If you wonder why governments care about lifestyles of their citizens, the reason is mainly money. Unhealthy diet, frequent consumption of addictive substances (mainly alcohol or tobacco), and lack of physical movement are all widespread and may lead to “non-communicable diseases”, such as diabetes or cardiovascular diseases. The governments have two possibilities – either encourage the change in lifestyles and decrease the occurrence of such diseases or pay for the cure. Obviously, prevention is a cheaper choice and in case of lifestyle issues, also feasible.
Moreover, if governments understand human behaviour, their attempts to change it will probably be more successful. That is why Behavioural Economics can be helpful in this domain.
Part I of this article was dedicated to the nudges related to food consumption. Part II will discuss nudges concerning tobacco and alcohol consumption and physical movement.
As for physical movement, there has been a very simple nudge trial conducted in the City of Melbourne in Australia. To encourage people to take the stairs instead of elevators in a train station building, the City of Melbourne had the stairs painted in a colourful and catchy way (see Picture 1). It may not seem like a very strong nudge; why would anyone struggle on the painted stairs if they can see them also from the elevators? But it seems that the citizens of Melbourne did not think like this – according to a report by the Behavioural Insights Team (that collaborated on this trial), the usage of the stairs increased by 25% during off-peak times and by 140% in peak times!
Moving to tobacco consumption, the nudges used around the world are quite uniform. There are two major manipulations that have been implemented.
1) The first one is plain packaging, whereby the tobacco producers cannot use the package as a marketing space and have to comply with rules for uniform font, size and colour of the text, as well as uniform package colour. The space previously used by companies is now dedicated to health warnings, both in words and in pictures (see Picture 2). The rationale behind such a policy is that it decreases the appeal of tobacco products and at the same time, gives more importance to the health warnings, which should deter people from smoking. It seems like a good idea at first glance, but when one thinks about it more, the following doubts arise. Firstly, there is a large amount of brand loyalty among smokers, so it is not probable that they will stop smoking only because of a change in design. Secondly, there is the optimism bias that goes against the effectiveness of health warnings. People usually overestimate the probability of positive things happening to them and underestimate the probability of the negative ones. Hence, when they see a health warning, they may simply think “it happens, but to the others, not me”.
2) The second widespread anti-smoking nudge-based policy is the tobacco display ban. In the countries where it has been introduced, tobacco products have to be displayed so as not to be visible to the customers in the shops (with the exception of specialised tobacco shops, of course). Again, such policy goes against marketing possibilities of tobacco producers and the hope is that it will decrease the amount of impulse purchases, which are frequent mostly among the young.
There are several papers trying to evaluate the impact of these two anti-smoking policies, but there is no clear conclusion to be drawn. It seems that smoking is a very complex issue and is cannot be easily solved by using only nudges. Another issue is that in many countries, these policies have been implemented only recently, so it is too early to know their impact. Anyway, even if the nudges are not the solution in this case, maybe they could still complement some other policies to make a real change.
The last lifestyle issue is alcohol consumption and there is a very nice example of the use of nudges in this domain. At the Northern Illinois University, a simple marketing campaign based on social norms (i.e. informing the students about how many drinks other students have when they party) was enough to decrease students´ binge drinking.
To conclude both articles about the nudges related to healthy lifestyles, I would like to say one thing. Clearly, nudges do not automatically solve all problems. But as long as they are low-cost and do not harm anyone (such as removing the salt shakers from restaurant tables or painting the stairs in a train station), I think they are worth trying, because even a small positive difference is a step forward towards a healthier life.
How can we nudge people to donate to charities? There are many ways to do so, but we would like to share one in particular which is very simple and surprisingly powerful.
It seems that peer effects are an effective tool to change people’s behaviour. We want to do what people like us are doing. If teenagers have friends that smoke, they are very likely to start smoking themselves (and much more likely than if their parents smoke). The same holds for donations – if our colleagues donate, we would like to donate as well.
This is what has been tested by the UK´s Behavioural Insights Team in cooperation with Her Majesty’s Revenue and Customs (HMRC). The HMRC employees in Essex were sent postcards describing the donation efforts of their colleagues and encouraging them to do the same, to see if more people would start donating. However the experiment went even further (and this is where it gets interesting). One group of employees got postcards featuring a picture of the donor in addition to the above information (see Picture 1). An insignificant change, you may think, but 6.4 % of people signed up for the donation scheme in the latter condition, compared to 2.9 % in the no-picture condition.
