Easynomics

Why we buy lottery tickets

lotteryThe funny thing about memories is that we remember what we remember. And those memories may not always be a true reflection of how things may have originally happened. What we live with are our versions of how things may have really happened. And this we tell ourselves is the truth.

One abiding memory that I have from my childhood is that of my father buying lottery tickets. I don’t remember how often he did it. Neither do I remember how long he did it for. But I do remember that there was a time when he used to buy lottery tickets regularly. And in my version of this memory, I remember him beaming on days he used to buy a lottery ticket. He looked genuinely happy on those days.

And all these years later, I wonder why he smiled on the days he bought a lottery ticket, given that he never really won anything. Of course, I did not understand the reason back then, but now with some understanding of why people behave in a certain way, I do.

As John Kay writes in Other People’s Money: “A lottery ticket, which millions of people buy each week, is a wager. Cynics have advised that you would do well to buy your ticket at the last minute, because otherwise the probability that you will die before the draw is greater than the probability that you will win the headline prize.”

Jokes apart, why do individuals actually buy lottery tickets, given that the probability of winning the big-prizes on offer on any lottery, is very low. Only a few people out of the millions who buy lottery tickets regularly, are likely to win the top prize.

Psychologist Daniel Kahneman explains this in Thinking, Fast and Slow: “The possibility effect…explains why lotteries are very popular. When the top prize is very large, ticket buyers appear indifferent to the fact that their chance of winning is minuscule.”

The point being that unless you buy a lottery ticket you have no chance of winning. As Kahneman points out: “A lottery ticket is the ultimate example of the possibility effect. Without a ticket you cannot win, with a ticket you have a chance, and whether the chance is tiny or merely small matters little. Of course, what people acquire with a ticket is more than chance to win; it is the right to dream pleasantly of winning.”

And that I guess explains my father’s beaming face every time he bought a lottery ticket. In fact as Kahneman puts it: “Buying a ticket is immediately rewarded by pleasant fantasies…The actual probability is inconsequential; only the possibility matters.”

In fact, promoters, companies and governments (as is the case in India and other parts of the world) which sell lottery tickets, understand this fact very well. As Kay writes: “Promoters have learned through experience how to design an attractive lottery product. A few very large prizes establish the dream. A large number of very small prizes encourage customers to maintain the belief that ‘It could be you’.”

This structure of the lottery also explains why people keeping going back to buying tickets even though their chance of winning the big prize is close to zero. As Kay points out: “When lottery patrons lose, as they mostly do, they can sustain the dream by promising themselves that they will buy a ticket again next week. ‘It could be you’ was the well-judged slogan with which Britain’s national lottery was launched.”

So, the story and the hope of winning a big lottery continues among millions of people all over the world. And it is hope which makes a dull and dreary life, liveable at the end of the day. If that means buying a lottery ticket, then so be it.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared in the Bangalore Mirror on Oct 7, 2015

Overconfidence of the ‘Bengaluru’ entrepreneur

flipkartThe last time I was in Bengaluru in late January and early February, almost everybody I met either wanted to be an entrepreneur or had already become one. I know I am stretching the truth here, nevertheless, the enthusiasm for entrepreneurship that I saw in Bengaluru is clearly missing in Mumbai, where I live, and Delhi, the city where my extended clan does.

A major factor that is needed for an individual to become an entrepreneur is “overconfidence”. As Gary Belsky and Thomas Gilovich write in Why Smart People Make Money Mistakes and How to Correct Them: “If people were not overconfident…significantly fewer people would ever start a new business…That their optimism is misplaced—that they are overconfident—is evidenced by the fact that more than two-thirds of the small businesses fail within four years of inception.”

It is worth clarifying here that overconfidence here does not mean arrogance. So what does it mean? As Belsky and Gilovich write: “What research psychologists have discovered about overconfidence is that most people—those with healthy egos and those in the basement of self-esteem—consistently overrate their abilities, knowledge, and skill, at whatever level they might place them.”

The entrepreneurs work along similar lines. In fact, research shows that even when entrepreneurs are told that their chances of survival are small, they don’t believe in it. As Nobel Prize winning psychologist Daniel Kahneman writes in Thinking, Fast and Slow: “The chances that a small business will survive for five years in the United States is about 35%. But the individuals who open such businesses do not believe that statistics apply to them. A survey found that

American entrepreneurs tend to believe that they are in a promising line of business…Fully 81% of the entrepreneurs put their personal odds of success at 7 out of 10 or higher, and 33% said their chance of failing was zero.”

Given that a whole host of Bengaluru denizens have worked in the United States or know someone who has, it is hardly surprising that the American way of doing things, has caught on, in the city as well. Nevertheless, this overconfidence works in several sways. It encourages people to become an entrepreneur in the first place. Further, it helps them to keep running the business in the face of all odds.

As Kahneman writes: “One of the benefits of an optimistic temperament is that it encourages persistence in the face of obstacles…[The] confidence [of the entrepreneurs] in their future success sustains a positive mood that helps them obtain resources from others, raise the morale of their employees, and enhance their prospects of prevailing. When action is needed, optimism, even of the mildly delusional variety, may be a good thing.”

