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What you have here

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is an electronic cigarette.

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It's something that's, since it was invented a year or two ago,

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has given me untold happiness.

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(Laughter)

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A little bit of it, I think, is the nicotine,

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but there's something much bigger than that.

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Which is ever since, in the U.K., they banned smoking in public places,

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I've never enjoyed a drinks party ever again.

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(Laughter)

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And the reason, I only worked out just the other day,

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which is when you go to a drinks party

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and you stand up and you hold a glass of red wine

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and you talk endlessly to people,

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you don't actually want to spend all the time talking.

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It's really, really tiring.

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Sometimes you just want to stand there silently, alone with your thoughts.

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sometimes you just want to stand in the corner and stare out of the window.

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Now the problem is, when you can't smoke,

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if you stand and stare out the window on your own,

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you're an antisocial, friendless idiot.

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(Laughter)

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If you stand and stare out of the window on your own with a cigarette,

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you're a fucking philosopher.

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(Laughter)

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(Applause)

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So the power of reframing things

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cannot be overstated.

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What we have is exactly the same thing, the same activity,

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but one of them makes you feel great

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and the other one, with just a small change of posture,

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makes you feel terrible.

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And I think one of the problems with classical economics

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is it's absolutely preoccupied with reality.

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And reality isn't a particularly good guide to human happiness.

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Why, for example,

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are pensioners much happier

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than the young unemployed?

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Both of them, after all, are in exactly the same stage of life.

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You both have too much time on your hands and not much money.

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But pensioners are reportedly very, very happy,

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whereas the unemployed are extraordinarily unhappy and depressed.

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The reason, I think, is that pensioners believe they've chosen to be pensioners,

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whereas the young unemployed

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feel it's been thrust upon them.

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In England the upper-middle-classes have actually solved this problem perfectly,

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because they've rebranded unemployment.

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If you're an upper-middle-class English person,

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you call unemployment "a year off."

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(Laughter)

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And that's because having a son who's unemployed in Manchester

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is really quite embarrassing,

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but having a son who's unemployed in Thailand

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is really viewed as quite an accomplishment.

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(Laughter)

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But actually the power to rebrand things,

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to understand that actually our experiences, costs, things

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don't actually much depend on what they really are,

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but on how we view them,

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I genuinely think can't be overstated.

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There's an experiment I think Daniel Pink refers to

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where you put two dogs in a box

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and the box has an electric floor.

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Every now and then an electric shock is applied to the floor,

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which pains the dogs.

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The only difference is one of the dogs has a small button in its half of the box.

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And when it nuzzles the button, the electric shock stops.

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The other dog doesn't have the button.

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It's exposed to exactly the same level of pain as the dog in the first box,

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but it has no control over the circumstances.

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Generally the first dog can be relatively content.

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The second dog lapses into complete depression.

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The circumstances in our lives may actually matter less to our happiness.

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than the sense of control we feel over our lives.

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It's an interesting question.

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We ask the question -- the whole debate in the Western world

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is about the level of taxation.

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But I think there's another debate to be asked,

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which is the level of control we have over our tax money.

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That what costs us 10 pounds in one context can be a curse.

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What costs us 10 pounds in a different context we may actually welcome.

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And pay 20,000 pounds in tax toward health

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and you're merely feeling a mug.

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Pay 20,000 pounds to endow a hospital ward

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and you're called a philanthropist.

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I'm probably in the wrong country to talk about willingness to pay tax.

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(Laughter)

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So I'll give you one in return. How you frame things really matters.

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Do you call it the bailout of Greece

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or the bailout of a load of stupid banks which lent to Greece?

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Because they are actually the same thing.

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What you call them actually affects

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how you react to them, viscerally and morally.

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I think psychological value is great to be absolutely honest.

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One of my great friends, a professor called Nick Chater,

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who's the Professor of Decision Sciences in London,

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believes that we should spend far less time

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looking into humanity's hidden depths

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and spend much more time exploring the hidden shallows.

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I think that's true actually.

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I think impressions have an insane effect

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on what we think and what we do.

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But what we don't have is a really good model of human psychology.

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At least pre-[unclear] perhaps,

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we didn't have a really good model of human psychology

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to put alongside models of engineering, of neoclassical economics.

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So people who believed in psychological solutions didn't have a model.

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We didn't have a framework.

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This is what Warren Buffett's business partner Charlie Munger calls

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"A latticework on which to hang your ideas."

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Engineers, economists, classical economists

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all had a very, very robust existing latticework

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on which practically every idea could be hung.

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We merely have a collection of random individual insights

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without an overall model.

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And what that means is that in looking at solutions,

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we've probably given too much priority

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to what I call technical engineering solutions, Newtonian solutions,

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and not nearly enough to the psychological ones.

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You know my example of the Eurostar.

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Six million pounds spent to reduce the journey time

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between Paris and London by about 40 minutes.

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For 0.01 percent of this money you could have put WiFi on the trains,

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which wouldn't have reduced the duration of the journey,

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but would have improved its enjoyment and its usefullness far more.

