Why Capitalism is Bad at Giving Advice

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I have a story up today on the website of our sister publication Fortune.com. It is part of Fortune’s excellent redesign issue. The story is focused on a study by Sendhil Mullainathan of Harvard that finds a disturbing truth about financial planners:

Experts have long counseled against using financial planners who charge commissions, given their incentive to simply sell products that pad their paychecks.

Now a new working paper concludes there is another risk — one that afflicts advisers of all stripes. The problem: Financial planners are yes-men and -women, asserts a report co-authored by Sendhil Mullainathan, a Harvard professor and top behavioral economist.

Most planners, his report finds, reinforce our bad investment behaviors instead of fixing them. And the problem, he says, may be harder to solve than the fee issue.

The story and the study are focused on financial planners, but I think it reveals a larger truth about capitalism and our system’s ability to create reliable advisers, financial or otherwise. I wonder if we need a new model for paying advisers. Here’s why:

So the problem that the study points out is that when individuals hire people to give them advice, the advisers they have a strong incentive to tell you what you want to hear. If they don’t do that, then you probably won’t hire them. No matter how impartial we think we are. We come to every topic with some inherent beliefs. If someone tells you something that doesn’t jive with those beliefs, you are likely to think they are either incompetent or just not smart.

That’s a problem for financial planners, as the study points out, but I would image it is a problem in other professions as well. Therapists I would image run into this problem all the time. Most probably don’t tell people on the first session that their mother is to blame, unless of course they think that is easier to hear than just to tell the patient the truth that the real problem is them.

It is also bad news for the economy in general. Consumers have to deal in markets all the time that are regularly prone to failures. Much of them happen because of a lack of information. So the thinking is that a well-incentivized intermediary could help consumers make better decisions and get better outcomes in markets that have had runaway costs like say health care or education. But if these advisers can’t be trusted because their incentive is to land your business and then keep you as a client, then they do nothing to halt you from going for that unnecessary MRI or putting all your money in technology stocks.

And I image this Yes-man problem had a role in the financial crisis. Bubbles form because of echo chambers. And Yes-men only make those echos louder. So I wonder if anyone has come up with another model for giving advice, where the advice seeker does not have as big a role in influencing the advice they end up getting. Anyone? And please don’t just tell me I’m right.

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