Dan Ariely

Dan Ariely is James B. Duke Professor of Behavioral Economics at Duke University’s Fuqua School of Business. He also holds an appointment at the MIT Media Lab. Ariely wrote the best-selling book Predictably Irrational while he was a fellow at the Institute for Advanced Study in Princeton, NJ. His work has been featured in leading scholarly journals and a variety of popular media outlets, including the New York Times, the Wall Street Journal, the Washington Post and Science. In this interview, Ariely discusses the uncertain world we live in and some of the irrationalities that creep into our decision making.

PwC: Do we live in times that are more uncertain than the past, and does that affect our decision making?

DA: I think so. There is a well-known phenomenon in psychology called “learned helplessness.” In the classic experiments, animals that had some control over when to end a mild shock stayed agile and resilient in the face of future shocks. Animals that experienced the same shocks as random and beyond their control essentially ended up whimpering in a corner. I think this phenomenon applies to the way humans experience uncertainty in the world today.

A sense of control or empowerment—or minimally, a clear understanding of causes and effects—keeps us alert, keeps our decision-making powers sharp. But that’s something we humans often lack in today’s very complex, fast-changing world. There’s a sense that our understanding of the world is eroding, and the relationship between what’s happening now and what will come next is increasingly cloudy. I think there’s a general depression because of that. For instance, the indicators of the economy are not that terrible, yet consumer confidence is at a 40-year low. We’re in a state of collective learned helplessness.

PwC: Do you have a recent example of this erosion of understanding about cause and effect in the world?

DA: Some of the Fed’s recent actions are a good example. It’s very unclear whom they decide to bail out under what conditions. It all looks so capricious and random. There’s no sense of order. Along those same lines, some of the complex financial instruments in place right now have obscured the relationship between cause and effect and decreased trust in the broader financial system dramatically. But for mental health and confidence, we need order, predictability and a sense of trust. I think it will take a long time to regain that. And I’m afraid that if we have another catastrophe soon, it will be just too much.

PwC: One way to think about risk is the probability of a negative outcome in an uncertain situation multiplied by the consequences of that outcome. We know you’ve thought a lot about the irrationalities that humans bring into their decision-making processes. How do we tend to be irrational when it comes to risk?

DA: A company has to make a lot of decisions having to do with risk and uncertainty. The tendency is to think about each of them separately; we’re so focused on each decision that we almost forget the other ones. But if you think about the questions collectively, you reach different conclusions. It turns out that it’s much better not to make one decision at a time but to try to make an overall decision about the strategy you’re taking in the face of uncertainty and then execute this strategy without trying to make a decision about every particular instance.

Here’s an illustration. If I offered you a gamble in which you’d win $150 for heads but lose $100 for tails, would you take it? Most people don’t; they are so worried about the possibility of losing $100 that the possibility of winning $150 doesn’t make up for it. However, if I asked if you wanted to play this gamble every day for a year and then settle up with me at the end, you would probably say yes. You can do the calculation over the long run and figure out that with approximately equal numbers of wins and losses, you’ll come out way ahead.

Now, rationally, rejecting a gamble when you will play it only once and accepting it when you will play it many times is inconsistent. This form of irrationality happens frequently when people focus too much on an isolated risk rather than on their entire portfolio of decisions.

PwC: So it sounds like we are often irrational in the present, but that we can counteract that irrationality by taking a longer term view?

DA: Take procrastination. If you left work to your own discretion every night, every night you will procrastinate, and eventually you will suffer the consequences because you’ll miss a deadline, or you’ll have to pull all-nighters, or the quality of your project will be bad. Because we just can’t leave it to our own discretion. But we can create mechanisms that force us to behave in a certain way by anticipating our inclination to procrastinate.

I’ll give an example. Imagine I was your physician and I told you, “May 15 you’re scheduled for a colonoscopy at 10:00 a.m.” Now, what’s the chance that you will wake up on May 15th and feel that today is a good day for a colonoscopy?

PwC: Zero

DA: Now, imagine if today I said, “On May 15 you’ll wake up and not feel like having a colonoscopy, but it’s important for you to have one, so I’m giving you a chance today to force your future behavior. How? Give me a check for $500. If you show up on May 15, I’ll give it back to you, maybe even with interest. But if you don’t show up, I’ll deposit the check.”

Now, on May 15 you will still not feel like having a colonoscopy, but you might also not feel like losing your money, and as a consequence you might actually show up for the exam.

PwC: What are some of the other major sources of irrationality in business?

DA: A big one is group decisions. Research shows that group decisions are poor decisions—and yet corporate America is full of groups and meetings. Another one is intuition. So many business decisions are based on intuition: people feel something or other. Advertising is run on intuition, with very little empirical testing. But if you believe that people are irrational, what does that imply about their intuition? Indeed, intuition can be very dangerous. The FDA forces people to do something extremely unnatural: not follow their intuitions and do very rigid experiments. And even then, big mistakes get made. Businesses don’t have the benefit of an FDA. No one forces them to do experiments.

PwC: We’ve talked about how we humans are irrational in many different spheres. Is there anything we can do to control our irrationality?

DA: One thing is to try to get the outside perspective. Think about how you would advise somebody else if it was their problem and their decision. Once we get a little less emotionally attached, we can sometimes see things a bit better.

Also, if we can create mechanisms that force us to behave in certain ways that counteract our irrational tendencies, we would actually behave better. The key is to recognize our irrationality, because if we understand the limitations, we can get ourselves to behave in different ways.

Humans are great at understanding our physical limitations—but not our mental limitations. We think we’re supermen of the mind: that we can compute everything and take in all considerations; that we’re basically rational. To the extent that we can think about where people are cognitively limited and how we fix that, I’m optimistic that we can build a much better world.