How Should Wealth be Distributed? (Part One)

US Wealth Distribution 

Recent research by Harvard's Michael Norton and Duke's Dan Ariely (described here) reported on a survey of respondents' views on how wealth should ideally be distributed (column 1), their perception of how wealth is distributed (column 2), and how wealth really is distributed (column 3).

There's stunning divergence between these charts.  People feel wealth should be fairly equally distributed.  They perceive that wealth is not distributed that equally, but that it's in the ball park.  However, they miss the fact that wealth is distributed much much more unequally than they perceive.

Wealth is extremely unevenly distributed in the US.  The top 1% hold 40% of the wealth, and the top 20% hold over 80% of the wealth.  Yet a random sample of 5,000 Americans perceive that the top 20% hold just over 50% of the wealth, and they feel that, ideally, they should hold about 30% of the wealth.

The research has provoked discussion on the topic, and has also spawned a video that expresses the data more visually which will appeal to those less comfortable with simple percentages and statistics.

The reason for this misperception among Americans might be explained by some of Dan Ariely's previous work in behavioural economics.  Dan Ariely is best known for his book Predictably Irrational.  It's a great read and I highly recommend it.  (I've written about Ariely's work before in posts here, here, and here.)  Ariely's research highlights the many behaviours exhibited by humans that are simply not rational.

One of Ariely's key points is that people assess choices in comparison to easily comparable choices in their own environment.  So one could postulate that people have a distorted perception of wealth distribution because they mostly pay attention to the people around them, people likely to enjoy similar levels of wealth to their own.  Then they extrapolate from that experience and assume the whole country exhibits a similarly flat wealth distribution.  They are also misled by evaluating people's wealth based on their apparent material possessions, yet one family might own their McMansion outright while the family next door is drowning in debt.

The survey did not uncover a big difference in attitude between those who voted Republican and those who voted Democratic.  They had a remarkably similar view on how wealth should be distributed.  American politics can be very puzzling to non-Americans.  If people voted purely based on their economic self-interest, then the top 1% - or let's be generous and say the top 20% - would vote Republican and the rest would vote Democratic.  However, we don't see those voting patterns.  Puzzling.

* For those interested in this topic, there's a second post on this topic here.

The Upside of Irrationality

Dan Ariely

There's a lot being written about behavioural economics these days.  Dan Ariely is one of the leaders of the crowd.  I mentioned his latest book, The Upside of Irrationality, was a recent TED Book Club selection.  (He's also been a TED speaker).

In this book, he describes many experiments, usually introduced by describing what sparked his curiosity about the effect, which makes it a rather chatty and breezy read.

Some experiments prove what we intuitively believe - how we adapt to either extreme happiness or extreme pain, with both losing intensity over time.  Well, we knew that - something can smell very strong when we first enter a room, but, with time, we no longer are conscious of it. .  When I was leading a business, I would often ask new employees what they thought was stupid about the way we did things.  You have to ask such a question within their first few weeks; after that, our stupidities had started to appear sensible to them.   Even though some of Ariely's research seems obvious, many things that we intuitively 'know' turn out to be false, so it's still useful to scientifically test their validity.

Another experiment showed that moderate bonuses motivate people to excel more than very small bonuses do.  But, perhaps counterintuitively, the experiment also demonstrated that very large bonuses result in poorer performances than moderate bonuses.  This experiment was carried out in rural India so that they could afford to offer bonuses that were significant relative to their total annual salaries.  Ariely often speaks to audiences in the financial industry, who greet these experiments with a stolid disbelief.

From the first book, and from a couple of times I've heard him speak, I knew a bit about Ariely's horrific accident as a teenager which left him with third degree burns over 70% of his body, but this book delves more deeply into this period of his life, and the very lasting influence the incident has had on his life.  Experiences from that time have inspired his research into reactions to pain, for instance.

I really enjoyed Ariely's first book Predictable Irrational (see this post for my reaction to that book), but in the last couple of years since reading it, I have read enough about behavioural economics that this book, if not redundant, was not very startling.