Picture 1: Postcard featuring a photo of the donor
“Scarcity” was published in 2013, written by Sendhil Mullainathan, professor of Economics at Harvard, and Eldar Shafir, professor of Psychology and Public Affairs at Princeton. The greatest strength of this book is also its greatest weakness: it’s educational. On the one hand this is good, because it brings Behavioral Economics to the general public and we certainly need it; on the other hand, the lack of a model makes the analysis shakier than we would like.
At the very beginning the authors define scarcity as “having less than you feel you need”; traditionally, development economists focused only on physical poverty. However,with this definition, they want to emphasize that scarcity can be both physical and mental. The main takeaway of the book is that scarcity is a mindset that lures people into a poverty trap, the leaving of which is very difficult.
To better illustrate this point, throughout the book they refer to several experiments that have taken place both in developed and developing countries. The best feature is that they test physical and mental scarcity in both settings, and more importantly how they interact. The interaction is fundamental, because their thesis is that physical scarcity causes mental scarcity, i.e. the scarcity mindset. It’s easy to imagine physical scarcity, it ranges from not having enough food, money, time or (spoiler alert!) enough blueberries in a videogame. However, it is more difficult to think of mental scarcity, even though we constantly experience it. To explain it, they use the concept of bandwidth, or mental capacity. We can think of it as the “RAM of our brain”, the precision and speed at which we process information and execute decisions.
What are the effects of scarcity?
When we experience scarcity we tunnel, i.e. we get extremely focused on solving the scarcity at hand. This focus can have 2 effects: one positive, and one negative. In the short run it is generally positive, because it makes us focus on the task at hand, operating at maximum capacity. However, it can have a negative effect too, since in this case when we are focusing we are actually tunneling, i.e. leaving everything else out of the picture, with possibly dire consequences. Moreover, in the long run scarcity erodes the availability of mental capacity, given that we can focus on nothing else.
To support this view, they refer to several experiments and I’m going to explain three of them to help you understand. There is one experiment where people with less bullets available in each round of a shooting game scored proportionately higher than people with more bullets: having less prompts efficiency. In another one, dieters found more difficult to concentrate on the next task if the previous one mentioned pastries: scarcity captures the mind and lets us focus on nothing else. The final experiment concerns Indian farmers, who score lower on an IQ test (measured with Raven’s matrix test) just before harvest than just after it. Why? Because they typically squander their harvest money in the months immediately following it, and the closer they get to harvest period, the poorer they are. That causes what is called a “bandwidth tax”; part of the brain continuously focuses on the scarcity at hand, leaving less room for other thoughts. It is really important to notice that all kinds of scarcity could cause that tax, ranging from money, time, love, etc.
Before turning to how to escape the scarcity trap, they focus on another negative side effect: borrowing. When tunneling, we leave everything else outside the tunnel, such as future consequences. To illustrate it , they make their case against the utility of payday loans. These loans are extremely short ones, with high interest rates. Moreover, they are extremely easy to get: in the US there are more payday lenders than McDonald´s and Starbucks outlets combined! Hence, once inside the tunnel, payday loans seem like the best way to get money, but in the long run they’re extremely detrimental.
How can we help people escaping the scarcity trap?
Seeing as scarcity is a lack of something, there are essentially 2 solutions: a windfall of the something needed or a more efficient use of the quantity at our disposal.
However, scarcity is insidious. For instance, they once gave Indian traders enough money to extinguish their debts, drastically increasing their disposable income, since they did not need to pay interests anymore. However, one by one they started borrowing again, eventually reverting to their previous situation. So a one time payment wasn’t enough to escape the poverty trap because they were not efficient, i.e. they did not reserve any slack. Indeed, the main reason to fall into the scarcity trap is that we are at the limit of the resource in question, so that when we face an unexpected “expense” we start borrowing from the future and taxing our bandwidth. Hence, the authors strongly advocate for the creation of slack, both to exit and to avoid (re)entering the scarcity trap.
Moving on to the strictly efficient part, they refer of the St.John’s Regional Center in Missouri: they were constantly operating at maximum capacity, so when an unexpected surgery came up all the elective ones needed to be rescheduled. The solution was brilliant: keep an Operating Room (OR) only for the unexpected surgeries. Having one less OR available actually increased the number of surgeries performed: the creation of slack solved the problem. The last example highlights another important feature of scarcity: it does not concern only individuals, but also organizations.
