Ethical failures: Where they come from and how to address them

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A review of

Gentilin, Dennis. The Origins of Ethical Failures. Lessons for Leaders. A Gower Book. Routledge (2016). ISBN: 978-1-138-69051-6

Ethical failures were in the press big-time in 2017. Prominently, creeps like Harvey Weinstein, James Toback, Bill Cosby, Larry Nassar, etc. were accused of sexual transgressions of various sorts (and in some cases admitted them to varying degrees). The sheer number of accusations leaves little doubt that, in their substance, they are correct. One thing that was truly shocking, on top of the specifics of many of the allegations, was that some of these transgressions went on for literally decades, that many people seem to have known about them for years (if not decades), and that the perpetrators did get away with them for an unconscionably long time. It is clear that organizational failures must have played a major role. This was implicitly acknowledged in the name of  The Royal Commision (RC) into Institutional Responses to Child Sexual Abuse, established under the Gillard government in 2013 and which reported all 17 volumes of its findings on December 15, 2017. The RC also laid out recommendations.

It did not really come as a surprise that once again massive organizational failure, in particular of the Catholic Church, was identified as a major finding. It did not come as a surprise because for years there had been a never-ending stream of trials, not just in Australia, suggesting just that, and providing plenty of evidence that the Catholic Church – in its (continued) belief that it is a law and world unto itself — had engaged for decades in what might generously be called economy with the truth.

Two weeks earlier, after another year of numerous reports of questionable practices, and record profits of the four major banks, the Turnbull government saw itself forced — by its own backbenchers, no less — to announce that it would establish a RC into misconduct in the banking industry. It was a step that Labor and the Greens had urged for more than a year. (The recent draft report of the Productivity Commission has made clear that some such RC is indeed overdue.) The Turnbull government’s acceptance of something that it could not prevent, and its subsequent attempts to undermine the effectiveness of the RC by simultaneously widening its scope and imposing an essentially unrealistic timeline, demonstrates, at the minimum, the kind of myopic opportunism that Australian politics seems drenched in.

Having graduated in 2001, Gentilin became a member of the FX trading desk of the National Australian Bank (NAB), one of the four major banks.  In 2004 that trading desk became involved in a trading scandal that rocked NAB and led, within a couple of weeks, to the resignation of both its chairman and CEO, the reconfiguration of the board of directors, and significant financial and reputational losses. Gentilin was the young trader who blew the whistle. Contrary to many other whistleblowers (who are typically harrassed out of the organizations on which they blew the whistle), he stayed with NAB for more than a decade – as head of the institutional sales team and a member of the corporate strategy team — before he resigned in January 2016 to found Human Systems Advisory, a name meant to be programmatic. The foreword of his book was written by the current chairman of NAB who states: “There are no simple answers in this book. But there are answers. And there are important truths, supported by deep and rigorous analysis. These should be of interest to all corporate leaders, in both executive and non-executive roles.” (p. xvi).   One such truth, says the chairman – apparently quoting Gentilin – is that “leaders must strive to articulate a meaningful social purpose for their organizations that is underpinned by a virtuous set of values.” That’s quite a mouthful, and the impending Royal Commission on the banking system suggests strongly that the major banks (that tried at first to fight off the RC until they realized that fight had been lost) have continuing trouble to understand that particular message, as does the recent draft of the related Productivity Commission report.

Below, I am interested in both the depth and rigor of the analysis and the truths that Gentilin establishes.  I am also interested in the implementability of the measures that he proposes.

In his Introduction, Gentilin states that he draws his evidence from “behavioural business ethics” which he defines as the intersection of business ethics and psychology (p. 5). While he is credited on his website with a degree in psychology, Gentilin makes clear that he wrote this book as a “practitioner” rather than “an academic, a philosopher or an ethicist” (p. 4). He does so in four chapters that explore “The Power of Context”,  “Group Dynamics”,  “Our Flawed Humanity”, and “What We Fail to See”.  A conclusion follows.

Gentilin relies heavily on summaries of articles from psychology that explore human nature and the circumstances under which nice behaviour might turn into, well, not so nice behaviour of different shades. While there is brief perfunctionary nod (p. 3) to the replicability crisis that has afflicted psychology, throughout the book there is little discussion of relevant laboratory design and implementation issues such as incentivisation, experimenter expectancy effects, external validity, and so on (Hertwig & Ortmann 2001; Ortmann 2005). Never mind the fact that much of the evidence on unethical behaviour paraded in this book has been produced with deceptive practices, arguably an unethical practice itself (Ortmann & Hertwig 2002; Hertwig & Ortmann 2008). There is no discussion of statistical issues such (lack of) power computations, p-hacking, publication biases, and what not here either.

