The

Marketplace of
Perceptions
Behavioral
economics explains
why we
procrastinate, buy,
Like all revolutions in thought, this
borrow, and
altruistic behavior. This is such a routine ob-
one began with anomalies, strange facts, servation that it has been made for cen-

grab chocolate
odd observations that the prevailing wis- turies; indeed, Adam Smith “saw psychology
dom could not explain. Casino gamblers, as a part of decision-making,” says assistant

on the spur of the

for instance, are willing to keep betting professor of business administration Nava
even while expecting to lose. People say Ashraf. “He saw a conflict between the pas-

moment.
they want to save for retirement, eat better, sions and the impartial spectator.”
start exercising, quit smoking—and they Nonetheless, neoclassical economics
mean it—but they do no such things. Vic- sidelined such psychological insights. As
tims who feel they’ve been treated poorly recently as 15 years ago, the sub-discipline
exact their revenge, though doing so hurts called behavioral economics—the study
their own interests. of how real people actually make choices,

by Craig Lambert
Such perverse facts are a direct a≠ront to which draws on insights from both psy-
the standard model of the human actor— chology and economics—was a marginal,
Economic Man—that classical and neo- exotic endeavor. Today, behavioral eco-
classical economics have used as a founda- nomics is a young, robust, burgeoning
tion for decades, if not centuries. Economic Portraits by Stu Rosner sector in mainstream economics, and can
Man makes logical, rational, self-interested claim a Nobel Prize, a critical mass of em-
decisions that weigh costs against benefits pirical research, and a history of upending
and maximize value and profit to himself. the neoclassical theories that dominated
Economic Man is an intelligent, analytic, selfish creature who has the discipline for so long.
perfect self-regulation in pursuit of his future goals and is Although behavioral economists teach at Stanford, Berkeley,
unswayed by bodily states and feelings. And Economic Man is a Chicago, Princeton, MIT, and elsewhere, the subfield’s greatest
marvelously convenient pawn for building academic theories. But concentration of scholars is at Harvard. “Harvard’s approach to
Economic Man has one fatal flaw: he does not exist. economics has traditionally been somewhat more worldly and
When we turn to actual human beings, we find, instead of empirical than that of other universities,” says President
robot-like logic, all manner of irrational, self-sabotaging, and even Lawrence H. Summers, who earned his own economics doctor-

50 March - Apr il 2006

ate at Harvard and identifies himself Professor of economics David Laibson,
as a behavioral economist. “And if whose research explores the fundamental
tension between “seizing available rewards
you are worldly and empirical, you in the present, and being patient for
are drawn to behavioral approaches.” rewards in the future”

Framing a New Field

Two non-economists have won
Nobel Prizes in economics. As early
as the 1940s, Herbert Simon of
Carnegie Mellon University put for-
ward the concept of “bounded ratio-
nality,” arguing that rational thought
alone did not explain human deci-
sion-making. Traditional economists
disliked or ignored Simon’s research,
and when he won the Nobel in 1978,
many in the field were very unhappy
about it.
Then, in 1979, psychologists Daniel
Kahneman, LL.D. ’04, of Princeton
and Amos Tversky of Stanford pub-
lished “Prospect Theory: An Analysis
of Decision under Risk,” a break-
through paper on how people handle
uncertain rewards and risks. In the
ensuing decades, it became one of the
most widely cited papers in econom-
ics. The authors argued that the ways
in which alternatives are framed—not
simply their relative value—heavily
influence the decisions people make.
This was a seminal paper in behav-
ioral economics; its rigorous equa-
tions pierced a core assumption of
the standard model—that the actual
value of alternatives was all that mat-
tered, not the mode of their presenta-
tion (“framing”).
Framing alternatives di≠erently
can, for example, change people’s
preferences regarding risk. In a 1981
Science paper, “The Framing of Deci-
sions and the Psychology of Choice,”
Tversky and Kahneman presented an
example. “Imagine that the U.S. is
preparing for the outbreak of an un-
usual Asian disease which is ex-
pected to kill 600 people,” they
wrote. “Two alternative programs to
combat the disease have been pro-
posed.” Choose Program A, and a
projected 200 people will be saved.
Choose Program B, and there is a
one-third probability that 600 people
will be saved, and a two-thirds probability that no one will be tain saving of 200 lives. The researchers then restated the prob-
saved. The authors reported that 72 percent of respondents chose lem: this time, with Program C, “400 people will die,” whereas
Program A, although the actual outcomes of the two programs with Program D, “there is a one-third probability that no one
are identical. Most subjects were risk averse, preferring the cer- will die, and a two-thirds probability that 600 people will die.”

