From my forthcoming book on Behavioral Economics:
You may not realize it, but you are irrational.
At least, that is what researchers in a growing new science are saying. That science is Behavioral Economics, and it is changing the way we see human thought and action.
For example, researchers have shown that people will pay more for a bottle of wine sitting next to an exorbitantly priced bottle than one sitting next to a cheaply priced bottle. The completely irrelevant price of the neighboring bottle affects how much we value the bottle we want. This tendency, no matter how common it might seem, is irrational according to behavioral economists; it shows that we’re not thinking, that we don’t reason when making decisions.
Likewise, researchers have shown that people go out of their way and spend more money to obtain a free drink or T-shirt, even if it’s something that they don’t want or need. Irrational, say behavioral economists. We fear plane crashes more than car crashes even though plane crashes are much less common and are much less deadly than car crashes. Again, irrational! The vast majority of us think that we’re above average when it comes to just about anything—driving, attractiveness, intelligence, and so on. Whenever 80 or 90% of a population thinks they are above average at anything, the answer must be that they are not seeing things clearly, that they’re irrational.
Now, you may feel rational, you may even think you make some good choices here and there, but, the science is hard to refute. In the last few decades, a number of separate disciplines have converged at the spot where Behavioral Economics now stands. Cognitive Science, Neurobiology, Psychology, Sociology, and traditional Economics have all made significant advances in the latter half of the 20th century and beginning of the 21st, giving us a comprehensive view of how the brain works and how we make decisions as a result.
What they’ve found counters everything we know about human thought and decision-making. To begin, we don’t make decisions based on intentional deliberation. Studies have found that almost all of what we think and do is based on brain processes that occur below the level of consciousness, in the subconscious or unconscious mind, as it is known. One study estimates that sense organs take in more than 11 million pieces of information every second, and that only about 50 of those pieces can be processed consciously . Think about that—11 megabytes of information every second—that’s War and Peace three and a half times in a split second. And only about 50 of those bytes—a single mention of Pyotr Kirillovich—can be focused on and made sense of.
Information transmission rates of the senses
sensory system bits per second
So what happens to the rest of those 11 million pieces of information? That is where the subconscious comes in. With its immense, modular processing capacity, the subconscious brain is where pretty much all of our thinking, and thus imagining, decision-making, and goal seeking takes place. How we walk, talk, and drive automobiles, to begin with, but also how we select groceries, identify good leaders, and choose career paths—all of these have been shown to be heavily influenced, if not completely dictated, by automatic subconscious systems, and not conscious thought as was formerly believed.
The implications are patently Freudian: Most of what we feel and experience is made up of unthinking processes. The substance that makes us who we are is almost wholly made up of the unintentional and instinctive activities of our brains.
As researchers have shown, this unconscious thought often results in harmful and self-defeating actions. Over the course of forty years, researchers have conducted scores of experiments that show how people reliably make choices that are based on random influences and which go directly against their own intentions.
Different studies focus on different aspects of behavior. The result is a list of some one hundred ‘cognitive errors’ that span the gamut. The more familiar errors include the ‘anchoring effect’, where people base decisions on information ‘anchors’ even if those anchors are irrelevant to the decision; ‘loss aversion’, where people fail to make economically sound decisions that require the loss of assets simply to avert the loss; and the ‘halo effect’, a part-to-whole fallacy where people tend to judge someone’s entire person based on a single, specific attribute.
According to behavioral researchers, everyone is subject to these errors at all times, even when intentionally trying to avoid them or aware of viable alternatives. This is how we end up paying more for wine that we want, going out of our way for a free item that we don’t want, and viewing ourselves as above average at just about everything when we’re really not. Whether considering day-to-day household activities, consumer preferences, career choices, executive decisions, or political elections, all of the science leads to the a single, provocative conclusion that human beings are irrational and cannot be trusted to make the right decisions.
