Irrational behavior in a time of pandemic — an economist’s take

Israeli-American behavioral economist Dan Ariely, well-known for his TED talks that have been viewed over 15 million times, recently agreed to share his most recent insights with Alternatives Watch.

He is the author of three New York Times best sellers: Predictably Irrational, The Upside of Irrationality, and The Honest Truth About Dishonesty, as well as the books Dollars and Sense, Irrationally Yours — a collection of articles from his popular Wall Street Journal advice column “Ask Ariely”; and Payoff, a short TED book.

The basic premise underlying much of Dan’s writing and the behavioral experiments that form the basis of his analysis, is that market players who perceive themselves to be acting rationally, based on level-headed empirical analysis and ‘common sense’ aren’t so purely logical. He posits that often classical economists look at actual human behavior and drivers less frequently, and instead assume that people act in their best interests when it comes to their investing and consumer choices.

Ariely’s theses often speak to how investors and political actors are more frequently playing into societal expectations, emotions, social norms and other illogical forces that lead individuals and groups of people to act against their best interests and to make repeated mistakes that lead to economic and other systemic / societal crises.

His message gained traction in 2009 when Predictably Irrational was published, a book that spoke in part to the subprime mortgage crisis.

“One by one, the institutional banks — all staffed by wonderful (rational) smart economists, who followed standard models, fell like so many dominoes. If the rational economic approach is not sufficient to protect us, what are we supposed to do? What models should we use?” he wrote.

In addition to his prolific body of writing, Ariely is the James B. Duke Professor of psychology and behavioral economics at Duke University. He is also the founder of the research institute The Center for Advanced Hindsight, co-founder of the companies Kayma, BEworks, Timeful, Genie and Shapa, the chief behavioral economist of Qapital, a personal finance mobile banking app, and the chief behavioral officer of Lemonade, an insurance company.

Ariely at an Institute for Advanced Studies event

Vailakis: Dan, thanks for agreeing to connect with me, as the COVID-19 pandemic and current economic picture surely present us with the sort of irrational behavior that your studies illuminate so well. Are you conducting any behavioral experiments that shed light on the ‘new normal’ we’re all living through? Although we are still in the midst of this health and economic crisis, do you have any early takeaways?

Ariely: During this time, I’ve been engaged in many behavioral studies.

I conducted experiments involving the education system, looking at what works and doesn’t in distance education. With my team, we’ve developed some programs aimed at reducing domestic violence. We looked at how we can stimulate the economy, specifically the local economy.

One of the most important studies we did is around the question of work and motivation. This is a topic that we have been studying for a long time and in general, we find that what motivates people at work is generally not the quality of the coffee or furniture. And it’s not even the level of salary or bonus. It’s more about a deep connection with the company, and a sense that employees understand the mission of the firm. That they feel appreciated and treated fairly (and that means regardless of race, gender of course). That they have agency with the company, that the company wants them to take the right risks. As long as people were in the workplace, it was easier to supervise and create control mechanisms, but when people are working from home many of these supervisory methods have gone away.

Productivity has always been at the heart of what businesses are trying to get from workers. How do we get people excited about what they’re doing, to really care enough to work to the best of their ability? Working from home and working from home with kids are really challenging. People who do that well are generally people who care deeply about their company and who feel that their company cares deeply about them. This was always true, but it’s much more important during this pandemic.

Vailakis: As this is an alternative investing publication, many market players are seeing (or driving) interest in distressed credit, tech infrastructure (as we’re all much more technology dependent) and select healthcare related investments. Any thoughts about these emerging trends?

Ariely: I’ve always thought that the best investments are in companies that treat their employees well.

We have bonds and stocks, and all kinds of assets in the sectors you mention, but an important asset is human capital. Companies that are able to cultivate their human capital will be the most successful in the time of the Coronavirus.

COVID-19 is causing stress, fear and worry. Companies that are able to empower their employees to not feel stressed or worried are going to be more successful. When people feel weighed down in this way, their capacity to work is dramatically reduced.

