Whenever justifying to myself and others precisely why I spend several hours a week taking part in online classes with Coursera rather than actually working on more pressing responsibilities, such as my job as a research fellow at the German research centre for consumer law or my nascent PhD thesis, I inevitably turn to the excuse that these courses are part of a broader continuing education, as well as being of interdisciplinary (such a useful term) relevance. Imagine my pleasant surprise then recently, at a conference co-organised by our research centre (Forschungsstelle für Verbraucherrecht) on consumer protection and investors, to find that not only once, but at multiple points during the conference my most recent sources of undisciplined distraction were of direct relevance to the talks being given. In a room packed with legal academics, practising lawyers, economists and various consumer protectors it is perhaps not that surprising that my new-found interest in behavioural economics, thanks to Dan Ariely’s fascinating “Beginners Guide to Irrationality” class, became extremely useful; furthermore, and somewhat surprisingly given the reputation of us legal-types for being amoral argumentative robots, my recent experiences of Paul Bloom’s “Moralities of Everyday Life” turned out to be relevant. The latter was discussed in reference to Daniel Kahneman‘s dual process theory of human reasoning – (1) intuition, and (2) reasoning – which I first encountered as a way of judging how and why we initially judge something as moral or immoral, but which of course is also of the utmost relevance when discussing how consumers reach decisions in a behavioural economics world. The former was discussed repeatedly as speakers discussed the failings of current preconceptions about the behaviour of “rational” consumers.
A little background for those of you as unaccustomed to economics as I; classical economics, more specifically “neo-classical economics”, its updated model which currently holds sway in the market reality (if not in academic circles and experimental experience), is based on the presumption that (at least for predictive purposes within economic theory) all customers are essentially rational actors, who take all the available information into account and rationally weight up the pros and cons of any economic action. As Duncan K. Foley characterises it[i]:
“Rationality” has played a central role in shaping and establishing the hegemony of contemporary mainstream economics. As the specific claims of robust neoclassicism fade into the history of economic thought, an orientation toward situating explanations of economic phenomena in relation to rationality has increasingly become the touchstone by which mainstream economists identify themselves and recognize each other. This is not so much a question of adherence to any particular conception of rationality, but of taking rationality of individual behavior as the unquestioned starting point of economic analysis.
The concept of rationality, to use Hegelian language, represents the relations of modern capitalist society one-sidedly. The burden of rational-actor theory is the assertion that ‘naturally’ constituted individuals facing existential conflicts over scarce resources would rationally impose on themselves the institutional structures of modern capitalist society, or something approximating them. But this way of looking at matters systematically neglects the ways in which modern capitalist society and its social relations in fact constitute the ‘rational’, calculating individual. The well-known limitations of rational-actor theory, its static quality, its logical antinomies, its vulnerability to arguments of infinite regress, its failure to develop a progressive concrete research program, can all be traced to this starting-point.
This rational actor, this mythical being is known as homo economicus and is rarely actually seen in the wild – much like the reasonable man, who is so fond of public transport in Clapham. Now, it doesn’t take long for the introductory paragraph of any book or article about behavioural economics to expose this understanding of the human decision-making process as unrealitisc in light of the reality of our biases, failings of logic, moods, susceptibilities and any number of cuirous behavioural quirks. I highly recommend Dan Ariely’s “Irrationality Bundle” and his website for anyone interested in reading a bit more on this area. Even before I was pleasantly surprised at this conference last week to find myself able to follow the behavioural economics arguments made by some of the speakers, I had been contemplating the effects which these sorts of insights do, could and should have on regulation and policy in the area of consumer protection. I feel that, much as in the world of neo-classical economics, the world of consumer protections policy-making still works under the presumption that consumers belong to the species homo economicus. But what if they don’t? What if consumers are in fact closer to homo irrationalis?
