Incentives for Environmentally Responsible Markets

Incentives for Environmentally Responsible Markets

When it comes to environmental issues, no single actor is completely to blame, and that means no single actor can make the necessary changes to prevent catastrophic climate change. This means we can’t put all the weight on governments to take actions to change the course of our climate future, and we can’t blame individual actors either. We have to think about economies, polities, and incentive structures.

 

In their book Nudge, economists Cass Sunstein and Richard Thaler look at what this means for markets and regulation as we try to find sustainable paths. They write, “markets are a big part of this system, and for all their virtues, they face two problems that contribute to environmental problems. First, incentives are not properly aligned. If you engage in environmentally costly behavior next year, through consumption choices, you will probably pay nothing for the environmental harms that you inflict. This is what is often called a tragedy of the commons.”

 

One reason markets bear some of the blame and responsibility for the climate change crisis is because market incentives can produce externalities that are hard to correct. Climate change mitigation strategies, such as research and development of more fuel efficient vehicles and technologies, are expensive, and the costs of climate change are far off. Market actors, both consumers and producers, don’t have proper incentives to make the costly changes today that would reduce the future costs of continued climate change.

 

A heavy handed approach to our climate change crisis would be for governments to step in with dramatic regulation – eliminating fossil fuel vehicles, setting almost unattainably high energy efficiency standards for furnaces and dishwashers, and limiting air travel. Such an approach, however, might anger the population and ruin any support for climate mitigation measures, making the crisis even more dire. I don’t think many credible people really support heavy handed government action, even if they do favor regulation which comes close to being as extreme as the examples I mentioned. Sunstein and Thaler’s suggestion of improved incentives to address failures in markets and change behaviors has advantages over heavy handed regulation. The authors write, “incentive-based approaches are more efficient and more effective, and they also increase freedom of choice.”

 

To some extent, regulation looks at a problem and asks what the most effective way to stop the problem is if everyone is acting rational. An incentives-based approach asks what behaviors need to be changed, and what existing forces encourage the negative behaviors and discourage changes toward better behaviors. Taxes, independent certifications, and public shaming can be useful incentives to get individuals, groups, and companies to make changes. I predict that in 10-15 years people who are not yet driving electric cars will start to be shamed for continuing to drive inefficient gas guzzlers (unfortunately this probably means people with low incomes will be shamed for not being able to afford a new car). In the US, we have tried to introduce taxes on carbon output, but have not been successful. Taxing energy consumption in terms of carbon output changes the incentives companies have with regard to negative environmental externalities form energy and resource consumption. And independent certification boards, like the one behind the EnergyStar label, can continue to play an important role in encouraging technological development of more efficient appliances. The incentives approach might seem less direct, slower, and less certain to work, but in many areas, not just climate change, we need broad public support to make changes, especially when the costs are high up front. This requires that we understand incentives and think about ways to change incentive structures. Nudges such as the ones I mentioned may work better than full government intervention if people are not acting fully rational, which is usually the case for most of us. Nudges can get us to change behaviors while believing that we are making choices for ourselves, rather than having choices forced on us by an outside authority.
Irrational Market Cycles - Joe Abittan

Irrational Market Cycles

I think about markets a lot, often focusing more on market failures than on market successes. I think our country generally views markets as infallible, and that drives me (in a somewhat contrarian strain) to look at spaces where markets don’t work. I also started my career in healthcare and have some relatively expensive healthcare concerns of my own, which also drives me to look at market failures with more energy than market successes. While there are many positive aspects of markets (they certainly do create a good level of efficiency and innovation and may also be generally pacifying across the globe), I think it is important to continue to highlight irrational market cycles, tragedy of the commons type situations, and areas where a market simply can’t be established because goods are nonrivalrous and nonexcludable. This post will specifically highlight an irrational market cycle, by which I mean a cycle of irrationality supported by market forces.