Harvard Magazine 51
 This time, 78 percent chose Program D—again, despite identical plains. “Although there are di≠erences, when walking along the
outcomes. Respondents now preferred the risk-taking option. surface of this planet, you’ll never encounter them. If I want to
The di≠erence was simply that the first problem phrased its op- build a bridge, pass a car, or hit a baseball, Newtonian physics
tions in terms of lives saved, and the second one as lives lost; peo- will su∞ce. But the psychologists said, ‘No, it’s not su∞cient,
ple are more willing, apparently, to take risks to prevent lives we’re not just playing around at the margins, making small
being “lost” than to “save” lives. change. There are big behavioral regularities that include things
“Kahneman and Tversky started this revolution in econom- like imperfect self-control and social preferences, as opposed to
ics,” says Straus professor of business administration Max Bazer- pure selfishness. We care about people outside our families and
man, who studies decision-making and negotiation at Harvard give up resources to help them—those a≠ected by Hurricane Ka-
Business School. “That 1979 paper was written on the turf of eco- trina, for example.”
nomics, in the style of economists, and published in the toughest Much of the early work in behavioral economics was in finance,
economic journal, Econometrica. The major points of prospect the- with many significant papers written by Jones professor of eco-

“Now, we want chocolate, cigarettes, and a trashy nomics Andrei Shleifer. In financial
markets, “The usual arguments in
conventional economics are, ‘This
movie. In the future, we want to eat fruit, to quit smoking, [behavioral irrationality] can’t be
true, because even if there are stu-
and to watch Bergman films.” pid, irrational people around, they
are met in the marketplace by smart,
—David Laibson rational people, and trading by these
arbitrageurs corrects prices to ratio-
ory aren’t hard to state in words. The math was added for accep- nal levels,’ ” Shleifer explains. “For example, if people get unduly
tance, and that was important.” In 2002, Kahneman received the pessimistic about General Motors and dump GM shares on the
Nobel Prize in economics along with Vernon Smith, Ph.D. ’55, of market, these smart people will sweep in and buy them up as un-
George Mason University, who was honored for work in experi- dervalued, and not much will happen to the price of GM shares.”
mental economics. (Tversky, Kahneman’s longtime collaborator, But a 1990 paper Shleifer wrote with Summers, “The Noise
had died in 1996.) Trader Approach to Finance,” argues against this “e∞cient mar-
In the 1980s, Richard Thaler (then at Cornell, now of the Uni- ket” model by noting that certain risk-related factors limit this
versity of Chicago Graduate School of Business) began import- arbitrage. At that time, for example, shares of Royal Dutch were
ing such psychological insights into economics, writing a regu- selling at a di≠erent price in Amsterdam than shares of Shell in
lar feature called “Anomalies” in the Journal of Economic Perspectives London, even though they were shares of the same company,
(later collected in his 1994 book, The Winner’s Curse). “Dick Thaler Royal Dutch/Shell. Closed-end mutual funds (those with a fixed
lived in an intellectual wilderness in the 1980s,” says professor of number of shares that trade on exchanges) sell at di≠erent prices
economics David Laibson, one of Har- than the value of their portfolios. “When
vard’s most prominent behavioral the same thing sells at two di≠erent
economists. “He championed these prices in di≠erent markets, forces of ar-
ideas that economists were deriding. bitrage and rationality are necessarily
But he stuck to it. Behavioral ap- limited,” Shleifer says. “The forces of ir-
proaches were anathema in the 1980s, rationality are likely to have a big im-
became popular in the 1990s, and pact on prices, even on a long-term
now we’re a fad, with lots of grad basis. This is a theoretical attack on
students coming on board. It’s no the central conventional premise.”
longer an isolated band of belea- Meanwhile, the Russell Sage Foun-
guered researchers fighting against dation, which devotes itself to research
the mainstream.” in the social sciences, consistently sup-
As with most movements, there ported behavioral economics, even
were early adopters. “In the 1980s the when it was in the intellectual wilder-
best economists in the world were ness. Current Sage president Eric Wan-
seeing the evidence and adopting it ner, Ph.D. ’69, whose doctorate is in so-
[behavioral economics],” Bazerman cial psychology, was running a program
says. “Mediocre economists follow in cognitive science at the Alfred P.
slowly—they continued to ignore it so Sloan Foundation in 1984 when Sloan
they could continue doing their work started a behavioral economics program
undisturbed.” as an application of cognitive science to
To be fair, the naysayers would have the study of economic decision-making.
agreed that the rational model only ap- (“The field is misnamed—it should have
proximates human cognition—“just as been called cognitive economics,” says
STU ROSNER

Newtonian physics is an approxima- Wanner. “We weren’t brave enough.”)

tion to Einstein’s physics,” Laibson ex- After Wanner became president of Rus-

52 March - Apr il 2006

sell Sage in 1986, the two institutions worked jointly to foster economists like David Laibson. “There’s a fundamental tension,
the new subfield. In the last 20 years, Sage has made well over in humans and other animals, between seizing available rewards
100 grants to behavioral economists; it also organizes a biennial in the present, and being patient for rewards in the future,” he
summer institute that has drawn younger scholars like Laibson says. “It’s radically important. People very robustly want instant
and professor of economics Sendhil Mullainathan. Princeton gratification right now, and want to be patient in the future. If
University Press and Russell Sage also co-publish a series of you ask people, ‘Which do you want right now, fruit or choco-
books in the field. late?’ they say, ‘Chocolate!’ But if you ask, ‘Which one a week
Behavioral economics, then, is the hybrid o≠spring of economics from now?’ they will say, ‘Fruit.’ Now we want chocolate, ciga-
and psychology. “We don’t have much to tell psychologists about rettes, and a trashy movie. In the future, we want to eat fruit, to
how individuals make decisions or process information, but we quit smoking, and to watch Bergman films.”
have a lot to learn from them,” says Glimp professor of economics Laibson can sketch a formal model that describes this dy-
Edward Glaeser. “We do have a lot to say about how individuals namic. Consider a project like starting an exercise program,
come together in aggregations—markets, firms, political parties.” which entails, say, an immediate cost of six units of value, but
will produce a delayed benefit of eight units. That’s a net gain of
The Seductive Now-Moment two units, “but it ignores the human tendency to devalue the fu-
A national chain of hamburger restaurants takes its name ture,” Laibson says. If future events have perhaps half the value of
from Wimpy, Popeye’s portly friend with a voracious appetite present ones, then the eight units become only four, and starting
but small exchequer, who made famous the line, “I’ll gladly pay an exercise program today means a net loss of two units (six
you Tuesday for a hamburger today.” Wimpy nicely exemplifies minus four). So we don’t want to start exercising today. On the
the problems of “intertemporal choice” that intrigue behavioral other hand, starting tomorrow devalues both the cost and the

