Loss Aversion, Capuchin Monkeys, and Customer Relations

David M. Jensen
David M. Jensen

By coincidence I read about loss aversion today in Superfreakonomics, then experienced it for myself some hours later. (I’d read the material before, but I wanted a refresher.) The book tells the story (pp. 212–14) of economist Keith Chen training a group of capuchin monkeys to trade tokens (“coins”) for food. At one point Chen and his researchers offered the monkeys either a single grape or two grapes, but, half the time, by chance, they’d add a second grape to the single grape or else subtract a grape from the pair. So, on average, a monkey got 1.5 grapes, and it was statistically irrelevant whether the initial offering was a single grape or two grapes.

But it was not irrelevant to the monkey’s behavior. The monkeys “strongly preferred the one-grape researcher”; they “behaved as if the pain from losing a grape was greater than the pleasure from gaining one,” the book relates. That is, the monkeys experienced loss aversion.

Later in the day I experienced something a little like that. After I referred a friend to my dentist, the dentist sent me a very nice, hand-written note thanking me for my referral; I received the note today. At first I was thrilled: “What a nice gesture, and a nice way to build customer loyalty,” I thought. But then my dentist urged me to “enjoy the enclosed gift card” that was a token of his thanks. I must have left the gift card behind in the envelope, I thought—but no. In irritation I thought, “So where’s my freakin’ gift card?”

Then I remembered the capuchins. Although I never actually had the gift card (much less whatever goods or services it might have procured for me), I thought I had it, and I momentarily felt perturbed that I’d “lost” it. In a flash, I my emotions had turned from gratitude to annoyance. But how silly, I thought; it was still very nice for my dentist to send me a hand-written note, and the fact that he or an assistant accidentally neglected to add the gift card made me no worse off than I was before.

The lesson for businesses is to not disappoint customers by offering them things you can’t deliver. It’s better not to promise something than to promise it and not deliver it. (Of course, businesses can overcome failure to deliver something by apologizing, explaining context, and so on.)

The lesson for individuals is to remember that we are wired for loss aversion—but we are also wired with the intellectual capacity to recognize that there are contexts in which our “gut” may lead us astray here. If someone offers us two dollars gratis but then delivers only one, it’s still a good thing that we got a dollar. And I should let my irritation over the “lost” gift card fade away, and focus on my gratitude that my dentist recognized my referral. It really was a nice gesture on his part.

In short, don’t let loss aversion make a monkey out of you.

The Neo-Luddites

Image: Wikimedia Commons
Image: Wikimedia Commons

The Objective Standard just published my article, “New Technologies, Same Old Fallacies,” a reaction to Jeff Elder’s article for the Wall Street Journal, “Tech Experts See Good and Bad Sides of Robots.” I write (among other things), “Elder predicts that new technologies, including advanced robotics and self-driving cars, will soon be commonplace. Undoubtedly these technologies will make some jobs obsolete, but they will also give rise to many new career opportunities.”

Reisman on Piketty’s Program for Economic Stagnation and Decline

capitalism-reismanEconomist George Reisman recently published a twenty-thousand word reply to Thomas Piketty’s Capital in the Twenty-First Century. Reisman writes, “Over the course of several generations, the US government has taxed away trillions upon trillions of dollars that otherwise would have been saved and invested and thereby added to the capital of the American economy. . . . The government’s massive assault on the supply of capital has begun to transform the American economic system from one of continuous economic progress and generally rising living standards into one of stagnation and outright decline.” Of course, Piketty’s program to “help” the less well-off consists of expanding government’s assault on capital. If after reading Reisman’s lengthy essay you find yourself hungry for more, you can find Reisman’s double-column, thousand-page book, Capitalism, for free online.

The Debate Over Public Choice Misdefines “Self Interest” and “Public Interest”

Gordon TullockAre political actors (politicians, voters, and bureaucrats) motivated by “self interest” or “public interest?” That is the central question as it is posed in the academic debate over the Public Choice school of economics. However, it is the wrong question.

