In theory, the Great Recession was never supposed to happen. According to the mathematical models of most economists, free markets regulate themselves efficiently, because human beings make economic decisions based on rational self-interest.
Now, a new field of research is challenging that portrait of Homo economicus, say two faculty researchers at the McCombs School of Business. It’s called behavioral economics. At the junction of economics and experimental psychology, it studies how real people make economic decisions.
Outside mathematical models, they say, the human mind is fertile soil for the weeds of greed. We have high ethical intentions, but an array of unconscious biases tilts us towards irrational self-interest.
“The more there is at stake, the more pressure there is on your mind to fool you,” says Professor Robert Prentice. “The human ability to rationalize is astonishing. We can do anything and still keep our positive images of ourselves.”
He rattles off a few of our built-in biases and some of the experiments that have documented them:
- Self-serving bias. We filter out information that contradicts our beliefs. In one experiment, fans of two football teams watched the same game, then disagreed on which team got the most breaks from referees. In another, subjects read an article on capital punishment. A month later, they remembered facts that supported their positions better than facts that did not.
- Overconfidence. We overestimate our own virtue. In one survey, 74 percent of people believed their ethics were higher than the average person’s. In another, 61 percent of doctors thought their judgments were not affected by gifts from drug companies. Only 16 percent thought so highly of their peers.
- Conformity bias. We pressure ourselves to agree with others around us. Psychologist Solomon Asch asked subjects which of three lines was the same length as a fourth. When alone, people gave accurate answers. But when surrounded by strangers who offered wrong answers, 60 percent of subjects responded with at least one whopper.
Changes in financial markets have also pushed ethics to the background, says senior lecturer Michael Brandl. Before 1980, bankers saw their duty as conservative stewardship of their depositors’ money. But as deregulation allowed riskier loans and investments, a new culture took hold.
“You began to see more people going into the financial markets because they could make a lot of money quickly,” says Brandl. He points to junk-bond king Michael Milken. “We started to put him and his kind on a pedestal, to be emulated rather than shunned.”
Governments rewarded ethical decline with a series of bailouts, starting with the savings and loans bailout in 1989. “As financial crises took place around the world,” says Brandl, “banks realized they could privatize their returns and push all the risk onto the public. This misalignment of incentives ultimately led us to the mortgage crisis.”
If something positive is to come from the crisis, says Brandl, it might be a return to teaching ethics at business schools. “If we did a better job of teaching how our markets have evolved, our students would get a much better understanding of their fiduciary responsibility to the rest of society.”
Prentice hopes to do just that. He’s heading up a new department at McCombs, called Business, Government and Society, which will make business ethics a focus.
“One hope is that we send a message to our students how important it is to us, to the university,” says Prentice. “Then, we hope to give them some tools to be more effective decision makers, to make it easier to act ethically.
“Part of it is studying this behavioral stuff, warning them not to be too cocky. Don’t just assume that you’re a good person, because you can end up walking blindly into embarrassing situations. You’ve got to keep your ethical antennae up.”