TED Book Club

TED has just sent out the latest books for the Book Club.
The Upside of Irrationality: The Unexpected Benefits of Defying Logic at Work and at Home is Dan Ariely's latest book. I loved his first book Predictably Irrational. It was full of great anecdotes and research about how irrationally people act in practice, although they are convinced they are behaving totally rationally. So I fully expect to like this book too. By the way, when I went to Dan's site to get the book cover image for this post, I discovered his blog, which I really love.




The other book is by Matt Ridley, The Rational Optimist: How Prosperity Evolves. This book argues that things are getting better, and we have good reason to be optimistic about the future. Again, this book looks pretty interesting. TED makes a practice of trying to bring forward optimistic themes - this year's TED Global theme was And Now the Good News.

Ridley also has a blog at his site, although it didn't seem as breezy and inviting as Ariely's.

Predictable Irrationality and Bernie Madoff

Dan Ariely is the author of the delightful book Predictably Irrational, a professor of behavioural economics at the Sloan School of Management at MIT, and a great speaker. He challenges the traditional notion in economics that people behave in a rational manner.

In fact, he has demonstrated that people are actually irrational, but in a predictable way. He told us about one series of experiments designed to test propensity to cheat.

The basic experiment had a group of student volunteers take a test with a number of math questions on it. The questions were all well within their capability, but there were too many for someone to possibly do within the time limit. They calibrated the test by giving it to lots of students which determined that the average number of questions solved was four. They then did a number of variations on this control experiment.

A lot of people will cheat a little
The first experiment administered the test and offered the students money for each question they got right. The students were asked to report how many questions they got right and then to shred their answer sheet. Many participants cheated - but only by shading their results up a bit. Ariely suggests that people cheat just enough that they still feel good about themselves.

People cheat less when they've been reminded of morality
In one variation, participants were asked to write down the Ten Commandments before starting the test. They didn't cheat. The students had very low recall of the commandments, suggesting that they weren't necessarily highly religious. Indeed the same effect was observed when they were asked to sign the MIT Honour Code before starting the test. This worked, even though MIT actually has no Honour Code!

People cheat more about things rather than money
In another variation, Ariely offered people tokens instead of money for reported correct answers. These tokens were then exchanged for money. By using tokens instead of money directly, cheating doubled.

He also described a simple test in a shared fridge. You can leave a Coke or an equivalent amount of money in the fridge to see how long before they are stolen. The half life of the Coke is much shorter than that of the money. Similarly, people who would never think of taking a dime from petty cash will nonchalantly take home a pencil from work.

People cheat more if members of their group are seen to be cheating
Another interesting variation on the math test had an actor taking the test, and claiming that he got all the answers; the other participants would know this had to be a lie. When this actor was wearing a sweatshirt from the participant's own university, this increased cheating. Without that affinity, the actor's claim had no impact.

Ariely tells a riveting story of how he became interested in how people make irrational decisions. As a young man, after an injury while he was in the Israeli army, he spent many months in hospital with third degree burns all over his body. During this time he suffered horrible pain during the changing of the bandages on his burns. The technique was to take the bandages off quickly, resulting in high pain levels. He proposed to the kindly nurses that they should experiment with removing the bandages more slowly - less pain over a longer period - but was unsuccessful in convincing them to try it.

He later did experiments that showed that we suffer less when we experience lower levels of pain over longer periods than more pain over shorter periods. Even when he returned to tell the nurses of this, he was unable to convince them they should consider changing their ways. This inspired him to investigate other areas in which humans hold strong views about how humans react, without necessarily having the evidence to support their position.

Ariely has commented on the lessons we might learn from the real-life "experiment" on cheating conducted by Bernie Madoff. As he points out, we're more at risk from many people cheating a little bit than from the the big cheaters like Madoff. He worries that the Madoff experience will cause us to shift our focus to catching the few big cheaters, instead of the thousands of little one. Click here to see what he has to say.