On the flip side overconfidence also leads many entrepreneurs to launch businesses without any business model in place. Take the case of the Indian ecommerce companies, many of which are headquartered in Bengaluru. A significant number of these companies are operating without any business model, backed by an unending amount of private equity and venture capital money that has been pouring in.

The money that keeps pouring into these companies shows the ability of the entrepreneurs to keep raising money from investors in the hope of their companies making money someday. And this couldn’t have happened without them being overconfident.

As Kahneman explains: “Inadequate appreciation of the uncertainty of the environment leads economic agents to take risks they should avoid. However, optimism is highly valued, socially and in the market; people and firms reward the providers of dangerously misleading information more than they reward truth tellers.”

Given this, at this point of time, ecommerce is the flavour of the season, and anyone raising points about the viability of the entire sector, is usually shouted down upon. Nevertheless, as Warren Buffett said during the course of the dotcom bubble which burst in 2000, “but a pin lies in wait for every bubble.” And that is something worth remembering here as well.

The column originally appeared in the Bangalore Mirror on Sep 30, 2015

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

Of Nehru and India’s unemployable

nehru
For many years, the most widely used economics textbook all over the world was written by the American economist Paul Samuelson. Samuelson in different editions of his textbook maintained for a very long period of time that in the years to come the economy of the Soviet Union would grow bigger than that of the United States.  

As Daniel Acemoglu and James A Robinson write in Why Nations Fail – The Origins of Power, Prosperity and Poverty: “The most widely used university textbook in economics, written by Nobel Prize-winner Paul Samuelson, repeatedly predicted the coming economic dominance of the Soviet Union. In the 1961 edition, Samuelson predicted that Soviet national income would overtake that of the United States possibly by 1984, but probably by 1997. In the 1980 edition there was little change in the analysis, though the two dates were delayed to 2002 and 2012.”

Of course nothing of this sort happened and the Soviet Union broke up in December 1991. But those were the days and the narrative of the success of the Soviet style of economics driven by five-year-plans was very popular. Samuelson was not the only one to be seduced by it. In fact, an entire generation was.

The trouble as Acemoglu and Robinson point out was: “In reality, what got implemented in Soviet Union had little to do with the five-year-plans, which were frequently revised and written or simply ignored. The development of industry took place on the basis of commands by Stalin and the Politburo, who changed their minds frequently and often completely revised their previous decisions.”

Closer to home, Jawaharlal Nehru was also a great fan of the Soviet style of economic development. So India had its own set of five-year-plans. The second five year plan (1956-1961) put into practice the idea of economic growth driven by public sector enterprises. Further, trained people were needed to run these public sector enterprises.

As PC Mahalanobis who was the Honorary Statistical Advisor to the government of India as well as the brain behind the second five year plan said in November 1954: “In dealing with the programme of industrial production one of the most important questions would be an adequate supply of trained personnel at all levels. This may indeed prove to be a serious bottleneck.”

In order to tackle this bottleneck the government moved its focus towards higher education. As Sanjeev Sanyal writes in The Indian Renaissance—India’s Rise After a Thousand Years of Decline: “Rather than invest in the general primary education, the country used up all its education budget to provide specialized personnel for grandiose public-sector-projects…The needs of the Mahalonobis model…meant that the country had invested heavily in tertiary education and built up a handful of world-class institutions.”

An impact of this, as Sanyal writes was that “the bulk of the country’s workforce was effectively not employable in anything other than subsistence agriculture.” And this is something which hasn’t really changed. Currently more than half of country’s population works in agriculture but contributes only around 18% of the gross domestic product (GDP).

This means there are many more people working in agriculture than there should be. If India needs to get its millions out of poverty, it is critical that other earning opportunities are created for these individuals. In fact, only 17% of the people who work on farms survive only on money they make from their farm. Everyone else does some extra work.

Hence, a bulk of these people need to be moved on to other jobs. The question is what kind of jobs they can really take on, given that many of them have very basic literacy skills or almost none at all. This pushes skilled or even semi-skilled jobs for that matter, out of the equation.

The point here being that the choice of a wrong economic model has had major consequences for India. And the sad part is that we still don’t seem to have learnt enough from the disaster of public sector driven development.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared in the Bangalore Mirror
on Sep 23, 2015

Big fish in a small pond

fish
One of my bigger regrets in life is having spent two years getting an MBA degree, though I made some good friends along the way. Ironically over the last decade I have lost touch with these friends.

I have often asked myself why things turned out the way they did, given that they were a good bunch of people. And the answer I have come up with is that these friends over the years started cribbing a lot. They were unhappy people in their daily lives.

They were unhappy with their bosses. They were unhappy with their sales targets. They were unhappy with their bonuses. They were unhappy with their colleagues. Different things on different days. The only thing that gave them happiness was planning their weekends and their holidays. As one of them told me with great pride a few years back: “This year we did New Zealand. Next year we will do Turkey.” This was hardly surprising given our fascination for anything phoren.