Getting more specific, I think the healthcare sector, particularly remote health and healthcare that is not delivered in big community centers are going to be important trends. I also think that distance education is going to gain a lot of value and will be an interesting direction for development, although it’s unclear what methods will make a lot of money at this juncture.

Vailakis: Firms with a heavy and established e-commerce presence are generally benefiting from the shelter-in-place regimes that many are subject to. Please speak to the upward price pressures (inflation?) for in-demand goods, the hoarding and other extreme consumer behaviors we’re witnessing.

Ariely: Hoarding in general is a bigger problem in the physical world, but not as much in the online world.

You go to the grocery store and you see that the toilet paper shelf is 3/4ths empty. You say to yourself that this item is in short supply, that this thing is a very popular item right now and so you buy some extra for yourself. And then there is less and less and less. But if you go to Amazon, you don’t see that things are missing in the same way.

The online world can show us the supply chain. If I go to Amazon they indicate to me that there’s a stable supply of toilet paper, I can relax more than if I see empty shelves in a physical store. Balancing demand is very important, especially in this period, and online hubs can counteract the over purchasing dynamic described above by saying ‘don’t worry, more is coming’.

Vailakis: You previously dissected the $700 billion bailout received by Wall Street firms after the credit crisis of 2008-2009, claiming that many ‘Main Street’ Americans were willing to harm themselves/society irrationally, opposing the bail out due to an emotional inclination toward revenge on wayward firms. Current consecutive bailout packages for the US economy in the time of COVID-19 far exceed the ‘sticker shock’ amounts of that prior downturn, but the dynamics are quite different. Still, do you see irrational dynamics here in terms of public perception or behavior around the recent bailouts?

Ariely: We need the bailout, there’s no question. But I think the bailout we need, to a large degree, is a bailout for small businesses and for low-income individuals.

Imagine you have a low-income individual who is working; that person is likely taking public transportation, they’re seeing people. They are unlikely to have a big office, so there’s a correlation between income and not meeting many people. The lower you are on the social and economic scale, the more likely you are to be at the workplace where you meet lots of people, especially at this time. Imagine that person wakes up in the morning and feels that they have a fever and they cough. That person is supposed to quarantine themselves for the benefit of everyone else, but they can’t. If they don’t work today, they won’t have money. So this person doesn’t quarantine themselves and they keep spreading the disease.

It’s amazing that we bailout businesses, but we’re focusing on things that are easy to bailout like banks and airlines. Some of this is important. The harder things to bailout are more directly connected to Main Street and the people, who need help in order to comply. If you have a country where 80% of people are adhering to the rules of self-quarantine, physical distancing, etc. and 20% don’t because they can’t afford to, they destroy it for everybody else.

Vailakis: Markets have been volatile since the onset of the coronavirus crisis, and people are generally inclined to become more obsessed with their investments when outcomes are seemingly less predictable. People may however make less logical choices when fear of extreme loss (or gain) comes into the picture, clouding judgement. What do your studies suggest individual investors be mindful of during uncertain times like these?

Ariely: Market volatility is dangerous. I’ll say a few things that are always true. Investments are forward looking, not backward looking. Looking at what happened in the past in your portfolio is not a good indication of what’s going to happen, so the rational way to invest is to follow your ideas. I think Microsoft is going to go up. I think Amazon is going to go down. I think demand for cookies will be lower. I think demand for home gym equipment will be higher. Whatever it is. Then you can take actions based on your assumptions. Looking at our portfolios and polluting our thoughts with fear and anxiety clouds this process of coming up with cogent actionable assumptions about what the future holds.

For more of Ariely’s insights, you can watch some of his TED Talks and other speaking engagements below:

Photos by Advanced Hindsight/Flickr. Used with permission.

Nancy Vailakis

Nancy Vailakis is a 16 year veteran of the alternative asset management industry, having held prior investor relations roles at Cerberus Capital Management and BlueMountain Capital Management. Vailakis holds an MBA in Finance from the NYU Stern School of Business.

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