Practically all of the Behavioral Economics literature out these days comes to the conclusion that philosopher David Hume came to nearly 300 years ago: “Reason is, and ought only to be the slave of the passions, and can never pretend to any other office than to serve and obey them.” When virtually all of one’s mental processes take place without awareness, and when one reliably shows contradictory preferences and actions, the inference becomes awfully compelling—we are unthinking beasts in a jungle of possibilities.
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The consequences of these findings are vast, and have only been slightly touched on in the popular literature. One thing is clear: If humans are irrational, then we’re in a lot of trouble. So much of our society hinges on the premise that we are reasonable and on our ability to make the right choices throughout the day—at the grocery store, on the daily commute, in the media, at the office, at the voting booth, and so on. Really, the entire free market, democratic system is based on the notion that human beings are rational.
And this is why the recent Behavioral Economics findings are so important. If they are correct, it means that our entire system is built on an illusion and is thus at risk of falling apart as a result.
Not surprisingly, then, as a result of the findings, arguments have been made to curtail the various choices that people have and to direct them toward more consistent and rewarding decisions. The notion is, since we are irrational, we need to be taken care of; since we can’t make the right decisions when it counts, someone else must make them for us. A variety of solutions have come forth in the popular texts, though all center on this fundamental argument.
In his book Predictably Irrational, behavioral economist Dan Ariely suggests that humans consistently make poor decisions to the extent that this conduct is expected or ‘predictable’. He goes so far as to refute the notion of supply and demand altogether, saying, “If you accept the premise that market forces and free markets will not always regulate the market for the best, then you may find yourself among those who believe that the government must play a larger role in regulating some market activities, even if this limits free enterprise.” In turn, he encourages regulations and safeguards on all kinds of social organizations—between doctors and pharmaceutical companies, in sex education, and in the insurance business. When people aren’t rational, government must step in and take over.
In their book, Nudge, behavioral economist Richard Thaler and jurist Cass Sunstein promote the use of ‘choice architecture’ to direct or ‘nudge’ people toward making good choices. Their work has garnered praise from all corners of the political spectrum for introducing creative ways to encourage sound decision-making. One such prized nudge is Save More Tomorrow, a personal finance mechanism that charges people a fee to withhold some of their income in the interest of growing their savings. Other nudges cover issues from organ donation to saving the planet. Simply, people are not capable of consistently making the right decisions, so, with the help of businesses and governments, they must trick themselves into doing good.
In another arena, journalist John Cassidy examines the rise of what he calls ‘Utopian Economics’ with his book How Markets Fail. The idea is that the modern economy has been built on what he considers a utopian ideal that all people are rational agents working in their best interests. Since of course all utopias are nonexistent, the system must be built on shaky ground and will occasionally go through periods of decline and financial distress as a result. Cassidy shows how the recent real estate bubble and subsequent financial crisis were the inevitable outcomes of such reveries. The only way to fix it, Cassidy argues, is to instate a grounded ‘Reality-Based Economics’, which entails large doses of government regulation and safeguards from human folly. The rational actor is a fiction, and so government must step in and make sure people don’t do stupid things and harm themselves.
And this is not limited to a few obscure theorists—Behavioral Economics is becoming a mainstay in American discourse. Thanks to these and a flurry of other fascinating bestsellers on the subject, Behavioral Economics jargon has rapidly infiltrated the lexicon. An attentive bystander cannot go far in business or politics without hearing terms such as ‘loss aversion’, ‘overconfidence bias’, or ‘planning fallacy’.
One of the early pioneers of Behavioral Economics, Daniel Kahneman, recently published his Thinking, Fast and Slow with the intent of providing standards for talking about the various intricacies of Behavioral Economics, the errors and biases, and their implications. Thanks to Kahneman’s book, the reader now knows how to identify ‘availability biases’, how to assess one’s ‘risk aversion’, and what to make of that pesky ‘regression to the mean’.