Claiming that “explanations of unethical conduct rarely give proper consideration to the system within which people operate … (and) tend to focus on identifying ‘bad apples’ or ‘rogues’” (p. 7), in Chapter 1, Gentilin explores how the environment can impact human (mis)behaviour and, on balance, concludes that “the ‘barrel’ within which the ‘bad apples’ operate must be given as much (if not more) attention as the ‘bad apples’ themselves.” (p. 8). Before he reviews the lessons to be learned from the Stanford Prison Experiment, Gentilin reviews literature on social norms and how they affect behaviour.  The well-known Cialdini et al. littering and Mazar et al. (dis)honesty studies are paraded, as is an interesting lab study by MacNeil & Sherif (1976) in which the authors demonstrate generational transfer of (questionable) practices, and a related field study by Pierce & Snyder (2008). Distinguishing between descriptive (“derived from what is”) and injunctive (“derived from what ought to be”) norms, Gentilin documents cases where unethical descriptive norms tear to smithereens injunctive ones. He relates this to his reading of what led to the FX trading scandal at the NAB: “young people in particular are vulnerable and endorsing immoral social norms … In the FX trading scandal that engulfed the NAB, immoral social norms emerged that promoted excessive risk taking and misstating the true value of the currency options portfolio.” (pp. 18 – 19). This is hardly surprising, and indeed Gentilin mentions the LIBOR rate-fixing scandal and the professional cycling drug-taking as other high-visibility events. He could have also mentioned the lending practices of major US banks before the housing and mortgage crises (e.g., Gjerstad & Smith 2014), the despicable transgressions at Abu Ghraib, or zillions of other real-world examples.  After having reviewed the Stanford Prison experiment in some detail, Gentilin identifies two important take-home lessons from it: first, a specific context “can cause people of sound character to behave in totally uncharacteristic and inappropriate ways.” (p. 24) and, second, the emergence of such contexts is possible only when leaders allow it. Drawing on more experimental evidence (such as Bandura’s children imitating adults’ behaviour experiments), he suggests the obvious parallel for what happened at NAB: “Just as the adults were the role models in Bandura’s experiments, leaders that control the bases of power are the role models in large organizations. For these leaders there will inevitably appear some key moments where, through their actions, choices and decisions, they will send powerful messages that shape the ethical climate for their organizations and types of social norms that emerge.  … how a leader responds in these ‘defining moments’ shapes the ‘character of their companies’.” (p. 30). Only leaders who are veritable role models will be able to prevent formal mechanism being eroded by informal mechanisms that hammer away at them. Again, Gentilin suggests that such failure of leadership is what happened at NAB and at the Barclays Bank during the LIBOR rate-fixing schedule, and for that matter in the phone-hacking scandal that led to the demise of News of the World. Gentilin concludes the chapter with a list of “ten questions for senior leaders within any organization” (pp. 37 – 38). Presumably, these questions are unlikely to be answered in an honest manner where it matters. It is the evidence accumulated in this chapter but also elsewhere (Dana et al. 2007 comes to mind, or Miller & Ross 1976) that suggests that much.

Gentilin starts off Chapter 2 with a Nietzsche quotation that sets the stage: “Madness is the exception in individuals but the rule in groups.” (p. 45). The basic point made is that group membership can reinforce – cue social media echo chambers – the drifting away from injunctive norms to descriptive ones. Writes he: “In my experience at the NAB, dysfunctional group dynamics in the currency options business played a significant role in promoting the emergence and maintenance of immoral social norms and unethical behaviour [such as flagrant and persistent limit breaches or excessive risk taking, AO]”.  To buttress the case, Gentilin presents Milgram’s 1974 obedience studies, as well as Gina Perry’s recent critique of them (Perry 2012) which, in light of considerable supporting evidence of the original studies (e.g., Haslam et al. 2014), he dismissesin their substance. He then highlights what we learn from Milgram’s inclusion of a variation that drew on the group paradigm.  That motivates a discussion of the conformity experiments through which Asch (1956) tried to identify the conditions under which participants would contradict a majority.  In this context, Gentilin also briefly discusses a between-subjects study by Woodzicka & LeFrance (2001) who had a male interviewer ask female applicants inappropriate questions. The basic result was that 6 out of 10 subjects claimed they would object (hypothetically) but none in the control group refused the answer in a “real-life” scenario.  That seems the kind of pattern that allowed the Weinsteins of this world to get their way for too long. Only in the case of Weinstein and similar assholes (here used in the technical sense of Sutton 2007), the stakes were arguably considerably higher. People’s lack of willingness to stand up and be counted is, unfortunately, so widespread that it is well documented and it is a recurrent theme of great movies such as Hidden Figures.  Gentilin makes clear that, based on his experience at NAB, “facing in the fork in the road in a hypothetical scenario is vastly different from facing it in reality.” (p. 67) He also states, “I am personally sceptical of other research into whistleblowing that focuses on ascertaining the types of personality or dispositional characteristics that may predict whether an observer of wrongdoing will take action and report it. …This line of enquiry fails to properly consider the power of the situation.” (p. 67). Gentilin concludes the chapter with another list of “ten questions for senior leaders (and followers) within any organization” (pp. 73). I doubt that these questions will be answered in an honest manner where it matters, for essentially the exact reason that Gentilin has identified in the chapter.

In Chapter 3, Gentilin – notwithstanding his, in my considered opinion, sensible stand on the relative importance of context and dispositional characteristics – dives into “our flawed humanity”. Programmatically, he starts with an epigraph featuring a quotation from Kant, “Out of the crooked timber of humanity, no straight thing has ever been made.” (p. 80).  Gentilin then tries to answer questions such as “Are Humans Self-Interested?”, cursorily sampling evidence from experimental economics, neuroscience, and evolutionary biology. Predictably he concludes that this research shows that “human nature (is) far different from the one suggested by the axiom of self-interest” (p. 86), though he qualifies the statement with the caveat that we are not always altruistic and cooperative.  This alleged “paradigm shift” (p. 87) is, unfortunately, the major bone of contention between those marketing Behavioural Economics (and often shamelessly benefitting from it) and those doing Experimental Economics, and I believe that the social-preferences literature that has created it has as much merits as the IN oxytocin, ego depletion, and power poses research now, for all I can see, thoroughly debunked. Better not plan your life, or organization, on such flimsy evidence. From an evidence point of view, and also a theory point of view (e.g., the important insights stemming from repeated game situations), this chapter is the weakest.  Gentilin’s sampling of the evidence strikes me as scattershot and unsystematic. After discussions of issues such as power and its corrupting influence and fear and awareness of our own mortality that feeds into it, Gentilin concludes the chapter with a list of “eleven questions for senior leaders within any organization” (pp. 118)  I fear, these questions, again, are unlikely to be answered in an honest manner where it matters.

