Dan Ariely, author of Predictably Irrational: The Hidden Forces That Shape Our Decisions and The Upside of Irrationality: The Unexpected Benefits of Defying Logic at Work and at Home was interviewed by Matthew Taylor for the RSA Journal. The topic was the importance of understanding our weaknesses in order to anticipate and avoid mistakes, which is a topic discussed on this sight in several places (falling under behavioural investing).
Matthew Taylor: The UK government has just set up a behavioural insight team, and behavioural economics has been subject to a surge of policy interest in recent years. What do you think has driven this trend?
Dan Ariely: Without the financial crisis, I don’t think behavioural economics would have gained the popularity it has. Almost everyone believed that the market was the most rational place on the planet, yet it failed in a magnificent way. This proved that people who deal with large amounts of money are as capable of irrationality – from reckless gambling to myopia and overconfidence – as anybody else.
In addition, over the years, behavioural economics has moved from the lab to the field. Early researchers, such as Daniel Kahneman and the late Amos Tversky, were working on theories of human behaviour using gambling. The application of their work to real life wasn’t immediately obvious to everyone. Now, however, we’re looking at what behavioural economics can teach us in a whole range of environments, from schools and kindergartens to banks and hospitals. We’ve shown that it matters in everyday situations, and in ways that almost everyone finds appealing.
MT: Can you give me some examples of these real-world implications?
DA: We’ve recently done a study looking at how people decide which loans to pay back. It turns out that, when people have multiple loans, they choose to pay back the small ones first, rather than the ones with the highest interest rate. Out of the thousands of people who took part in the study, not a single one chose the perfectly rational strategy. Here, there’s a clear opportunity to stop people from wasting money by encouraging them to make better financial decisions.
Another study we’re doing is about why people don’t look for second opinions in medicine. There’s an obvious financial motivation for doctors and dentists to overtreat people, which explains why, for instance, 75% of wisdom tooth extractions in the US are estimated to be unnecessary. Second opinions are one of the best remedies for this type of conflict of interest, because they enable patients to get advice from someone other than the person they are paying for treatment.
Conflicts of interest are a good example of the importance of behavioural economics. In standard economics, there’s no such thing as a conflict of interest: a doctor or dentist simply calculates the comparative benefits of giving bad advice and remaining honest. Yet what our study has shown is that, while many practitioners believe they’re always acting in the best interests of their clients, the reality is that they often see the world in terms that are more compatible with their own financial interest. They don’t realise how influenced they are by conflicts of interest, so they don’t even think that it’s important for them to fight against these forces.
(h/t Farnam Street)
See the full interview here.
Talk to Frank about Behavioural Finance
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