In this episode, Ramanan speaks with Robert Frank, the Henrietta Johnson Louis Professor Emeritus of Management and Professor Emeritus of Economics at Cornell's Johnson Graduate School of Management and a Distinguished Senior Fellow at Demos.
For more than a decade, Frank’s "Economic View" column appeared monthly in The New York Times. His book The Winner-Take-All Society, which examined the concentration of wealth and power in the contemporary economy, received a Critic's Choice Award, was named a Notable Book of the Year by The New York Times.
His most recent book, Under the Influence, describes how our environments are in part products of our behavior and explains how we can structure our environments to catalyze positive behavior change at scale. Frank is a co-recipient of the 2004 Leontief Prize for Advancing the Frontiers of Economic Thought.
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[00:00:14] Ramanan Raghavendran: Hello everyone. I'm here with Robert Frank or Bob, for the latest in our interview series. Dr. Frank is one of the legends of the field of behavioral economics. His most recent book, which I would urge you to read because it builds on themes that have held his attention throughout his career, also touches on one of our favorite topics, which is peer pressure and how it can be a force for bad and good. The title of the book is Under the Influence. Bob, we're very grateful for your time.
[00:00:40] Can we kick ourselves off, as it were, with a few autobiographical comments from you about the long arc of your career, just to help frame the conversation?
[00:00:51] Robert Frank: I got my PhD from Berkeley in 1972. The first job I took was at Cornell, that's really been the only job I've held for 50 odd years. I retired officially from Cornell in July of 2020. It was a good time to leave in the midst of the pandemic. I've been called off the bench a couple of times. I teach a large group of very able students in a joint program that Cornell runs with Tsinghua University in Beijing. I feel like that's been really a thrill for me to have access to them. They're going to go on to hold high posts in government and industry in China. I think one of the real concerns we have in this country is our inability to take collective action. We see case after case where individuals do what's in their own interest to do, that ends up being quite contrary to what it's in everyone's interest that we all do.
Normally we have responded in the past by passing laws and regulations and other measures that try to harmonize individual incentives with group incentives, but we're up against the wall on that these days, there's a lot of skepticism about government, it's very difficult to get anything through. China, in contrast, for all the things we might find problematic about their system, they're able to act collectively. Not always in ways that we would approve, but the idea of being able to speak to that audience about steps that it would be useful for the collective to take on issues like climate change, is just an enormously valuable opportunity, I feel.
[00:02:32] Ramanan Raghavendran: This is a digression from the main thread of our discussion, but I have to ask the question, does this class contain both the Chinese and Americans? And if so, do you see a difference in how they perceive what you're teaching?
[00:02:47] Robert Frank: They are all Chinese nationals. Most of them are in Beijing, some of them are scattered in other cities in China. But no, there are no Americans in this group.
[00:02:55] Ramanan Raghavendran: Well, we might come back to that before we're done. I want to get into the main thread of our discussion. You've been in or adjacent to the field of behavioral economics for decades. Cornell was the birthplace of behavioral economics, and you taught the first undergraduate course there in the subject in 1983. That's a long time and I think it would be useful for us to get a couple of snippets from you on how you've seen the field change and develop.
[00:03:25] Robert Frank: When I started, there had been courses taught before. Richard Thaler taught a course in the Cornell Business School that was essentially behavioral economics, but there wasn't a standard menu of things to teach and so my own vision of what the field ought to look like was, of course a big factor in the design of my own syllabus. I split material up into two parts. I called one part... well, first of all, the name of the course I chose was Departures from Rational Choice. I'm sorry now to have chosen that name, it led to a lot of silly debates about what it meant to be rational. We could have avoided all that, I think quite easily with a different title, but that's the title I chose.
Under it, I had two headings, one was Departures from Rational Choice With Regret, that was really the focus of the work by Daniel Kahneman and Amos Tversky and other cognitive scientists who said, look, we're not very good at processing information, we use shortcuts. If you put us in the right set of circumstances, you can make us make a mistake without any difficulty. And in fact, we do identify systematic errors that people are prone to making. You shouldn't take sunk cost into account when you make decisions. Why? Because they're beyond recovery when you act, why worry about them if all you're really concerned about is which is the best decision, going forward? You ought to ignore those. People, when they get that idea, they seem motivated to change their behavior. There is a tendency to take sunk cost into account when you make decisions, people try to avoid that when they learn why they shouldn't do it.