 

One of the strongest points of markets is that they help to weed out poor performers and eliminate waste. Someone selling a product that doesn’t provide value shouldn’t be able to find any customers. They might dupe a few people into buying their product, but overtime, we expect the market to marginalize the seller and for his business to eventually go bust. But this market efficiency mechanism only works if people are rational, and irrationality can be manipulated and exploited in a market, creating irrational market cycles. Cass Sunstein and Richard Thaler use extended warranties (not the spam ones you get calls about for your car but real ones offered when you buy a fridge) in their book Nudge to describe irrational market cycles. They write:

 

“If consumers have a less than fully rational belief, firms often have more incentive to cater to that belief than to eradicate it.”

 

There are products that don’t make sense. Sometimes they pop up as a fad, sometimes they are deliberate scams, and sometimes they are a new gadget that is attached to a new technology as an additional aid, but are in reality effectively useless. People can get sucked into purchasing these items, and they can be marketed as effective and must-have items, only to be irrational junk. The people selling the junk don’t have an incentive to help us think clearly about the product, they have an incentive to hide the truth and make their product appear more attractive by playing into and reinforcing irrational behaviors.

 

Using the extended warranty example Sunstein and Thaler continue, “If Humans realized that they were paying twenty dollars for two dollars’ worth of insurance, they would not buy the insurance. But if they do not realize this, markets cannot and will not unravel the situation. Competition will not drive the price down.”

 

An irrational market cycle can arise when incentives exist to encourage people to participate in irrational markets. People’s fear, lack of information, and cognitive biases can be leveraged by market actors to further irrational spending. A market on its own cannot correct this issue as Sunstein and Thaler show. Nudges can be helpful in diverting people out of the market, but it is worth recognizing that there is a role for outside forces to shape markets that fall into these irrational cycles.
We Think of Ourselves as Rational

We Think of Ourselves as Rational

In Daniel Kahneman’s book Thinking Fast and Slow, Kahneman lays out two ideas for thinking about our thought processing. Kahneman calles the two ways of thinking about our thought processing System 1 and System 2. System 1 is fast, automatic, often subconscious, and usually pretty accurate in terms of making quick judgments, assumptions, and estimations of the world. System 2 is where our heavy duty thinking takes place. It is where we crunch through math problems, where our rational problem-solving part of the brain is in action, and its the system that uses a lot of energy to help us remember important information and understand the world.

 

Despite the fact that we normally operate on System 1, that is not the part of our brain that we think of as ourselves. Kahneman writes, “When we think of ourselves, we identify with System 2, the conscious, reasoning self that has beliefs, makes choices, and decides what to think about and what to do.” We believe ourselves to be rational agents, responding reasonably to the world around us. We see ourselves a free from bias, as logically coherent, and as considerate and understanding. Naturally, it is System 2 that we see ourselves as spending most of our time with, however, this is not exactly the case.

 

A lot of our actions are influenced by factors that seem to play more at the System 1 level than the System 2 level. If you are extra tired, if you are hungry, or if you feel insulted by someone close to you, then you probably won’t be thinking as rationally and reasonably as you would expect. You are likely going to operate on System 1, making sometimes faulty assumptions on incomplete data about the world around you. If you are hungry or tired enough, you will effectively be operating on auto-pilot, letting System 1 take over as you move about the cabin.

 

Even though we often operate on System 1, we feel as though we operate on System 2 because the part of us that thinks back to how we behaved, the part of us required for serious reflection, is part of System 2. It is critical, thoughtful, and takes its time generating logically coherent answers. System 1 is quick and automatic, so we don’t even notice when it is in control. When we think about who we are, why we did something, and what kind of person we aspire to be, it is System 2 that is flying the plane, and it is System 2 that we become aware of, fooling ourselves into believing that System 2 is all we are, that System 2 is what is really in our head. We think of ourselves as rational, but that is only because our irrational System 1 can’t pause to reflect back on itself. We only see the rational part of ourselves, and it is comforting to believe that is really who we are.

How Helpful Are We?

“People are willing to help, but the amount they’re willing to help doesn’t scale in proportion to how much impact their contributions will make.” Author’s Kevin Simler and Robin Hanson write this in their book The Elephant in the Brain when discussing our behaviors around donations and charity. “This effect,” they continue, “known as scope neglect or scope insensitivity, has been demonstrated for many other problems, including cleaning polluted lakes, protecting wilderness areas, decreasing road injuries, and even preventing deaths.”