In conclusion, the authors offer an exciting, novel interpretation of poverty, tackling it from different angles, following a new framework: scarcity. Even though they lack a formal model (so far), the book offers an interesting view on one of the oldest problems, using several hints from Behavioural Economics. In short: a must read.
Review of a paper by Fryer, Levitt, List and Sadoff (2012)
Improving the productivity of teachers has long been a priority in Public Policy. In recent years, there has been growing enthusiasm among policy makers for initiatives that tie teacher incentives to the achievement of their students. However, evidence as to the efficacy of such policies is mixed. Studies in developing countries have shown that linking pay to teacher performance helps reduce teacher absenteeism and dramatically improves students’ test scores. In contrast, the only two field experiments conducted in the US have shown small, if not negative, treatment effects.
The authors of this paper conducted a field experiment to test whether the psychological bias we call “loss aversion” can be exploited to design better incentives.
To be sure we’re all on the same page, let’s take a minute to define what loss aversion means. A perfectly rational person should feel the same amount of pain on losing say $5 as the joy felt on gaining $5. However, for a loss averse individual, the pain of losing is greater than the pleasure of gaining, even for the exact same amount. Studies have shown that losses may be more than twice as powerful as gains!
There is overwhelming laboratory evidence for loss aversion, but the paper in question is one of the first to demonstrate it in a field experiment. The study was conducted in Chicago Heights, Illinois during the school year 2010-2011. Chicago Heights is made up of primarily low-income minority students who struggle with low achievement rates.
Two methods of framing teacher incentives are compared:
The teacher gets a sum of money at the end of the academic year if his/her students perform well (gain frame; the one we’re most familiar with in this context)
The teacher is given the sum of money at the beginning of the year andit is withdrawn if the students do badly (loss frame)
At the beginning of the school year teachers were randomised into Treatment and Control groups. Within the treatment group, some were assigned the gain frame and others the loss frame. Further, within the “Loss” and “Gain” groups, the authors tested for heterogeneous effects for individual rewards compared to team rewards. Thus, participating teachers were randomly assigned to one of four treatment groups or a control group. Rewards were based on students’ end of the year performance on the ThinkLink Predictive Assessment, an otherwise low stakes standardised diagnostic assessment that is designed to be aligned with the high-stakes Illinois Standards Achievement Test (ISAT) taken by 3rd-8th graders in March and the Iowa Test of Basic Skills (ITBS).
They estimate intent-to-treat (ITT) effect by taking the difference between treatment and control group means. They find large impacts on both the ThinkLink as well as ISAT and ITBS scores, but only in the LOSS frame. There is no significant difference for student scores of teachers in the “Gain” treatment, in line with findings from previous studies done in the US. Also, no significant difference was found between individual and team incentives under either the Gain or the Loss treatment.
But can we really be sure that it is loss aversion that is driving these results? There could be 3 other possible explanations. These are listed below, along with the reasons why they are implausible in this case:
Attrition- Perhaps teachers found a way to discourage weaker students from taking the exams. The authors run a probit regression on all of their covariates, where the dependent variable is an indicator for missing any of the exams considered. They find no significant difference between the gain and loss groups. Furthermore, the ISAT scores were not directly incentivised and they found similar rates of attrition even there. So attrition is unlikely to explain the results.
Liquidity constraints- Teachers under the loss treatment have more money at the beginning of the year, which may enable them to spend more on resources for the classroom. However, surveys on the amount of spending reveal that this was not the case.
Cheating- Teachers may cheat and give their students high scores. However, they cannot manipulate the ISAT and ITBS scores, which mirror the results found on the ThinkLink tests.
Thus, by spending the same amount of money, but just changing the way the incentive was framed, they obtained dramatically better results. This suggests that there may be significant potential for exploiting loss aversion for designing Public Policy (as well as for maximising profits, of course)!
Carrots or French fries? Fruit salad or a chocolate bar? These are the dilemmas that children face when choosing their meals in school lunchrooms. From convincing them that veggies will give them superpowers to ominous threats of what will happen to their bodies if they don’t eat healthy, there are few options left unexplored on how to get kids to eat right.
Unsurprisingly, when all else fails, BE swoops in and saves the day. Discarding classical solutions such as information campaigns, it offers a much simpler alternative: make the healthy options more tempting.