Now, this is obviously not to say that rationality and logic play no part in decision-making, but merely that the less-well-understood influences on human behaviour might not be sufficiently taken into account when discussing the best way to promote consumer protection and good decision-making. As Professor Andreas Oehler asked during his talk; can we really expect the average consumer to be an omni-competent multi-specialist, who forever has the most up to date information? Furthermore, a number fo speakers and attendees pointed out the dangers of the out of date idea of a perfectly rational “responsible consumer” (“mündiger Verbraucher“). These misunderstandings of the capacity of consumers to make rational decisions can and do lead to ineffective or even counter-productive measures being employed in the name of consumer protection. If this is all sounding a bit abstract, and unnecessarily judgemental of the motivations, biases and capacities of the average consumer (a group to which we all, to some extent, belong) , I will attempt to illustrate some of these inconsistencies and irrationalities using some of Ariely’s examples and studies. It is important to remember than “irrational” does not mean “arbitrary” and as Ariely’s book “Predictably Irrational” makes clear, we as consumers are not simply irrational in many of our behaviours, but in fact are irrational in often consistent, measurable and understandable ways – and as such “predictably” irrational. The upside of these rather pessimistic sounding view of our rational capacities is that our behaviours can at least be studied and understood, allowing us to develop methods for encouraging more contemplative, rational and consistent economic behaviour.
“Jam[…]”, to quote Bernard Black, “[…] jam, jam; jam, jam, jam…”. Jam is the subject of our first example of how something seemingly of obvious benefit to consumers can in fact have negative consequences. The general consensus is that more consumer choice is a good thing – this goes hand in hand with the idea that a competitive market with plenty of choice for consumers is the ideal economic model. The logic here is that if you are shopping and you see one type of jam, you may want to buy that particular jam, but perhaps not – perhaps it is not your favourite jam, perhaps you like a different brand, flavour, texture or jam, or maybe even you prefer organic, vegan and/or fair trade jam. Presumably then, if there were 5 jams available in this shop, rather than simply 1, you would have a greater chance of finding a jam you want to buy. Likewise, the likelihood of you buying jam would increase as the choice increased from 5 to 10, to 20, to 50 and so on. But how did this play out in real life?
Ariely discusses an experiment, “The Jam Study”[ii], conducted in a trade show in California, in which a display of 24 jams versus a display of 6 jams were set up to investigate the standard economics claim that more choice is always a positive factor. The 24-jam display generated many more views (that is, people stopping by the stand to take a look), and about the same number of sampling tries. However, while 30% of the visitors to the 6-jam stand ended up buying at least one of the jams, only 3% of the visitors to the 24-jam stand did. As Ariely points out, “Jams are hardly complex things, but people saw 24 stacked together and thought: ‘I have no idea how to deal with this.'”
This study showed that increased consumer choice does not linearly lead to increased benefit for the consumer. You can of course argue that buying jam doesn’t translate perfectly as a benefit to consumers, but rather benefits the manipulative evil jam tycoons, but for the sake of argument let’s presume that you, as the consumer, wanted to buy the jam – of course you did, jam is delicious – and this presumption is supported by the fact that the consumers were in fact more likely to buy jam when given a somewhat wider choice. It simply seems that after a certain level (which surely varies for different types of products and services) more choice ceases helping the consumer to decide which one the want, and instead merely scares them away from the more complex action of deciding amongst many alternatives.
This aversion to making complex choices can also have more worrying consequences, such as the decision of a doctor as to which treatment to recommend to a patient. In his TED Talk “Are We In Control of Our Own Decisions?” Ariely describes the troubling realisations about how easily we let ourselves subconsciously be swayed away from a decision which involves even slightly more complex choices, as seen in a study by Redelmeier and Sahfir in 1995[iii]:
I’ll give you one more example for this. This is from a paper by Redelmeier and Schafir. And they said, “Well, this effect also happens to experts, people who are well-paid, experts in their decisions, do it a lot.” And they basically took a group of physicians. And they presented to them a case study of a patient. Here is a patient. He is a 67-year-old farmer. He’s been suffering from a right hip pain for a while. And then they said to the physician, “You decided a few weeks ago that nothing is working for this patient. All these medications, nothing seems to be working. So you refer the patient to hip replacement therapy. Hip replacement. Okay?” So the patient is on a path to have his hip replaced. And then they said to half the physicians, they said, “Yesterday you reviewed the patient’s case and you realized that you forgot to try one medication. You did not try ibuprofen. What do you do? Do you pull the patient back and try ibuprofen? Or do you let them go and have hip replacement?” Well the good news is that most physicians in this case decided to pull the patient and try the ibuprofen. Very good for the physicians.