In Chapter 4, Gentilin starts with a quotation from Kahneman’s best-seller Thinking Fast and Slow: “We can be blind to the obvious, and we can also be blind to our blindness.”  This double-whammy – a variant of the Dunning – Krueger effect — is why questions to senior leaders are unlikely to be answered honestly and self-critically.  After a brief mention of another persistent bone of contention – the System 1 / System 2 delineation  – and our alleged propensity to rely too much on automatic system 1 which makes us, presumably, liable to various biases (in this chapter loss aversion, framing, overconfidence, moral disengagement, euphemistic labelling), Gentilin lays out the slippery-slope argument that in his view was at the heart of the events that led to the NAB trading scandal: “The FX trading incident at the NAB classically illustrated the slippery slope in action. Not only did ethical standards erode over time, but the seriousness of the ethical transgressions accelerated … “ (p. 130). Laboratory evidence is provided to  make that point (e.g., the interesting Gino & Bazerman 2008 study) along with field evidence from the NAB case (pp. 131). An intervention discussed here is to give people more time and essentially get them to break out of their System 1 mode: “There are now numerous studies that illustrate how providing a person with more time whenever they are confronted with an ethical dilemma tends to lead to a more virtuous decision being made.” (pp. 146-7). I have serious doubt about the relevance of, say, the Good-Samaritian study mentioned here for real-world decision making and suspect that a theoretical grounding in organizational economics and repeated game theory would really help to address the challenges that organizations and their leaders face.

Gentilin concludes his book with a plea for more (business ethics) education, a call for the installation of Chief Ethics Officers, and more Lessons for Leaders. He wants business schools to challenge their students intellectually, emotionally, and spiritually. That sounds like something straight out of a high-gloss advertisement such schools produce. The reality, however, of Australian business schools (and undoubtedly business schools everywhere) is that they are rarely intellectually demanding. Their inability to challenge their students emotionally and spiritually is shown effectively by their treatment of casuals and staff. What business schools typically do not have are, in particular, truly independent ethics officers, and HR departments, that could hold the feet of currently widely unaccountable senior leadership to the fire. So, while the idea of a Chief Ethics Officer, who has “a genuine ‘seat at the table’” (p. 161), and is independent, able to freely raise matters of concern, and able to freely “speak truth to power” (p. 161), is conceptually on the money, realistically it is very unlikely to be implemented any time soon, as are truly independent HR departments. As to Lessons for Leaders, Gentilin wants them to be virtuous in the sense of having some community-oriented values.  There is a lot of wishful thinking on display here (e.g., that others are willing to take the same risks that he took in 2004) but I think, after everything we learned through the flurry of recent examples mentioned at the beginning of this review, there is not much reason for hope. Even something that should have been uncontroversial, such as the Royal Commission on banking, and the way it came about, demonstrates that common ground is hard to find and cannot be relied on. I fear much harder thinking will be needed to address ethical failures and I fear some strategies will be of the innovative kind provided by the #MeToo campaign that not only has brought down some true monsters but is likely to have changed power and gender relations in the working world irreversibly.

In summary then, Gentilin tackles arguably the most important issue of our times – ethical failures within organizations and for that matter ethical failures more generally. His book is strongest where he illustrates the emergence of his insights with examples from his own NAB 2004 experience. His illustration of various arguments he makes with evidence from behavioural business ethics is wanting. As pointed out above, to his credit Gentilin himself – although unaware of important methodological debates among psychologists as well as between psychologists and economists – grasps intuitively the lack of external validity of some of the evidence that he presents and it is clear that his NAB 2004 experience has been a good guide to identify which laboratory evidence has some external validity, and which does not. I think the book could be considerably improved with a more even-handed and complete assessment of the evidence from psychology and other social sciences (and here in particular economics) as well as an additional focus on incentive-compatible organizational design.  To rely on business ethics education in business schools (whether in Australia or elsewhere) or a sense of community oriented-ness of business leaders is just not going to cut the mustard, as the widely perceived need for the Royal Commission in the banking system demonstrates.

Having recently interacted with NAB, once again, with mortgage related issues, I have no doubt that NAB culture is pervaded with everything but a meaningful social purpose that is underpinned by a virtuous set of values (e.g., the loan officer I dealt with did everything to prevent me from comparison shopping, and essentially gave me misleading information about the rates that I would be getting), and I have little doubt that the same applies to each of the other three major banks. There is a reason why the major banks in Australia have had outsized profits and some of the highest returns on equity in the world. The recent draft of the related Productivity Commission report spells them out.

 

I appreciate Dennis Gentilin’s comments on a draft of this review.

 

Review: Tomer’s Advanced Introduction to Behavioral Economics

In the next couple of months I shall, in preparation for an invited longer review essay on recent books on BE, post reviews of individual books such as Tomer’s, Angner’s A Course in Behavioral Economics, Cartwright’s An Introduction to Behavioral Economics, and Dhami’s The Foundations of Behavioral Economic Analysis. Comments are welcome.