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For maybe 10 percent of the money,

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you could have paid all of the world's top male and female supermodels

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to walk up and down the train handing out free Chateau Petrus to all the passengers.

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You'd still have five billion pounds in change,

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and people would ask for the trains to be slowed down.

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(Laughter)

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Why were we not given the chance

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to solve that problem psychologically?

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I think It's because there's an imbalance, an asymmetry,

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in the way we treat creative, emotionally-driven psychological ideas

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versus the way we treat rational numerical spreadsheet-driven ideas.

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If you're a crazy person, I think quite rightly,

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you have to share all your ideas for approval

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with people much more rational than you.

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You have to go in and you have to have a cost-benefit analysis,

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a feasibility study, an ROI study and so forth.

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And I think that's probably right.

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But this does not apply the other way around.

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People who have an existing framework,

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an economic framework, an engineering framework,

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feel that actually logic is its own answer.

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What they don't say is "Well the numbers all seem to add up,

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but before I present this idea, I'll go and show it to some really crazy people

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to see if they can come up with something better."

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And so we, artificially I think, prioritize

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what I'd call mechanistic ideas over psychological ideas.

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An example of a great psychological idea:

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The single best improvement on customer satisfaction on the London Underground per pounds spent

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came when they did add any extra trains nor change the frequency of the trains,

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they put dot matrix display board on the platforms.

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Because the nature of the wait

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is not just dependent on its numerical quality, its duration,

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but on the level of uncertainty you experience during that wait.

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Waiting seven minutes for a train with a countdown clock

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is less frustrating and irritating

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than waiting four minutes, knuckle-biting

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going, "When's this train going to damn well arrive?"

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Here's a beautiful example of a psychological solution deployed in Korea.

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Red traffic lights have a countdown delay.

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It's proven to reduce the accident rate in experiments.

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Why? Because road rage, impatience and general irritation

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are massively reduced when you can actually see the time you have to wait.

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In China, not really understanding the principle behind this,

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they applied the principle to green traffic lights.

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(Laughter)

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Which isn't a great idea.

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You're 200 yards away, you realize you've got five seconds to go, you floor it.

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(Laughter)

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The Koreans, very assiduously, did test both.

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The accident rate goes down when you apply this to red traffic lights;

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it goes up when you apply it to green traffic lights.

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This is all I'm asking for really in human decision making,

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is the consideration of these three things.

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I'm not asking for the complete primacy of one over the other.

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I'm merely saying that when you solve problems,

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you should look at all three of these equally

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and you should seek as far as possible

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to find solutions which sit in the sweet spot in the middle.

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If you actually look at a great business,

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you'll nearly always see all of these three things coming into play.

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Really, really successful businesses --

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Google is great, great technological success,

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but it's also based on a very good psychological insight:

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People believe something that only does one thing

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is better at that thing than something that does that thing and something else.

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It's an innate thing called goal dilution.

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Ayelet Fishbach has written a paper about this.

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Everybody else at the time of Google, more or less,

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was trying to be a portal.

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Yes, there's a search function,

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but you also have weather, sports scores, bits of news.

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Google understood that if you're just a search engine,

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people assume you're a very, very good search engine.

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All of you know this actually

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from when you go in to buy a television.

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And in the shabbier end of the row of flatscreen TV's

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you can see are these rather despised things called combined TV and DVD players.

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And we have know knowledge whatsoever of the quality of those things,

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but we look at a combined TV and DVD player and we go "Uck.

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It's probably a bit of a crap telly and a bit rubbish as a DVD player."

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So we walk out of the shops with one of each.

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Google is as much a psychological success as it is a technological one.

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I propose that we can use psychology to solve problems

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that we didn't even realize were problems at all.

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This is my suggestion for getting people to finish their course of antibiotics.

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Don't give them 24 white pills.

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Give them 18 white pills and six blue ones

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and tell them to take the white pills first and then take the blue ones.

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It's called chunking.

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The likelihood that people will get to the end is much greater

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when there is a milestone somewhere in the middle.

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One of the great mistakes, I think, of economics

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is it fails to understand that what something is,

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whether it's retirement, unemployment, cost,

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is a function, not only of its amount, but also its meaning.

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This is a toll crossing in Britain.

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Quite often queues happen at the tolls.

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Sometimes you get very, very severe queues.

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You could apply the same principle actually, if you like,

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to the security lanes in airports.

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What would happen if you could actually pay twice as much money to cross the bridge,

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but go through a lane that's an express lane?

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It's not an unreasonable thing to do. It's an economically efficient thing to do.

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Time means more to some people than others.

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If you're waiting trying to get to a job interview,

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you'd pay a couple of pounds more to go through the fast lane.

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If you're on the way to visit your mother in-law,

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you'd probably prefer to stay on the left.

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The only problem is if you introduce this economically efficient solution,

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people hate it.

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Because they think you're deliberately creating delays at the bridge

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in order to maximize your revenue,

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and "Why on earth should I pay to subsidize your imcompetence?"