Assistant professor of business

administration Nava Ashraf helped
adapt a home-grown savings technique
she saw in West Africa to the
Philippines, where the “cute” SEED
(“Save, Earn, Enjoy Deposits”) bank
(opposite) helped ordinary citizens
save money.

Harvard Magazine 53
benefit by half (to three and four units, respectively), resulting in Sirens’ songs, but he may hear the Sirens’ beautiful voices without
a net gain of one unit from exercising. Hence, everyone is enthusi- risk if he has his sailors lash him to a mast, and commands them
astic about going to the gym tomorrow. to ignore his pleas for release until they have passed beyond dan-
Broadly speaking, “People act irrationally in that they overly ger. “Odysseus pre-commits himself by doing this,” Laibson ex-
discount the future,” says Bazerman. “We do worse in life be- plains. “Binding himself to the mast prevents his future self from
cause we spend too much for what we want now at the expense countermanding the decision made by his present self.”
of goodies we want in the future. People buy things they can’t Pre-commitments of this sort are one way of getting around
a≠ord on a credit card, and as a result they get to buy less over not only the lure of temptation, but our tendency to procrasti-
the course of their lifetimes.” Such problems should not arise, ac- nate on matters that have an immediate cost but a future payo≠,
cording to standard economic theory, which holds that “there like dieting, exercise, and cleaning your o∞ce. Take 401(k) retire-
shouldn’t be any disconnect between what I’m doing and what I ment plans, which not only let workers save and invest for retire-
want to be doing,” says Nava Ashraf. ment on a tax-deferred basis, but in many cases amount to a bo-
Luckily, Odysseus also confronts the problem posed by nanza of free money: the equivalent of finding “$100 Bills on the
Wimpy—and Homer’s hero solves the dilemma. The goddess Sidewalk” (the title of one of Laibson’s papers, with James Choi
Circe informs Odysseus that his ship will pass the island of the and Brigitte Madrian). That’s because many firms will match
Sirens, whose irresistible singing can lure sailors to steer toward employees’ contributions to such plans, so one dollar becomes
them and onto rocks. The Sirens are a marvelous metaphor for two dollars. “It’s a lot of free money,” says Laibson, who has pub-
human appetite, both in its seductions and its pitfalls. Circe ad- lished many papers on 401(k)s and may be the world’s foremost
vises Odysseus to prepare for temptations to come: he must order authority on enrollment in such plans. “Someone making
his crew to stopper their ears with wax, so they cannot hear the $50,000 a year who has a company that matches up to 6 percent

Certain patterns of response to

rewards seem to be biologically
embedded in the human brain. A
Neuroeconomics thinking. It’s not based on past expe-
rience; you could have the rules of a
brand-new game explained and the
branch of behavioral economics analytic system would be able to
called neuroeconomics looks inside the figure out how to play.”
brain with scanning tools like mag- Brain researchers have shown that
netic resonance imaging (MRI) to investigate patterns of mo- an interaction of the limbic and analytic systems governs
tivation. Neuroeconomics is controversial, as the link between human decision-making. The limbic system seems to radically
cerebral blood flow and decision-making is less straightfor- discount the future. While the analytic system’s role remains
ward than, say, playing slot machines and losing money. Yet it constant from the present moment onward, the limbic system
is one of the most fascinating and provocative aspects of the assumes overriding importance in the present moment, but
young field. rapidly recedes as rewards move into the future and the emo-
“Economists specialize in taking really complex things and tional brain reduces its activation. This explains impulsive-
boiling them down to simple principles,” says David Laibson. ness: the slice of pizza that’s available right now trumps the di-
“So, rather than treat the brain as billions of neurons, or trillions etary plan that the analytic brain has formulated. Seizing
of neurotransmitters, we want to ask, what is the right level of available rewards now might be a response pattern with evo-
analysis? It turns out that the brain has two key subsystems. lutionary advantages, as future benefits are always uncertain.
One, the limbic and paralimbic system, rules the Consider an experiment that scans the
intuitive and a≠ective parts of our psyches. brains of research subjects o≠ered a
It’s shared by all mammals and seems to choice between present and future re-
do a lot of emotional cognition—how wards: $20 now, or $23 a month from
we feel emotionally, how we re- now. Both limbic and analytic sys-
spond to other humans, or to tems show activity. Then change
being treated unfairly. This sys- the o≠er to two future prospects:
tem seems to function uncon- $20 two weeks from now, or $23 in
sciously; we don’t have access a month. In this case, the limbic
to it and maybe can’t even con- system pretty much drops out.
trol it. It’s experiential and The analytic system, in contrast,
rapid in function. shows the same activation pat-
“Contrast that with the ana- terns regardless of the delay, be it
lytic system, centered in the hours or months. When the ana-
frontal and parietal cortexes,” Laib- lytic system is more active, people
GETTY IMAGES

son continues. “It controls a lot of the choose the “ patient” reward; when
thought processes we learn to do: cal- both systems are active, temptation
culated, conscious, future-oriented usually trumps prudence.