Here is the first review, for your entertainment:

Tomer, John F. Advanced Introduction to Behavioral Economics. Elgar (2017). ISBN: 978 1 78471 991 3 (cased), ISBN: 978 1 78471 993 7 (paperback)

Tomer, an Emeritus Professor of Economics at Manhattan College, covers much ground in a fairly superficial manner. We are lectured about the scientific practices of “mainstream economics” (narrow, rigid, intolerant, mechanical, separate, individualistic; see p. 10) and the emergence of behavioral economics (BE). In passing, we hear about different “strands” of BE (chapter 3: “The bounded rationality strand”, chapters  4 and 5: “the psychological economics strand”, chapter 6: “behavioral finance”), “BE, public policy, and nudging” (chapter 7), “law and BE” (chapter 8), “behavioral macroeconomics” (chapter 9), “the empirical methods of BE” (chapter 10), and neuroeconomics (chapter 12).  We are also treated to an answer (I am sure you can guess it) to the question: “Are mainstream economists open-minded toward behavioral economics or do they resist it?” (chapter 11) In chapter 13 the author enlightens us about paths “Toward a more humanistic BE” and in chapter 14 we can read about “Behavioral economic trends”.

Each of these chapters are about 10 – 12 pages long. Along the way we hear about ENE’s  (Early Neoclassical Economics) and NE’s (Neoclassical Economics) “lack of behavioral realism. NE’s lack of connection to other social sciences in particularly regrettable for those who place a high value on a unified social science or at least on having many viable linkages among the different social sciences.” (p. 9) Referring to a decade-old study of his that was published in an inconsequential journal, we learn that “The results for NE (also referred to as mainstream economics) are quite clear. NE is rated high on all six dimensions (narrowness, rigidity, intolerance, mechanicalness, separateness, and individualism,” (p. 12).  After this paper tiger has been successfully constructed, we are told how it is being torn to smithereens: “ In contrast, the eight strands of BE … are in general far less narrow, rigid, intolerant, mechanical, separate, and individualistic than NE. … Overall, there is clear evidence that BE is 1) less positivistic than NE … , 2) distinctively different from NE, and 3) much more integrated with other social science disciplines than NE. In other words, BE is arguably better than NE in the way it conducts its scientific practices.” (p. 12)

This tired rhetorical figure has been used by those marketing BE for a long time. It also shows up regularly in the press (e.g., Elliott 2017 but see Attanasio et al. 2017 or for that matter Ortmann 2012), the related blogosphere, and even literature (Schumacher 2014): while BE is much more realistic and useful, NE is the old staid economics (that has done little for us). In the words of the protagonist of Dear Committee Members, “ … sociology has gone the way of poli-sci and econ, now firmly in the clutches of rabid number crunchers who have abandoned or forgotten the link between their abstruse theoretical  musings and the presence of human beings on the planet’s surface; .. ” (p. 152)

That lack of behavioral realism is, so we learn, addressed by behavioural economists’ wholesale adoption of psychological insights which inevitably “enrich” the dismal models of mainstream  economists.  Ignoring the interesting question what the trade-off is that these richer models come with – in this book this trade-off is never discussed –, there are at least two issues here.

First, and to repeat a theme that I have belabored elsewhere (see also this comment here), there is no such thing as a monolithic body of evidence in psychology that economists could mine to inject more behavioral realism in their allegedly dismal models. The fact is, much of the evidence on heuristics and biases that is being appealed to has been questioned left and right. Every halfway knowledgeable (behavioral) economist will agree that the only interesting question about cognitive biases (such as reference dependence, endowment effects, availability, anchoring & adjustment, and representativeness) is when, and under what circumstances, they exist (if they exist at all).

Second, and more importantly, psychology as a field has, at least since Bem (2011), gone through what many people have called a replicability crisis (e.g., OSC 2015, Spellman 2015, Schimmack 2018) that played at first in blogs and discussion groups such as the Facebook Psychological Methods Discussion Group, but increasingly also in journals and their practices. You would not know that some such upheaval is happening from reading Tomer’s book.

Take, for example, Tomer’s telling discussion of Zak’s oxytocin research in chapter 13. We learn that he is “a well-known economist who appreciates the softer, more intangible side of human behavior” (p. 145) and has shown through his research that “there is a direct link between the amount of oxytocin in humans’ blood and brains and humans’ concerns for each other. … Most importantly, oxytocin fosters trust. Oxytocin surges in a person’s bloodstream when an individual is shown a sign of trust and/or when something engages in a person’s sympathies and they experience empathy. ” (lit cit) Unfortunately, these claims have been thoroughly debunked and even effectively ridiculed in one of John Oliver’s excellent shows. All the literature I know suggests strongly that Intranasal oxytocin has no discernible effect and claims to the contrary are about as much bogus science as claims of ego depletion and the empowering effects of power poses:  what these alleged phenomena reflect is little but shoddy science that people got away with for too long, demonstrating a cavalier attitude to questionable research practices from p-hacking over lack of proper powering up to hiding unsuccessful trials in drawers. You would not know about this crisis if you trusted Tomer who seems completely unaware of these developments that are slowly also starting to be recognized in economics.

