Speech at Harvard Law School (1995)
Transcription, comments [in brackets] by Whitney Tilson (feedback@Tilsonfunds.com)
Moderator: ...and they discovered extreme, obvious irrationality in many areas of the economy that they looked at. And they were a little bit troubled because nothing that they had learned in graduate school explained these patterns. Now I would hope that Mr. Munger spends a little bit more time around graduate schools today, because we've gotten now where he was 30 years ago, and we are trying to explain thoseHT: Alea
patterns, and some of the people who are doing that will be speaking with you today.
So I think he thinks of his specialty as the Psychology of Human Misjudgment, and part of this human misjudgment, of course, comes from worrying about the types of fads and social pressures that Henry Kaufman talked to us about. I think it's significant that Berkshire Hathaway is not headquartered in New York, or even in Los Angeles or San Francisco, but rather in the heart of the country in Nebraska....
24 Standard Causes of Human Misjudgment
1. Under-recognition of the power of what psychologists call 'reinforcement' and economists call 'incentives.'
Well you can say, "Everybody knows that." Well I think I've been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I've underestimated it. And never a year passes but I get some surprise that pushes my limit a little farther.
One of my favorite cases about the power of incentives is the Federal Express case. The heart and soul of the integrity of the system is that all the packages have to be shifted rapidly in one central location each night. And the system has no integrity if the whole shift can't be done fast. And Federal Express had one hell of a time getting the thing to work. And they tried moral suasion, they tried everything in the world,
and finally somebody got the happy thought that they were paying the night shift by the hour, and that maybe if they paid them by the shift, the system would work better. And lo and behold, that solution worked .
Early in the history of Xerox, Joe Wilson, who was then in the government, had to go back to Xerox because he couldn't understand how their better, new machine was selling so poorly in relation to their older and inferior machine. Of course when he got there he found out that the commission arrangement with the salesmen gave a tremendous incentive to the inferior machine.
And here at Harvard, in the shadow of B.F. Skinner -- there was a man who really was into reinforcement as a powerful thought, and, you know, Skinner's lost his reputation in a lot of places, but if you were to analyze the entire history of experimental science at Harvard, he'd be in the top handful. His experiments were very ingenious, the results were counter-intuitive, and they were important....MUCH MORE