How? By changing their names. Several research teams in the US have tried this strategy in various school canteens and they found that making the names “seductive”, catchy or funny can induce children to eat healthier.
Hence, instead of offering carrots as “vegetable of the day” or simply “carrots”, call them “X-ray vision carrots” or “twisted citrus-glazed carrots” and you will increase the probability that children will pick them!
Review of a paper by Kjell Arne Brekke and Olof Johansson-Stenman (2008)
Taking into account economic behavior in the environmental economic political process could change the impact of economic measures
Cap and Trade, Pigouvian Taxes; Kyoto Protocol yesterday, Paris Agreement today. Why does environmental policy never work? As economists struggle for developing new economic models to address environmental threats, our planet fights to survive. What is the main obstacle to environmental economic policy? In this sense, one word is essential: implementation.
Economists talk about environmental damages (Greenhouses emissions, SO2, etc.) as social costs: harms that affect the societyas a whole, but that are not relevant in private economic choices (hence the title “negative externalities”). The reason is that clean production is costly and not efficient, both for firms and for the government. Measures to protect the environment, such as taxes and restrictions on production, raise the cost of production for firms, and their implementation is difficult for political reasons.
Therefore, when it comes to decision making, firms and countries tend to consider only their own costs and benefits, ignoring negative externalities: why should one country care about trans-border emissions, when it is a global matter and when the others do not?
Someone would then argue that international agreements are necessary to enforce environmental regulations, in order to address this moral hazard problem. However, when it comes to transnational regulation, global commitments are even harder to be enforced. In this context, is there any possibility left of “saving the planet”?
It has been demonstrated that, even if not considered in the private costs-benefits analysis, environmental damages matter at a psychological level.
Economic agents do not consider all the environmental measures that restrict economic private profits equally. The key difference lies in the way those measures influence the “environmental moral” (Frey, 1999): the intrinsic motivation for pro‐environmental activity. In this view, if we look at all the diverse economic measures each government can take, we find that not only do they differ in terms of economic and administrative efficiency, but also in terms of the impact that they have on people’s environmental moral. As a result, some measures are more likely to be implemented than others (Pollitt and Shaorshadze, 2011).
Frey (1999), for example, argues that both “tradable permits” (that allow firms for the production of a maximum emission as determined by the government) and “Pigouvian taxes” (on the generator of negative externalities) have two opposing effects on consumers. Not only the higher price that derives from their implementation discourages the aggregate demand, but the individual intrinsic environmental moral also goes down (crowding‐out effect).
Moreover, it has been demonstrated that low and high rate environmental taxes on emissions are more effective than the moderate ones in encouraging individuals to accept the environmental policy. In fact, with low taxes, consumers may be persuaded that the reason why they are being taxed is only moral, and they would be more positive to pay. On the other hand, high Pigouvian taxes make harmful behavior prohibitive: therefore, the economic effect dominates the crowding-out effect. Furthermore, according to Goodin (1994), tradable permits will reduce consumers’ motivation even more than taxes, because they may convey the impression that it is acceptable to sin as long as one pays the price for it.
However, since most of the climate policies address firms rather than final consumers, behavioral economics has a very limited influence on the choice of the level of production. On the other hand, public perception of the effect of these instruments is still relevant for policy because, when the public perceives that taxes and tradable permits are morally superior, governments may find it politically easier to implement them.
Similar results are valid internationally, in the context of global agreements. Given that humans are less self-serving than the “economic man”, cooperation has been demonstrated to be possible. However, it must be conditional and require the existence of sanctioning mechanisms (Kjell Arne Brekke and Olof Johansson-Stenman, 2008).
In BE there is a wide experimental literature focused on individual decisions, trying to understand under what conditions people cooperate, even when it is not in their own material interest. Conditional cooperation is usually the answer, suggesting that many people (in our case, countries) choose to cooperate only if others do too (Gächter, 2007). In addition, the evidence suggests that people are more willing to contribute to social causes when they think others are doing the same (Levitt and List, 2006).
In conclusion, what makes negotiations effective? We could summarize the best practices in three Ps:
Principles are essential to persuade people that they are paying for a moral reason. In this way, the individual intrinsic environmental moral also goes up and dominates the private cost bias.
They are fundamental for the long-term effectiveness. Kyoto protocol, for example, without including any penalty, lacked effectiveness, and commitments had never been really implemented.