Public Choice economists and their critics agree that, at least sometimes, political actors pursue financial gain and power at the expense of others, and obviously that is true. To take a few examples, recall the Youtube video in which a woman recites her reasons for supporting Barack Obama: “I won’t have to work [to] put gas in my car, I won’t have to work [to] pay my mortgage.” Does anyone doubt that political actions over the last few years to expand food stamps, expand unemployment benefits, increase subsidies for students loans, bail out auto unions, subsidize solar and wind companies, and expand Medicare coverage were calculated to gain political support? The typical member of congress today sees it as his primary responsibility to bring home the pork to (select voters within) his district.

The problem lies in describing the issue as “self interest” versus “public interest.” Before addressing that issue, though, let us first look in more detail at the debate surrounding Public Choice.

In his book Government Failure, Gordon Tullock (one of the founders of Public Choice) describes what he sees as the problem with the traditional view of politics, as well as his alternative:

Throughout the 19th and well into the 20th century, economists assumed that individuals are primarily concerned with their own interest and worked out the consequences of that assumption. In contrast, during this same period political science largely assumed that political actors are mainly concerned with the public interest. . . .

Economists changed this bifurcated view of human behavior by developing the theory of public choice, which amounts, in essence, to transplanting the general analytical framework of economics into political science. The statement that the voter in the voting booth is the same person as the customer in the supermarket does not seem radical, but it is nevertheless a very dramatic change from the political science literature. (pp. 4–5)

While Tullock grants that political actors do not necessarily act in a “self interested” way (as he uses the term), he thinks they ordinarily do:

Of course, empirical confirmation of any theoretical proposition is more important than analytical elegance. When considering the behavior of any individual politician, most people realize that the politician behaves in a self-interested way; similarly, when considering the factors that affect votes, most people assume that personal gain is certainly an aspect. (p. 6)

The critics of Public Choice, on the other hand, argue that political actors tend to act in the “public interest.” Jeffrey Friedman, editor of Critical Review, describes the debate in the Winter-Spring 1995 issue (Vol. 9, Nos. 1–2) of his journal:

[A] distinction should be drawn between two terms that are often used imprecisely or synonymously: rational choice and public choice. One understanding of the difference holds that public choice theory applies economic analysis to political (i.e., “public”) decision making, while rational choice theory goes even farther, applying economics to other nonmarket realms, such as family life. This distinction, to adopt John Ferejohn’s [citation omitted] terminology, attributes to both public and rational choice theory a “thin” understanding of the economists’ rationality postulate: individuals are assumed to have only the inclination to satisfy their stable and ordered preferences, whether these are selfish or not. But outside the academy, public choice theory has a decidedly “thick” connotation, referring to the alleged propensity of political actors to pursue their material self-interest. . . .

Like most important ideas . . . public choice theory is liable to polemical oversimplification. The main danger is that the possibility that people are as self-interested in their political as their economic behavior may be treated as the assumption that self-interest is always and everywhere the real fountainhead of politics. . . .

[T]he effort of comparing public choice hypotheses against alternatives frequently falls to non-public choice scholars. One such effort is Leif Lewin’s Self-Interest and Public Interest in Western Democracies, published by Oxford University Press in 1991. Reviewing in detail the empirical literature on a variety of public choice claims—almost all of which was written by non-public choice researchers—Lewin found that in no case does public choice theory withstand scrutiny as a general hypothesis about the ubiquity of self-interest in politics. (pp. 1–3)

Friedman goes on to explain that, according to Lewin’s findings, voters tend to select politicians they deem “likeliest to benefit the economy of their society as a whole,” and bureaucrats too frequently act outside the boundaries of what the Public Choicers predict for them (pp. 3–4).

Notably, a recent issue of Critical Review (Vol. 23, No. 3 from 2011) explores Lewin’s work in more detail, featuring an essay by Lewin himself.

Lewin writes that, today, even many Public Choicers agree “that voters, politicians, and bureaucrats are much more public spirited than public-choice theorists originally maintained” (p. 361). However, Lewin acknowledges the problem of interest groups in politics. He writes, “[I]t is hardly unexpected that people pursue their self-interest when they enroll in interest groups. That is the whole rationale for membership.”