The second category though, was Departures from Rational Choice Without Regret, and those were behaviors that, when the economist tells you, "That's not what a rational person would actually do in that situation," nobody seems to have any regret about it. You leave a tip in a restaurant you never plan to visit again. Okay, you don't need to do that, the waiter can't deny you good service on your next visit because there's not going to be a next visit, but you feel like it's the right thing to do. He's counting on that to feed his family, you'd feel like a heel if you didn't, and so you do it.
Standing to get a better view is more like the focus of most of my work, it's something that's individually rational. If somebody's standing in front of you, you can't see at all unless you stand too. If we all stand though, nobody sees any better than if everybody had remained comfortably seated. So it's situations like that that were, at the time, my biggest interest. They have become far and away an even bigger focus for me in the years since. I think the evolution of the field was, in many ways, to me a disappointment. It focused almost exclusively on cognitive errors, mistakes people make.
The nudge movement grew out of that orientation—if we just push people a little bit, they'll decide more sensibly. That's a good movement, it's led to huge gains. It's way more cost-effective than most other government programs; the countries that have set up nudge units have done very well with them. But the losses from those kinds of errors are small potatoes compared to the losses from collective action problems, climate being one, the runaway spending arms races that we see in modern society, all those together waste literally many trillions of dollars a year, just in the US alone.
I mean, the scale of the waste is almost incalculable. And the frustration is that some fairly simple changes in tax policy would steer people to spend their money in different ways, eliminating a lot of that waste. And yet we haven't really done anything much of that, so that's been my disappointment. I'm still at it. I'm writing a memoir now. I'm going to take one more crack at explaining why these are not charlatan ideas, they're really ideas that we ought to take up seriously, but who knows whether I'll live to see any of that happen.
[00:07:34] Ramanan Raghavendran: Well, if it makes you feel better, we're in violent agreement with everything you have written, so we will continue the good work even if you choose not to write another book after the memoir. I'm going to move us to a concept that's threaded through much of your body of work, which I suspect is not as well known in my world as it should be, which is the idea of positional arms races.
[00:07:56] Could you explain that concept for our listeners here today, if you don't mind?
[00:08:02] Robert Frank: Yes, the standard approach in economics is to say that the utility you get from a good, depends only on its absolute qualities, characteristics. So a house, how big is it? How many bathrooms does it have? How well located is it? Those things obviously matter, but context matters too. In Nepal, when I was a Peace Corps volunteer, I lived in a two room house that didn't have any electricity or running water. Never was there a moment during the two years I lived in it, that it seemed in any way inadequate. I was always delighted to have colleagues over as guests. If I lived in that same house here, it would not be adequate at all, it would be a screaming signal about how miserably I had failed to meet even the most minimal demands of social existence in this context. So a house, whether you like the house you're in, depends on, well, what's the context?
Are we almost there yet? You're taking your daughter to visit her grandparents. You've gone 10 miles on a 300 mile journey, "Are we almost there yet?" "No, we've just gotten started." There's 10 miles left on a 12 mile journey. "Are we almost there?" "Yeah, we're almost there. We're about to arrive." So context clearly shapes every evaluation that we ever make. Economic theory completely ignores those. When you ignore that, you don't see in plain sight, right in front of you what I call the positional arms race. That is, well I'll maybe couch it in terms of the expenditure cascade, a related phenomenon.
The income gains, as we've seen, have almost all gone to people at the top over the last decades. They're normal, they do what everyone does, when they get more money, they spend it on things, they build bigger. They build bigger houses. It doesn't seem to offend the people in the middle, they in fact seem to like seeing pictures of the mansions and the fancy surroundings. Maybe they'll be rich someday, they think. They probably won't, but that's good if they take pleasure in that. The people who are influenced by the big mansions built by the people right at the top, are the people just below the top. They go to the wedding receptions now held in the homes of the super-rich instead of in a country club or a hotel, and so they leave thinking, "Well, we need a ballroom now. We should host our daughter's wedding reception at home." They build bigger, their friends just below them have dinner with them. They leave thinking, "We need a dining room that seats 18, not just 12," they build bigger.