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On the other hand, change the frame slightly

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and create charitable yield management,

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so the extra money give goes not to the bridge company, it goes to charity,

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and the mental willingness to pay completely changes.

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You have a relatively economically efficient solution,

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but one that actually meets with public approval

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and even a small degree of affection,

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rather than being seen as bastardy.

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So where economists make the fundamental mistake

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is they think that money is money.

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Actually my pain experienced in paying five pounds

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is not just proportionate to the amount,

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but where I think that money is going.

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And I think understanding that could revolutionize tax policy.

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It could revolutionize the public services.

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It could really change things quite significantly.

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Here's a guy you all need to study.

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He's an Austrian school economist

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who was first active in the first half of the 20th century in Vienna.

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What was interesting about the Austrian school

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is they actually grew up alongside Freud.

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And so they're predominantly interested in psychology.

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They believed that there was a discipline called praxeology,

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which is a prior discipline to the study of economics.

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Praxeology is the study of human choice, action and decision making.

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I think they're right.

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I think the danger we have in today's world

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is we have the study of economics

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considers itself to be a prior discipline to the study of human psychology.

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But as Charlie Munger says, "If economics isn't behavioral,

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I don't know what the hell is."

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Von Mises interestingly believes economics is just a subset of psychology.

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I think he just refers to economics as

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"The study of human praxeology under conditions of scarcity."

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But von Mises, among many other things,

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I think uses an analogy which is probably the best justification and explanation

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for the value of marketing, the value of perceived value

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and the fact that we should treat it as being absolutely equivalent

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to any other kind of value.

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We tend to, all of us -- even those of us who work in marketing --

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to think of value in two ways.

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There's the real value,

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which is when you make something in a factory and provide a service,

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and then there's a kind of dubious value,

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which you create by changing the way people look at things.

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Von Mises completely rejected this distinction.

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And he used this following analogy.

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He referred actually to strange economists called the French Physiocrats

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who believed that the only true value was what you extracted from the land.

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So if you're a shepherd or a quarryman or a farmer,

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you created true value.

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If however, you bought some wool from the shepherd

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and charged a premium for converting it into a hat,

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you weren't actually creating value,

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you were exploiting the shepherd.

294
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Now von Mises's said that modern economists make exactly the same mistake

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with regard to advertising and marketing.

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He says, "If you run a restaurant,

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there is no healthy distinction to be made

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between the value you create by cooking the food

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and the value you create by sweeping the floor."

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One of them creates, perhaps, the primary product --

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the thing we think we're paying for --

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the other one creates a context

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within which we can enjoy and appreciate that product.

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And the idea that one of them should actually have priority over the other

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is fundamentally wrong.

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Try this quick thought experiment.

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Imagine a restaurant that serves Michelin-starred food,

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but actually where the restaurant smells of sewage

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and there's human feces on the floor.

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The best thing you can do there to create value

311
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is not actually to improve the food still further,

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it's to get rid of the smell and clean up the floor.

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And it's vital we understand this.

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If that seems like some strange, abstruse thing,

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in the U.K., the post office had a 98 percent success rate

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at delivering first-class mail the next day.

317
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They decided this wasn't good enough

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and they wanted to get it up to 99.

319
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The effort to do that almost broke the organization.

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If at the same time you'd gone at asked people,

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"What percentage of first-class arrives the next day?"

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the average answer, or the modal answer would have been 50 to 60 percent.

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Now if your perception is much worse than your reality,

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what on earth are you doing trying to change the reality.

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That's like trying to improve the food in a restaurant that stinks.

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What you need to do

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is first of all tell people

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that 98 percent of mail gets there the next day, first-class mail.

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That's pretty good.

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I would argue, in Britain there's a much better frame of reference,

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which is to tell people

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that more first-class mail arrives the next day

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in the U.K. than in Germany.

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Because generally in Britain if you want to make us happy about something,

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just tell us we do it better than the Germans.

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(Laughter)

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(Applause)

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Choose your frame of reference and the perceived value

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and therefore the actual value is completely tranformed.

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It has to be said of the Germans

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that the Germans and the French are doing a brilliant job

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of creating a united Europe.

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The only thing they don't expect is their uniting Europe

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through a shared mild hatred of the French and Germans.

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But I'm British, that's the way we like it.

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What you also notice is in any case our perception is leaky.

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We can't tell the difference between the quality of the food

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and the environment in which we consume it.

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All of you will have seen this phenomenon

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if you have your car washed or valeted.

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When you drive away, your car feels as if it drives better.

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And the reason for this,

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unless my car valet mysteriously is changing the oil

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and performing work which I'm not paying him for and I'm unaware of,

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is because perception is in any case leaky.

356
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Analgesics that are branded are more effective at reducing pain

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than analgesics that are not branded.

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I don't just mean through reported pain reduction,

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actual measured pain reduction.

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And so perception actually is leaky in any case.

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So if you do something that's perceptually bad in one respect,

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you can damage the other.

363
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Thank you very much.

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(Applause)