Since we are dealing with global externalities, everyone should commit. Only a global solution could be the best response to a global problem.
Peter Ayton is a Professor of Psychology, Associate Dean of Research and Deputy Dean of Social Sciences at City University of London. His research interests cover behavioural decision theory, risk, uncertainty, affect and well-being.
In May, he visited Bocconi University as a part of seminar series co-organised by B.BIAS and BELSS (Bocconi Experimental Lab for Social Sciences) and he was kind enough to give us an interview.
BB: A cliche but necessary question: what got you interested in BE? Peter Ayton: It was a bit of an accident. After graduating in Psychology (which itself was a lucky outcome as I went to university from school not having much idea what Psychology was), I went on to do a PhD on the psychology of metaphorical language comprehension. At that time, there was almost no research that could explain how people understood metaphors and I found myself completely intrigued by it. However, due to a lack of opportunities in this field, I applied for a job as a postdoctoral research assistant on a project investigating subjective confidence in forecasts and was introduced to the world of decision research and have never looked back.
I became a Behavioural Economist the day that people decided that Psychologists who studied decision making could be called Behavioural Economists. In this way, I am a victim (or beneficiary) of a rebranding exercise. The term Behavioural Economics has been around for a long time but gained real momentum after Kahneman’s Nobel prize. I notice lots of my Psychologist colleagues describing themselves as Behavioural Economists and suspect that one reason they do this is because there is no Nobel prize in Psychology. Of course the use of this term also invites Economists to join in with the investigation of those behaviours that are not anticipated by classical Economics – and that is a tremendous benefit to the research. Before this time Economists and Psychologists viewed each other with suspicion. While governments around the world used to be advised by Economists – and no Psychologists at all – now we see both Economists and Behavioural Economists (aka Psychologists) in a position to influence policy.
BB: Could you tell us a little about your areas of research and the work you’ve done?
PA: After my PhD research on metaphors I did some work on memory retrieval, before working on judgment and decision making. I started out looking into subjective confidence in forecasts and then looked at probability judgment, the “calibration” of uncertainty judgments and decision making under uncertainty. I have also done work on risk perception and some cognitive illusions, e.g. the sunk cost effect and the hot hand fallacy.
More recently I have been studying human well-being, in particular people’s predictions of how happy they would be under certain circumstances, e.g. if they had a chronic illness, or suffered an amputation. These judgements can be compared with the experience of people under these circumstances. The comparison reveals that people appear to mis-predict the likely effects of these conditions on their own well-being. This has some implications for public policy – specifically how we determine how much money should be devoted to medical research or care for people suffering from particular health conditions. If the predictions of people without the conditions are used as a guide, the spending priorities will be different from the case where the evaluations of the people with the conditions are used.
I am also interested in the impact of computerised advice on decision making. Despite society’s increasing dependence on computerised tools which alert people to risks (e.g. cancers on X-ray images, weapons in air passenger luggage, spell checkers), the understanding of their potential harm is very limited. Sometimes decision aids cause decision errors: one example of this we have found is that when a computer alerting tool misses a “target” (e.g. cancer on X-ray, bomb in luggage, spelling error in your dissertation), then people can be less likely to spot the unprompted target than they would be if they weren’t using the decision support tool in the first place. A phenomenon called “automation bias” occurs whereby people become dependent on the computerised tool. That goes unnoticed because quite often it is easy to demonstrate that people detect more targets when they use the computer than when they don’t, and unfortunately the aggregate improvement conceals the particular errors. This kind of issue is at the junction between Computer Science and Cognitive Psychology and I have been collaborating with some Computer Scientists to try to understand how we can improve the influence of computers on people.
BB: Have you ever had a “professional failure” that was a turning point in your career?
PA: There are some who seriously propose a CV of failures as an endeavour (see this article), and mine would be much more extensive than my CV of successes. It’s unfortunate that failures are buried, because when you are starting out as a student, you tend to look at successful role models and think “How could I be as good as one of these guys?”, but actually they were pretty bad as well, they just don’t tell you.
Most of the things that I started doing, I didn’t finish. We just stopped because we realized we weren’t going anywhere, or it wasn’t interesting anymore. But sometimes those decisions can be rather questionable. I will give you one good example.