And if you refer to that cascade all the way down the income, you just can't explain why the median new house built in the US today is 50% bigger than its counterpart from 1970. The people in the middle don't earn higher real wages, why are they building bigger and spending so much more? Because people like them are spending more, but why are they spending more? It's because people at the top are spending more, that's the ultimate answer. And we could do something about that.
There's a huge literature on the determinants of human flourishing. It's a contentious literature, there's lots of stuff people argue about. But one of the most secure findings in it, is that beyond a certain point, and it's one we've long ago passed in most Western countries, further increases in most forms of private consumption don't really cause any enduring increase in happiness or health or wellbeing, any other thing we can measure. They just raise the bar that defines what we think of as adequate, in the very same way that what I think of as an adequate house here, is different from what I would've thought of as an adequate house in Nepal.
If there were nothing else useful we could spend money on, then that wouldn't matter probably, but the same literature identifies many categories of things where, if we had more resources, we could do real good for people. There are so many legitimate human goals that are far from being met, just freeing up resources that aren't doing any good at all, in some areas, the $36,000 we spend on average on wedding receptions now, that's three times in real terms, what it was in 1980. Nobody's any happier because of that, if we could steer those dollars to providing more hospital surge capacity or more research on vaccine development, or better infrastructure maintenance, any of a host of things that we know would actually make a difference, that would be better. And it would be easy to do that.
[00:12:36] Ramanan Raghavendran: I'll move us to our next question in a second, but I just want to comment on the wedding reception point. I'm an immigrant to the United States from India, and runaway wedding reception competition, just beggars disbelief in a country with-
[00:12:50] Robert Frank: Yes, I'm familiar.
[00:12:51] Ramanan Raghavendran: No, I figured.
[00:12:53] Robert Frank: And funeral competition in India as well.
[00:12:57] Ramanan Raghavendran: I mean in a country with such grinding poverty and squalor, the idea that you could book an entire resort for 40 people to fly in on private jets, is insane. But as you said, the game just keeps getting upped and people just jockey for position.
[00:13:16] Robert Frank: And I think it's a mistake to wag your fingers at them in this specific sense. If my friends from Nepal would see the house I live in here in Ithaca, they would wonder, had I taken complete leave of my senses? Why would anyone need such a grand palace? Why so many bathrooms? Those are the kind of questions that would spring to their minds. You wouldn't think to ask those questions. Every context is local. And everyone wants the guests to leave feeling like you celebrated the occasion in a fitting way. The standards that define what it means to do that, are just different in different circles. It would be better for the people at the top if they didn't feel they had to meet those standards. They would be grateful not to have to spend that much money.
[00:14:01] Ramanan Raghavendran: Well, my next question is a variation on that. In your most recent book you write, “Many people who have written about peer effects and consumption describe them as a manifestation of the familiar notion of keeping up with the Joneses. The first advice I offer a junior colleague who wants to work in this area is never to use this expression.”
[00:14:23] So the question for you is what do you think people misunderstand about the motivations for our consumption patterns?
And you just spoke at length about a big chunk of it, and so I wanted to open it up to all the other thoughts you might have on the same topic.
[00:14:35] Robert Frank: Yeah. I made that statement in a recent book, not in jest, it's actually what I do tell junior colleagues. I think the common perception is that, oh this is just envy or jealousy. It's a petty, negative emotion. Why should we ratify it by designing public policies to respond to it? First of all, that's an incoherent argument, greed motivates bank robberies, do we say we don't want to have policies to discourage bank robberies? They're going to happen unless we do, so of course we want to have policies to discourage jealousy and envy, if that were the main problem, but it's not the main problem. It's just this simple link between context and evaluation. The things we regard as special, special is just inherently a context-dependent phenomenon. You can't know what's special unless you know what is the norm in a particular time and place.