54 March - Apr il 2006

of his contributions could receive an additional $3,000 per year.” for companies to choose opt-out [automatic enrollment] 401(k)s
The rational model unequivocally predicts that people will cer- rather than opt-in [self-enrollment] 401(k)s,” he says. “In classical
tainly snap up such an opportunity. But they don’t—not even economics, it doesn’t matter. But large amounts of empirical evi-
workers aged 59¹⁄₂ or older, who can withdraw sums from their dence show that defaults do matter, that people are inertial, and
401(k) plans without penalty. (Younger people are even more un- whatever the baseline settings are, they tend to persist.”
likely to contribute, but they face a
penalty for early withdrawal.) “It
turns out that about half of U.S. Associate professor of public policy
workers in this [above 59 ¹⁄₂] age Iris Bohnet, who has played games that
measure “aversion to betrayal” with
group, who have this good deal subjects from Brazil to Switzerland
available, are not contributing,” to Kuwait
says Laibson. “There’s no down-
side and a huge upside. Still, indi-
viduals are procrastinating—they
plan to enroll soon, year after year,
but don’t do it.” In a typical Ameri-
can firm, it takes a new employee a
median time of two to three years
to enroll. But because Americans
change jobs frequently—say, every
five years—that delay could mean
losing half of one’s career opportu-
nity for these retirement savings.
Laibson has run educational in-
terventions with employees at
companies, walking them through
the calculations, showing them
what they are doing wrong. “Al-
most all of them still don’t invest,”
Laibson says. “People find these
kinds of financial transactions un-
pleasant and confusing, and they
are happier with the idea of doing
it tomorrow. It demonstrates how
poorly the standard rational-actor
model predicts behavior.”
It’s not that we are utterly help-
less against procrastination. Laib-
son worked with a firm that
forced its employees to make active
decisions about 401(k) plans, insist-
ing on a yes or no answer within
30 days. This is far di≠erent from
giving people a toll-free phone
number to call whenever they de-
cide to enroll. During the 30-day
period, the company also sent fre-
quent e-mail reminders, pressur-
ing the sta≠ to make their deci-
sions. Under the active-decision
plan, enrollment jumped from 40
to 70 percent. “People want to be
prudent, they just don’t want to
do it right now,” Laibson says.
“You’ve got to compel action. Or
enroll people automatically.”
When he was U.S. Treasury Sec-
retary, Lawrence Summers applied
this insight. “We pushed very hard

Harvard Magazine 55
Marketing Prudence bank created a savings account, called SEED (“Save, Earn, Enjoy
These insights can also be writ large. Laibson’s former student Deposits”), with two features: a locked box (for which the bank
Nava Ashraf, who has worked extensively with non-governmen- had the key) and a contractual agreement that clients could not
tal organizations, is now applying behavioral economics to inter- withdraw money before reaching a certain date or sum. The
ventions in developing countries. She lived for a year in Ivory clients determined the goal, but relied on the bank to enforce the
Coast and Cameroon, where she “noticed that farmers and commitment. The bank marketed the SEED product to literate
small-business owners were often not doing the things that a de- workers and micro-entrepreneurs: teachers, taxi drivers, people
velopment policymaker or economist thinks they should do,” she with pushcart businesses.
says. “They wouldn’t take up technologies that would increase The SEED box, designed to appeal to the bank’s clients (“In
agricultural yield, for example. They wouldn’t get vaccines, even the Philippines, they like ‘cute’ stuff,” Ashraf explains ), helped
though they were free! They also had a lot of trouble saving. In mobilize deposits. “It’s similar to automatic payroll deduction,
January they had a lot of money and would spend it on feasts and but not enough of the customers had direct deposit to make
special clothes, but in June their children would be starving.” that work,” she says. To further encourage deposits, Ashraf
Still, some found ways to o≠set their less-than-prudent ten- worked with the bank on an additional program of deposit col-
dencies. One woman had a cashbox in her home, where she lectors who, for a nominal fee, would go to the customer’s home
saved money regularly—and gave her neighbor the only key. on a designated day and collect the savings from the SEED box.
Another timed the planting of her sweet-potato crop so that The withdrawal restrictions on the account helped clients avoid
the harvest would come in when school fees were due. Her the temptation of spending their savings. The SEED savings ac-
farm became an underground bank account that allowed with- count made a designed choice available in the marketplace that,
drawal only at the proper moment. so far, has helped a growing number of microfinance clients in
Ashraf worked with a bank in the Philippines to design a sav- the Philippines reach their savings goals.
ings plan that took o≠ from the African woman’s cashbox. The Ashraf is now working with Population Services Interna-

“Policymakers think that if they

get the abstractions right, that will
drive behavior in the desired
direction,” says professor of economics
Sendhil Mullainathan. “But the
world happens in real time.”