Yes, I am not impressed by Tomer’s book. The knowledge laid out in Tomer’s slim volume is severely out of date and unabashedly partisan. According to the December 2017 IDEAS/RePeC data,  there are at least 50,000 research economists out there world-wide and they innovate every day in what is most likely one of the most brutally competitive industries the world has seen. The idea that somewhere someone (“mainstream economics”) has a monopoly on doctrinal truth and can enforce it, shows a stunning cluelessness about the current state of the art (and science) of economics and its sociology.  In his recent presidential address, Alvin E. Roth – an outsider of sorts himself — has argued that economics has been very open to various outsiders and their ideas and practices and you have surely seen that in the emergence of experimental economics and also in some quarters of BE (although BE remains afflicted with many charlatans, often of the non-academic kind that sell BE as panacea to everyone who thinks they can get something for nothing).

I doubt that Tomer’s slim volume is “particularly useful for advanced undergraduate students, graduate students, policymakers, and other professionals who participate economic-related matters.”  (statement on the  back of the book)  In fact, I fear it will promote more sloppy science of the kind that is on display in this book. That kind of sloppy science is also too often on display when you speak with policy makers and Behavioral Insights architects and the like these days.

When all is said and done, it is this kind of sloppiness that undermines trust in the joint enterprise called science.

Boehmermann vs Erdogan – an update

You might remember the case of German comedian Boehmermann and the poem with which he demonstrated what you could, by then-German law (paragraph 103 StGB, the Criminal Code), *not* say about high-office holders abroad. Because the poem targeted him, and since wanna-be dictators like him tend to lack a sense of humor, Turkish PM Erdogan fell into the trap and took Boehmermann to court, demanding at the same time that all traces of it, and the earlier brilliant song that motivated it, be removed by the German government. Much hilarity ensued. Also much publicity for both, the song (now at more than 12 million views on youtube alone) and the poem.

That obscure paragraph 103 StGB with which Erdogan tried to silence Boehmermann goes back to 1871 and had been invoked only a few times previously. Equally obscure, and absurd, was paragraph 104a which stipulated that the government must decide whether it allows the complaint to go forward under 103. Merkel copped much opportunistic criticism, mostly from spectacularly ill-informed media writerlings and pollies, for her considered decision to let the suit go ahead, arguing correctly that it was not her job to decide whether Boehmermann had run afoul of paragraph 103 StGB.

I predicted then – confidently, because clearly the poem was meant to illustrate what you were *not* allowed to say — that Erdogan did not stand a chance. And sure enough he never did.

It must have been quite the lesson for Erdowahn. Be it only for the additional wave of ridicule it generated.

As of January 1, 2018, that silly paragraph in the criminal code (StGB), is gone for good. A  pity really because teachable moments for wanna-be dictators are few and far between.

Lessons to be learned: First, in a functioning democracy, satire can be used to speak truth to power even if that power feels perpetually offended. Second, a bit of knowledge of what laws say carries a long way. Spectacularly ill-informed opinions about what ought to be done, not so much. Third, a bit of sound game-theoretic reasoning carries a long way. Almost always.

Lemonade and the question of (laboratory) evidence

Lemonade Inc., the New York based fintech startup that sells home and renters insurance has been in the news recently. It has raised tens of millions in venture capital  and also considerable interest in the top echelons of corporate Australia. I know because I was asked to reflect on it as part of a workshop on behavioral economics/behavioral science that I conducted a couple of months ago. I have to admit that I did not know about Lemonade before that request.

Turns out that Lemonade uses “Behavioral Science (and Technology) To Onboard Customers and Keep Them Honest”, so the title of a piece in Fast Company earlier this year. Lemonade bets that insights from Behavioral Economics (BE) will give it the edge over incumbent competitors. It bets specifically that the BE insights of Dan Ariely (he of Predictably Irrational and TED talk fame, and now Lemonade’s CBE = Chief Behavioral Officer) will provide that edge, important components being “trusting our customers” and “giving back” to charity all unused excess funds. On top of these components, or maybe undergirding it, is the promise that Lemonade commits to spending at most 20 percent of its income on administration and marketing, which presumably prevents it from profit maximizing at the expense of its customers. Lemonade also promises that it will process claims fast and relatively un-bureaucratically, at least by the standard of an industry that has a reputation for delaying tactics and for its persistent attempts to evade having to pay up. Examples of speedy processing are featured prominently on Lemonade’s website.

And not only that: A couple of months ago, Lemonade launched its Zero Everything policy which gets rid of deductibles and rate hikes after claims and is supposed to pay for itself through elimination of the paperwork that comes with relatively small claims.

BE principles are also appealed to when customers that make claims are asked to submit a brief video outlining their claim and to provide at the same time a honesty pledge which supposedly induces more honesty.

In sum then, Lemonade builds its business allegedly on the trust(worthiness) of its customers, and of itself, and also honesty on the part of both parties.

Let’s start with the (laboratory) evidence for trust(worthiness). On its web page, Lemonade illustrates the advantages of trust(worthiness) with one of the workhorses of experimental economics, the trust, or investment, game. According to the web page, a person that invests (the trustor) will see her investment to a trustee of $100 quadruple and then see the trustee return half of that $400 to herself (the trustor), for an impressive ROI of one hundred percent. Trust pays off, we learn: “We are more trusting and reciprocating than what standard economic theory predicts.”

Ignoring the stab at economic theory (which shows little more than a lack of elementary knowledge of modern economic theory), there are at least three problems with the Lemonade narrative. First, it is not clear at all why this particular game, in this particular parameterization, captures the customer – insurance company situation. Second, I am not aware of anyone ever having experimentally tested this game with that specific parametrization (specifically, a multiplication factor of 4), and I am not aware — the multiplication factors typically used being 3 or 2 — of responders returning more than what was invested. In fact, the results of my own work (which are very much in line with the literature in this area) suggest that trustors invest about half of what they were given and trustees return slightly less than what was invested. It is noteworthy that there is much heterogeneous behavior to be found in these experiments, with many of those that trust (“invest”) being brutally exploited.

