Can behavioural economics help markets to work better?

In his book, ‘The Upside of Irrationality’, Dan Ariely claims to have identified a market failure in the online introductions market. He refers to a survey indicating that people participating in that market spent on average 5.2 hours per week searching profiles and 6.7 hours per week emailing potential partners for a payoff of 1.8 hours actually meeting them.

He comments:

‘Talk about market failures. A ratio of 6:1 speaks for itself. Imagine driving six hours in order to spend one hour at the beach with a friend (or even worse, with someone you don’t know and are not sure you will like)’.

When I read that my first thought was that it would not be particularly uncommon in Australia for young people to drive three hours to spend an hour with a friend and then drive for another three hours back to where they came from.

I think the term market failure is thrown around too loosely. The situation described clearly involves high transactions costs, but that doesn’t mean the market has failed. The existence of high transactions costs in a market should not be viewed as a symptom of market failure unless we can point to some reason why the market cannot function efficiently.

In this instance the market seems to be working well because evidence relating to the existence of high transactions costs has induced some enterprising people to consider what innovations might be introduced to reduce those transactions costs. The fact that the innovators were a university professor and his associates suggests to me that university staff may be becoming more entrepreneurial.

I think Dan Ariely has done a good job of demonstrating the potential for behavioural economics to help entrepreneurs to design innovations that may reduce transactions costs. He considers survey and experimental evidence which suggests that the high transactions costs associated with online introductions stem from the attempt to reduce humans to a set of searchable attributes. The problem is that the searchable attributes convey little information about what it might be like to spend some time with particular individuals.

Ariely and his associates developed a virtual online dating site that enabled participants to engage anonymously in instant message conversation about various images e.g. movie clips and abstract art. They found that participants were about twice as likely to be interested in a real date after meeting in person following the virtual date than following a conventional online introduction. It seems that when we experience something with another person we gain much more information about compatibility than when we just look at searchable attributes. He has discussed his research here.

It is too soon to know whether Dan Ariely and his associates have prompted a market innovation that will help large numbers of people to live happier lives. However, I think Ariely has demonstrated that behavioural economics may be able to help markets work better. As he points out, there is potential for firms to do a better job of satisfying consumer demand by conveying to consumers what it might actually be like to have the experience of using their products. I think that means, among other things, that if retail stores didn’t exist already they would probably need to be invented to give consumers the opportunity to experience goods before they buy them.

Coming back to market failure, does the fact that some consumers buy goods cheaply online after inspecting them in a retail outlet constitute a market failure? I don’t think so, even though such behaviour is evidence of positive spillovers associated with retailing. Manufacturers will work out before long that retailers provide them with a useful service by enabling consumers to experience their products in real life - and think up some way to encourage ongoing provision of that service.

Why do some people become grumpy senior citizens?

When I was in my 20s I could not imagine what it might be like to be old. I would not have believed it possible that one day the government would issue me with a ‘Seniors Card’ declaring that I am ‘a valued member of our community’ and asking for ‘every courtesy’ to be extended to me.

Actually, I still find it hard to believe that I have been given this card. Wasn’t I a valued member of the community when I was younger? Aren’t young people and old people equally entitled to courtesy?

Perhaps the purpose of the card is to warn young people that old people can be grumpy. A few days ago an elderly person - a person considerably older than me who has to cope with considerable pain and limited mobility - told me that a young man in a health services profession recently made a remark to her along the lines: ‘So, we are feeling a bit grumpy today, are we?’ She apparently tore strips off him (metaphorically) to teach him a lesson in courtesy. He now knows how she behaves when she is feeling particularly grumpy!

A few days ago another person mentioned to me that she had observed that the minor irritating behaviours that some of her friends had displayed when they were young have tended to worsen as they grow older. I think I have observed something similar, but I wonder whether the behaviour actually worsens or whether my threshold for irritation might have fallen as I have aged. There may be tendencies for both of these things to occur in some people. Some other people seem to improve with age.