As a result, one can hear the terms in daily conversation at home, at school, and at the office. At least one health insurance provider has recently touted its new plan, which was designed with attention to “Behavioral Economics throughout”. And the trend has swept all the way to the top: In recognition of his work on Nudge, co-author Cass Sunstein was recently crowned ‘Regulation Czar’ for the Obama administration, a title that has been affectionately dubbed ‘Nudge Czar’.
The upshot has been a steady swelling of new programs and policies based largely on the science. Thanks to the sensation Behavioral Economics has caused, it might not be a stretch to consider the last ten years as the irrational decade. New York Times columnist David Brooks summarized the success of Behavioral Economics in praise of the revolutionary work of Daniel Kahneman and his late collaborator Amos Tversky, saying their research “will be remembered hundreds of years from now, and how their work helped instigate a cultural shift that is already producing astounding results.”
And, one must admit, the appeal of Behavioral Economics thinking is rather irresistible. The surge in its success is due largely to the fact that it has been developed by a group of brilliant minds, in which Kahneman and Tversky are standouts. These researchers and others have provided some of the most fascinating discoveries in science in recent times. And the future promises more of the same.
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But the objective spectator will not be so easily convinced by the conclusions reached by behavioral economists or the measures taken to institute them. After all, rationality is a dear possession for most of us, and, whether we have it or not, will never be tossed aside nonchalantly, even by ardent believers of modern behavioral research.
And so, before Behavioral Economics is enshrined as the definitive truth of human thought and action, a thorough appraisal is called for. Are the foundations of the science sturdy? Are its methods sound? Are its conclusions viable? Or is the fervor for the science exaggerated in any way or otherwise misleading?
The skeptic begins his scrutiny with the very premise behind the science. The discipline has always been about human beings’ blatant irrationality, and yet those involved in the discipline are scientists, conducting scientific research, and proposing scientific inferences, all of which requires human rationality. Thus, the irony of Behavioral Economics is that it has tried to disprove rationality by means of rationality; it disowns reason by using reason.
This paradox is displayed wonderfully in Malcolm Gladwell’s bestseller Blink, in which the author promotes the concept of ‘thin slicing’, or what he describes as “thinking without thinking”. The premise is that thinking the old-fashioned way—deliberate reasoning and scientific study—leads to abstractions and ultimately misguided decisions. But in order to prove this theme, Gladwell presents a number of very well thought out experiments that break down exactly how people think and make decisions. Ironically, he uses well-reasoned arguments and thorough analysis all in effort to show why people shouldn’t use reason and analysis.
The average reader ends up scratching his head. If reasoning is so precarious, and thinking so unreliable, then doesn’t that make this well-reasoned, scientific argument precarious and unreliable as well? Gladwell uses abstract experiments to show why abstract experiments cannot be trusted. Doesn’t that mean his argument cannot be trusted and that reasoning might be okay after all? Of course, that would make his argument more credible, which would mean science is incredible . . . and so on. The intellectual loops one could go in are alone exasperating to think about.
The reason for this frenzy, of course, is that in all of the Behavioral Economics texts no one ever thinks to define ‘rationality’ or how it comes about, and so claims on human irrationality are hardly ever well founded. Rationality is a familiar concept, so most authors take its meaning for granted. But, since the definition is not clearly laid out, writers are free to add to and subtract from it at leisure, whenever it suits their argument. At one point it is rational to do one thing, and later it is irrational. The result is a flimsy sketch of reason that more often than not wavers and even contradicts itself.
In the 2009 How We Decide, author Jonah Lehrer investigates the rationality of teenagers with respect to staying in school. His argument is that teens’ brains are not fully developed and so cannot make rational decisions when it comes to long-term goals like education and career. According to Lehrer, “Teens make bad decisions because they are literally less rational.”
He then goes on to explain how state governments have made moves to counter this irrationality to get kids to stay in school longer. Lehrer explains how the state of West Virginia instituted a program that actually got teens to stay in school by threatening to take away their driver’s licenses. They don’t care about grades and career, but they do care about cars and freedom. So, the state instated a law that stripped dropouts of their licenses. Evidently the program worked, and West Virginia’s retention rate has risen since the law was enacted.