56 March - Apr il 2006

tional—a nonprofit organization that seeks to focus private-sec- others a high one. “It was done like a randomized clinical trial of
tor resources on the health problems of developing nations—on a drug,” Mullainathan explains.
a project in Zambia to motivate people to use a water purifi- The bank also randomized several aspects of the letter. In one
cation solution known as Clorin. “We can use what marketing corner there was a photo—varied by gender and race—of a bank
people have known all along,” Ashraf says. “There are ways of employee. Di≠erent types of tables, some simple, others complex,
manipulating people’s psychological frameworks to get them to showed examples of loans. Some letters o≠ered a chance to win a
buy things. How do you use this knowledge to get them to adopt cell phone in a lottery if the customer came in to inquire about a
socially useful products or services? It’s so practical, and very im- loan. Some had deadlines. Randomizing these elements allowed
portant in development, for anybody who wants to help people Mullainathan to evaluate the e≠ect of psychological factors as op-
reach their goals.” posed to the things that economists care about—i.e., interest
Carefully designed programs like the SEED bank are examples rates—and to quantify their e≠ect on response in basis points.
of what Richard Thaler called “prescriptive economics,” which “What we found stunned me,” he says. “We found that any
aims not only to describe the world but to change it. “Behavioral one of these things had an e≠ect equal to one to five percentage
economics really shines when you talk about the specifics of points of interest! A woman’s photo instead of a man’s increased
what the policy should look like,” says Sendhil Mullainathan, who demand among men by as much as dropping the interest rate five
received a MacArthur Fellowship
in 2002. “The di≠erence in impact
between two broad policies may
“An economist would say, ‘With $50,000 at stake,
not be as great as di≠erences in
how each policy is framed—its
the forms can’t be the obstacle.’ But they can.”
deadlines, implementation, and the —Sendhil Mullainathan
design of its physical appearance.
“For example, in Social Security privatization,” Mullainathan points! These things are not small. And this is very much an eco-
continues, “the di≠erence between private accounts and the sta- nomic problem. We are talking about big loans here; customers
tus quo may be less than that between two di≠erent ways of im- would end up with monthly loan payments of around 10 percent
plementing private accounts. What is the default option? Are of their annual income. You’d think that if you really needed the
you allowed to make changes? What’s the deadline for making money enough to pay this interest rate, you’re not going to be
changes? How are the monthly statements presented—just your a≠ected by a photo. The photo, cell phone lottery, simple or com-
returns, or are the market returns printed alongside your own? plicated table, and deadline all had e≠ects on loan applications
In terms of impact, the devil really is in the details of how the comparable to interest. Interest rate may not even be the third
program is designed. We know that people have a tough time most important factor. As an economist, even when you think
making these choices. So how are the choices framed? What psychology is important, you don’t think it’s this important. And
metrics do they focus on?” changing interest rates is expensive, but these psychological ele-
“We tend to think people are driven by purposeful choices,” he ments cost nothing.”
explains. “We think big things drive big behaviors: if people don’t Mullainathan is helping design programs in developing coun-
go to school, we think they don’t like school. Instead, most behav- tries, doing things like getting farmers to adopt better feed for
iors are driven by the moment. They aren’t purposeful, thought- cows to increase their milk production by as much as 50 percent.
out choices. That’s an illusion we have about others. Policymak- Back in the United States, behavioral economics might be able to
ers think that if they get the abstractions right, that will drive raise compliance rates of diabetes patients, who don’t always
behavior in the desired direction. But the world happens in real take prescribed drugs, he says. Poor families are often deterred
time. We can talk abstractions of risk and return, but when the from applying to colleges for financial aid because the forms are
person is physically checking o≠ the box on that investment form, too complicated. “An economist would say, ‘With $50,000 at
all the things going on at that moment will disproportionately stake, the forms can’t be the obstacle,’” he says. “But they can.” (A
influence the decision they make. That’s the temptation ele- traditional explanation would say that the payo≠ clearly out-
ment—in real time, the moment can be very tempting. The main weighs the cost in time and e≠ort, so people won’t be deterred by
thing is to define what is in your mind at the moment of choice. complex forms.)
Suppose a company wants to sell more soap. Traditional econo- Economists and others who engage in policy debates like to
mists would advise things like making a soap that people like wrangle about big issues on the macroscopic level. The nitty-gritty
more, or charging less for a bar of soap. A behavioral economist details of execution—what do the forms look like? what is in the
might suggest convincing supermarkets to display your soap at brochures? how is it communicated?—are left to the support sta≠.
eye level—people will see your brand first and grab it.” “But that work is central,” Mullainathan explains. “There should
Mullainathan worked with a bank in South Africa that be as much intellectual energy devoted to these design choices as
wanted to make more loans. A neoclassical economist would to the choice of a policy in the first place. Behavioral economics
have o≠ered simple counsel: lower the interest rate, and people can help us design these choices in sensible ways. This is a big hole
will borrow more. Instead, the bank chose to investigate some that needs to be filled, both in policy and in science.”
contextual factors in the process of making its o≠er. It mailed
letters to 70,000 previous borrowers saying, “Congratulations! The Supply of Hatred
You’re eligible for a special interest rate on a new loan.” But the While some try to surmount or cope with irrationality, oth-
interest rate was randomized on the letters: some got a low rate, ers feed upon it. In the wake of (please turn to page 93)