The other group of the physicians, they said, “Yesterday when you reviewed the case you discovered there were two medications you didn’t try out yet, ibuprofen and piroxicam.” And they said, “You have two medications you didn’t try out yet. What do you do? You let them go. Or you pull them back. And if you pull them back do you try ibuprofen or piroxicam? Which one?” Now think of it. This decision makes it as easy to let the patient continue with hip replacement. But pulling them back, all of the sudden becomes more complex. There is one more decision. What happens now? Majority of the physicians now choose to let the patient go to hip replacement. I hope this worries you, by the way – when you go to see your physician. The thing is, that no physician would ever say,“Piroxicam, ibuprofen, hip replacement. Let’s go for hip replacement.” But the moment you set this as the default it has a huge power over whatever people end up doing.
This sort of realisation is scary, but interesting, as physicians are (for the most part) well-educated and (for the most part) concerned with the well-being of their patients, but even they can fall victim to these sorts of irrational decision-making. Obviously the physicians were not conscious of the fact that they seemed to be avoiding the option with a slightly more complex choice, and would, if asked, most likely post hoc rationalize their decisions with something along the lines of “If the other medications didn’t work, then it’s unlikely these two would” or “Surgery is actually the most suitable option in this patient’s case”. Once again, you cannot simply accuse the physicans of being trigger-happy scalpel-jockeys who are too quick to recommend surgery, as in the first case, without the need to chose between medications, they were happy to stop the surgery. Nonetheless, it seems that these physicians, who were happy to delay surgery to try one more medication, were subconsciously discouraged from delaying the surgery in the second case due to an aversion to having to make the slightly more complex decision between two possible medications. These sorts of examples show how decision-making and choice, even in cases where you might expect a rational decision more than usual, can lead to a very counter-intuitive reality. Policy makers would do well to keep in mind the fickleness of human decision-making processes.
Another short, but telling, example of our irrational decision-making is the appeal of the concept of “free” to consumers, which I have also mentioned briefly when writing a short suggestion regarding organ donation policies. In Ariely’s book “Predictably Irrational”, Chapter 3 “The Cost of Zero Cost” discusses the concept which easily demonstrates how our ability to reach rational decision as consumers can be severely hampered by circumstances involving the price “zero”. (“Free stuff makes people crazy“, – Adam Smith […maybe?]) Again, Ariely refers to an experiment he conducted[iv], this time deliciously involving chocolate rather than jam, in which the concept of “free” is introduced.
In one experiment, Kristina Shampanier (a PhD student at MIT), Nina Mazar (a professor at the University of Toronto), and I went into the chocolate business. Well, sort of. We set up a table at a large public building and offered two kinds of chocolates – Lindt truffles and Hershey’s Kisses. There was a large sign above our table that read, “One chocolate per customer.” Once the potential customers stepped closer, they could see the two types of chocolate and their prices.
So what happened when the “customers” flocked to our table? When we set the price of a Lindt truffle at 15 cents and a Kiss at one cent, we were not surprised to find that our customers acted with a good deal of rationality: they compared the price and quality of the Kiss with the price and quality of the truffle, and then made their choice. About 73 percent of them chose the truffle and 27 percent chose a Kiss. Now we decided to see how free! might change the situation. So we offered the Lindt truffle for 14 cents and the Kisses free. Would there be a difference? Should there be? After all, we had merely lowered the price of both kinds of chocolate by one cent. But what a difference free! made. The humble Hershey’s Kiss became a big favorite. Some 69 percent of our customers (up from 27 percent before) chose the free! Kiss, giving up the opportunity to get the Lindt truffle for a very good price. Meanwhile, the Lindt truffle took a tumble; customers choosing it decreased from 73 to 31 percent.