I'm a car guy. I went to car shows as a boy, growing up. And I'm a little embarrassed to reveal that to people, but how fast your car seems, really depends on what's out there at any moment. The classmate of mine in high school had a '55 Thunderbird, let me drive it one day. It had a manual transmission, three speeds on the floor of a big 289 cubic inch V8. I looked up the figures on it recently, it got from zero to 60 in 11.5 seconds. There's probably not a production car made today that is as slow as that. Maybe a diesel semi-truck couldn't get to 60 any quicker than that, but it felt breathtakingly fast when I drove that car, I couldn't believe how fast it seemed.
My car today gets from zero to 60 in under five seconds. It's in the middle of the pack today. The new Tesla sedan, the Plaid, gets from zero to 60 in 1.99 seconds, that's an almost incomprehensible number. But you get a thrill from going fast, how fast do you have to go to get that thrill? It just depends on the context. If you go 30 miles an hour in a boat, in a small boat on a lake surface, that feels like you're going fast. 30 miles an hour driving on an interstate, people are honking behind you. It's context.
[00:16:59] Ramanan Raghavendran: Agreed. I'm going to shift the thread of our conversation to an area that is pertinent to our investment thesis, but our thesis arises from our beliefs and research. One of your key insights is that, while our concern with the peer group can spur negative behaviors and we talked about a few of them, including wedding receptions, it is also a powerful tool for positive change.
[00:17:24] Would you mind describing an example, if you will, the flow of a positive behavioral contagion? Maybe an example from your book?
[00:17:33] Robert Frank: Ramanan, there's a terrific one right up your alley and that's the influence of solar installations, on neighbors' decisions about whether to adopt them.
[00:17:44] Ramanan Raghavendran: I love that example in the book.
[00:17:46] Robert Frank: Yeah, there is a series of studies now, but the original one was quite well-designed. Let there be a random new installation at time zero, then controlling for income and prices and subsidies and everything else that might matter, they're able to identify that a second installation will occur within four months, on average, of that first one. An installation that wouldn't have occurred, except that people saw the first one, so now we've got two, four months into the process. Those two themselves spawn an additional installation just from the demonstration effect on neighbors, conversations, visual sight lines, so we've got then not two but four after another four months pass. Then another four months, we've got eight.
After two years elapse, we've got 32 solar panel installations in that one zip code, that completely ignores all the family members and relatives they've got in distant places that they've talked to and influenced, probably those chains of influence are even stronger than the ones that affect neighbors, but it's an explosive exponential process. It doesn't go on forever, you eventually saturate, but in the early going, people like to think, "Whether I do it or not, well, I'm just virtue signaling, and it's not going to really matter." It matters enormously and it changes who you are in the process of doing it. If you weren't a climate advocate to begin with, you become one or more of one by virtue of having done these things. That makes you more likely to vote for the candidates who will enact legislation, which we also obviously need, to pair the climate threat. And so it's really a huge new window in the possibility of effective action.
[00:19:37] Ramanan Raghavendran: I mean the link between individual behavior at scale and the effect of that on, in fact policy decisions, is a very interesting point you've made a few times, and really the light bulb went off in my head. My quick little solar example, I'm obviously a climate activist in some ways. I did not have solar panels in my house, my neighbor did. I could see them every day and I cannot deny it was a spur to me finally getting my act together and saying, "Okay, damn it. He's got them, clearly he's a smart guy. He knows what he's doing, and I need to do the same thing." So I am exhibit A in all of these examples.
[00:20:19] Robert Frank: Yeah, and I think people sometimes feel embarrassed that they are influenced by the examples of others, but that's just how humans work. The world is so indescribably complex, no individual has even a tiny fraction of the information you would need to know to figure out what the right thing to do is in all the different situations you confront, but together we've got quite lot of information. And so taking cues from what others do, is absolutely an essential part of making your way in the world. You shouldn't be uncritical about it. As parents, we warn our kids, "Don't follow the idiot examples."
[00:20:58] Ramanan Raghavendran: They don't listen to me. I have teenage boys, they're not paying any attention, I just want you to know.
[00:21:05] Robert Frank: But you got to pay attention to what others are doing if you want to have any chance of making your way in the world.
[00:21:12] Ramanan Raghavendran: Agreed. I'm going to take us to our last question, because I think it's going to be a lengthy one and a discussion. It is about this in intersection of policy and individual behavior and I want to get to the idea of a consumption tax in this section of the conversation. You described several policy interventions in the book that can help put the dynamic of pure influence to good use.