In his book, ‘The Upside of Irrationality’, Dan Ariely provides a discussion of the long-term effects of short-term emotions, which may be helpful to an understanding of how some people develop habits of grumpiness. He provides experimental evidence that the way we respond to particular events when we are angry (even for unrelated reasons) can have an ongoing influence on our future decisions in similar circumstances and even become part of our identity.

The experiment involved influencing the mood of participants by showing them different videos chosen to make them feel either angry or happy, observing how they then respond to unfair treatment (unfair offers in the ultimatum game) and then observing how fairly they treat other people when roles are reversed. As might be expected, the angry participants were more likely to reject unfair offers. However, the offers that those participants subsequently made to other people tended to be fairer than the offers made by the happy participants who had accepted the unfair offers.

Ariely’s interpretation of the results seems to me to make sense. He suggests that the angry people tended to attribute their decision to reject the offer to its unfairness rather than to their emotional state and then to act as though they think other people are just like themselves. Similarly, the happy people who accepted the unfair offer would have tended to think that other people would be similarly willing to accept unfair offers. In both cases the decision made has an ongoing influence over future decisions, after the initial emotional state has passed.

The results are consistent with the idea that individuals have a tendency to interpret their own past decisions to indicate the kind of person they are and how the world works. A grumpy person who reacts negatively when some other person is perceived to be disregarding his or her commands is not necessarily acting out of character when showing generosity towards that person at other times. A decision made at the heat of the moment at some time in the distant past could have initiated a pattern of behaviour and sense of identity that prompts the person to act in this way. (The grumpiness shown at a particular time could, of course, be aggravated by pain or frustration.)

It is sometimes argued that society benefits from the actions of people who are prepared to sacrifice their own well-being in order to punish people who act unfairly. However, people who engage in such vindictive behaviour do not necessarily spend much time feeling grumpy. Chronic grumpiness is obviously undesirable for the individuals directly affected as well as for the victims of their grumpiness.

Dan Ariely’s research findings suggest an additional remedy for those of us who are concerned that we might become grumpier as we grow older. We should avoid making decisions while we feel grumpy!

What is wrong with the way governments are pursuing happiness objectives?

There can be no doubt that western democratic governments have been attempting to promote the happiness of citizens for a long time. They may not talk much about attempting to achieve the greatest happiness for the greatest number, or any similar high-sounding principle, but they have a wide range of policies intended to promote the well-being of citizens in general or of various groups. When it comes to discussion of government policy most citizens could be broadly described as utilitarians. We may feel strongly about rights, but we have come to expect policy debates to focus on the effects of proposed policy changes on particular groups of gainers and losers and on the wider community.

As I see it there is nothing inherently wrong with governments seeking to enable us to live happier lives, particularly since this is what many citizens want. It is certainly better to have people in government trying to enable us to live happier lives than for them to be trying to make themselves happier at our expense. The main problem as I see it is that the approaches that we – the people in western democracies – have been encouraging governments to adopt to help us to live happier lives have often been counter-productive.

The first problem has to do with our perceptions of the nature of happiness. I think we have been too ready to assume that the best way to enable people to live happier lives is to attempt to control their lives for them. Thus, for example, people are taxed during their working lives to provide health care or retirement incomes that they could afford to provide for themselves. Added to this we have proposals to prevent people from saving too little, working too hard, gambling too much, eating too much and so forth. We need to consider whether the humans are able to flourish if they do not have control of their own lives.

The second problem has to do with the idea that governments could promote the happiness of society if only it could be measured correctly. There has been an ongoing debate about the shortcomings of GDP as a well-being measure and various alternatives are being proposed, including some involving direct measurement of happiness. We need to consider whether it makes sense to discuss the relative merits of different indicators as though all the different factors that are important to the flourishing of any group of individuals can be captured by a single statistic.

The third problem has to do with the effects of government pursuit of happiness on individual flourishing. The more governments take over responsibility for our happiness, the more restrictions they impose on the opportunities that are available to us. For example, if governments regulate to reduce working hours in order to enable people to enjoy more leisure, this restricts the opportunities available to people who have strong personal reasons for working longer hours. We need to consider more carefully the likely effects of such government interventions.

