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What you have here

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is an electronic cigarette.

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It's something that, 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 UK,
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 and you stand up

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and hold a glass of red wine
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 of 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 is,

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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,
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 the pensioners believe

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they've chosen to be pensioners,

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whereas the young unemployed
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 re-branded 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 re-brand things --

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to understand that
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 of 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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You know, 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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(Laughter)

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Because they are actually the same thing.

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What you call them
actually affects how you react to them,

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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 we should spend far less time
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
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-Kahneman, 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

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to reduce the journey time
between Paris and London

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by about 40 minutes.

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For 0.01 percent of this money,
you could have put wi-fi 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 usefulness 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 Château Pétrus

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to all the passengers.

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(Laughter)

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You'd still have five million
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
to solve that problem psychologically?

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I think it's because there's an imbalance,

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an asymmetry 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 creative 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 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 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
in passenger satisfaction

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on the London Underground,

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per pound spent,

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came when they didn't add
any extra trains,

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nor change the frequency of the trains;

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they put dot matrix display boards
on the platforms --

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because the nature of a wait is not just
dependent on its numerical quality,

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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, going,

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

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Here's a beautiful example
of a psychological solution

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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?

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Because road rage, impatience and general
irritation are massively reduced

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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 same 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,

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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 successful businesses --

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Google is a 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,
but you also have weather,

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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,
from when you go in to buy a television,

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and in the shabbier end
of the row of flat-screen TVs,

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you can see, are these
rather despised things

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called "combined TV and DVD players."

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And we have no 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,

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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,

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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

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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;

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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 patently 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 --

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(Laughter)

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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 incompetence?"

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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 you get
goes not to the bridge company,

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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

00:12:37.182 --> 00:12:39.147
is they think that money is money.

00:12:40.275 --> 00:12:44.506
Actually, my pain experienced
in paying five pounds

00:12:44.530 --> 00:12:46.677
is not just proportionate to the amount,

00:12:46.701 --> 00:12:48.685
but where I think that money is going.

00:12:49.314 --> 00:12:52.310
And I think understanding that
could revolutionize tax policy.

00:12:52.334 --> 00:12:54.337
It could revolutionize
the public services.

00:12:54.361 --> 00:12:56.874
It could actually change things
quite significantly.

NOTE Paragraph

00:12:56.898 --> 00:12:58.360
[Ludwig Von Mises is my hero.]

NOTE Paragraph

00:12:58.384 --> 00:13:00.098
Here's a guy you all need to study.

00:13:00.122 --> 00:13:01.727
He's an Austrian School economist

00:13:01.751 --> 00:13:06.315
who was first active in the first half
of the 20th century in Vienna.

00:13:06.339 --> 00:13:08.531
What was interesting
about the Austrian School

00:13:08.555 --> 00:13:11.588
is they actually grew up alongside Freud.

00:13:11.612 --> 00:13:14.265
And so they're predominantly
interested in psychology.

00:13:14.289 --> 00:13:18.842
They believed that there was
a discipline called praxeology,

00:13:18.866 --> 00:13:21.462
which is a prior discipline
to the study of economics.

00:13:21.486 --> 00:13:25.934
Praxeology is the study of human choice,
action and decision-making.

00:13:26.660 --> 00:13:27.985
I think they're right.

00:13:28.009 --> 00:13:30.077
I think the danger
we have in today's world

00:13:30.101 --> 00:13:31.781
is we have the study of economics

00:13:31.805 --> 00:13:35.835
considers itself to be a prior discipline
to the study of human psychology.

00:13:35.859 --> 00:13:38.828
But as Charlie Munger says,
"If economics isn't behavioral,

00:13:38.852 --> 00:13:40.399
I don't know what the hell is."

NOTE Paragraph

00:13:41.804 --> 00:13:47.605
Von Mises, interestingly, believes
economics is just a subset of psychology.

00:13:47.629 --> 00:13:49.534
I think he just refers to economics

00:13:49.558 --> 00:13:52.838
as "the study of human praxeology
under conditions of scarcity."

