Psychology teaches us that humans are irrational, adaptable, constantly changing beings with cognitive abilities greater than any other animal. Economics would have us think we are rational, unchanging, robots devoid of empathy or feelings towards anyone else. So what happens when these two branches of the social science tree meet: welcome to behavioral economics.
Capitalism was built on false pretenses.
There are two principles that we now know are not true (and never were): (1) that humans are rational, (2) that we are motivated by financial rewards above everything else. Behavioral economics or good economics or new economics, is trying to take this new knowledge and apply it to update old theories on economics. Psychology and the field of social sciences more broadly are providing the evidence we need to do this… so let’s dig deeper there.
One of the best books I’ve read this decade (and there are a lot) is Daniel Khaneman’s Thinking Fast and Slow. It is the latest in a growing movement of books that blend psychology, economics, and the other social sciences to create a more authentic theory of human behavior and decision making. Khaneman quotes behavioral economist Richard Thaler throughout and uses the terms ‘Econs’ and ‘Humans’ for the different species that traditional economists and traditional psychologists have been studying.
Dan Airely famously declared that humans regularly and predictably act in ways traditional economists would declare irrational in his aptly titled book Predictably Irrational. Airley is a professor of both Psychology and Behavioral Economics and combined with Thaller’s best-seller, Nudge, was a part of my introduction to the world of behavioral economics.
The basic overview is that psychologists have been studying what they call cognitive biases and heuristics for years, and recently (as early as the 1970s, but not widely until the 1990s/2000s), they have been applying the science of decision making with theories laid out in classic economics. What they’re finding is that humans do not normally act like Econs. There are a number of instances where we favor fairness and relationships over profit, and default to laziness over cognitive effort, all of which debunks the truths held in classical economics.
There is an easy solution for this particular problem. As a company, offer automatic enrollment to such plans with an opt-out for those who don’t want to join. A 2001 study by Brigitte Madrian and Dennis Shea found that with the opt-in clause the company they studied had a 20% adoption rate of employees choosing to sign up to the company-sponsored 401k plan from the time of hiring which slowly rose to 65% after 3 years working for the company. When they switched their policy to an opt-out clause the immediate adoption rate was 90% rising to 98% after 3 years. In a land of Econs it wouldn’t matter whether the clause was opt-in or opt-out, but it clearly does.
The first player (the proposer) receives a sum of money and proposes how to divide the sum between himself and another player. The second player (the responder) chooses to either accept or reject this proposal. If the second player accepts, the money is split according to the proposal. If the second player rejects, neither player receives any money. The game is typically played only once so that reciprocation is not an issue. Let’s say we start with $100 and choose only Econs to play. In this scenario the proposer would always offer $1 to the responder and keep $99. The responder would raionally understand that it is better to have $1 than $0 and accept the offer, but this rarely happens in reality. In reality, the responder views the $1 offer as ‘unfair’ and rejects the offer with no one receiving anything. Humans sense of fairness trumps our economic rationality.
In the real world, with Humans playing instead of Econs, subjects usually split the pie pretty evenly. Those who propose too little, get rejected and neither party gets anything. Culturally, this split changes from country to country, but Americans value fairness more than most. In fact Jonathan Haidt claims in his book, The Righteous Mind: why good people are divided by religion and politics, that the value of ‘fairness’ is one of the universal values that both democrats and republicans can agree on (of course they have different definitions for what fairness means, but that’s for another post).
So what does this have to do with purpose? If we know we can’t reliably make decisions based off of sound reason, logic, and rationality, than what are we left with? Purpose. By having a clear sense for what you’re trying to achieve and where you want to go, it will always be easier to make decisions. You can escape some of the mind traps and create shortcuts that will allow you to make easier, more decisive decisions.
As a bonus, Purpose also helps provide you with a more realistic, long term perspective (good for retirement savings), and encourages you to treat all people (investors, employees, suppliers, neighbors, etc.) fairly which is apparently what we all want anyway.
Having a strong purpose works because it motivates people. It motivates people because it reaches a deeper level, something more inspiring, then just making money. Studies show that contrary to economic theory, employees are motivated more by having a strong sense of commitment to a greater power, than they are by monetary rewards. This is why some teachers, nurses, clergy and soldiers happily work for less than they deserve. They’re not doing it for the money. They are doing it out of a sense of duty, to serve others, a noble calling.
‘‘The highest levels of motive — which can be truly extraordinary — arise when people understand that they are serving a genuinely good purpose.’’
- The Book of Life
Motive is very important in economics, it dictates human behavior towards achieving goals. Understanding what motivates employees has been a key source of knowledge for companies for generations. Where the banks still predominately ‘motivate’ with financial bonuses, a growing number of purpose driven organizations are motivating with non traditional means.
And what about our first example, Tesla and Ford. How many engineers are interested in ‘delivering profitable growth for all’ vs ‘to accelerate the world’s transition to sustainable transport’? I know where I’d want to work.
Next week I want to get back to a question thats been plaguing me for years. As a society we have opened our arms to corporations and through our government we have even given them the legal power of ‘personhood.’ But can corporations really live up to that ideal? Are they humane enough to be human? And if so, can a corporation have a soul?
This post was originally published on LinkedIn on September 9, 2015.