Public Choice economists and their critics, then, agree that sometimes political actors act in their “self interest” and sometimes in the “public interest.” They disagree over how prevalent one is over the other.

The huge problem with this debate is that neither of the sides presented offers a coherent definition of “self interest” or “public interest.”

As the scholars quoted above use the term, “self interest” applies to political practices of taking others’ wealth by force, forcibly blocking or harming competitors, gaining special political favors, and the like. The opposite of “self interest,” goes this line of thinking, is “public interest,” which means acting for the general well-being of society as a whole. Neither of those definitions withstands scrutiny.

Begin with “self interest.” One’s actual, long-term, selfish interests consist substantially in achieving and supporting a government that protects individual rights, not one that forcibly transfers wealth and doles out favors. It is only within a rights-respecting society that an individual is free to act consistently for his own purposes and in accordance with his own, unhindered judgment. If one holds that the “public interest” consists in establishing a rights-protecting government—the only sensible use of the term—then there is no clash between pursuing the “public interest” and pursuing one’s “self interest,” properly conceived.

With the sloppy treatment of “public interest” within the debate over Public Choice theory, however, the “public interest” can be conceived in any number of contradictory ways, ranging from the American Founders’ support for a rights-respecting government to the communists’ support for collectivism and mass slavery. What matters is the content of one’s ideology, and referring to some undefined “public interest” only obfuscates that issue.

History shows that what we have to fear are not primarily the petty politicians who act to advance their narrow interests of wealth and power by abusing their positions, as annoying and destructive as they are. What we should fear are those politicians who sincerely act in the “public interest” conceived apart from individual rights—and who stop at nothing to achieve it.

Image of Gordon Tulluck: Mercatus Center

Thank the Industrial Revolution for Longer Life

The following article by Linn and Ari Armstrong originally was published October 28 by Grand Junction Free Press.

Growing older comes with its problems, but, as we’ve all heard, it surely beats the alternative. Earlier this month Ari turned 40. (We don’t need to go into details of Linn’s age.) An interesting fact about the age of 40 is that it’s older than the average lifespan of almost all of human history. So if you’re older than 40, or hope to be, thank the industrial revolution, which radically extended human life.

The industrial revolution, fueled by the philosophical Scottish Enlightenment, gained steam in England in the late 1700s. This was right around the time of the founding of the United States, which, as the freest country in the history of the earth, soon adopted the industrial revolution as its own and created unparalleled prosperity.

Modern humans have walked the earth for roughly a quarter of a million years. So you are extremely lucky to have been born during the tiny fraction of human history in which you have a good chance to live to see old age as we now understand it.

According to the CIA’s World Factbook, one nation still has a life expectancy less than 40: Angola. Several African nations still have life expectancies less than 50. Why the difference? Much of Africa remains ravaged by tribal warfare, political corruption, and an almost total lack of industrial progress, exacerbating such problems as famine and the AIDS epidemic.

Throughout almost all of human history, most people faced conditions roughly comparable to those of the poorest regions of modern Africa. Violence, starvation, and disease were the normal conditions of life.

The Wikipedia entry on “life expectancy” offers some good leads; for example, it cites a recent text on American history that discusses England in the early 1600s. That book summarizes, “Life expectancy was only about thirty-five years, and two-thirds of all children died before the age of four.” Today children rarely die. Throughout much of human history, many or most children died, and that was considered normal.

In the industrial world, life expectancy has risen into the upper 70s and 80s. The United States comes in only 50th on the CIA’s list with a life expectancy of 78.37. (Monaco tops the list at 89.73.) But the U.S. suffers relatively high rates of auto fatalities and homicides; adjusted for those factors, our country approaches or hits the top of the list.

But how could early industry, with its dirty coal and poor working conditions, so dramatically extend human life? Prior to industry, most people lived in abject poverty, and even the few wealthy of the time had relatively few of the amenities even America’s poor now take for granted. (Andrew Bernstein does a good job of reviewing early industrial advances in Capitalism Unbound.)