Ariely also offers more concrete, consumer-policy-relevant, real world examples of how we engage in this kind of predictable irrationality; would not most of us be enticed by a FREE! bank account, which had no monthly or transaction charges, even if it had significantly worse interest rates? More than likely many of us have made this decision, I’m almost certain I have, for a “free” bank account which costs us more in the long run from high interest on debts or overdrafts and low interest on deposits, BUT THAT DOESN’T MATTER BECAUSE IT WAS FREE! As funny as it sounds, it is important to keep in mind the mysterious and powerful attraction we have to the idea of getting something for “free” – especially in a digital world where we frequently trade off getting “free” products and services for the nebulous concept of giving people access to our personal data.
Another important area where these counter-intuitive quirks of human behaviour can severely, if indirectly, affect consumers is closely linked to the topic of the conference I attended – investments, and more generally the financial sector. In this area of human endeavour there has been a catastrophic misunderstanding of people’s propensities for both rational and irrational, but most importantly rationalized dishonesty. One of the collapses discussed at the conference was that of Lehman Brothers and it is not hard to extrapolate how such examples of institutionalised less-than-completely-honest behaviour has had a knock-on effect to world wide financial instability and the general lack of trust in financial markets. Whilst it is very easy (and undoubtedly therapeutic) to blame the world’s financial woes on an evil, unified cabal of thoroughly corrupt bankers, CEOs and assorted shady financial-types, in most cases you cannot have massive institutionalised abuses and breaches of trust, and more importantly laws, with just a few bad apples. Although there are of course good examples of thoroughly corrupt and remorseless individuals (the charming gentlemen behind the Anglo-Irish bank bailout fiasco spring to mind, as well suggestions that Wall Street attracts and rewards psychopaths), scandals like Enron, Lehman Brothers and Anglo-Irish Bank seem more often than not to be facilitated by generally decent people working under conditions that institutionalise and normalise dishonesty and obscure the negative consequences of illegal or immoral actions. Indeed in other areas of human endeavour, such as the famous Stanley Milgram electric shock experiments (as I’ve written about before) it can be shown that perfectly ordinary people can take part in otherwise unconscionable behaviour under certain circumstances.
Ariely has done much work in the area of dishonesty and the rationalisations of those who directly or indirectly hurt others, since his interest was first peaked by the Enron scandal. Of particular interest are Chapters 13 and 14 “The Context of Our Character” from his book “Predictably Irrational” as well as, more specifically for our case here, Chapter 8 “Cheating as an Infection: How We Catch the Dishonesty Germ” from his book “The (Honest) Truth About Dishonesty”. His findings might surprise you, in that the majority of people involved in dodgy financial behaviours, which seem so obviously morally wrong to us, and in which we could never see ourselves engaging, seem to be normal people like you or I (ok, I’m not a particularly good example of moral or normal, but you get the idea), who simply subconsciously or even wilfully engage in the self-delusion that they are doing nothing wrong, there are no (serious) negative consequences to their actions, or that no one is getting hurt. Even outside of these denials, corrupt structures can put people in a situation where they simply cannot or do not empathise with potential victims as they usually would, either not caring about harm caused, or rationalising that if they didn’t do their morally questionable job (for example, Wolf-of-Wall-Street-style convincing of consumers that they should make dodgy investments) then someone else would. Research in this area and interviews with some of those involved in these big financial scandals reveal a truth which is perhaps more worrying than the idea that markets are consciously immorally and remorselessly run by a cabal of thoroughly rational, evil characters, and in fact Ariely and Yael Melamede are currently raising funds on Kickstarter for “DisHonesty: The Truth About Lies“, a documentary film which deals with many of these issues, and in particular features interviews with people who were involved in these scandals, to shed light of how the best of us can lose sight of how dishonest we are being.