I did some research with a student few years ago about how one can use the compromise effect and the attraction effect in moral reasoning. The attraction effect occurs when you change the relative attractiveness of one option by introducing a new one that is definitely superior to it. For example more people prefer a nice pen to $6 if you add the option of a bad pen. The compromise effect is similar – when making a choice between, say, two cameras – a basic cheap one and a more elaborate expensive one, you may favour the cheaper one. But upon the introduction of a third highly advanced but extremely expensive camera, you are likely to change your preference to the one in the middle as a compromise. As for the moral choices, take the trolley problem, where you have a runaway train coming down a track where five people are working. You could press a button to divert the train to another track, and save the five people, but that would kill one person working on the other track. We tried to see if the answers that people give to these sort of problems would be similarly malleable like preferences are – maybe the attractiveness of a moral option would vary if you make something really bad close to it. But it didn’t “work”, it didn’t change people’s decisions. I remember being disappointed because I wanted to write a paper saying people’s moral decisions are really manipulable, that is, people like to think they’ve got moral sense but actually they can be manipulated. I realized only much later that I should have kept on with this, because if I had clearly established that there was no effect of context on moral choices, I could have written a more interesting paper about how context does affect consumer preferences, but not moral choices.
BB: What would you say is your favourite nudge?
PA: I’m not sure I have a favourite nudge, I’m a bit suspicious of the idea of identifying behaviours as “nudges”. Many “nudges” referred to even in the Nudge book are actually behavioural phenomena discovered by social psychologists many years ago, long before anyone referred to them as nudges! But one that makes me smile is the one with stairs and escalator, and then there is a thin matchstick man pointing to the stairs and a fat matchstick man pointing up to the escalator. You need a bit of nerve to get on the escalator after seeing that.
BB: Is there any finding from behavioural research that surprised you? As in, where you found results contrary to what you expected or to what is accepted as intuitive?
PA: When I read Joshua Miller’s paper on hot hand, I was so excited that I couldn’t sleep for about 3 days.
(Note by BB: “Hot hand” is the belief that a person who has just experienced success in a task, such as shots in basketball, has a greater probability of success in the upcoming rounds in the task. The hot hand fallacy refers to the finding that such a belief is wrong – for basketball at any rate – and it has been cited as a prominent example of a cognitive illusion by many researchers. However, the paper of Joshua Miller and Adam Sanjuro proves that there may have been flaws in the statistical analyses and that the hot hand indeed exists an so there is no fallacy).
This development is quite fantastic because the hot hand fallacy has been around since 1985 when it was originally discovered by a group including Tom Gilovich and Amos Tversky and (and, in decision research, you don’t get any higher than that – they are royalty). Famously, basketball coaches reacted by saying: “It’s all rubbish, I know that there is a hot-hand effect”. Some academics too have crashed and burned while trying to contest this phenomenon. Until I understood the Miller and Sanjurjo paper, I was quite certain that the case was rock solid. People have found that there are sequential dependencies in other areas, for other sports even. However, the case for a hot hand fallacy in Basketball has been scrutinised so much that it’s truly astonishing that somebody’s come up with such a game-changing analysis of the statistics. I got into trouble a few years ago, when I gave a talk called “The cognitive illusion illusion” which somewhat audaciously argued that while there are cognitive illusions, they are mainly suffered by Cognitive Psychologists who think that their subjects suffer from cognitive illusions, when they don’t. Feeling rather pleased with myself I had the nerve to give this talk at Princeton University with Daniel Kahneman in the room. He made it very clear he wasn’t very impressed with my argument which admittedly was a little overstated. If only Josh and Adam had got their paper out before, I might have been spared admonishment from Kahneman!
The discovery of cognitive illusions is of particular interest for the agenda of business schools. The idea that there is a problem with the way people think is popular for two reasons. Firstly, people need to learn how to run businesses rationally – you don’t want business personnel making mistakes. But also, and more disturbingly, maybe you could exploit the irrationalities of your competitors or the consumer and exploit their vulnerability.
Review of Hawton K., Bergen H., Simkin S., Dodd S., Pocock P., Bernal W., Gunnel D., Kapur N. (2013)
Have you ever noticed that sometimes very small obstacles prevent you from completing a task or pursuing an objective? For instance, you might have thought about changing your phone provider since your offer was not convenient anymore, but you never did it. Why? Probably just because you’d have to walk to a store and sign a couple of papers. Rationally you should do it: not even an hour of your time could possibly save you hundreds of euros, but still you do not. And your phone company knows about it and doesn’t bother to decrease the price of your plan, even though it is not competitive anymore.