  “Everyone has a price, the important thing is to find out what it is.” (P. Escobar)

Which brings us to the question of honesty. There is indeed some evidence that the way in which people are being prompted makes a difference and, more generally, that context matters (see Various, JEBO 2016). Friesen & Gangadharan  (Economics Letters 2012) use an individual performance task (“matrix task”) after which they ask their subjects to self-report the number of successes that participants had. While very few of their participants – only one out of 12 — are dishonest to the maximal extent, about one out of 3 are to different degrees, with men (in particular those of Aussie and NZ provenance) being more dishonest, and more frequently so, than female participants. Rosenbaum, Billinger, & Stieglitz  (Journal of Economic Psychology 2014) review experimental evidence of (dis)honesty 63 experiments from economics and psychology (including Friesen and Gangadharan EL 2012) and find the robust presence of unconditional cheaters and non-cheaters with the honesty of the remaining individuals being particularly susceptible to monitoring and intrinsic lying costs. Most of these experiments involve fairly low stakes, so those intrinsic lying costs are unlikely to be much of a constraint when stakes increase. The fraction of unconditional non-cheaters is almost certain to shrink towards the Escobar limit when stakes increase.

Interestingly, notwithstanding its public declarations in the good of people, Lemonade tells itself that, while trust is good, control is better.  It runs its claimants, on top of the honesty pledges, through 18 different fraud detection algorithms before it pays up. On top of this, Lemonade engages in blatant cream-skimming. For example, it did not quote half of their customers that wanted to insure their homes. And it reports that the customers that are joining, or allowed to join, are younger, educated, tech-savvy, above-average earners, and female. So much for trust, trustworthiness, and all that BE marketing horsemanure. Pretty cold-blooded standard economic theory if you ask me. Note that this screening takes care of a key problem with their advertised approach: the likely adverse selection of bad types that mere trusting would invite, a very likely whammy on top of the moral hazard problem that every insurer faces.

So is Lemonade a viable business model?

Time will tell.

In the State of New York, Lemonade claims to have overtaken Allstate, GEICO, Liberty Mutual, State Farm, etc. in what is probably the single most critical market (renters and home insurance) share metric of all: NY renters buying new insurance policies since 1 Jan 2017.

Lemonade, we are told, is growing “exponentially” = “new bookings have doubled every ten weeks since launch, and show no sign of letting up.” According to its most recent Thanksgiving Transparency ‘17 report, Lemonade has now branched out into, and is selling in, Illinois, California and Nevada, Texas, New Jersey and Rhode Island, and has been licensed in 15 other states.

Of course, collecting insurance premia is one thing. Paying insurance claims and balancing the books is another thing altogether and the verdict on that one will be out for a while.

If Lemonade succeeds – and we all should hope it does –, it will do so because it engages in cream-skimming, targeting of low-risk market segments, and massive control and surveillance of its clientele. It will not do so because of its invocation of the feel-good alleged BE findings so prominently displayed on its web page.

 

 

 

 

 

 

 

 

In Memoriam Thomas C. Schelling

Tom Schelling was a US American economist (born April 14, 1921); until his death yesterday (Aussie time) he was Distinguished Professor of Economics at the University of Maryland, College Park. He was awarded the 2005 Nobel Memorial Prize in Economic Sciences which he shared with Robert Aumann, a belated completion of the NASH quartet that was not possible in 1994 because the Nobel Prize is given to maximally three people.

Schelling was awarded the Nobel Prize mainly “for having enhanced our understanding of conflict and cooperation through game-theoretic analysis”.  This is true to the extent that he typically thought about interdependent decisions, i.e., decisions whose outcomes depend on the decisions of others. Schelling wanted game theorists to pay more attention to strategic uncertainty, issues such as promises and threats, strategies of credible commitments, tacit bargaining, the role of communication, and the design of enforceable contracts and rules. Schelling is probably right in saying (as he did in the biographical sketch that he supplied to the Nobel Prize Committee) that his work in this area – at least initially – did not have noticeable influence on game theorists but that it reach sociologists, political scientists, and some economists. His interests in such issues were in the first couple of decades clearly motivated by his having one foot in academia and the other firmly in various policy making bodies.  He ended his work for the government upon the U.S. invasion of Cambodia in the Spring of 1970 but in later years took up important advisory and consulting activities.

Schelling wrote numerous widely cited articles which were the basis for the half dozen books that he wrote. These are Schelling (1960, 1961, 1966), Schelling  (1978), and Schelling (1984, 2006). The first three – as also suggested by their title – deal with strategic interaction between entities such a nations but Schelling (1960) is a very fundamental, and eminently readable, treatise that tries to inject new themes into game theory. Almost three decades later it inspired a literature on what is now known as coordination games (Devetag & Ortmann 2007). Schelling (1978) provides models of racial dynamics that are as insightful as they are simple – Schelling’s work is almost always non-technical — and elegant. He showed specifically how seemingly fairly innocent micro-motives could bring about undesirable macro-outcomes. This particular work is said to have inspired what is now known as agent-based computational economics.  Schelling (1984) is dedicated to issues of self-command and Schelling’s interest in substance abuse and addictive behavior; this interest guided much of his research in the seventies and eighties.  The strategic interaction between competing selves is at the heart of his personalized narratives of strategic conflict.  Schelling (2006) covers all aspects of his work and in this sense is the idea starting point for an exploration of the astonishing range of ideas pursued by this very public intellectual.  The book contains also three essays on climate change, and related collective action problems, that interested him since 1980.  Schelling is on record as saying that “global warming and climate change is what I expect to be, during this century, what nuclear arms control was during the century past, namely an immense challenge to ‘cooperation amid’ conflict.” His solution to climate change – geoengineering rather than a world-wide cap and trade system – is controversial.

