The Key to Making Smarter Long-term Decisions

If we were rational, we would make choices based on our long-term goals, not our short-term desires. Spoiler alert: We’re not, and we don’t — which can present real dangers to us as individuals and as a society. But recent research from Wharton operations and information management professor Howard Kunreuther and Elke Weber of Columbia University suggests that it’s possible to hack our decision-making processes for the better. Their working paper is titled, “Aiding Decision Making to Reduce the Impacts of Climate Change.”

In an interview with Knowledge@Wharton, Kunreuther talks about the flaws in our thinking that lead us to ignore major long-range problems until they become imminent disasters, and how, with the right incentives and strategies, we could be nudged into wiser behaviors.

An edited transcript appears below.

Incentivizing long-term thinking:

The question that this paper is focusing on is really: How do we link short-term decision making with long-term strategies? In particular, we are concerned with respect [to the idea] that individuals do not adopt measures prior to a disaster, or focus on climate change before it actually may have a serious effect — and how we can develop measures for actually getting them to do this, by literally highlighting not only the long-term aspects of decision-making, but also the fact that they can benefit in the short term by doing so. This builds on some of the work that Daniel Kahneman has done in his book, Thinking Fast and Slow, as well as a whole program of research that the Wharton Risk Management and Decision Processes Center is following.

“People expected others to take these measures, but they weren’t going to take them themselves.”

Key takeaways:

The key takeaways from this particular paper are that unless you can develop some short-term incentives to get people to think about a long-term issue like climate change, it’s going to be very hard for them to take measures today Twitter . We have been looking at two elements in this respect. One of them has to do with energy efficiency, and the challenges that people have in terms of adopting measures that can reduce the carbon in the atmosphere, but may cost them more money up front to actually invest in. Similarly, we are looking at protection against floods and the use of flood insurance, and also adapting measures that could be fairly costly to reduce the damages in the future. Unless we can develop strategies for dealing with that, we’re not going to be able to get people to do them.

Surprising conclusions:

I think that the conclusion that surprised us the most was that people expected others to take these measures, but they weren’t going to take them themselves. They expected that people should be concerned about climate change, and that other people might be concerned, but they themselves had less of a concern with respect to adopting these measures. And I think that’s what led us to really say, we’ve got to figure out some ways that they, themselves, will pay attention to taking these steps, rather than thinking that others may do that, but they, themselves, would not.

Cost-benefit analysis:

The one thing that the study dispels is that if we believe that people are rational in the sense that they make the trade-offs between the costs and the benefits, and think over long periods of time — which is what they should do in theory when they’re thinking about the benefits of a measure to reduce the cost of energy or to improve their house — they should be thinking over a period of years rather than days or weeks or months. And people don’t do that. I think that is something we have to really appreciate if we’re going to be able to make [these the types of] decisions that people will actually undertake.

Creating short-term incentives for long-term thinking:

What we concluded on the basis of the research is that if we could provide some type of long-term loans for individuals so that they wouldn’t have to pay the up-front cost of an energy-efficient measure or the adaptation to make their house safer, they would be a lot more willing to undertake them, particularly if they could see the short-term benefits. Let me illustrate with respect to flood insurance. If you actually have a risk-based insurance premium, a premium that reflects risk, and you have a person who is willing to make their house safer, by let’s say elevating their house or flood-proofing their house, they would get a loan to do this.

“We’re trying to understand how one should behave. [And] we’re trying to understand how one does behave.”

If the measure is cost-effective, the reduction in the premium will be greater than the cost of the loan. And if that’s the case, then the individual would say, “This is financially attractive to me in the short run.” But it also has the benefit of making the house safer in the long run, reducing the cost if there happens to be another severe flood in the future, such as the ones we’re having currently in Texas. And as a result, it’s something that will be attractive not only to them, but also to all of us taxpayers because we’ll have to pay a lot less in the way of disaster relief.

Understanding why we do what we do:

I think what sets this research apart is we are really trying to link several features of risk assessment, which is the science of risk, with risk perception, which is how people behave, to risk management, which is what we can do to improve decision making. A similar analogy is we’re trying to understand how one should behave. We’re trying to understand how one does behave. And then we’re trying to suggest measures as to how we can improve behavior so we come closer to how one should behave.

Looking ahead:

This research is part of a much larger strategy that the Wharton Risk Management and Decision Processes Center is following where we’re trying to really understand ways that we can develop long-term strategies. We’ve just finished a book, Leadership Dispatches: Chile’s Extraordinary Comeback from Disaster, about Chile and how they responded to the 2010 earthquake. We’re in the process — myself, and my colleagues Mike Useem and Erwann Michel-Kerjan — of working on a project on how CEOs and CROs of the S&P 500 are dealing with catastrophic risk, and how we can improve behavior. And I’m also working with my co-director Robert Meyer on ways that we can better understand developing incentives for people to undertake protective measures before the disaster, rather than waiting for the disaster to occur before they take action.

 

 

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