Looking Behind Bad Decisions

Why is it that the U.S. federal government allows local communities to give tax dollars to wealthy sports team owners rather than to create better benefits for citizens? Why are organ-donor programs constrained to the point where thousands of Americans die needlessly each year? Why did the South African government take a stand against an effective AIDS treatment drug?

The inability of government to make wise tradeoffs—give up small losses for much larger gain—has been investigated by HBS professor Max Bazerman (author of Judgment and Managerial Decision Making) and his research colleagues for years. Much of this work used economic science and political science to explain drivers behind the crafting of public policy. When unaddressed, irrational individual behaviors can snowball, leading to suboptimal communal outcomes. Among other things, Bazerman found Goverment decisions are influenced by parochialism, nationalism, and dysfunctional competition

Let's take a closer look.

Organ Donation
Consider this hypothetical question posed in the paper:

A. If you die in an auto accident, your heart will be used to save another person's life. In addition, if you are ever in need of a heart transplant, there will be a 90 percent chance that you will get the heart.

B. If you die in an auto accident, you will be buried with your heart in your body. In addition, if you are ever in need of a heart transplant, there will be a 45 percent chance that you will get the heart.

Which would you prefer?

Most people choose Option A—the benefits of the tradeoff are quite clear. Yet the U.S. government, yielding to what psychologists term omissions bias, the “irrational preference for harms of omission over harms of action,” follows an organ-donation program that favors Option B. The irrational preference for harms of omission over harms of action is known as the omission bias. Back to the question, if most people prefer A why does the United States maintain a policy that is more like B?

Presumed consent laws can be expected to save thousands of American lives each year. Why hasn't the United States enacted these reforms? The relative lack of concern about failure to donate appears to result from the common intuition that harms arising from omissions are less blameworthy than those caused by acts.

The omission bias is usually correlated with another bias, the bias toward the status quo. Risky decisions, such as changes to government policy, usually require action.Thus, when contemplating a change, people are more likely to be concerned about the risk of change than about the risk of failing to change, and will be motivated to preserve current systems and beliefs.

Should governments subsidize sports teams? (The Winners Curse)

In recent decades, state and local officials across America have spent billions of tax dollars on new sports facilities in the hope of luring or retaining a professional sports franchise in their region. Team owners have fuelled this building boom, pitting city against city in the scramble for new sports venues with profit generating restaurants, luxury suites, and seat licenses. Team owners faced with losses or low profits have a strong incentive to demand public assistance to build or improve their stadiums. Yet this support comes despite the fact that, according to a Media Research and Communications poll, 80 percent of Americans oppose having their tax dollars spent on sports stadiums and arenas (Rosentraub, 1997).

When a team threatens to leave a city, some residents will pressure their local government to enter a bidding war with other communities. Public officials must ask themselves whether the public benefits of retaining a team justify the associated public costs. One study found that of fifteen new or renovated stadiums, only the Dodger stadium in Los Angeles generated enough tax revenue to pay for the original public assistance plus interest cost. New jobs generated by new sports facilities tend to be low-wage (janitors, concession workers, and parking lot attendants); meanwhile, the high salaries paid to players and managers typically flow out of the local economy (Rosentraub, 1997). Because public resources are finite, stadium deals reduce the amount of funding available for critical community needs, such as education or community policing.

Bad stadium deals are the product of dysfunctional competition between governments. Private-sector competition generally improves the local or national economy, creating better and more affordable goods and services. Competition can become dysfunctional, however, when organizations invest resources simply to achieve the satisfaction of winning or to hurt a competitor. Government competition can be far more destructive than private-sector competition because, unlike corporations, governments must provide public services such as highways and libraries. When competitive practices backfire, citizens suffer the consequences in the form of service cutbacks or tax increases. In private industry, competition fuels creativity and innovation; between governments, competition fuels the flow of taxpayer funds to selected private interests. Valuable, finite resources such as tax dollars and government land are squandered in destructive competition between cities, states and regions.

Dysfunctional competition between communities and regions for professional sports teams, manufacturing plants, and corporate headquarters can be explained by a psychological mechanism known as the winner's curse. When a bidder wins an auction in which parties have made varying estimates of the prize's worth, the highest bidder is likely to have overvalued the prize commodity in comparison to other bidders.The winning bidder has failed to draw a key inference: The party who most overestimates the value of the prize often makes the winning bid. Similarly, when city leaders estimate the value of a baseball team, the “winning” city will be the one with the most overoptimistic estimate of the team's value. If a bidder assumes that her organization, city, or state will win an auction, she should recognize that she may have overestimated the value of the commodity in comparison to other bidders. The other bidders may not value the prize for reasons the winning bidder has not considered.

Secondary Effects

Many actions have two effects: an immediate effect and a secondary effect. Usually the action is taken to bring about the immediate effect, rather than the secondary effect, even if the secondary effect is larger. Thus, for example, an increase in the minimum wage has the immediate effect of raising wages for the poor and a secondary effect of reducing employment of those same people. Similarly, the immediate effect of a state business tax may be to raise money for the state government, but the action may have the secondary effect of driving businesses into other states. In many instances, the secondary effect is so much greater than the primary one that a near-Pareto improvement could be obtained by choosing not to act, so that neither effect comes about.

When evaluating the attraction of the tax or other payment mechanism, lawmakers and voters tend to overlook or discount the significance of secondary effects. This general phenomenon has been called the isolation effect, but is closely related to what others have called the focusing effect. The focusing effect sprang from the theory that people reason from mental models when possible, we use a single, simple, model that represents only the information that we are given, and ignore or discount other factors.

A related example of the tolerance for detrimental secondary effects is the U.S. public's acceptance of large budget deficits that result from a combination of tax cuts and unchanged government spending. Most people, when asked about appropriate levels of government taxation and spending, preferred low taxes and even lower spending, leading to a budget surplus. However, the same people were then asked the spending question in a different way. Specifically, they were asked whether spending should be increased or decreased for particular programs on a list that included most of the programs supported by national governments. When the question was asked this way, the preferred net change in spending was approximately zero, even though the same subjects, on the same page, continued to support substantial tax reductions. Thus, the problem may be that people support spending cuts in the abstract but fail to think through where those spending cuts will fall. Few people are willing to advocate significant cuts to many programs, especially programs such as pensions and health care for the retired.

Sources and Further Reading:
Enlarging the Societal Pie through Wise Legislation: A Psychological Perspective
Working Knowledge Article on “Enlarging the Pie” and an Interview with Bazerman
Rosentraub, M. S. (1997). Major League Losers: The Real Cost of Sports and Who's Paying for it. New York: Harper Collins.