 

In the United States, we have a high regard for charitable donations and activities. We encourage people to donate their time and money and our tax system has a way for people to get something back from the government by reducing how much they own in taxes if they gave enough in charitable donations. What Hanson and Simler highlight in their book, however, is that our human brains are not well suited to ensure that all of our charitable donating is having the greatest impact possible.

 

I am a public policy student and practitioner, and a key thing to understand about public policy is that at the core, it is not rational. The deepest level of policy is entirely based on values and sometimes pure emotions. You cannot rationally come to a reasonable conclusion for whether the nation (city, county, state) should invest its final $1 million dollars in policy to reduce tobacco use, or increase educational support for children with autism, or clean and remodel a popular park. The final decision is going to come down to the values of the voters and of the government’s leadership.

 

The same is true for our individual donations. Is it really best for us to make donations to the Against Malaria Foundation to save lives in countries far away from us? Should we use our donations to help improve the lives of children living right here in our own community? Are we obligated to use our donations to help other people like us who have also gone through medical crisis, trauma, or natural disaster challenges that we have experienced and survived? The heart of these decisions will always be an emotional values decision.

 

We can, however, try to develop institutions that help people ensure that once they have made these value judgement they use their charity in the most meaningful way possible. We can develop social systems and attitudes that encourage people to pool their charitable resources toward one meaningful purpose that aligns with their values, rather than donating a few bucks here and there to a charity that pulls at their emotions (a single large donation to an effective charity can do much more good in the world than multiple smaller donations to charities that range in terms of effectiveness). We can develop organizations that do more to analyze the effectiveness of given charities and develop new systems for looking at how we can make sure our donation does the most good based on where we want to do our good (whether it is saving lives, helping local development, improving education, or something different). We can use our tax system to encourage smart charity rather than stupid charity where celebrities just buy overly priced pictures of themselves from random foundations that claim to have philanthropic purposes but really just pay off porn stars to protect the political prospects of their benefactors (cough-Trump-cough).

 

Ultimately, our brains our wired to be charitable to show people that we are nice caring people. As a result, we don’t really care about the effectiveness of our donation, we just want people to see that we made a donation and that we are the kind of person who is caring and generous enough to help others. This leads us to make stupid donations rather than smart an effective donations, but by changing the institutions surrounding our charitable activity, we can start to actually do good in a rational manner with our charity.

Our Mind Seems Counterproductive

I listen to a lot of science podcasts, and really love the discoveries, new ways of thinking about the world, and better understandings of the world that we gain from science. Science is a process that strives to be rational and to build on previous knowledge to better understand an objective reality. What is also interesting about science, is that it operates against the way our brains want to work. As much as I love science and as much as I want to be scientific in my thinking and approaches to the world, I understand that a great deal that shapes human beings and the world we build is not rational and seems counterproductive when viewed through a rational lens.

 

Part of the explanation for our minds being so irrational might be explained by Kevin Simler and Robin Hanson in their book The Elephant in the Brain. The authors describe one reason for why our brains evolved to be as complex and irrational as they are: we evolved to be political and deceptive creatures, not to be rational and objective creatures with a comprehensive view of reality. “Here’s the puzzle:” write Simler and Hanson, “we don’t just deceive others; we also deceive ourselves. Our minds habitually distort or ignore critical information in ways that seem, on the face of it, counterproductive. Our mental processes act in bad faith, perverting or degrading our picture of the world.”

 

We act so irrationally and have such an incorrect view of the world according to Simler and Hanson because it helped our ancestors to be more deceptive and to survive. If you wish to tell a white lie to someone or if you really want to appear sincere in your thoughts and actions, it is much easier if you believe the things you are lying about. If you know you are lying and acting in bad faith, you have to be a really good actor or poker player to convince everyone else. We actually benefit if our brains fail to recognize exactly what is driving us and help us systematically not recognize inconvenient truths.

 

For example, I use Strava, a social media platform geared toward runners and cyclists. The app allows us to upload our GPS data from our runs and bike rides and to compare our routes and see who went the fastest along a particular street or who ran up a trail the fastest. At a base level I know that I am using the app because it allows me show off to other people just how good of a runner I am. But if you asked me at any given point why I upload all my workouts to Strava, I would tell you a story about wanting to keep up with friends, wanting to discover new places to go running, and about the data that I can get to analyze my performance. The first story doesn’t look so great for me, but the second one makes me sound social and intelligent. I am inclined to tell myself that is why I use the app and to deny, even to myself, that I use it because I want to prove that I am a better runner than someone else or to show off to my casual running friends who might log-in and see that I went on a long run.