Prior to industry, people had to walk wherever they went; the lucky few had horses and carriages (which left stinking, pestilent messes in city streets). Steam-powered boats and trains, then petrol-powered automobiles, gave mobility to the masses. Today we can ride by helicopter to a far-away hospital if we need urgent medical care. We can jet around the world in the time it used to take to traverse a state. A relative recently flew to Europe for discretionary health care.

In the good old days, often you were luckier if you did not have access to a doctor with his leeches and concoctions. If you got an infection, often you would die. Today advanced machinery can scan your bones or peer into your heart. We have access to mass-produced drugs effective at alleviating a wide range of ailments. We have access to heart surgery and advanced cancer treatments.

At America’s founding, roughly 90 percent of all working people farmed. Eking a living from the dirt without the aid of tractors and trucks, irrigation pipes, and modern fertilizers imposed severe hardships. Today less than three percent of the workforce raises all our food—freeing up the labor of others to provide our other wants and needs.

Prior to industry, people made their few items of clothing by hand. With industrial production of cotton clothing, the masses could afford to buy clothes and subject them to the rigors of routine cleaning. Today, we can clothe ourselves modestly for perhaps a couple hour’s worth of labor.

True, industrial progress requires legal stability and relative freedom. Capital formation—the development of the tools and machines that expand our productivity—drives our improving standard of living. People don’t invest in capital when others loot or destroy the products of their effort. The prosperity of capitalism derives from the political protection of people’s rights. To the degree we stray from that standard, we undermine our prosperity and threaten our futures.

If you value your high standard of living and your potential to live into your 70s and beyond, live in gratitude for the industrial revolution—and help protect its future.

Fun with the Dismal Science

I presented this talk September 10 for a Liberty Toastmasters meeting oriented toward humor. Funny isn’t usually my thing, but I had a go with the “dismal science.” So, yes, I’m exaggerating certain points; however, most of the underlying ideas are based in real economics.

I’ve written about the potty-training story from Freakonomics before, as well as the discussions about alien invasions from economists and environmentalists. Bastiat’s essay about the candlemakers is reproduced inThe Economics of Freedom.

Alien Invasions: Where Economic and Environmental Insanity Meet

“You’re traveling to another dimension. A dimension not only of sight and sound, but of mind. … Your next stop: the Twilight Zone.”

If the Onion covered the Twilight Zone, you’d end up with the sort of actual headlines we’re seeing today.

Consider the first headline, from Time“Paul Krugman: An Alien Invasion Could Fix the Economy.” What Krugman said was this: “If we discovered that space aliens were planning to attack, and we needed a massive build-up to counter the space alien threat, and inflation and budget deficits took secondary place to that, this slump would be over in 18 months.” He actually referenced the Twilight Zone.

And thus Krugman, a Nobel-winning economist, commits the simplest of economic fallacies, what Bastiat in 1850 called the broken-window fallacy, a type of the error of accounting for the seen but not the unseen.

The next headline comes from the land of environmental nuttiness, from the Guardian“Aliens may destroy humanity to protect other civilisations, say scientists: Rising greenhouse emissions could tip off aliens that we are a rapidly expanding threat, warns a report.” (For context, read the report from NetworkWorld.)

For any consistent leftist, this creates a paradox of unprecedented proportions. For clearly the solution is to expand CO2 production as rapidly as possible, so as to exacerbate global warming and incite an alien invasion, so that we can “stimulate” the economy and reelect Barack “The Chosen One” Obama in 2012.

(Hat tip to Aaron Bilger for blending the two stories.)

The Folly of ‘Buy Local’ Campaigns

Grand Junction’s Business Times quotes my dad Linn in an article today exploring a “buy local” campaign.

The article by Mike Moran cites the May 27 Free Press column by my dad and me on the topic and also summarizes our review of Bastiat.