Harvard Magazine 57
ilar analysis to the news media). For example, George W. Bush Because successful persuasive messages are consistent with
wearing a $3,000 cowboy hat was not a problem, because it prevailing worldviews, one corollary of Shleifer’s analysis is that
matched his image, but John Kerry riding a $6,000 bicycle was a persuasion is definitely not education, which involves adding
problem—that luxury item appeared hypocritical for a candi- new information or correcting previous perceptions. “Don’t tell
date claiming to side with the downtrodden. people, ‘You are stupid, and here is what to think,’ ” Shleifer
Citing Republican pollster and communications consultant said. During presidential debates, he asserted, voters tune out or
Frank Luntz, Shleifer noted how the estate tax was renamed the forget things that are inconsistent with their beliefs. “Educa-
“death tax” (although there is no tax on death) in order to suc- tional messages may be doomed,” he added. “They do not res-
cessfully sell its repeal. The relabeling linked the tax to the un- onate.” In economic and political markets, he said, there is no
pleasant associations of the word “death,” and the campaign tendency toward a median taste; divergence, not convergence, is
asked questions like, “How can you burden people even more at the trend. Therefore, the successful persuader will find a niche
this most di∞cult time in their lives?” “Messages, not hard at- and pander to it.
tributes, shape competition,” Shleifer said; he noted that the fear When making choices in the marketplace, “People are not re-
of terrorism is a bigger issue in probable non-target states like sponding to the actual objects they are choosing between,” says Eric
Wyoming, Utah, and Nevada than in New York and New Jersey. Wanner of the Russell Sage Foundation. “There is no direct rela-

“People care not only about outcomes,

but about how outcomes came to be,” says as-
sociate professor of public policy Iris Bohnet
Games of a second option that brings even greater win-
nings for B—but less than the “safe” option
would have given A. In other words, the
of the Kennedy School of Government. “That “good” (i.e., trustworthy) B player will take
doesn’t strike anyone but an economist—like
me—as a surprise.” Game theory, as concep-
tualized by conventional economics, suggests
Trust and the win-win alternative, while the “selfish” B
will maximize his own outcome at A’s ex-
pense. When the researchers ask subjects
that players care only about substantive re- playing A, “What percentage of good people
sults. With Ramsey professor of political
economy Richard Zeckhauser, Bohnet devel-
oped a concept of “betrayal aversion,” build-
ing on the well-established psychological
Betrayal would there have to be in the room [of 15 po-
tential B players] before you would be willing
to trust this stranger [the B player]?” the an-
swer has consistently been 50 to 80 percent.
principle of risk aversion—by and large, hu- The second game has the same rules as the
mans simply don’t like to take risks. first, except that an urn containing 100 blue
It turns out they don’t like to trust, either, because trust is a and green marbles takes the role of Player B. The urn is a proxy
form of risk that makes one vulnerable to betrayal. To buy an for an impersonal force, such as nature. If a blue ball is randomly
item on eBay, one must trust the seller. We also trust attorneys, chosen, B selects the “trustworthy” win-win alternative; if a
doctors, and politicians to tell us the truth and to represent our green ball, the “selfish” one. The researchers then asked A players,
interests. “These are principal-agent relationships,” Bohnet says. “What percentage of blue balls would the urn have to contain for
“An agent does something on your behalf. But principals’ and you to be willing to take this risk?” A rational money-maximizing
agents’ incentives are not always completely aligned, and there’s person—one who cares only about outcomes—would give the
asymmetric information.” same answer to this question as to the analogous one in the first
Traditionally, academics have linked trust to risk tolerance, game. But when playing with “nature,” respondents generally
since it involves taking a risk. Instead, “We’re saying that risk- peg the figure at 30 to 40 percent, far lower than in the first game.
taking when the agent of uncertainty is nature is very di≠erent “People are less willing to take risks when confronted with an-
from when the agent is another person,” Bohnet asserts. A other person than when confronted by nature,” Bohnet explains.
farmer, for example, faces natural risks like weather and soil “Trust is not only about willingness to take risks, but about the
conditions. But there are also social risks—speculative willingness to be betrayed.”
bubbles, HIV infection, terrorism—where other By comparing the di≠erence between “Minimal Acceptable
people produce the uncertainty. Probabilities” in the first and second games, the researchers
Bohnet and Zeckhauser have been run- have been able to distinguish risk aversion from betrayal aver-
ning two games, now with about a thou- sion. The “nature” game establishes a baseline level of risk aver-
sand subjects around the world, playing sion, but the game with a human Player B introduces the addi-
in groups of 30 at a time. They are two- tional possibility of betrayal. Thus, the gap between
person games, a variant of the classic percentages on the two games gives a rough index of betrayal
Prisoner’s Dilemma. In the first game, aversion. In the United States, Switzerland, and Brazil, the be-
Player A can choose a “safe” alternative trayal aversion di≠erential is 10 to 20 percent. Zeckhauser and
GETTY IMAGES

or choose to trust Player B, who can in Bohnet have also played the games in the Persian Gulf region,
turn choose an option that rewards both with subjects in Kuwait, Oman, and the United Arab Emirates.
of them more than the safe alternative, or (They are the first social scientists to run economic experi-