 

Our brains are not the scientifically rational things I wish they were, but in many ways that is important for us as we try to build coalitions and social groups to get things done. We connect in ways that are beyond rationality, and sometimes we need the generous (though often false) view of ourselves as good actors to help us get through the day. We can strive for more rationality in our thoughts and actions, but we should accept that we will only get so far, and we shouldn’t hate ourselves or anyone else for not always having the nice and pure motives that we present.

Attribution Bias

Our brains are pretty impressive pattern recognition machines. We take in a lot of information about the world around us, remember stories, pull information together to form new thoughts and insights, move through the world based on the information we take in, and we are able to predict the results of actions before they have occurred. Our brain evolved to help us navigate a complex, dangerous, and uncertain world.

 

Today however, while our world is arguably more complex and uncertain than ever, it might not be as dangerous on a general day to day basis. I’m pretty sure I won’t encounter any animals who may try to eat me when I sit at the park to read during my lunch break, I won’t need to distinguish between two types of berries to make sure I don’t eat the poison kind, and if the thunder storms scheduled for this evening drop golf ball sized hail, I won’t have to worry to much about where I will find safety and shelter. Nevertheless, my evolved brain is still going to approach the world as if it were the dangerous place it was when my ancestors were evolving their thought capacities, and that will throw some monkey-wrenches into my life and lead to me to see patterns that don’t really exist.

 

Colin Wright has a great quote about this in his book Becoming Who We Need to Be. He writes, “You ascribe meaning to that person’s actions through the lens of what’s called “attribution bias.” If you’re annoyed by their slow driving, that inferred meaning will probably not be generous to the other driver: they’re a bad person, they’re in the way, and they’re doing this because they’re stupid or incapable. That these assumptions about the situation are possibly incorrect – maybe they’re driving slowly because thy’re in deep thought about elephant tool usage – is irrelevant. Ascribing meaning to acts unto itself is impressive, even if we often fail to arrive at a correct, or fully correct understanding of the situation.”

 

We often find ourselves in situations that are random and try to ascribe a greater meaning to the situation or event we are in. At least in the United States, it is incredibly common to hear people say that everything happens for a reason, creating a story for themselves in which this moment of inconvenience is part of a larger story filled with lessons, staircases, detours, success, and failure that are all supposed to culminate in a larger narrative that will one day all make sense. The fact that this way of thinking is so prevalent suggests to me that the power of our pattern recognition focused brains is still in full swing even though we no longer need it to be as active in as many situations of our life. We don’t need every moment of our life to happen for a reason, and if we allow for randomness and eliminate the running narrative of our life, we don’t have to work through challenging apologetics to understand something negative.

 

Attribution bias as described by Wright shows us how wrong our brain can be about the world. It shows us that our brains have certain tendencies that elevate ourselves in thought over the rest of the world that doesn’t conform to our desires, interests, wishes, and preferences. It reveals that we are using parts of our brains that evolved to help our ancestors in ways that we now understand to be irrational. If we can see that the slow person driving in front of us with a political sticker that makes our blood boil is not all the terrible things we instantly think they are (that instead they are a 75 year-old grandfather driving in a new town trying to get to the hospital where his child is sick) then we can recognize that not everything in life has a meaning, or at least not the meaning that our narrow pattern recognizing brain wants to ascribe. Remembering this mental bias and making an effort to recognize this type of thinking and move in a more generous thought direction will help us move through the world with less friction, anger, and disappointment because we won’t develop false patterns that let us down when they fail to materialize in the outcomes we expected.

Rational Relationships

In his book Some Thoughts About Relationships, author Colin Wright starts by examining what it means to be rational in a relationship. Often times we assume that relationships are built on emotional connections like love, fondness, and collegiality and we balk at the idea that we can bring a rational approach to a relationship or to anything that is driven by emotional feelings. Wright acknowledges the importance of emotions, but believes that bringing a rational approach to a relationship is key to having a successful relationship.