Our failure to predict how choice affects consumer decision-making and the world’s legislators’ and regulatory authorities’ failures to predict and control the behaviour of companies, financial players and banks, shows quite clearly how the stubbornness of the insistence that we are rational homo economicus consumers can lead to practical difficulties both great and small, in both micro- and macro-economic models. I do no suggest it will be easy to come up with alternative systems, regulatory practices and consumer protection measures, but at the very least many of these neo-classical presumptions about human behaviour need to be reassessed and no longer taken for granted to be true. One of the many suggestions of how to make better policy decisions in light of these insights was suggested at this conference by Professor Andreas Hackethal as a practical way of utilising both Kahneman’s System 1 and System 2 decision-making processes. The obvious, relatively uncontroversial, suggestion is to promote System 2 logical decision-making by “engaging” people to think more deeply about their decisions as consumers, rather than to make System 1 snap decisions based on intuition and immediate impulses. The difference between the automatic, intuitive decision that 2+2=4, and the slower, more considered, less impulsive decision that 173+2,758=2,931. The second suggestion is to manipulate our System 1 decision-making propensities to make more desirable decisions, closer to rational System 2 decisions. A good example of this were apps such as the bank Sparkasse’s “Klicksparen” or “Impulsspar” ideas, and similar websites and apps which seek to harness our weakness to impulse buying and use it to promote responsible financial behaviour by prompting consumers who are about to make an impulse purchase to perhaps “impulse save” a portion of the cost price instead. These sorts of measures use our System 1 weaknesses and behaviours (impulse decisions) to help us make more System 2 decisions (showing restraint, saving for the future, considering opportunity cost).
Ariely, along with Klaus Wertenbroch, similarly found that imposing responsible behaviours or at least giving people the chance to set themselves rules for responsible behaviour had significant positive effects. In his experiment he took different approaches with three different university classes of his regarding deadlines for handing in three assignments over the course of the semester.[v] Some were given only one final deadline at the end of the semester; others were allowed set their own deadlines in advance, which they then had to stick to on pain of a penalty to their marks; and the final group were given evenly spaced deadlines as set by the professor. The study ultimately showed that those with the externally imposed deadlined did best, those who set their own did quite well (in proportion to how evenly spaced they set the deadlines, with grades deteriorating the more closely bunched at the end of the semester the deadlines were); and those who had only one deadline suffered in their marks, seemingly as a result of rushing all of the assignments in the latter half of the semester, rather than using the whole semester efficiently. Of course, in a standard model of economic behaviour, the no-deadline group would be the obvious choice, as it would leave the most time to complete each assignment, as assignments could always be submitted early, but due to our innate weakness to impulse procrastination, it is often good to set ourselves strict deadlines.
Procrastination is all too familiar to most people. People delay writing up their research (so we hear!), repeatedly declare they will start their diets tomorrow, or postpone until next week doing odd jobs around the house. Yet people also sometimes attempt to control their procrastination by setting deadlines for themselves. In this article, we pose three questions: (a) Are people willing to self-impose meaningful (i.e., costly) deadlines to overcome procrastination? (b) Are self-imposed deadlines effective in improving task performance? (c) When self-imposing deadlines, do people set them optimally, for maximum performance enhancement? A set of studies examined these issues experimentally, showing that the answer is “Yes” to the first two questions, and “No’’ to the third. People have self-control problems, they recognize them, and they try to control them by self-imposing costly deadlines. These deadlines help people control procrastination, but they are not as effective as some externally imposed deadlines in improving task performance.
Ariely and Wertenboch’s study, and others like it, show that we can most effectively influence consumer behaviour (in certain cases) positively by mandating relatively strict rules, deadlines and penalties for non-compliance. Naturally, in many cases, such as when or whether to exercise and what food to buy and eat, these sorts of strict rules at a legislative or policy level will not be welcomed. But, as Ariely points out, they could in some cases be appropriate, especially considering the fact that we already engage in these sorts of policy measures in other areas, with a view to coercing better behaviour; such as requiring the wearing of seatbelts, or banning smoking in workplaces. Furthermore, even in cases where we might shy away from our more dystopian paternalistic urges to create a race of perfectly rational über-consumers, we can still reap many of the benefits of encouraging rational consumer decision-making by encouraging consumers to set themselves rules, limits and deadlines as in Ariely’s second class and Hackethal’s impulse saving apps.
