Thursday, July 21, 2011

Notes on Charlie Munger on The Psychology of Human Misjudgment

This talk comes from Charlie Munger on The Psychology of Human Misjudgment. This speech was given at Harvard University, around June, 1995.

Also see his book Poor Charlie's Almanac, and the talk given at USC Business School in 1994.

  1. In my words, perverse incentives. The Cobra effect is particularly illustrative. He gave an example of switching workers from hourly to paid per shift.
  2. Agency costs. I had to verify that the government does indeed prohibit cost-plus percentage contracts. The problem being that this gives the company an incentive to raise prices, so that they can raise margins.
  3. He calls it "bias from consistency." He alludes to The Structure of Scientific Revolutions by Thomas Kuhn. I hadn't heard about Chinese brainwashing before and it was an interesting read.
  4. Pavlovian association. This is similar to his first point, where he talked a lot about B.F. Skinner. At one time I used to think that I was immune to marketing. I was wrong. Some of the gimmicks used in commercials may not affect me, but I still have "brand loyalty" and in a Bayesian sense, it takes more for me to switch away from a "well known" brand. He also talks about "Persian messenger syndrome" and states that Persians killed messengers who brought bad news. I did a quick Google search, and all I found was references to the movie 300. I wonder what history book he's citing here. He also talks about how raising the price of a product might sell more, because we correlate price with quality. My favorite quote from this section: "an institution that gets sloppy accounting commits a real human sin."
  5. Reciprocation tendency and acting as others expect. This is a common negotiation tactic. Doesn't everyone do this? Start off higher than what you would sell for? Act as the person you want to be? He also talks about the Stanford prison experiment. The last sentence reminds me of this quote: "Watch your thoughts, they become words. Watch your words, they become actions. Watch your actions, they become habits." etc.
  6. Bias of social proof. The murder of Kitty Genovese. Munger states that "50, 60, 70" people "sat and did nothing while she was slowly murdered." Wikipedia lists a dozen. He also pokes at the efficient-market hypothesis.
  7. Great quote: "It is better to be vaguely right than exactly wrong." He attributes this to Keynes, but it was Carveth Read.
  8. Bias from contrast-caused distortions. I have no idea what he meant by "it's a scale with quantum effects in it too." Interesting quote: "cognition mimics sensation." He gives an interesting example of the real estate broker showing the "rube" two highly overprices houses, and then to a moderately overpriced house. The "rube" will be more likely to buy the moderately overpriced house.
  9. Bias from over-influence by authority. Similar to point 6 about the Stanford prison experiment, he talks about the Milgram experiment.
  10. Bias from deprival [sic] super-reaction syndrome. Illustrative example: New Coke.
  11. Bias from envy/jealousy.
  12. Bias from chemical dependency.
  13. Bias from mis-gambling compulsion. I don't know what "mis-gambling" means. He summarizes one of Skinner's experiments, and says that variable reinforcement works better than any other enforcement pattern. He seems to be trying to explain why people gamble, when they should know better. Why gamble when you can prove that the expected payoff is negative?Munger thinks that when people are given a trivial choice, it makes them think they are in control. So, if you have a lottery where the number is picked by a machine, versus a lottery where you pick the number. You have slot machines, and for the "high IQ-crowd" you have poker machines.
  14. Bias from liking distortion. Quote from The Doctor's Dilemma: "In the last analysis, every profession is a conspiracy against the laity." A man likes who he is, and so "he believes that the demons that he's the guardian against are the biggest demons and the most important ones." Great quote: "I have never seen a management consultant's report in my long life that didn't end with … [this situation] needs more management consulting."
  15. Bias from the non-rational heuristics (my phrasing). This is a very interesting point. He goes on to reference Kahneman and Tversky and the various cognitive biases we have.He talks about firing an old lady caught stealing. She says "I never did it before, I'll never do it again." How all the biases prevent you from rationally calculating the chances that she has not done it before, and she won't do it again. Munger references Serpico and why letting people get away with such trivial behavior will "cause the evil behavior to spread, and pretty soon the whole damn… your place is rotten, the civilization is rotten."
  16. Bias from over-influence by extra-vivid evidence. I wasn't able to follow Munger here. He gives an example of passing up an opportunity to buy 1,500 shares of a stock because he wanted some time to think about it.
  17. I didn't get the title of this point (it's rather long). It talks about Solomon Brothers Inc., and John Gutfreund. Munger tells us that Feuerstein (general counsel with Salomon) was unable to convince Gutfreund that firing Mozer was the right thing because he didn't explain the why he should fire him. Feuerstein said that you have to do it because it is a "matter of prudent conduct and proper dealing", when he should have said "you're likely to ruin your life and disgrace your family and lose your money." Munger says that this was a failing of elementary psychology on Feuerstein's part.
  18. He skips this point titled "Other normal limitations of sensation, memory, cognition and knowledge."
  19. Stress-induced mental changes. I don't get what Munger was trying to say here. He was talking about Pavlov's experiments with dogs (I could only find this link) and stress. He says that stress was able to reverse conditioning in dogs.
  20. He skips this point talks about common mental illnesses.
  21. Confusion from say-something syndrome. I think this is best summarized as "I don't know" is a perfectly good answer.
Munger's "most important question":
  1. What happens when all these standard psychological tendencies combine?He gives examples (Tupperware, The Unification Church, Alcoholics Anonymous) of multiple tendencies coming together. He takes a good jab at the board of directions of any major American company: "they only act when it gets so bad it starts making them look foolish, or threatening legal liability to them."
  2. Asks if the list is as good as it can get, and replies, no, it can be improved.
  3. What good, in the practical world, is the thought system indicated by the list?Tendencies are party good, and probably much more good than bad.
    In the text that followed, he talks about the above listed psychological tendencies being put to good use. I especially liked the following examples:
    • Karl Braun's communication practices: you have to tell Who, What you wanted to do, Where and When, and you had to tell him Why. If you left out the Why, you got fired.
    • Clinical training in medical schools: watch one, do one, teach one.
    • Rules of the U.S. Constitutional Convention: totally secret, no vote until the whole vote, then just one vote on the whole Constitution.
    • Granny's rule: organize your day so you force yourself to do what's unpleasant and important by doing that first, and then rewarding yourself by doing something you really like doing.
    • Harvard Business School's emphasis on decision trees. I liked the Wikipedia article on decision trees.
    • The use of postmortems at Johnson & Johnson. Although I would add that you should continually improve and evaluate projects. A project can limp along and lose money for a long time.
  4. What special knowledge problems lie buried in the thought system indicated by the list?Munger is calling for more behavioral economics.
  5. If the thought system indicated by this list of psychological tendencies has great value not recognized and employed, what should the education system do about it?Munger skipped this question.


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