[00:21:38] Our audience is a bunch of individuals and they're passionate about positive change, what can be done by them today to work towards catalyzing these policy goals?
So I realize that's kind of an amorphous question, but you can take it in any direction you wish.
[00:22:00] Robert Frank: You know, I think setting good examples personally has more impact than most people realize, we've talked about that already. I'm not going to assume that your listeners are the usual mix of conservative-leaning investors. I think now we're in a moment of political crisis of sorts, there's a party that seems to have retreated from its commitment to governing, to taking collective action that is in the interest of citizens, generally, and another party that's more focused on that. What we know is that the state legislature, both houses in Virginia changed hands in 2018. And in the wake of that change, the Virginia legislature enacted one of the very most green energy pieces of legislation of any state in the country. Now their timetable for utilities to convert to all green energy is on a very, very rapid short string and it's just because of a few extra people who got elected.
So pay attention to who's running, write a check to people who are in favor of the kind of collective steps you think would be good to take. It's not beyond imagination to think that that could make a difference even in the short run. The Senate is the big bottleneck, obviously. The Senate is very close, a couple of different seats changing hands there could make an enormous difference. So yeah, that's one of the biggest things I focus on. I write lots of checks to candidates I think are going to do the right thing in that arena.
But basically beyond that, on the personal example front, I don't have solar panels on a roof and it's not because we didn't investigate that. We did have them come out, they said our orientation wasn't quite right. We had some big trees that weren't going to let us get the exposure we needed. And so instead what we did was, we bought a share in a solar farm, and that turned out to be maybe an even better deal, just because the solar panels at a farm are exactly oriented correctly and they even change the orientation to make it just right throughout the day, which normally you don't do on a rooftop installation, or not yet anyway. And I said, "Well, but nobody will know we're a member of your solar farm, so we won't be getting these magical spillover effects." He said, "Aha, we've thought of that." He brought me a sign saying, we've gone solar, so that sign sits out in front of our house. People don't see any panels on our roof, but they see our sign that says we've bought our share in the solar farm.
[00:24:39] Ramanan Raghavendran: May I just touch on the consumption tax, which, when we read about in the book. Now I hadn't thought a whole lot about it and what we read about it, my colleague, Mary Marsh and I, in your writings, it seems like an awesome idea.
[00:24:58] So how do we make it happen?
[00:25:01] Robert Frank: It's such a simple idea. It was proposed long ago. Conservatives have always been in favor of consumption taxation, they propose flat taxes, which are quite regressive, I don't like that idea. The progressive consumption tax is a variation that makes the tax actually as progressive as you would want it to be. You report your income to the tax authorities as you do now, then you document how much you added to your savings during the course of the year, people do that already for IRAs and other tax-exempt retirement vehicles. And the difference between those two numbers, your income this year, minus how much you saved this year, that's how much you spent this year. Then we knock off a standard deduction, maybe 10,000 per person in a family. And that's your taxable consumption.
The rate starts out either zero or very low. The more you consume each year, the higher that rate can go. It needs to be higher than the income tax since we're exempting savings from tax, so just to keep the same revenue, we would need a higher rate on the higher amounts of taxable consumption. But we could raise it almost without limit compared to the income tax where we're always constrained by the worry that if we raise it too high, people will stop saving and investing. Here, raising the marginal rate is an open cry to invest more and save more. In the long run, if we do invest more and save more, that means the capital stock grows, productivity grows, wages grow. So even though we might, in the end be consuming only 80% of our GDP, rather than then 95% of it, we would have such a much bigger GDP as a result of the growth, that the absolute consumption level would be higher.
That sounds bad because people think of consumption as polluting. Some consumption types are polluting. We want to discourage those with separate policies. There's no reason to discourage my kids from taking piano lessons or from us hire a garden to plant flowers in our front yard. There are lots and lots of consumption that's totally benign in terms of its environmental consequences. And growth is a good thing insofar as we can channel it into benign spending patterns. So yeah, I think it's a huge opportunity.