94 March - Apr il 2006

 tion of stimulus and response. Neo-
classical economics posits a direct “Educational messages may be doomed. They
relationship between the object and
the choice made. But in behavioral do not resonate.” Voters tune out or forget things that are
economics, the choice depends on
how the decision-maker describes the ob-
jects to himself. Any psychologist
inconsistent with their beliefs.
knows this, but it is revolutionary —Andrei Shleifer
when imported into economics.
“We are vulnerable to how choices are described,” Wanner ex- that the successful seller will produce a better product, the mar-
plains. “Advertising is a business that tries to shape how people ket will price the product correctly, and the buyer will buy it at a
think about their choices. Neoclassical economics can explain price that maximizes everyone’s interest—the market is simply
ads only as providing information. But if the seller can invest in where the buyer and seller come together. But once you intro-
advertising that frames the choice, that frame will skew the duce framing, you can argue that the buyer may no longer be act-
buyer’s decision. The older economic theories depend on the idea ing entirely in his own self-interest if the seller has invented a
frame for the buyer, skewing the choice in favor of the seller.
“Then, the model of the market is not simply buyers
and sellers coming together for mutually beneficial
ments in the Gulf region, and will go to exchange,” Wanner continues. “Instead, the ex-
Saudi Arabia in March.) In these coun- change between buyers and sellers has aspects of a
tries, betrayal aversion is markedly zero-sum game. The seller can do even better if he
higher, with a di≠erential in the 30 to 40 sells you something you don’t need, or gets you to
percent range. “Many in this area say buy more than you need, and pay a higher price for
they are willing to trust only if 100 per- it.” The classical welfare theorem of Vilfredo
cent of the people are trustworthy,” Pareto was that markets will make everyone as
Bohnet reports. well o≠ as they can be, that the market distribu-
She had an enlightening experience tion will be an e∞cient distribution that maximizes
when teaching negotiation and decision welfare. “But once you introduce framing, all bets are
analysis to a group of government ministers o≠,” Wanner says. A zero-sum game between buyer and
from the Persian Gulf region in a Kennedy School seller clearly does not maximize everyone’s welfare, and
executive-education program. “I started the class by hence suggests a di≠erent model of the marketplace.
asking them to recall a time when they lost trust in someone,” There are many political implications. We have had 30 years of
Bohnet recalls. “One minister said, ‘Trust is not an issue for us. We deregulation in the United States, freeing up markets to work
never trust.’ What a beginning! It opened up a very interesting dis- their magic. “Is that generally welfare-enhancing, or not?” Wan-
cussion. A minister said, ‘We cannot dare to trust because we may ner asks. “Framing can call that into question. Everyone agrees
lose face. I would never come to a meeting and put something on that there’s informational asymmetry—so we have laws that en-
the table that other people could decline.’ The meeting-before-the- sure drugs are tested, and truth-in-advertising laws. Still, there
meeting is absolutely critical in the Gulf, because being let down is are subtle things about framing choices that are deceptive,
terribly humiliating.” though not inaccurate. We have the power of markets, but they
Trust has other policy implications. Social capital, per capita are places where naive participants lose money. How do we man-
income, economic growth, and political stability all have positive age markets so that the framing problem can be acknowledged
correlations with trust in a society. “Trust is a generally good and controlled? It’s an essential question in a time of rising in-
thing,” says Bohnet. And nations deal with breakdowns of trust in equality, when the well-educated are doing better and the poorly
di≠erent ways. “In the Western world, especially the United educated doing worse.”
States, contract law builds on the notion of damages or e∞cient It’s a question that behavioral economics raises, and, with
breach,” Bohnet says, “meaning that someone who breaches a luck, may also be able to address. The eclipse of hyper-rational
contract must compensate their counterpart. But if people are re- Economic Man opens the way for a richer and more realistic
ally betrayal averse, damages won’t satisfy them, because what model of the human being in the marketplace, where the brain,
they are concerned with is the fact of betrayal. U.S. contract law with all its ancient instincts and vulnerabilities, can be both
focuses on decreasing the material cost of betrayal, but what be- predator and prey. Our irrationalities, our emotional hot-but-
trayal aversion asks for is to decrease the likelihood of betrayal, tons, are likely to persist, but knowing what they are may allow
which causes emotional hurt. In Islamic law, which seems to en- us to account for them and even, like Odysseus, outwit tempta-
courage building trust by personal relationships rather than legal tion. The models of behavioral economics could help design a so-
means, damages play a much smaller role than in the West. In ad- ciety with more compassion for creatures whose strengths and
dition to differences in law, there obviously are other contributing weaknesses evolved in much simpler conditions. After all, “The
factors. For example, group-based social organization, typical in world we live in,” Laibson says, “is an institutional response to
the Gulf but not in Western countries, is based on long-standing our biology.”
relationships. This substantially reduces the likelihood of betrayal
and thus, the social uncertainty involved in trust.” Craig A. Lambert ’69, Ph.D. ’78, is deputy editor of this magazine.

