The psychology of human misjudgment

In a talk enumerating the 24 behavioral biases he says lead to human misjudgment, Charlie Munger neglects an important 25th: cognitive bias overload.

That’s when too much information leads to the same kinds of cognitive blunders Munger is hoping to save us from. 

Munger’s core message is that economics and psychology are inextricably linked: “[T]he man who doesn’t understand both is a damned fool.”

So he might be OK with me trimming his talk (according to the psychology principle Miller’s Law, which states that the average person can hold no more than nine items in their working memory).

Being average myself, I’ve picked out nine points (numbers according to Munger) that seem like some combination of useful and memorable. 

There will be a quiz.

1. Under-recognition of the power of what psychologists call reinforcement and economists call incentives.

Even the man most famous for popularizing the primacy of incentives — “show me the incentives and I’ll show you the outcome” — had to constantly remind himself just how powerful they are. “I think I’ve been in the top five percent all my life in understanding the power of incentives,” Munger says, “and all my life I’ve underestimated it.”

His favorite illustrative example is FedEx, where the “heart and soul” of the business is to process packages as quickly as possible. When the packages weren’t moving fast enough, the company tried everything to speed their systems up, Munger recounts, but nothing worked — until “finally someone had the happy thought” to pay employees by the shift and not the hour.

Hourly workers are incentivized to spread the work over more hours — shift workers want to get the job done as fast as possible.

3. Incentive-caused bias.

Here Munger cites the real-life story of a doctor, paid to remove gallbladders, who sincerely convinced himself that everyone would be better having their gallbladder removed.

This is what economists call “agency costs” — the urge (often subconscious) to serve your own interests over the interests of the people you’re supposed to represent. It’s a bias that’s present in every human being, Munger says, and it leads to “perfectly terrible behavior” in both business and life. 

It can, however, be cut off at the pass.

“The cash register,” Munger believes, “was one of the great moral instruments when it was created” — because sometimes the only way to prevent bad behavior is to make it impossible.

People who design things that remove the incentive for bad behavior “are some of the effective saints of our civilization.”

4. Bias from consistency and commitment tendency, including the tendency to avoid or promptly resolve cognitive dissonance, includes the self-confirmation tendency of all conclusions, particularly the expressed conclusions with a special persistence for conclusions that are hard-won.

Got that? 

Me, neither. Munger’s bullet points sometimes read like 18th-century book titles. (The original title of Robinson Crusoe was 64 words long).

But he clarifies his idea with a memorable analogy:  “The human egg has a shut-off device — once one sperm gets in, it shuts down so the next one can’t.”

The human brain has a similar device, Munger says, “shutting off new ideas once an initial conclusion is formed to avoid cognitive dissonance.”

Disabling that device to keep your mind open to new ideas is a “superpower,” Munger says.

One way to do it? “Always pay attention to the disconfirming evidence.” 

6. Bias from Pavlovian association. 

Munger cites B.F. Skinner’s experiments with pigeons to show how easily we manufacture cause-and-effect. When rewards are randomized, the birds develop ritualistic behaviors, mistakenly believing their actions are what triggers the food.

“We all know people who are the equivalent of superstitious pigeons,” Munger says.

He wants you to not be a pigeon.

Unnumbered: The cardinal sin of bad accounting standards.

“People who have loose accounting standards are just inviting perfectly horrible behavior in other people,” Munger laments. “And it’s a sin.”

Munger expresses some sympathy for Joseph Jett, who once held the record for causing the largest trading fraud in banking history: “The Joe Jetts are always with us and they’re not really to blame.”

But he has no sympathy for the accountant who made Jett’s fraudulent trading possible: “[t]hat bastard who created the foolish accounting system — who so far as I know has not been flayed alive, but ought to be.”

In Munger’s eyes, succumbing to bad incentives is forgivable. Designing them is not.

7. Bias from reciprocation tendency.

This is the subconscious tendency to reciprocate favors and concessions, which Munger illustrates with Robert Cialdini’s famous “zoo trip” experiment.

The psychologist, asking for student volunteers to supervise juvenile delinquents, deliberately opened with an exaggerated request — volunteering two days a week. Correctly expecting rejection, he then stepped down to a smaller ask: chaperoning a single afternoon trip to the zoo. By appearing to concede first, he triggered a subconscious need in the students to reciprocate.

Many did: Students first exposed to the larger ask were far more likely to agree to the smaller one.

It’s a common trick, and falling for it, Munger says, makes you “like a one-legged man in an ass-kicking contest.”

8. Bias from over-influence by social proof.

This is the tendency to assume something is correct because others believe or act as if it is.

You might be thinking of teenagers, because teenagers are dumb, right?

Maybe. But investors are dumber: “The prices in the market are the ultimate form of social proof,” Munger says.

9. Bias from contrast-caused distortions of sensation, perception, and cognition.

Munger warns that the first two houses a real estate broker shows you will likely be the two most overpriced you’ve ever seen — because that will make the next, only-moderately-overpriced house seem reasonable by comparison.

“The sensation apparatus of man is over-influenced by contrast,” Munger says, “it has no absolute scale.”

He compares this to the proverbial frog that allows itself to be boiled if the water comes to a boil slowly enough.

“I don’t know if it’s true about a frog. But it’s sure as hell true of many of the businessmen I know.”

Beware of the “contrast phenomenon,” he warns.

Unnumbered: Bias from envy and jealousy.

Almost completely ignored in psychology textbooks, Munger says, is a fundamental truth: People care less about getting rich than about others not getting richer.

“It's not greed that drives the world, it’s envy.”

17. Bias from the non-mathematical nature of the human brain.

Math is hard, so our brains resort to crude shortcuts — like “anchoring bias” — instead of thinking in probabilities or numbers.

You, for example, failed to notice that was the tenth of my promised nine points.

Being well above average, I'm sure you won’t have any trouble remembering one additional bias. 

But because your non-mathematical brain didn’t notice, you’ve failed the quiz.

Let that be a behavioral lesson to you.

— Byron Gilliam