My dad told the paper, “When you start ‘buying locally’ and not buying the best for the lowest cost, the allocation of resources gets distorted.” Specifically, the article goes on to review, spending more for the same product made locally makes the purchaser poorer and deprives other local businesses of the residual.

Moroever, Moran reviews, different “buy local” campaigns begin to compete for business. Certain Grand Junction businesses may benefit from a “buy local” campaign within the city, for example, but other businesses may lose if customers elsewhere also “buy local.” The result is that people in various communities spend a lot of time and energy depriving their neighbors of business. Meanwhile, consumers foolish enough to play along get hammered with higher prices.

Now, sometimes buying locally makes sense. For example, due to the soil, climate, and large river, the Grand Valley grows excellent peaches, grapes, and other fruit. Thus, it can indeed make sense to buy those products locally, especially considering the reduced transportation costs. It also makes sense for Grand Valley producers to export their products elsewhere, such as Denver markets. Yet, somehow, the “buy local” crowd in Junction doesn’t complain when Denver residents purchase those items from across the pass.

Many types of services cannot be provided at a distance. For example, my dad used to manage properties for a living, a job that requires extensive on-site labor. That’s simply not the sort of job a person can hire done by somebody living at a distance. But other sorts of services can be purchased at a distance; for example, one of my friends once worked at a national hotel calling center out of Grand Junction.

An interesting exercise would be to figure out how many businesses in Grand Junction export goods or services to other cities, states, and countries, and how many Grand Junction businesses depend on spending by travelers. Yet the hypocrites preaching “buy local” hardly complain about locals selling their goods or services elsewhere or doing businesses with people from out of town.

The basis of trade is comparative advantage. Different people and different regions should make what they’re good at, and exchange their produce for the goods and services others are relatively good at providing. The only thing the consumer should worry about is finding the best products at the best prices.

What’s the Real Price Inflation?

Recently economist Bruce Yandle wrote, “Inflation doubled from 1.1% in the fourth quarter to 2.2% in the first quarter, but that’s when they take out food and energy prices. For real people, inflation is 3.8% (including food and energy prices).” (We can appease the Austrians by distinguishing price inflation from monetary inflation.)

But I wonder if even that figure is wildly understated for at least some consumers. Consider some examples from my local grocery store:

* I noticed that the same package of sausage dropped in size from 16 to 14 ounces, a 14 percent price increase.

* Milk has gone from $1.99 per gallon to $2.69, a 35 percent increase. June 1 Update: I notice that milk is now on sale for $2.29, so a 15 percent increase.

* Whereas a package of cream cheese used to go on sale for $1 per package, the new sale price is $1.25, a 25 percent increase.

* I’ve been able to find fewer good markdown deals lately, which I take to be a combination of more people looking for them and grocers fighting tighter margins. A non-markdown item easily can cost double.

The wealthy, who already spend a ton of money on food, easily can reduce their spending with marginal shopping changes. But I suspect that, for lower-income shoppers, the real pain of inflation is considerably higher than the official figures indicate. These are also the people probably last in line for wage hikes or even getting hired.

And, according to one source, the April rate is 3.16 percent.

Why Spending More for Local Goods Harms the Economy

The following article by Linn and Ari Armstrong originally was published May 27 by Grand Junction Free Press under the title, “Channel 11 piece peddles economic nonsense.” Stay tuned for a related update about the views of Denver mayoral hopeful Michael Hancock.

If Bernie Lange had taken to the airwaves to promote therapeutic magnetic underwear or report alien anal probes, he rightly would have been laughed off the station. But apparently peddling economic nonsense fits perfectly well with the editorial policies over at Channel 11 News, the local NBC affiliate.

Last week the station broadcast the segment “Made In America,” a silly editorial masquerading as news that falsely argues buying overpriced American products creates jobs. Spending less for the same products made overseas, Lange intones sinisterly, costs Americans not only jobs but “billions in lost dollars.” That’s due to “the multipliers,” you see.

