Or, why the Army gets away with low salaries.
If you’ve read this blog at all since its inception, you’ve probably detected that I’m on a little behavioral finance tear. It’s definitely a subject that fascinates me. One problem in behavioral finance is that it deals a lot with the “average human”. You hear things like “Humans suffer from loss aversion. Most wouldn’t take a 50-50 bet where winning would mean making $100 and losing would mean giving up $10.” But of course, there’s that 49% (or whatever) of people who would take the bet. What makes them so unique?
Economists George Akerlof and Rachel Kranton might have part of the answer. For about a decade now, they’ve pushed a new subdivision of behavioral finance dubbed “identity economics.” The argument? That our “sense of self” might be the singlemost important factor in the economic decisions we make.
That probably sounds abstract, but let’s bring it home with a real-life example. The Army has smart people working for it. They have engineers who design helicopters. They have Ivy League graduates. Many of them risk their lives daily. Yet the Army pays their employees a fraction of what soldiers would earn in the private sector. And yet, people spend their entire careers working in the Army.
Why? Well, if you talk to someone who works in the military, and I have a couple relatives who do, they’ll tell you about a sense of service and respect that comes with serving. In other words, their “payment” comes not just in the form of money, but in the form of honor.
There’s no doubt that guys or gals who choose to join the military are predisposed to that kind of payment even before they enlist. But the Army promotes that way of thinking as soon as you join. You shave your head, wear a uniform, and partake in drills that quickly replace whatever sense of identity you had before the service with a new, Army-style one. And voila, the Army doesn’t have to pay its soldiers with cash. It pays them with respect. (Which is much cheaper, by the way.)
Gender influences your economic decisions, too. And no, I don’t just mean via straight-up discrimination. Akerlof and Cranton cite a study on women working as trial lawyers—a traditionally male-dominated profession where lawyers are told to “act like Rambo” and “take no prisoners”. In an interview, one female trial lawyer said, “To be a lawyer, somewhere along the way, I made a decision that it meant acting like a man. To do that I squeezed the female part of me into a box, put on the lid, and tucked it away.” As a result, the female lawyers in the study always felt a bit at odds with their role and behavior in their professions. One would think that could result in worse performance and lower pay.
How does who you are affect what you make?
So what are you supposed to take away from the whole exercise? For me, it was the first step toward understanding that just because the “average man” might make certain decisions based on his emotional make-up, that doesn’t necessarily mean I or you will.
I grew up in a family that was more apt to reward good grades with praise than with money, games, or other tangible rewards. And you know what? I bet that at review time, my boss has gotten away with telling me what a good job I’m doing (but not given me a big raise) a few times as a result of that.
I work among a very financially savvy group of people. And you know what? I save a ton, have an emergency fund, and generally keep my financial house in order. That can’t have to do with how I’m perceived by my peer group (they don’t know my finances), but I can see myself subconsciously thinking that those kinds of moves make me part of the team.
Of course, the most powerful effects of my identity on my finances are probably ones I’ll never recognize.
The bottom line is that our social make-up is a major influence on our economic decisions, whether it be in investing, our careers, or spending. I’ve done a mediocre job at describing the theme, but take a look at Akerlof and Kranton’s paper or check out their new book, Identity Economics. May your sense of self bring you profit.
Full disclosure: I get commission from Amazon if you buy the book through that link, though that’s not why I wrote about the theme at all. The free paper will actually give you a pretty good handle on what’s in the book. Also, I need lessons in salesmanship.