What I found surprising was these friends spent more time figuring out what to do over a couple of weeks of holidays than trying to figure out what to do over the 50 weeks that they were slogging at their ‘unhappy’ jobs. Why would you want to be unhappy 50 weeks in a year, so that you can be happy for two weeks? Beats me.

The Nobel Prize winning psychologist Daniel Kahneman talks about the focussing illusion in Thinking, Fast and Slow. As he writes: “Any aspect of life to which attention is directed will look large in global evaluation. This is the essence of the focusing illusion, which can be described in a single sentence: Nothing in life is as important as you think it is when you are thinking about it.”

And this possibly explains why my MBA friends had turned themselves into non-stop cribs. Whatever bothered them at a given point of time took precedence in their thoughts and they chose to crib about it.

But cribbing was essentially a symptom to the problem. These friends were constantly comparing themselves with others while working for large companies. In other words they were small fish in a big pond. As Barry Schwartz writes in The Paradox of Choice: “If there were only one pond—if everyone compared his position to positions of everybody else—virtually all of us would be losers. After all, in the pond containing whales, even sharks are small.”

What this tells us clearly is that a major part of satisfaction from what we do comes from how well we look at ourselves in comparison to those around us. Hence, things are relative. As Schwartz writes: “As others start to catch up, the desires of those who are ahead in the “race” escalate so that they can maintain their privileged position.” And if they can’t stay ahead all the time, they crib.

In fact, a few years back an interesting piece of research was carried out. In this research participants where were asked to choose whether they would be like to be in a situation where they were earning $50,000 per year, while others were earning $25,000 or they would like to be in a situation where they were earning $100,000 per year, while others were earning $200,000. And the results were rather surprising.

As Schwartz writes: “In most cases, more than half of the respondents chose the options that gave them better relative position. Better to be a big fish, earning $50,000, in a small pond than a small fish, earning $100,000, in a big one.”

Hence, the trick to be happy is not keep comparing ourselves with those around us. As Schwartz writes: “Instead of comparing ourselves to everyone, we try to mark off the world in such a way that in our pond, in comparison with our reference group, we are successful. Better to be the third-highest-paid lawyer in a small firm…than to be in the middle of the pack in a large firm.”

The column originally appeared in the Bangalore Mirror on Sep 9, 2015

Why ‘good’ restaurants make you wait

cutlery
A few weekends back I met a friend, who wanted to study economics, but ended up becoming an engineer under parental pressure. As the story often goes in such cases, he was told by this father that nobody studies “Arts” in our family.

Most Indian universities offer an economics degree under their “Arts” course. Would fathers look at their children wanting to study economics differently, if universities offered a BSc in economics rather a B.A.? I really don’t know and that is really not the subject of this column as well.

I and my friend, met for dinner at a popular restaurant in the Western suburbs of Mumbai. As usual there was a waiting time of 15-20 minutes. Given his passion for economics, this friend has the habit of asking the most unusual questions at the most unlikely places.

So, here we were standing almost on the road, waiting for a table to eat, and he asked me: “Why do restaurants make you wait?” I didn’t understand what he was really trying to ask and replied: “Well, because there is only so much space that they have and if more people turn up on a given day, someone has to wait.”

“You are not getting my point,” he replied. “What I mean is that the restaurant doesn’t benefit in any way, when more people turn up than it has space for. People waiting doesn’t benefit them in any direct way.”

“Yes. So?” I asked.

“I mean, why not just raise prices and make more money in the process. I am sure enough people would be ready to pay more, if they don’t have to wait. And those who don’t want to pay more, will drop out and go somewhere else. Simple,” he said. “Higher prices will lead to no waiting.”

We couldn’t continue the conversation because our turn to eat came and there are better things to talk about while eating than economics. Nevertheless, the question stayed with me and a few days later, I luckily discovered the answer, while reading a book by a Nobel Prize winning economist Alvin E. Roth. In Who Gets What and Why—The Hidden World of Matchmaking and Market Design, Roth provides the answer to the restaurant question.

As he writes: “Restaurants don’t just rely on ads to signal how tasty their food is, since any eating establishment can advertise that it serves good food. It’s also a part of the reason restaurants sometimes have prices low enough that long lines form outside.” And how does this help?

When a customer waits for his turn to eat he is essentially wasting time and this doesn’t help the restaurant either, as my friend had suggested. So why not just raise prices and make more money in the process? And by not raising prices why is the restaurant letting go of the money it could easily make?

As Roth explains: “That long line sends a signal that the restaurant across the street with empty tables can’t easily mimic—that is, a lot of people think this is a good restaurant, worth waiting for, and if you haven’t tried it, maybe you should get at the end of the line instead of going across the street.”

So, long lines go a long way in building the story around any restaurant.

This also possibly explains why some restaurants survive the test of time despite a fall in quality standards over the years. The lines at the door ensure that people keep coming and convince themselves that the “food” continues to be as good as it was in the past.

Further, the lesson here is that next time there is a long line at your favourite restaurant, it might just make sense to hop on to some other place in the vicinity. Chances are that the food might not be that bad. It’s just that the restaurant may have never had the benefit of long lines forming in front of it.

The column originally appeared in the Bangalore Mirror on Sep 2, 2015