The following is an interview with Dr. Dan Ariely, MIT professor and author of the book, “Predictably Irrational” an outstanding book on behavioral economics. Janet Walsh was the host of the Human Capital Show in Atlanta, GA for four years and this interview was one of the most popular broadcasts. The original program aired several years ago, but the comments Dan makes are worth considering.

Janet: Dan works at MIT, he is a professor of economics, and he researches how people actually work in the marketplace, as opposed to how they should or would perform if they were completely rational.

Janet: What is behavioral economics?

Dan: Behavioral economics says that we don’t really have a starting point. We can exam people empirically and see whether they are rational or irrational. (He gave many examples of this, one being the law of 228, where homosexuals receive two years of cheap interest and 28 years of really high interest. Another example is going to a restaurant on a diet and the waiter brings chocolate cake and then the person takes the cake and forgets the diet that day and commits to start the diet tomorrow.) The consequences are that people borrow too much money and succumb to temptation. People make many mistakes in a predictable, repeatable way. One way to deal with them is to understand their mistakes and capitalize on them. When people had foreclosures with the 228 laws, a great deal of money was lost. The more promising direction is to say if we can understand where people fall short, we can think about how to actually improve the world. We have to understand what kind of physical limitations we have and we design the world to fit those physical limitations. When it comes to our thinking ability, somehow people assume that we are “superman of the mind,” that we can compute everything and know everything. Therefore, when we design health insurance and retirement plans, we assume we are superman when instead we are more like Homer Simpson.

Janet: Are we just eternally optimistic and is that why we assume we are “superman?”

Dan: It is not just optimism. There is something that blinds us to our irrationalities. It is easy to see in others but hard to see in ourselves. We often don’t see the reality that would have emerged if we had made a different decision. An HR example would be that HR hires people they think are good and does not hire people that they think are bad. The only way to test if HR is correct in doing this is to hire the bad people and see what happens. An organization that does this is the Airforce. The Airforce does this with testing to help the organization determine how to do a better test. Another example given was going on a blind date. The first five minutes are awful and that person is given a chance to leave and never see that person again or that person can say maybe I am not a good judge of character and let me spend five more hours with this person just to see if their first impression is wrong. We often do not have a chance to realize that we were wrong.

Janet: In other words, we do not open our decision making to a pool of people.

Dan: Exactly. A medical example given was: medicine after the 19th century was mostly placebos. Imagine a doctor was told that leaches were beneficial and so that doctor gives leaches to everyone who comes in with pain. The doctor would not deprive the patient of a leach to figure out if the leach is useful or not. The FDA forces people to do experiments. In behavioral economics, we often have wrong intuitions about what drives people. Often times we need to do things in much more rigorous testing. Most companies want to be told what to do, instead of run experiments. Companies need to gouge their intuitions and do the experiments.

Janet: How might we use behavioral economics in a law firm to suggest they try and obtain factual information before making gut-based decisions?

Dan: There is one way to be rational and many ways to be irrational. You can think about how, the way we are designed can change businesses. What would it say about you and motivation or the relationship between the customer and the lawyer or about successful or unsuccessful cases when being presented to a jury? Social security number example discussed people being given a price with the last two digits of their social security number and people may not be willing to pay that price for an item but they will stay close to that number. A guy who is involved in jury selection called him about floating numbers by a jury because he thought it changes how people view punitive damages once they start considering a certain number.

Janet: How do we get people to overcome the impression they have about what products should cost?

Dan: It is hard to compute the value of products, so we do things like relative comparison where we compare if a product is cheaper here than there. We create habits because habits help us not to think about something every time from scratch, which is incredibly difficult. It is very hard to figure out the value of a consulting service. It is hard to change a habit because habits mean that people do not actively consider a decision. The only time you can influence people is when they consider it actively. People consider things actively when changes happen or when external conditions command our rethinking about things. McKenzie consulting firm defines the status quo of what is good and not good. A different company could focus on redefining what people need to be good at instead of fighting with McKenzie. Another consulting firm can give people something that McKenzie is not giving them. A business needs to define the attributes that people are going to compare them to. The more control you have over it, the better you would look.

