Inescapable Truth #2: People Act in Their Own Self Interest

One of the keystones of the scientific method is the concept of reproducibility. If you perform an experiment, someone else should be able to reproduce your results. Few experiments have been subjected to this test as often as that of the Prisoner’s Dilemma. In this experiment, two prisoners can either stay quiet or rat on each other. Depending on how each prisoner acts, they can either both be released (quiet/quiet), both pay a small penalty (rat/rat) or one released and while the other pays a big penalty (rat/quiet). Wikipedia’s detailed description of this experiment is as good as any.

Every Psych 101 student who has performed this experiment finds the same thing: if you keep repeating the test, prisoners learn to avoid getting “taken advantage of”. A prisoner who rats every time will suffer no worse than the other prisoner and can go free if the other prisoner stays quiet. Prisoners will quickly figure out the “payout table” and work to maximize their “economic advantage.”

Note that midway through the last paragraph, I move from talk of prisoners to talk of payouts and economics. It is my premise in discussing this post’s Inescapable Truth, that humans perform similar economic calculations every time they act and that their goal is always to maximize their payout.

For some readers, this premise is obvious and they will wonder why it needs to be expanded upon; people will do what they think is best for them. Other readers, however, will immediately object, citing examples of personal sacrifice and altruism to the benefit of others. Let me address this dichotomy so that I can get to the meat of this post.

When I give money to charity, when I drive my mother to church, when I give my son the big piece of chicken, I am acting in my own self-interest. It makes me happy to see my son eat. It makes me happy to see my mom spend time at church with her friends. It makes me sad to see helpless people so I give money to charity because it makes me feel better about myself.

I would gladly give my wife one or both of my kidneys. I would throw myself in front of my children and take a bullet for them. I would prefer to die than to live with the knowledge that I did not do something to save my family. I would sacrifice myself to avoid intolerable personal suffering.

Sometimes, acting in one’s own interests happens to be of benefit to others, too. It is the nature of love that we find our personal suffering more acceptable than that of our loved ones’. It is economically more “valuable” to us to incur our own suffering than to subsequently tolerate the suffering of those whom we love.

What is great about this Inescapable Truth is that it is so reliable. We can build on any foundation, as long as it is solid!

The modern notions of free enterprise and free markets are based on the premise that we can rely on people to solve the complex math that results in the best economic return towards their own self interests. It is much more reliable to count on people acting towards their own self interest than it is to expect them to act in the interests of a broader, more abstract, sense of community. (N.B.: another psychology/sociology topic that covers this area is referred to as The Problem of the Commons. See here for more information).

It drives me crazy when I hear my fellow liberals sneer at “corporate greed.” There is no such thing as corporate greed. Corporations are ephemeral – they have no emotions. Corporations are run by human executives, of course, and they are capable of being greedy but why would they? Executives do not benefit directly from high prices or by defeating union votes.

When corporate executives behave badly it’s because they have been given incentives to do so. These are typically “performance-based” bonuses that are given them if they meet certain financial objectives, for example, revenue goals or stock price goals. Who sets these objectives and why are these objectives set?

Ultimately, corporate executives report to the Board of Directors and the board represents the interests of the shareholders. If the company does well, the company stock price goes up and the shareholders are happy. If the company doesn’t do well, the stock price falls and the shareholders are unhappy. Executives are given financial incentives to keep the shareholders happy. Corporate greed, then, is simply a misnomer for what should be shareholder greed.

Who are these greedy shareholders? Well, for the most part, they’re you and me. Most stocks are “institutionally owned.” Your IRA, my mutual fund, your savings account, and my aunt’s life insurance policy all typically end up investing in the stock market. Stocks have traditionally been great long-term investments (because their prices go up!).

When you chose your 401K investment plan, did you choose it for its moral business practices or because it has the best combination of low fees and high rates? When you chose your mutual fund, did you make sure that it was managed my ethical directors or did you simply find the highest rate of return with the lowest beta? Even if you do look for banks, funds and stocks with stated “green” goals, you still have choices. Given two ethical companies, which stock do you buy? Obviously, the one you think will make you the most money.

Welcome to the ranks of the Corporate Greedy. We want good returns. Corporate executives want to keep their jobs. The net result: directors that try to maximize returns. Everyone is acting in their own self interests.

There is nothing wrong with acting in one’s self interest. Once we understand that we are all acting consistently, it is simply a matter of aligning personal interests with some broader objective.  Economists love consistency – it’s so predictable! Make it profitable (e.g. through tax credits) to buy a hybrid and people will do so. Make it expensive (e.g. through regulation and civil penalties) and corporations will stop polluting. Making the math work is a lot easier than convincing people to do something simply because it’s the right thing.