Behavioural economists call those apparently insignificant impediments “frictions”. They help explain why in some countries only a few people decide to donate organs, while in others more than 90% of adults do so. Organ donation is quite an important matter and it sounds reasonable to invest a few minutes to express a preference on it. However, in reality, people do not. Indeed, the number of donors in countries in which donation is an opt-out (people are registered as donors by default) is 60 percentage points higher than in countries in which people have to opt-in (a 30 seconds procedure). Huge right? (for further details, refer to Johnson and Goldstein, 2004).
Similar results were found when investigating savings plans for retirement (check Madrian and Shea, 2001) and there are hundreds of such examples: frictions affect our decisions. But what about more important decisions, such as committing suicide? Here is an example of how changing a marginal element in drug packaging actually kept people alive.
In many western countries, the ingestion of a large dose of paracetamol is a common method of suicide. Moreover, in case of survival, it causes hepatotoxicity, a fatal liver dysfunction that requires transplantation.
Hawton et al (2013) studied the effects of a legislation introduced in the UK in 1998 that reduced the maximum number of tablets per package to 32 when sold in pharmacies and 16 in stores (original version here). It also forbade the purchase of more than one packet in the same store. The law created a “friction”: although the obstacle created was very small, as people could easily purchase as much paracetamol as desired, just going to different stores.
To understand the consequences of the legislation, the authors implemented an interrupted time series design using the deaths tolls of paracetamol ingestion (excluding those labelled as accidents) from 1993 to 2009, the number of registrations to the waiting list for liver transplantation and actual liver transplants due to paracetamol poisoning from 1995 to 2009. The chosen cut-off point is the 3rd quarter of 1998, when the law was implemented. From that date, the authors compare the estimated numbers of deaths and liver unit registrations and transplantations, which might have occurred in the post-intervention period without the legislation, with the actual values.
Estimates were made with different methods, including a conservative one that assumed no increase after 1998 in the number of deaths, of registration to the waiting list or of actual liver transplantation, according to the regression considered. Moreover, since in those years there had been a reduction in poisoning with drugs in general (but not as significant and as steep), analysis has been adjusted accordingly. Results are still significant: over the 11 years after the law was introduced there has been a 43% reduction in deaths, equivalent to 765 fewer deaths labelled as suicide or left as open verdicts, and 990 fewer deaths if accidental poisoning verdicts were included.
For what concerns liver transplants there has been a 61% reduction in registrations at liver units (482 fewer registrations), but the actual percentage of transplants has not significantly decreased. Results are not significant if the conservative method is used. However, authors explain that in those years, legislation made it easier to receive a transplant by lowering the required critical values, and that a new antidote had been made available, thus increasing the chances of getting a transplant on one side and reducing the need for one on the other. Hence, a non-significant decrease might actually hide a significant one.
To conclude, reducing the number of tablets of paracetamol per package, an inexpensive and easy to implement policy, produced remarkable results reducing the number of suicides and of registration at liver units (consequently also lowering NHS costs and the demand for transplants, usually undersupplied). Thus, frictions do influence even very serious decisions and this is true especially in situations in which people are less rational, or act under an impulse. Now the question is – can we use this knowledge in other contexts to make people’s lives better?
It is well-known that increased alcohol consumption of young people is a persistent problem and college and university students are no exception.
The Northern Illinois University (NIU) came up with a solution that has since spread to other US universities and even high schools. It all started by conducting a survey about students´ drinking behaviour, which revealed the presence of a large knowledge gap. Most of the students thought that binge drinking was more widespread than it really was.
The Health Enhancement Services Office at NIU decided to take action – develop a campaign to correct the perceptions of the students. What is the logic behind this? It is the belief that people are sensitive to social norms and tend to behave in line with them. For example, we all know that when we ask for something, we should say “please” and “thank you”. We do it because it is a norm accepted in our society and everyone does so. There are several papers proving thatperceptions about the drinking behaviour of other students are a strong predictor of the actual drinking behaviour, so norms are at work also in this case (for the reference, see Graham et al., 1991 or Prentice and Miller, 1993).
The organisers of the NIU campaign were very careful with the design, since they wanted to spread the message as much as possible. They chose the campus newspaper, widely read by the students, as their medium to publish the following very simple message: “Most NIU students (55 percent) drink five or fewer drinks when they party”. This message was repeated on flyers, posters and on any occasion the students were likely to hear it.