The above entry has been culled, with slight modifications, from Morris Altman’s Encyclopedia of Behavioral Decision Making (Praeger 2015)

See also: Strategic Uncertainty, Coordination games, Theory of conflict, Self-command

Further Reading:

Devetag, Giovanna and Andreas Ortmann. 2007. “When and Why? A Critical Review of Coordination Failure in the Laboratory.” Experimental Economics 10, 2007, 331 – 44.

Ortmann, Andreas and Angelika Weber. 2007. “Thomas Schelling und die Theorie der Self-Command,” Pp.121 – 34 in Ingo Pies and Martin Leschke (eds), Thomas Schellings strategische Ökonomik. Tübingen: Mohr-Siebeck, 2007.

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2005:

Biographical http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2005/schelling-bio.html

Press release http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2005/press.html

Avanced information http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2005/advanced-economicsciences2005.pdf

Schelling, Thomas. 1960. The Strategy of Conflict. Cambridge, MA:  Harvard University Press.

Schelling, Thomas and M.H. Halperin. 1961. Strategy and Arms Control. New York: Twentieth

Century Fund.

Schelling, Thomas. 1966. Arms and Influence. New Haven, CT: Yale University Press.

Schelling, Thomas. 1978. Micromotives and Macrobehavior. Cambridge, MA:  Harvard

University Press.

Schelling, Thomas. 1984. Choice and Consequence. Cambridge, MA:  Harvard University Press.

Schelling, Thomas. 2006. Strategies of Commitment and Other Essays. Cambridge, MA:

Harvard University Press.

Zeckhauser, Richard (1989): “Reflections on Thomas Schelling”, in: Journal of Economic

Perspectives 3, S. 153–64.

 

In Memoriam Reinhard Selten (1930 – 2016)

German economist extraordinaire Reinhard Selten has died. Born October 1930, he was 85.

In 1994 he was awarded the Nobel Memorial Prize in Economic Sciences which he shared with John Harsanyi and John Nash, three quarters of the NASH quartet of Nash, Aumann, Selten, Harsanyi that has been widely credited to have advanced decisively the theory of games in the fifties, sixties, seventies, and eighties. Aumann received his Nobel Prize, together with Thomas Schelling, in 2005.

Selten was awarded the Nobel Prize mainly on the strength of his game-theoretic contributions. Specifically, he was credited by the Nobel Prize Committee with the introduction of the concept of subgame perfection which defined conditions under which to exclude from a set of equilibria those which are unreasonable by some standard (non-credible threats). A decade later he provided as a further tool in the game theorist’s toolbox the concept of a trembling hand equilibrium which likewise helped to reduce the set of equilibria.

The Nobel Memorial Prize Committee in Economic Sciences credited Selten in addition explicitly with “powerful new insights regarding evolutionary games and experimental game theory”. Indeed, after he had finished his master’s thesis in 1957, Selten was hired by professor Heinz Sauermann who held a chair at the University of Frankfurt and for whom he worked in various roles as assistant for about a decade. Selten was given considerable leeway by Sauermann and, influenced by characteristic function experiments done by Kalisch et al. (1954) as well as Simon’s Models of Man (1957), embarked on the study of oligopoly experiments which ended a couple of years later in his first experimental paper (Sauermann & Selten 1959). It was through Simon’s influence as well as his own experimental work that Selten started thinking about the bounded rationality that defines much of the decision making of individuals and firms. In fact, from the very beginning of his academic career it has been this methodological dualism that has defined his work (and occasionally confounded his colleagues).

Selten – while being famously dismissive of some of the rites of the scientific community – has worked on too many topics to even start an enumeration here: “I do not want to convey the false impression that my research is single-mindedly organized around a grand question. I am easily attracted by the opportunity to shift my interests into unforeseen exciting new directions. The little coherence there is in my work is due to a desire to understand both fully and boundedly rational economic behaviour, especially in the context of game situations.” (Selten 1993, p. 113)

Selten (1993) remains a good primer of his research interests over the first three or so decades; it is also an enjoyable read. Ortmann (1999) is a succinct introduction to a set of articles selected in collaboration with Selten. Selten (1999) has a brief but very informative biographical sketch by himself. Easily accessible information about both his life and his work may be found on the website of the Nobel Prize Committee .

Acknowledgment: The above draws on a contribution I wrote for Real World Decision Making: An Encyclopedia of Behavioral Economics. (editor: Morris Altman, Praeger 2015)

References.

Kalisch, G., Milnor, J.W., Nash, J., and Nering, J.D..1954. “Some experimental n-person games.” Pp. 301-27 R.M. Thrall, C.H. Coombs, and R.L. Davis (eds). Decision processes.  New York and London.

Ortmann, Andreas. 1999. “Introduction (to Selten 1999).” Pp. xi – xxi in Selten (1999)

Sauermann, Heinz, and Selten, Reinhard. 1959. “Ein Oligopolexperiment.” Zeitschrift fuer die gesamte Staatswissenschaft 115, 437-71.