 

He describes rationality within relationships with the following, “Being rational in relationships means that you acknowledge cause and effect, the possibility of iterative improvement, and the potential to pull apart and assess problems to find solutions.”

 

Contrasting rationality is irrationality within relationships, which Wright describes as, “Being irrational means that you rely on a story line to make things right: that if you just believe hard enough, want it bad enough, or go through enough struggle, life will work itself out. No assessment possible, no change necessary.”

 

A rational relationship is one that requires awareness and requires that you get beyond your own perspective. You must interrogate your feelings and opinions and try to understand the thoughts, decisions, feelings, reactions, and behaviors of another person. Once you have worked through yourself and made an effort to view the world from the eyes of the other person, you must ask what factors contributed to the outcome you observed, and in a realistic and honest way ask how things could have been different in a different situation or if other factors had worked out a different way. Rational relationships are built on thought and observation which is challenging and requires concentrated effort to understand everyone’s needs, desires, feelings, and perspectives.

 

If we abandon these rational characteristics, we are left with the story we tell ourselves about the world. What we feel and what we believe is simply the way the world works. The problem is that our story and how we view everything the perspective from which we create our story is incomplete. A sense of injustice, insult, or injury is as serious as a direct threat on who we are. Our feelings constitute truth and the meaning we attach to certain things becomes iron clad.

 

The rational relationship steps back and pulls away the meaning we attach to events. It asks what happened, why did that happen, and how did everyone involved react? Was the outcome of the situation positive for all, damaging for me, threatening for others, or in some way less than desirable for all involved? If the view for any of these is that things could have been better, than a rational relationship rethinks how we interact and behave and seeks a way to improve the relationship for everyone, not just for ourselves.

 

If we choose to live our relationships without this rationality, we instead have nothing but what we tell ourselves and believe. We cannot change because we are simply stuck with another person who is the way they are and not capable of being anything different. The outcomes we face are unavoidable and people cannot be expected to improve their behavior unless you can fully change who they are.

 

Living irrationally is perfectly fine for an individual, but if we all approach the world in this way we will tear it apart. By bringing rationality to our relationships we can work better with other human beings to support their needs and to identify and build relationships that align with our needs and desires. We can better connect and recognize ways of interacting that further our connections and improve our interactions. Irrationality however, will create a world in which we are all building dishonest stories of the world to make us feel better about who we are or to create false narratives to make other people seem worse than they are. Each of us acting from our own limited perspective will have a net negative impact on the world as the micro-gravity of our own story pulls in and distorts the world around us.

Being Irrational

Author Colin Wright addresses irrationality in his book Some Thoughts About Relationships. He dives into what irrationality looks like in our daily lives, and extends irrationality to relationships and our behaviors and actions in relationships. He writes, “Being irrational means that you rely on a storyline to make things right: that if you just believe hard enough, want it bad enough, or go through enough struggle, life will work itself out. No assessment possible, no change necessary.”

 

Wright’s views on irrationality really resonate with me. There is certainly nothing wrong with living ones life based on stories, in fact it is truly unavoidable no matter how rational one becomes (human rights, money, and political parties are useful stories in our lives, but they are stories none the less). Striving for rationality however, means that you are willing to examine the stories that shape your outlook, and you are willing to take your own responsibility for the shape and direction of your life, your community, and the world. Falling back on stories and believing that life is beyond your control and the result of forces that can’t be understood may align with reality in some way, but it leaves us in a place where conscious and active thought is meaningless, and our decisions, behaviors, and actions are instead guided by emotion, perspective, and impulsiveness resulting from the stories we tell ourselves about the world.

 

What Wright encourages us to do, is to build more reflection and awareness into our lives to be able to begin living in a more rational manner. Thinking more clearly and striving to be rational gives you more control over the stories that you tell yourself about the world. Irrational behavior lacks continuity and can be hijacked by people who make emotional arguments, rouse up fear, or present a particular story that highlights only part of reality. Living irrationally in relationships can be damaging since both parties may begin to rely on their own stories and perspectives as opposed to relying on reflection, measured decisions, and shared understandings of decisions and behaviors.