00:13:53.742 --> 00:13:56.838
But Von Mises, among many other things,

00:13:56.862 --> 00:14:01.512
I think uses an analogy which is probably
the best justification and explanation

00:14:01.536 --> 00:14:05.743
for the value of marketing,
the value of perceived value

00:14:05.767 --> 00:14:09.044
and the fact that we should treat it
as being absolutely equivalent

00:14:09.068 --> 00:14:10.551
to any other kind of value.

NOTE Paragraph

00:14:11.054 --> 00:14:14.006
We tend to, all of us, even those of us
who work in marketing,

00:14:14.030 --> 00:14:15.328
think of value in two ways:

00:14:15.352 --> 00:14:18.249
the real value, which is when
you make something in a factory

00:14:18.273 --> 00:14:19.427
or provide a service,

00:14:19.451 --> 00:14:21.069
and then there's a dubious value,

00:14:21.093 --> 00:14:23.904
which you create by changing
the way people look at things.

00:14:23.928 --> 00:14:26.222
Von Mises completely rejected
this distinction.

00:14:26.246 --> 00:14:28.137
And he used this following analogy:

00:14:28.161 --> 00:14:33.494
he referred to strange economists
called the French physiocrats,

00:14:33.518 --> 00:14:37.148
who believed that the only true value
was what you extracted from the land.

00:14:37.172 --> 00:14:39.657
So if you're a shepherd
or a quarryman or a farmer,

00:14:39.681 --> 00:14:41.102
you created true value.

00:14:41.126 --> 00:14:43.985
If however, you bought
some wool from the shepherd

00:14:44.009 --> 00:14:46.990
and charged a premium
for converting it into a hat,

00:14:47.014 --> 00:14:48.796
you weren't actually creating value,

00:14:48.820 --> 00:14:50.580
you were exploiting the shepherd.

NOTE Paragraph

00:14:51.439 --> 00:14:55.162
Now, Von Mises said that modern
economists make exactly the same mistake

00:14:55.186 --> 00:14:57.243
with regard to advertising and marketing.

00:14:57.577 --> 00:14:59.459
He says if you run a restaurant,

00:14:59.483 --> 00:15:01.722
there is no healthy distinction to be made

00:15:01.746 --> 00:15:04.299
between the value you create
by cooking the food

00:15:04.323 --> 00:15:06.626
and the value you create
by sweeping the floor.

00:15:07.203 --> 00:15:09.693
One of them creates, perhaps,
the primary product --

00:15:09.717 --> 00:15:11.582
the thing we think we're paying for --

00:15:11.606 --> 00:15:14.447
the other one creates a context
within which we can enjoy

00:15:14.471 --> 00:15:15.995
and appreciate that product.

00:15:16.019 --> 00:15:19.191
And the idea that one of them
should have priority over the other

00:15:19.215 --> 00:15:20.365
is fundamentally wrong.

NOTE Paragraph

00:15:20.944 --> 00:15:22.611
Try this quick thought experiment:

00:15:22.635 --> 00:15:25.286
imagine a restaurant
that serves Michelin-starred food,

00:15:25.310 --> 00:15:27.957
but where the restaurant smells of sewage

00:15:27.981 --> 00:15:30.119
and there's human feces on the floor.

NOTE Paragraph

00:15:30.143 --> 00:15:31.552
(Laughter)

NOTE Paragraph

00:15:31.576 --> 00:15:34.069
The best thing you can do there
to create value

00:15:34.093 --> 00:15:37.109
is not actually to improve
the food still further,

00:15:37.133 --> 00:15:39.932
it's to get rid of the smell
and clean up the floor.

00:15:42.259 --> 00:15:44.812
And it's vital we understand this.

NOTE Paragraph

00:15:44.836 --> 00:15:47.483
If that seems like a sort
of strange, abstruse thing --

00:15:47.507 --> 00:15:51.405
in the UK, the post office
had a 98 percent success rate

00:15:51.429 --> 00:15:53.613
at delivering first-class
mail the next day.

00:15:54.192 --> 00:15:56.077
They decided this wasn't good enough,

00:15:56.101 --> 00:15:57.893
and they wanted to get it up to 99.

00:15:59.234 --> 00:16:02.607
The effort to do that
almost broke the organization.