The NIU team also came up with incentives for students to pay attention to the message. Two students were hired to work as “Money Brothers” (inspired by the movie The Blues Brothers).They would ask students how many drinks most NIU students consume and give $1 to anyone who answered correctly. They also created some posters and would give $5 to those students living inuniversity dorms who were found to have it on the wall of their rooms during random checks.
It is clear that the NIU team really worked hard to make students notice the message. The result? After the first year, there was an 18 % reduction in perceived binge drinking and a 16 % reduction in real binge drinking. Obviously after such success, the campaign has been repeated in the following years and binge drinking decreased further.
The take home message of this initiative is that social norms are powerful and capable of changing our behaviour. However, the message needs to be simple, truthful and most importantly, noticed by the target audience.
Since then, other universities and high schools applied the same technique to fight binge drinking of their students. Here are some of the campaign materials:
Even the most expert and talented trader can be misled by human irrationality
It is a widespread belief that greed for money has always been driving financial markets since their foundation. Both the fruitful transformations and the toughest crises, which have affected the financial industry, have been strongly guided by the desire of achieving new profits. Undoubtedly, greed is the main reason why investors take excessively risky positions without properly considering the characteristics of their portfolios. The Dot-com bubble and the subprime crisis are the most recent cases of this risk underestimation, but the history of finance provides many similar examples.
In addition to the desire of obtaining easy and quick gains, human behaviour can be influenced by other biases which make traditional rational investors theories inappropriate. Irrational investment decisions, although taken by one trader, can have disastrous consequences for the entire financial institution. The story of Nick Leeson, considered to be the main cause of Baring Bank’s bankruptcy, shows how a solid and centenary institution can lose its fortune due to an employee.
80s and 90s are often considered as the golden age for finance. As new financial markets were opening around the world, in particular in South-East Asia, European and North-American banks were trying to enlarge their business and their activities. Among the several English institutions, Baring, the world’s second oldest merchant bank, was one of the most active in the Singapore exchange, which was considered the most important Asian market. Nick Leeson joined the institution in 1989, after some years spent at Morgan Stanley. As reported in his autobiography, Rogue Trader, after having obtained profits of £ 10 million in 1992, he became “the rising star” at the firm. The success and the ability of the English trader led him to obtain at the age of 28 the full responsibility of the derivatives desk on Singapore International Monetary Exchange. His activity was to consist of only looking for arbitrage opportunities from contracts on Nikkei 225 traded in different exchanges. However, Leeson, seeking larger profits, started to take positions in the market. To hide the losses suffered by his desk, he created a secret account which was registered as client’s account. Between 1992 and 1993 the accumulated losses were negligible. However, at the end of 1994 the account was negative for £ 208 million. The situation became extremely dangerous when Leeson placed a short straddle on Nikkei 225. A short straddle is a strategy consisting in the simultaneous sale of a call and a put option on the same underlying asset with a strike price equal to the price of the underlying. This options-based strategy is profitable for the trader when the price of the underlying asset, the Japanese equity index in this case, does not move too much from the strike price.
However, due to the Kobe earthquake, the index dramatically fell and the succeeding trades placed by the Baring’s trader were completely ineffective. After having left a note reading “I’m Sorry”, he fled Singapore. Nevertheless, Leeson was arrested and spent four years in a Singapore jail.
The Rogue Trader’s case is quite interesting from different points of view. In addition to the importance of risk management in financial institutions, we can highlight how traders’ decisions can be affected by excessive optimism. This bias, as underlined by Kahneman, the father of Behavioural Finance, can assume several forms. In this case, Leeson seems to be affected by the so-called overconfidence bias. Indeed, past positive results made him confident and risk loving. Some colleagues defined him as a “high-flyer who liked to dabble in dare-devil trades”. Furthermore, if we analyse the contracts he tried to trade, we can point out another significant bias. After having suffered the first
dramatic loss, Leeson began placing similar orders waiting for a recovery of Nikkei 225, which did not occur in the short term. From a behavioural point of view, this is called over-reaction to chance events. It is quite common for those gamblers who consider more likely a head after many tails. Also traders believe in the existence of given trend, which, may never actually show up.
Effective risk management along with double-checking of accounts can prevent single traders from taking unbalanced positions. Nevertheless, human behaviour is likely to be negatively affected by a wrong perspective of the reality.