The Honest Truth
Game Theory and
The Dangers of
It emerged from one of the most brilliant minds of the twentieth century, John von Neumann. Neumann was a Hungarian-American mathematician and physicist, but was also the son of a banker who had a habit of discussing the day’s business over the dinner table. This was enough to tell Neumann that key decisions in the industries of banking and finance didn’t work the way economic theory said they did.
They didn’t follow abstract computations of profit and loss. Whether a decision was good or bad depended on how others responded to it, and you could not predict that in advance. To better make decisions under conditions of uncertain outcomes Neumann invented a new discipline, Game Theory.
This gave rise to a famous puzzle known as the Prisoner’s Dilemma. This showed that two or more rational agents, each acting in their own self interest, will produce an outcome that is bad for both, individually and collectively. This was to classical economics what Einstein was to Newton. It proved that there are things the invisible hand can’t handle.
The key variable turns out to be trust. With it, the market economy works. Without it, it fails. The choice is simple. Either you have a trust economy or a risk economy. In the first, you can rely on people to act with due regard to the interests of those they serve.
In the second, you depend instead on a structure of supervising authorities, laws, contracts, regulations, courts, fines, and punishments. Transaction costs are high. Even so, ingenious people will find ways of outwitting the most elaborate regulations. Without trust, self-interest defeats regulations, undermines institutions and eventually causes systems to collapse.
The key, says Ariely, is the “fudge factor.” We want to benefit from cheating, but we also want to view ourselves as honest, honorable people. We resolve the conflict by “our amazing cognitive flexibility” – academic-speak for self-deception. He illustrates it by a simple story.
Eight year old Jimmy comes home from school with a note from his teacher saying, “Jimmy stole a pencil from the student sitting next to him.” His father is furious. “If you needed a pencil, why didn’t you ask? I could have brought you dozens back from work.” We notice other people’s dishonesty, blind to our own.
Ariely and his academic colleagues found that the “fudge factor” is greatest when there is a distance between act and consequence, where there are grey areas, and where we have financial incentives to act against the interests of clients. We are more likely to cheat when stressed or exhausted. The more creative we are, the greater our ability to find self-justifying reasons for bad behavior. We believe our own fictions (Harvard sociologist David Riesman once defined sincerity as “believing your own propaganda”).
Dishonesty is contagious. Seeing colleagues cheat makes us more likely to do so. Most tempting of all, says Ariely, is “altruistic” cheating. If we can persuade ourselves that an act of dishonesty is for the good of our colleagues, even the best can go bad.
How do you change a corporate culture? You need to go beyond codes of conduct, says Ariely. He and his team tested students from two universities. The first were asked at the outset to sign an agreement that they would abide by their university’s code of honour. The second weren’t. Predictably, the second group cheated, the first did not. The irony is that the first university didn’t have a code of honor, while the second did. What matters, says Ariely, is not the code but the constant reminder.
The vast rewards, skewed incentives, high pressure and extreme opacity of modern finance combine the maximum of temptation with the maximum of opportunity. We have, it seems, an impressive capacity for bending the rules in our favour while telling ourselves we are doing nothing wrong. But the market economy needs trust, and without it, it will fail. Essential though legislation and regulation are, they are not enough. Trust depends on virtues of self-restraint, embedded in a culture, embodied by its leaders and embraced by individuals. Until morality returns to the market, we will continue to pay a heavy price.
Next week in the Jewish community we’ll observe Yom Kippur, the Day of Atonement, the holiest day of the Jewish year. We’ll spend the whole day in synagogue, fasting, confessing our sins, admitting what we did wrong, and praying for forgiveness.
Something like that seems to me essential to the health of a culture. Often we see things go wrong. Yet rarely do we see someone stand up, take responsibility and say: I was wrong. I made a mistake. I admit it. I apologize. And now let us work to put it right.
Instead we do other things. We deny there’s a problem in the first place. Or if that’s impossible, we blame someone else, or say, it’s due to circumstances beyond our control. The result is that we lose the habit of being honest with ourselves.
In America in 1863, in the midst of the Civil War, Abraham Lincoln proclaimed a national day of fasting and prayer. It was an extraordinary thing to do. Lincoln, after all, was fighting for a noble cause, the abolition of slavery. What did he or those on his side have to atone for?
Yet, America was being torn apart, so he asked the nation to set aside one day for reflection and prayer. “It is the duty of nations as well as of men,” the proclamation said, “to confess their sins and transgressions, in humble sorrow, yet with assured hope that genuine repentance will lead to mercy and pardon.” It was America’s ‘Day of Atonement’.
The result was that two years later Lincoln was able, in his Second Inaugural, to deliver one of the great healing speeches of all time, calling on Americans “to bind up the nation’s wounds,” and care for those who had suffered during the war and were still suffering.
We’re living through tough times globally, and we’ll need all the inner strength we have to survive the turbulence, learn from the mistakes of the past, and begin again. The real test of a society is not the absence of crises, but whether we come out of them cynical and disillusioned, or newly strengthened by our rededication to high ideals. Is the age of greed is over.? Will a new age of responsibility now begin? That will depend on whether we are capable of admitting our mistakes, and renewing our commitment to the common good. Atonement, the capacity for honest self-criticism, is what allows us to weather the storm without losing our way.