00:16:03.520 --> 00:16:05.910
If, at the same time,
you'd gone and asked people,

00:16:05.934 --> 00:16:08.753
"What percentage of first-class mail
arrives the next day?"

00:16:08.777 --> 00:16:12.683
the average answer, or the modal answer,
would have been "50 to 60 percent."

00:16:13.381 --> 00:16:16.095
Now, if your perception
is much worse than your reality,

00:16:16.119 --> 00:16:19.143
what on earth are you doing
trying to change the reality?

00:16:19.167 --> 00:16:22.782
That's like trying to improve the food
in a restaurant that stinks.

00:16:24.362 --> 00:16:27.080
What you need to do is,
first of all, tell people

00:16:27.104 --> 00:16:31.611
that 98 percent of first-class mail
gets there the next day.

00:16:31.635 --> 00:16:33.156
That's pretty good.

00:16:33.180 --> 00:16:36.388
I would argue, in Britain,
there's a much better frame of reference,

00:16:36.412 --> 00:16:39.779
which is to tell people that more
first-class mail arrives the next day

00:16:39.803 --> 00:16:42.518
in the UK than in Germany,
because generally, in Britain,

00:16:42.542 --> 00:16:44.826
if you want to make us happy
about something,

00:16:44.850 --> 00:16:47.042
just tell us we do it
better than the Germans.

NOTE Paragraph

00:16:47.066 --> 00:16:48.796
(Laughter)

NOTE Paragraph

00:16:48.820 --> 00:16:51.072
(Applause)

NOTE Paragraph

00:16:51.096 --> 00:16:54.317
Choose your frame of reference
and the perceived value,

00:16:54.341 --> 00:16:57.747
and therefore, the actual value
is completely transformed.

00:16:57.771 --> 00:16:59.416
It has to be said of the Germans

00:16:59.440 --> 00:17:02.142
that the Germans and the French
are doing a brilliant job

00:17:02.166 --> 00:17:03.620
of creating a united Europe.

00:17:03.644 --> 00:17:06.514
The only thing they didn't expect
is they're uniting Europe

00:17:06.538 --> 00:17:09.536
through a shared mild hatred
of the French and Germans.

00:17:09.560 --> 00:17:11.610
But I'm British;
that's the way we like it.

NOTE Paragraph

00:17:11.634 --> 00:17:13.759
(Laughter)

NOTE Paragraph

00:17:14.099 --> 00:17:16.220
What you'll also notice
is that, in any case,

00:17:16.244 --> 00:17:17.434
our perception is leaky.

00:17:17.458 --> 00:17:20.336
We can't tell the difference
between the quality of the food

00:17:20.360 --> 00:17:22.373
and the environment
in which we consume it.

00:17:22.397 --> 00:17:24.435
All of you will have seen this phenomenon

00:17:24.459 --> 00:17:26.441
if you have your car washed or valeted.

00:17:26.465 --> 00:17:29.586
When you drive away,
your car feels as if it drives better.

NOTE Paragraph

00:17:29.610 --> 00:17:30.951
(Laughter)

NOTE Paragraph

00:17:30.975 --> 00:17:32.231
And the reason for this --

00:17:32.255 --> 00:17:34.903
unless my car valet
mysteriously is changing the oil

00:17:34.927 --> 00:17:38.270
and performing work which I'm not paying
him for and I'm unaware of --

00:17:38.294 --> 00:17:40.601
is because perception
is, in any case, leaky.

NOTE Paragraph

00:17:40.625 --> 00:17:44.542
Analgesics that are branded
are more effective at reducing pain

00:17:44.566 --> 00:17:46.377
than analgesics that are not branded.

00:17:46.401 --> 00:17:49.019
I don't just mean through reported
pain reduction --

00:17:49.043 --> 00:17:50.714
actual measured pain reduction.

00:17:50.738 --> 00:17:55.362
And so perception
actually is leaky in any case.

00:17:56.021 --> 00:17:59.039
So if you do something
that's perceptually bad in one respect,

00:17:59.063 --> 00:18:00.286
you can damage the other.

NOTE Paragraph

00:18:00.310 --> 00:18:01.461
Thank you very much.

NOTE Paragraph

00:18:01.485 --> 00:18:03.873
(Applause)