Selten, Reinhard. 1993. “In Search of a Better Understanding of  Economic Behaviour.” Pp. 115-39 Arnold Heertje (ed). The Makers of Modern Economics, Vol. 1. Harvester Wheatsheaf.

Selten, Reinhard. 1999. Game Theory and Economic Behaviour. Selected Essays Volumes One, Two. Cheltenham, UK and Northhampton, MA, USA: Edward Elgar.

Simon, Herbert A. 1978. “Rationality as a Process and as a Product of Thought.” American Economic Review 70: 1–16.

What she sees at the revolution

Peggy Noonan is a writer and columnist for the WSJ.  Part of her reputation stems from her writing speeches for Reagan and the elder Bush, and for coming up with memorable phrases. Some of these phrases apparently did not work out well for whom she coined them. Read my lips.

In a recent WSJ opinion piece titled How Global Elites Forsake Their Countrymen – a piece much shared on social media — Noonan enlightens us about the failure of global elites to empathize:

“The larger point is that this is something we are seeing all over, the top detaching itself from the bottom, feeling little loyalty to it or affiliation with it. It is a theme I see working its way throughout the West’s power centers. At its heart it is not only a detachment from, but a lack of interest in, the lives of your countrymen, of those who are not at the table, and who understand that they’ve been abandoned by their leaders’ selfishness and mad virtue-signalling.”

Noonan, presumably to impress on us her status among the well-connected, opens her piece recounting a meeting with “an acquaintance of Angela Merkel, the German chancellor and the conversation quickly turned, as conversations about Ms. Merkel now always do, to her decisions on immigration.” Noonan then recounts Merkel’s announcement in late 2014 that refugees from Syria, Iraq and elsewhere were welcome in Germany, the following influx (net) of more than a million in 2015, the resultant public discussions in Germany about this fact, and the claim that, coming “from such a sturdy, grounded character as  Ms. Merkel the decision was puzzling – uncharacteristically romantic about people, how they live their lives, and history itself …”. We learn that the acquaintance of Merkel attributes her puzzling decision to her upbringing as the daughter of a Lutheran minister in East Germany, and as yet another attempt of providing “a kind of counter-statement, in the 21st century, to Germany’s great sin of the 20th.”

We learn that, while this was as good an explanation as Noonan heard, there was a fundamental problem with the decision:

“Ms. Merkel had put the entire burden of a huge cultural change not on herself and those like her but on regular people who live closer to the edge, who do not have the resources to meet the burden, who have no particular protection or money or connections. Ms. Merkel, her cabinet and government, the media and cultural apparatus that lauded her decision were not in the least affected by it and likely never would be.”

“Nothing in their lives will get worse. The challenge of integrating different cultures, negotiating daily tensions, dealing with crime and extremism and fearfulness on the street—that was put on those with comparatively little, whom I’ve called the unprotected. They were left to struggle, not gradually and over the years but suddenly and in an air of ongoing crisis that shows no signs of ending—because nobody cares about them enough to stop it.”

Noonan goes on to invoke the Cologne transgressions at last new year’s eve celebrations and Merkel’s adjustment to the considerable political backlash that her policies have brought about (the strong emergence of the AfD and the growing support of other populists such as Seehofer, the head of her own party’s Bavarian branch) and her pleading with her own populace to  deal with both the positive and the negative aspects of globalization. Quoting a fellow journalist, Noonan argues: “’This was the chancellor’s … way of acknowledging that various newcomers to the national household had begun to attack her voters at an alarming rate.’ Soon after her remarks, more horrific crimes followed, including in Munich (nine killed in a McDonald’s) Reutlingen (a knife attack) and Ansbach (a suicide bomber).”

Now, it is rather rich that as prominent a megaphone for the global elites as Noonan virtue-signals her compassion for the disenfranchised masses that allegedly have fallen victim to the NIMBY syndrome. For all we know, Noonan got paid royally for her piece and was writing it in a brownstone home in an affluent residential New York City neighborhood.

All that hypocrisy aside, while we have come to expect false and silly claims from presidential candidates in the USA, it is noteworthy that Noonan seems not to check the facts that she parades to make her case. Of the three horrific crimes that she mentions, at best two can be clearly linked to Merkel’s open-door immigration policy (the suicide bomber in Ansbach, and maybe the Reutlingen knife attack, which — while committed by an immigrant asylum seeker from Syria — seems to have been a crime of passion). Importantly, the McDonald’s killings were committed by some kid born in Germany that was as confused and unhinged as some of the school shooters in the USA from which he seems to have taken his cues. Apparently, fact-checking is not Noonan’s thing. Never let the facts get in the way of a story that sells. True journalism, that.

Yes, there is no doubt that the open-door policy was ill-advised, lacked appropriate consultation, and was poorly implemented in particular on the federal level, but the fact is that murders in Germany — currently about 250 annually — have been cut by 40 percent since 2000 and – at least for 2015 — this number has not increased, notwithstanding the influx of the various newcomers to the national household. For all I can tell, Germany is far from falling apart at the seams as some of the hysteric press and social-media responses have tried to suggest.

The Independent — a British newspaper, no less — has argued that Angela Merkel’s open-door immigration policy will protect Germany from terrorism in the long run. It seems that for now things have worked out remarkably well even in the short run, notwithstanding the fact that this policy has been implemented poorly.

While it is way too early to assess all the benefits and costs of the developments in Germany since late 2014, it seems self-evident that Noonan is mostly uninformed about the current state of affairs there. That, unfortunately, seems to be the modus operandi of post-truth journalists like her who are no better than the illiterati and inumerati populating social media.