Thankfully, French economist Frédéric Bastiat* exposed Lange’s brand of foolishness way back in 1845 in his “Candlemakers’ petition.” To update the example, consider an obvious way to create jobs galore for manufacturers of light bulbs and the electricity required to run them. Simply block out all sunlight from your home. Board up all the windows. Think of all the American jobs we’d create if we all followed that one simple step. Say no to extraterrestrial sunlight!

Or consider the blight of foreign-made bananas and coffee. Scandalously, Americans tend to buy both those products from Central and South America. Think of all the American jobs we could create if we bought those goods only from U.S. suppliers, or better yet Colorado suppliers.

Impossible, you say? If you check out the web page of Denver Botanic Gardens, you will discover the center currently grows bananas, coffee, and chocolate right here in Colorado (as one of our friends pointed out). No doubt we could grow all those things locally if farmers spent enough on greenhouses and heaters.

Sure, the products would cost more, but just think of “the multipliers!” We could add billions upon billions of dollars to our economy just by spending more on the goods we consume every day. Indeed, by Lange’s logic, the more we spend, the more we prosper!

Clearly there’s something wrong with Lange’s reasoning. To get a better idea of the problem, consider Bastiat’s wisdom about the seen and the unseen. Bastiat writes, “The bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.”

What Lange sees are the manufacturing jobs lost. What Lange ignores are the exporting jobs created and the additional wealth made possible by trade.

Lange sees that spending more money on American-made products would contribute to the paychecks of American workers. Lange ignores the fact that spending more money on the same goods would deprive other businesses of those dollars. If you spend more money on toys and household items, you have less to spend with the local fruit grower or massage therapist.

Let’s get back to basics. Why should we trade at all? Why shouldn’t each individual produce everything he needs, all by himself? The answer should be obvious: everyone would become horrifically poor, and only a tiny fraction of today’s population would manage to survive at all. Just imagine making all your own clothes, growing all your own food, building your own shelter, and acting as your own dentist.

By trading, we benefit from other people’s skills, expertise, accumulated machinery, and natural advantages. Why does Lange think it’s any different when we trade with people in other towns, other states, or other nations?

China features lots of cheap labor. We would be fools not to take advantage of that. America, on the other hand, features lots of complex machinery and other capital goods made possible by industrialization and relative economic liberty. That’s why (as the CIA reports) per capita product in China is around $7,400 annually, whereas in the United Statesit’s $47,400.

If we stop buying stuff that China’s relatively good at making, that means we have to make stuff that we’re relatively bad at making. Such a policy is self-destructive. Buying cheap goods from China and elsewhere allows American workers to specialize on the things they make best.

Of course, it is worth looking into artificial reasons why some American companies move overseas, including high tax rates and business-crushing union policies. We should also explore the reasons for continued high domestic unemployment, particularly the Obama administration’s policies of blowing out the deficit and meddling in the economy. But let’s fix the underlying problems, not succumb to economic fantasies.

We doubt very seriously that Bernie Lange or anyone else at Channel 11 makes much of an effort to buy only American-made goods. And they’d be foolish to do so. Trade is all about specialization according to one’s strengths. We hope, therefore, that Channel 11 sticks to reporting the news and leaves the economic commentary to people like Bastiat.

* Note: I was paid a modest sum to help run Liberty In the Books, which has reviewed select works of Bastiat.

***

Elisheva Hannah Levin commented June 2, 2011 at 8:35 AM
I agree, should the local goods be identical to those from elsewhere. After all, I enjoy coffee as much as most Americans do. My caveat, is that often locally produced food is fresher and/or is produced in ways that make it tastier than mass produced food that is shipped in. And in many cases, such as the one of corn-fed beef in CAFO’s, the real cost is obscured because the federal government subsidizes the production of the corn heavily, and the cost to defend oil sources (need for transportation of feed and of product) is never factored in. Since this makes the American food supply chain an artificial economy, most people do not really know what the true cost of “cheap” food is, and how they are paying for it.
Sadly, although the term “free market” should be a redundancy, the understanding of the term “market” is so poor for most consumers, that we have to say it. Free markets, for all goods, across all boundaries produces a vital economy.