Decisions Have An Opportunity Cost That Require Tradeoffs

(Bad) Decisions

Apr 24, 2012 • Behavioral Economics, Economic Thinkers, Financial Markets, Thinking Economically • 163 Views    No Comments

By Mira Korber, guest blogger.

Why might have most notorious fraudsters committed their crimes? The traditional answer seems obvious: severe character flaws, lack of ethics, unbridled greed. But there may be more to the picture than simply this “bad person.”

In a recent Planet Money podcast, economist Lamar Pierce of Washington University in St. Louis set out to discuss why people make unethical decisions. The story in question refers to Toby Groves, a seemingly upstanding citizen who later committed multimillion-dollar fraud crimes. Upon discovering his mortgage company was $250,000 in debt, Groves decided to mortgage his own home. Lying to the bank, he said his income was $350,000 when it wasn’t even close to that number. Later on, Groves needed more, so he solicited the” help” of his employees and a title company to fabricate and verify “air loans” — made-up mortgages for made-up people. Every employee he asked and the title company colluded with no hesitation.

Incentives are clearly at the heart of illegal decision making such as this; Groves needed to get his business out of debt and back on track however he could. When he sought help, it was readily available; perhaps his employees feared losing their jobs, or anticipated a bonus for “helping” to preserve the company.

According to Pierce, and a second economist on the podcast, Francesca Gino, decisions to help Groves were made because a short-term “favor” seemed far more tangible than potential future repercussions. Additionally, Gino theorized that as human beings naturally “like” each other, they are prone to assisting even immoral behavior.

This analysis brings me to Adam Smith’s The Theory of Moral Sentiments. Smith argues that a mutual sympathy between human beings causes us to empathize with each other, simply because “how selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him…” Smith continues, “the greatest ruffian, the most hardened violator of the laws of society, is not altogether without it,” “it” being a sense of kindred emotion.

Perhaps that shared feeling is what actually prompts said “ruffian” to perpetrate group fraud. We empathize through a self-centered perspective; only by imagining ourselves in equal agony can we feel sympathy for the one suffering in reality:

As we have no immediate experience of what other men feel, we can form no idea of the manner in which they are affected, but by conceiving what we ourselves should feel in the like situation. Though our brother is upon the rack, as long as we ourselves are at our ease, our senses will never inform us of what he suffers…By the imagination we place ourselves in his situation, we conceive ourselves enduring all the same torments…and thence form some idea of his sensations, and even feel something which, though weaker in degree, is not altogether unlike them. His agonies, when they are thus brought home to ourselves, when we have thus adopted and made them our own, begin at last to affect us…

Imagining ourselves “on the rack” might help us make a bad choice — say — fabricating mortgage papers?

The Bottom Line: While fraud predictably leads to questioning of the perpetrator(s)’ incentives, it also relates to a basic psychological tendency: mutual sympathy among people who identify with each other, or offering “favors” expected to be returned in the future.  Therefore, favors are not altruistic, but may be motivated by a mutual financial dependency later on.

Related Sources: Find the Planet Money podcast “Why People Do Bad Things” here. Adam Smith, here. And for a previous Econlife post on cheating, here. You also may wish to read “How We Decide” by Jonah Lehrer, which received a favorable NY Times review, and is on my future reading list.

Related Posts

« »