Harvard Magazine 95
T H E M A R K E T P LAC E O F P E RC E P T I ON S Party favored large-scale redistribution of wealth from the rich to
(continued from page 57) the poor, and got substantial support from African Americans.
“Wealthier Southern conservatives struck back, using race hatred”
the 9/11 attacks, Edward Glaeser began using behavioral eco- and spreading untrue stories about atrocities perpetrated by
nomic approaches to research the causes of group hatred that blacks, Glaeser says. “ ‘Populists are friends of blacks, and blacks
could motivate murderous acts of that type. “An economist’s are dangerous and hateful,’ was the message—instead of being
definition of hatred,” he says, “is the willingness to pay a price supported, [blacks] should be sequestered and have their re-
to inflict harm on others.” In laboratory settings, social scien- sources reduced. [Rich whites] sold this to poor white voters,
tists have observed subjects playing the “ultimatum game,” in winning votes and elections. Eventually the Populists gave in and
which, say, with a total kitty of $10, Player A o≠ers to split the decided they were better o≠ switching their appeal to poor, racist
cash with player B. If B accepts A’s o≠er, they divide the money whites. They felt it was better to switch policies than try to
accordingly, but if B rejects A’s o≠er, both players get nothing. change voters’ opinions. The stories—all about rape and murder—
“In thousands of trials around the world, with di≠erent stakes, were coming from suppliers who were external to poor whites.”
people reject o≠ers of 30 percent [$3 in our example] or less,” Glaeser applies this model to anti-American hatred, which, in
says Glaeser. “So typically, people o≠er 40 or 50 percent. But a degree, “is not particularly correlated with places that the United
conventional economic model would say that B should accept a States has helped or done harm to,” he says. “France hates America
split of even one cent versus $9.99, since you are still better o≠ more than Vietnam does.” Instead, he explains, it has much to do
with a penny than nothing.” (If a computer, rather than a with “political entrepreneurs who spread stories about past and
human, does the initial split, player B is much more likely to ac- future American crimes. Some place may have a leader who has a
cept an unfair split—a confirmation of research conducted by working relationship with the United States. Enemies of the leader
professors at the Kennedy School of Government; see “Games of o≠er an alternative policy: completely break with the United States
Trust and Betrayal,” page 94.) and Israel, and attack them. We saw it in the religious enemies of
Clearly, the B player is willing to su≠er financial loss in order the shah [of Iran]. The ayatollah sought to discredit the secular
to take revenge on an A player who is acting unfairly. “You don’t modernists through the use of anti-American hatred.”
poke around in the dark recesses of human behavior and not find For Glaeser, behavioral economics can take “something we have
vengeance,” Glaeser says. “It’s pretty hard to find a case of mur- from psychology—hatred as a hormonal response to threats—and
der and not find vengeance at the root of it.” put this in a market setting. What are the incentives that will in-
crease the supply of hatred in a
“You have to investigate the supply of hatred. Who has specific setting?” Economists, he
feels, can take human tendencies
the incentive and ability to induce group hatred? rooted in hormones, evolution, and
the stable features of social psychol-
Politicians or anyone else will supply hatred when hatred ogy, and analyze how they will play
out in large collectivities. “Much of
complements their policies.” psychology shows the enormous
sensitivity of humans to social
—Edward Glaeser influence,” Glaeser says. “The Mil-
gram and Zimbardo experiments
The psychological literature, he found, defines hatred as an [on obedience to authority and adaptation to the role of prison
emotional response we have to threats to our survival or repro- guard] show that humans can behave brutally. But that doesn’t ex-
duction. “It’s related to the belief that the object of hatred has plain why Nazism happened in Germany and not England.”
been guilty of atrocities in the past and will be guilty of them
in the future,” he says. “Economists have nothing to tell psy- Zero-Sum Persuasion
chologists about why individuals hate. But group-level hatred Andrei shleifer has already made path-breaking contribu-
has its own logic that always involves stories about atrocities. tions to the literatures of behavioral finance (as noted above),
These stories are frequently false. As [Nazi propagandist political economy, and law and economics. His latest obsession is
Joseph] Goebbels said, hatred requires repetition, not truth, to persuasion—“How people absorb information and how they are
be e≠ective. manipulated,” he says. At the American Economic Association
“You have to investigate the supply of hatred,” Glaeser contin- meetings in January, Shleifer described “cognitive persuasion,”
ues. “Who has the incentive and the ability to induce group ha- exploring how advertisers, politicians, and others attach their
tred? This pushes us toward the crux of the model: politicians or messages to pre-existing maps of associations in order to move
anyone else will supply hatred when hatred is a complement to the public in a desired direction.
their policies.” Glaeser searched back issues of the Atlanta Consti- The Marlboro Man, for example, sold filtered cigarettes by
tution from 1875 to 1925, counting stories that contained the key- mobilizing the public’s associations of cowboys and the West
words “Negro + rape” or “Negro + murder.” He found a time-se- with masculinity, independence, and the great outdoors. “There
ries that closely matched that for lynchings described by is a ‘confirmation bias,’” Shleifer explained, which favors persua-
historian C. Vann Woodward: rising from 1875 until 1890, reach- sive messages that confirm beliefs and connections already in the
ing a plateau from 1890 until 1910, then declining after 1910. audience’s mind (see “The Market for News,” January-February,
In the 1880s and 1890s, Glaeser explains, the southern Populist page 11, on work by Shleifer and Mullainathan that applies a sim-

Harvard Magazine 93