – but it doesn’t stop there. Look at politics, wall street, consulting — it is everywhere and I worry that unless we  understand just how big this problem is,  we are not going to deal with it.

A few days ago there was lots of happiness and excitement in the street and you must have wondered what was the source of this excitement.

Well, it was the publication of Peter Ubel‘s new book on behavioral economics — Free Market Madness

To celebrate, here is a web interview with Peter and you are all welcome to join in on the conversation.

Dan: You are a physician writing a book about politics and behavioral economics.  Not to get all Blagojevichy on you, but what the f%^# qualifies you to write about this topic?

Peter: I am a big fan of yours too!

Dan: But seriously.

Peter: I conduct research on the irrational forces that influence people’s medical decisions.  In addition, I take care of patients in clinic every week whose health problems arise, in large part, from their own decisions and behaviors — people with diabetes who cannot lose weight despite their best efforts, smokers who can’t kick the habit despite covering their body with nicotine patches.

Dan: What does that have to do with politics?

Peter: It means that when we leave people to fend for themselves in the free market, we can predict that they will hurt themselves by making bad decisions.  Starting from this perspective I try to expose the unconscious forces that influence our behaviors.  And then I try to show people what that means for the kind of debates we have about whether unfettered free markets deserve some, um, fettering.

Dan: All this looks a bit too general to me.  Can you give me an example of one disease, one mistake that patients make, and one policy recommendation?

Peter:  Diabetes.  We have an epidemic of adult onset diabetes in developed countries now, because people are gaining so much weight.  And the obesity that causes diabetes is a direct result of the market:  capitalism has spurred on innovation in food production, so that people now can eat tasty, calorie dense food without having to spend much time preparing or cleaning up the food (open the bag of chips, insert in mouth, yum . . .).   

What’s the mistake here?  Well, people’s appetites are influenced by unconscious forces. Change the size of my dinner plate and I’ll eat 24% more calories; tell me the food is made of “healthy fat,” and I’ll tell you it doesn’t taste good (even though, as experiments have shown the same cracker will “taste great” if I convince you it is made out of unhealthy fat.)  How much food we eat, then, and how that food tastes is far less rational than most of us believe.

Dan:  So, does this mean that the fault is with capitalism and innovation in food production?  And if this is the case what policies would you try to implement to overcome this problem?

Peter:  We need to experiment on a whole slew of policies to combat obesity: New York is requiring restaurants to post calories on their menus, a good start, but one that is likely susceptible to biases.  For example, if I was trying to sell Big Macs now, I’d add a new line of “Bigger Macs”–add a couple slices of bacon, 3 more kinds of cheese.  I’d proudly label this new burger’s calories: 50% more than the original Big Mac.  And I’d expect two things to happen:  first, some people would be drawn to this meal — risk takers, contrarians, Homer Simpson wannabees and so on; second, most people would not want this new burger, but they’d look at the Big Mac and think, “Wow, that burger is pretty darn healthy!”

I’d like to see someone try to label unhealthy food with emotive pictures, signaling that people should consider trying out another entrée.  Maybe a profile of people in varying stages of obesity?  

Ok, maybe some other symbol.

Dan: Your book is actually not much about medicine and medical related mistakes and it is largely about individuals and markets.  It seems that you believe that markets are efficient in the way that they operate, but that the outcome they arrive at is not optimal.  Can you explain this?

Peter:  Hmm, efficient wouldn’t be on my short list of words to describe markets.  Efficient sounds so uncontroversially good.  

I am a fan of capitalism. Very happy I grew up in the USA rather than the USSR.  But that doesn’t make capitalism, or free markets, perfect.  Look at all the people who bought mortgages they shouldn’t have bought, or SUVs that they mistakenly thought were safer than other cars.  (SUVs are more dangerous than minivans and even sedans, because they have a nasty habit of rolling over–very inconsiderate of them!)

Our brain can tell us that a long commute isn’t a big deal, or an adjustable rate mortgage isn’t a big risk, and the market efficiently provides us with suburban homes and fancy mortgage packages.  That doesn’t mean we picked the right home at the right price.

Confession: I live in the suburbs (barely), drive a sedan (because I don’t feel manly enough for an SUV), based the last decade of my savings and spending behavior on the assumption that my stock holdings (retirement accounts in mutual funds) would grow at 10% a year, and that my house’s value would grow faster than inflation.

At age 46, I have lots of time to rejigger my retirement plans.  But my fingers are crossed that my kids don’t get into college!!

Dan: So now that we know we should not take any advice from you, what are you hoping is the main thing that readers will learn from your book?

Peter:  This may be too personal but if they can go home at Christmas armed with good arguments to take on their insanely libertarian older brother, who really does think the market can solve all the world’s problems (“we need more free market in medicine, schools . . .”), then I will be happy.