The fourth problem has to do with the effects of government pursuit of happiness objectives on the social fabric. The opportunities available to individuals depend to a large extent on the kind of society they live in. If they live in a corrupt society in which rule of law is breaking down, their opportunities for mutually beneficial interactions with other citizens are likely to be diminished. Incentives for corruption are obviously stronger when governments intervene extensively to regulate the behaviour of citizens. We need to consider how successful different societies have been in containing corruption in the face of such incentives.

These issues are to be discussed in a book I am currently writing, with the provisional title:

We need to be

Free to Flourish

The introductory chapter of the book is available here. Comments would be appreciated. (Please do not be offended if I do not respond immediately because it may take a few days to re-surface, or come down to earth from other activities.)

Is Bhutan's GNH experiment a success or failure?

This charming little video provides some history of the concept of Gross National Happiness and its application in Bhutan.


It is amazing how much passion has been aroused by Gross National Happiness outside Bhutan. In August last year Jeffrey Sachs, a distinguished development economist, suggested that western countries should follow Bhutan in adopting Gross National Happiness as a national objective. His concern is that trends toward ‘hyper-consumerism’ have accelerated in the United States in recent decades and that this is destabilizing social relations and leading to aggressiveness, loneliness, greed, and over-work to the point of exhaustion. It is not self-evident that Sachs’ claims are true – and he provides no evidence in support of them. More importantly, it is not clear how he thinks adopting Gross National Happiness as a national objective in western countries would lead to better outcomes. I fear that the remedy he has in mind for alleged hyper-consumerism is additional paternalistic interventions by governments to further remove from individuals the responsibility to control their own lives.

On the other side of the canvas, Julie Novak, a free market liberal whose views I normally respect, has described Bhutan’s adoption of the GNH objective as a failed experiment. Julie’s reasoning seems to be that the experiment must have failed because Bhutan has a relatively low per capita GDP level and its ratings on various social indicators are also relatively low. However, I doubt whether many people would claim that adopting GNH as an objective can immediately lift the average well-being of people in a low-income country like Bhutan to a level comparable to that attainable in the most affluent countries. That would be just as silly as claiming that an increase in economic freedom can convert a low-income country immediately into a high-income country.

It makes more sense to compare Bhutan’s performance on various economic and social indicators with that of other low-income countries. The comparison I made between Bhutan and India, here, suggests that Bhutan has performed reasonably well. For example, Bhutan’s average economic growth rate of around 8 per cent per annum over the decade to 2007 was substantially higher than that for India.

It seems to me that it is far too soon to come to a judgement about Bhutan’s GNH experiment, particularly since it is only in recent years that a serious attempt has been made to measure GNH and there is little evidence to suggest how this information will actually be used in policy development. I concluded my research on this topic for APEL by suggesting that it is not yet clear to what extent the judgments implicit in the methodology reflect the values of the people of Bhutan on such matters as the dimensions of well-being that are important and the weighting that should be given to each dimension. One of my concerns is that the weight that people living in urban centres may wish to give to resilience of cultural traditions may differ substantially from that of people living a traditional rural lifestyle. It would not make sense to claim, for example, that the happiness of any individuals can be enhanced by forcing them to adopt traditional lifestyles if they would prefer more cosmopolitan lifestyles (or vice versa).

Postscript: May 8, 2011

In discussing GNH I have avoided discussing the Nepalese refugee problem because I don't know much about it. It is clear, however, that the government of Bhutan has been slow to repatriate refugees who were long-term residents of Bhutan prior to being forced to leave.

It is also of concern that in implementing its GNH policy the government of Bhutan is now apparently jailing people for having more that a very small amount of tobacco products in their possession. This is discussed by Sonam Ongmo on her Dragon Tales blog.

The idea that you can make people happy by jailing them seems peculiar.