Finally, it is important not to go power-mad with our new-found understanding of the irrationality behind much of our behaviour as consumers; applying our initial conclusions about such research without careful consideration and perhaps trial runs could lead to as many problems as it might help alleviate. A good example of the dangers of blindly applying our understanding of behavioural economics is the temptation to conclude that consumers do not really need that much information or choice, as in many cases it seems that more information and choice can lead to negative consequences. This sort of thinking can lead companies, both consciously (if we’re feeling cynical) or subconsciously (if we’re feeling generous), using the worries about “information overload” to justify providing consumers with far too little information. What seems more important for consumer information and choice than simply the quantity of information is the transparency and comparability of the relevant information. It seems to be the increased complexity of reaching a decision that in fact discourages consumers rather than the quantity of available information per se. This is perfectly obvious in the case with the physicians and the possible medication-based treatments – one more possible treatment option to try does not bring much new information to the table, but it increased the complexity of the decision enough to discourage making the rational decision to try one or both of the treatments before resorting to surgery.
A practical example, close to my own heart, of where this issue has proven problematic, is the question of how much information internet service providers (ISPs) should have to provide their consumers with to allow them make a decision on which package or which provider is best for them. ISPs often raise worries about information overload to justify not providing more information up front on the details of their services.[vi] However, as Darren Read points out,[vii] a study by the Tilburg Law and Economics Centre (TILEC), from August 2010, entitled “Network Neutrality and Transparency: Theory, Experimental Research, Policy Conclusions”, seemed to indicate that increased levels of information being available to consumers did not per se have a negative effect or lead to any sort of information overload – those who understood the extra information found it useful, those who did not simply ignored it. – but that the more important foctors were how transparent this information was and how easily it could be compared with other offers in the ISP market. For example, I find standardised tables of relevant information really rather useful for comparing offers, and in fact here’s one (in German) I made earlier for ISPs (a rough attempt, truth be told,):
Yes, it could do with a bit of work, and might be a bit more comprehensible in English, but such a table is at least in theory an example of how we can make comparisons and decisions easier for consumers in these sorts of situations. It’s a fine line we need to tread; between not falling foul of people’s inherent biases and behavioural quirks by overloading them with too much choice and information; and not treating them like simpletons who need to be protected from big scary decisions and complicated information. One way or another it seems that policy makers would benefit from taking some of these common misconceptions and mistakes about consumer behaviour and decision-making into account when they next consider how we should best be behaviourally manipulated for our own good.
[i] Foley, D.K., “Rationality and Ideology in Economics”, (2003), Lecture in the World Political Economy course at the Graduate Faculty of New School UM, New School.
[ii] Iyengar, S. S., and Lepper, M., “When Choice is Demotivating: Can One Desire Too Much of a Good Thing?” (2000), Journal of Personality and Social Psychology, 79, 995-1006.
[iii] Redelmeier DA, Shafir E. Medical Decision Making in Situations That Offer Multiple Alternatives. JAMA. 1995;273(4):302
[iv] Shampanier, K., Mazar, N., and Ariely D., “Zero as a Special Price: The True Value of Free Products.” (2007), Marketing Science, Vol. 26, No. 6: 742-757.
[v] Ariely D, Wertenbroch K., “Procrastination, Deadlines, and Performance: Self-control by Precommitment”, Psychol Sci, 2002 May;13(3):219-24.
[vi] Ofcom, “Approach to net neutrality” 24 Nov 2011, para 1.14, available at http://stakeholders.ofcom.org.uk/binaries/consultations/net-neutrality/statement/statement.pdf
[vii] Read, D., “Net neutrality and the EU electronic communications regulatory framework” (2012) International Journal of Law and Information Technology, 20, 48.