Janet: Change or modify a pricing practice in conjunction with a visual change to maybe your website or to your product material. If you make this type of a change in how you price your product, you want to tie it with a visual change that is new or different, even if it was as simple as changing colors or the way your website looked.

Dan: That’s right. You want to give it some reason in people’s minds. He discussed how to decrease cheating. He told of an experiment where people lied about how many test questions they answered because they were not asked to turn the paper back in. He found that when people sign an honor code at the beginning, they think about their own morality even if there is not an honor code and they cheat less. MIT does not have an honor code. Most people think that consumers exaggerate a little bit. He proposes people sign the insurance form at the beginning, instead of at the end to see if this will decrease cheating.

Janet: What about comparisons with colleges that do have honor codes? Might you see a difference between universities that have honor codes vs. those who do not reflected in student incidents?

Dan: Princeton has a strong honor code and he did this experiment with this college. The university spends a tremendous amount of resources trying to get the students to be more honorable but when you just see them on the street, they are just as likely to cheat as MIT students without an honor code. When either of them signs the honor code, nobody cheats. One important lesson about cheating is that it is not so much about the probability of being caught. What really seems to matter is how people think about their own morality in the moment. If you pry people to think about morality they cheat less. If you get them to think about something that has less to do with morality, they cheat more. When you remove something from money, it is easier to cheat on it.

Janet: You mentioned the Enron example given in book.

Dan: Differences between direct cheating vs. indirect cheating. Direct cheating we have to confront ourselves and indirect we could easily justify to ourselves. You can think about this as a problem of conflict of interest. Can we see life as it is or are we biased to see things in the way it suits us? We are incredibly biased that even small incentives make us see things in the way that suits us. People cheat not because they are bad people but because they are designed to see things in the way that it fits them and cannot help it.

Janet: How can a job seeker use behavioral economics to improve their chances for selection in an interview?

Dan: Interviews are bad mechanisms. It is a lot about the chemistry between the employer and potential employee, as well as, idiosyncrasies. As the interviewee, emphasize your benefits relevant and irrelevant to the job.

Janet: How does behavioral economics influence how HR makes compensation decisions?

Dan: I think one of the things many people in HR do not recognize is the importance of social rewards. Businesses seem to miss that the employee and employer should care for each other and build relationships, believing in the long run that things will work out. Giving employees a gift of a nice vacation spot and time is socially efficient. There is another concern, which is change in employees’ benefits. Instead of paying for their healthcare, employers are offering another $10,000 for the employee to pay for their own healthcare. Loyalty, care and motivation from the employee towards the company would drop tremendously. It has short-term financial benefits and long-term negative consequences. People would be more motivated if the company paid their healthcare.

Janet: Why do so many business leaders seem to ignore the cost benefits of a strong HR strategy and continue to under value human capital financial management?

Dan: I think one of the reasons is that it is very hard to see the value. Hr as a field has not come up with good, quantifiable ways for people to see the advantage. People are not going to understand the financial benefit until HR is able to prove more directly the positive and negatives of HR.

Janet: What are the implications of behavioral economics for social networking?

Dan: Social networking shows us some of the incredible motivations that people have for links and connections. If we understood those motivations, we could think about how to incorporate them into other things. What about giving people social rewards, recognition, and reputation and how do we use that in a business.

Janet: Of all the forces that shape our irrational behavioral economics, which do you consider to be the most powerful and why?

Dan: The difficulty of making choices. We have created a very complex world.

There are three lessons to take away from the book. The first one is how much fun social science is. Everything in life could be a source for experimenting with something we do not understand. The second thing is about recognizing some of the mistakes we do in our individual lives and thinking about how we can fix some of them. Try to change the things that matter to you the most. The last is about businesses policy-what kind of world do we want to design. Do we want to design a world that assumes people are rational and therefore creates traps for us to fail or do we want to recognize our irrationality and design our products, services and policies according to this and therefore create a better world?