The carbon tax has gotten a bad name, people have tried it and it makes people angry. What a prime example of political malpractice that is. If you would make the carbon tax revenue neutral, which means only you collect all the revenue you get from it and then you give the revenue back to the taxpayers in lump sum amounts each month. Since most of the revenue would come from high income earners, worldwide half of all emissions are due to the top 10% of income earners, if you rebated the revenue from the tax in a progressive way, concentrating it on low and middle income households, then you could set it up so that 80% or 90% of voters would get more back each month than they had paid in carbon taxes.
And the people at the top would end up paying more, that's fine, but it's their property that's getting damaged disproportionately by the extreme weather we've seen, so they come out ahead too, and the effect of that over time would be enormous.
You wouldn't make vegans out of people overnight. We eat because that's what we're in the habit of eating. What we do, we've grown up with people who ate meat, we eat meat, our friends eat meat, we feel embarrassed if we don't serve meat when they come to dinner. But if meat-based products got more expensive, relative to plant-based products, people would, at the margins, substitute a bit. As some did, then it would seem more normal to do that, others would follow suit.
It's the same thing we saw with smoking. We tax smoking heavily, most people didn't quit. They're addicted to smoking, they just went right on. But there were people at the margin who had low income, maybe they couldn't afford to keep smoking, they quit. Maybe they were about to start and thought better of it when they saw the size of the tax. They didn't start smoking, or they quit smoking, that meant every peer group now had a smaller proportion of smokers in it. People in those peer groups were more likely to quit or not start because of that, that meant the proportion went down still further. If you don't invoke that kind of process, you don't come close to being able to explain the steady downward trajectory of smoking rates in the US. It's now 13%. When we started taxing, it was close to 50%. You don't see a decline like that, except for this kind of contagion.
[00:29:39] Ramanan Raghavendran: I actually did not know it was down that low, so that's kind of an amazing example. Do you think there are specific states in the union or countries outside the United States, that are closer to this idea of a consumption tax in the forms that you've described it, than others? And if so, should we all move there?
[00:29:58] Robert Frank: I remember after one book came out where I'd proposed the progressive consumption tax, I got a visitor from one of the provinces in Canada, wanting to know, "Could you do this at the province level?" And normally you're cautious about being aggressive with tax policy at the local level. If you tax them here heavily, they'll move to the state next door. That was, by the way, the big wrap against California's recent move to raise top marginal tax rates. Over the span of a few years, they went up 50% and there were dire predictions, everybody's going to move to Nevada or Oregon or somewhere.
A Stanford study showed that the top 1% in California left the state at a far lower rate than anyone else along the income scale. No other percentile slot left the state as infrequently as the top 1%. You have a life in California, you're wealthy there. If your taxes go up, you'll still be wealthy because wealth is a relative thing and you'll have better public goods, you won't have as many potholes for your Ferrari to bump into, so what's not to like?
[00:31:05] Ramanan Raghavendran: And it is California.
[00:31:06] Robert Frank: It would be a reason to move to a state that had a tax like this. As far as I know, they did not adopt it. We actually have a progressive consumption tax for 90% of tax payers, the problem is that it's capped. The amount you can deduct in IRAs and [KIOs] and other sheltered accounts, is limited to a certain absolute amount and it's the expenditure cascade that causes the waste, the spending at the top in response to the great gains and income at the top. If you can't curb those, then you don't curb the expenditure cascade. So even though most people can deduct their savings now, at least in retirement accounts, the real gain from slowing the expenditure cascade wouldn't come until we made those accounts completely unrestricted. You can save as much as you want and you don't get taxed on one nickel of it until you take the money out.
[00:32:01] Ramanan Raghavendran: As I suspected would happen, you have left me and I suspect our listeners, with our heads exploding with ideas that maybe we can do something about. So Bob, I just want to thank you for your time and an amazing conversation. I would urge everybody to run out and read Bob's book. He's written several books. The Winner-Take-All Society may be a place to start, because if anything, those issues have gotten bigger in modern times with technology. But Under the Influence, I think is a direction that much good can come of if it unfolded in the right way. So thank you, Bob.
[00:32:43] Robert Frank: Thank you for the chance to talk to your community, I appreciate it very much.