Now, to Lehrer, this was a way of getting around teenage irrationality, but, the discerning observer will realize that the teens are making decisions that are just as rational as any other decision—they are just based on different incentives. Teens will not stay in school to get a degree or to listen to teachers, but they will stay in school in order to keep their driving privileges. And who is to say that this is any less rational? Perhaps a degree holds no apparent value; perhaps the teachers are really bad. A brief visit to West Virginia public schools might show just how reasonable it is to drop out.
Behavioral economists make these kinds of leaps in logic as a matter of course. What is most interesting about these intellectual hijinks is their inherent contradiction. The authors want to make a point, naturally, but all points must be backed by a reasonable argument to be at all interesting. In order to prove that people pay more for a bottle of wine, they have to explain why they do it; in order to show that people fear plane crashes more than automobile accidents, they have to show the rationale behind it. In general, in order for behavioral economists to prove that people are irrational, they are forced to explain that irrationality. It just so happens that, once an explanation is given for an action, that action is given a reason. And, when there is a reason for an action, it must be reasonable at least in some way. As such, the notion that we are irrational comes immediately into question.
In the West Virginia example, it was assumed that teens drop out of school because they aren’t thinking. But in order to prove that they aren’t thinking, Lehrer delves into their thought process and reveals that indeed they are thinking. They aren’t thinking about grades or college, they’re thinking about cars and freedom, but they have reasons for their actions, and so it must be seen as reasonable to some extent.
Nearly all references to rationality in the Behavioral Economics texts are liable to the same incongruity. In Predictably Irrational Dan Ariely chronicles a number of supposedly irrational things that people do, and then goes on to explain exactly why people do them, giving very logical reasons for the behavior. Take, for instance, Ariely’s survey of the supposed irrational desire for free goods. He describes a number of experiments in which people chose free goods over much more valuable goods that came with a price tag. “Why do we have an irrational urge to jump for a free item even when it’s not what we really want?” he asks rhetorically. And then, he promptly answers, “Most transactions have an upside and a downside, and, when something is free, we forget the downside.” In other words, there is no downside to the decision maker, and so it seems as though he really wants the free good more than the pricier option. By explaining his argument, Ariely gives good reason for the behavior of his subjects—people want the free good because there is no risk, which is perhaps the most rational decision there is.
If scholars give good reasons for human irrationality, then the fundamental premise that humans are irrational is wrong. Everything we do, even if it seems irrational, is based in some sort of reason. Paying more for free goods, fearing plane crashes more than car crashes, and thinking we’re above average at everything, all have very reasonable origins (we’ll take a closer look in later chapters), and so must be considered reasonable, themselves.
The fact is that people do things for reasons; they might not be admirable reasons, and they might not be the reasons that researchers are looking for, but they are reasons. And this makes the actions rational. Ultimately, the very premise of Behavioral Economics is contradictory and must be taken with a healthy dose of skepticism.
But what about all the experiments? Don’t they all prove that we do things against our intentions and best interests? Here again the skeptic has valid concern. That is because most Behavioral Economics studies are based in thought experiments, psychological tests, and surveys. While this does not mean that the conclusions are automatically false, it does mean that findings are limited—a fact that researchers and writers are seldom able to guard against.
The problem lies in the nature of scientific studies in general. Studies such as those examined in the Behavioral Economics texts necessarily abstract from reality, and so the results can only be applied to real life with caution. For example, an experiment that asks the participants to choose between two or more gambles necessarily strips away all irrelevant factors such as the subject’s real world status and financial standing. It cannot therefore determine how the participant would behave when status and financial standing are taken into account.
This is not a fault in the studies, themselves—the experiment must do this to remain consistent and objective across the spectrum of test-takers. But by doing this, the experiment becomes unrealistic. While it might tell researchers something about the way we answer questions in test-taking situation, it cannot reveal what we would do in real life situations when ulterior factors such as status and financial standing play significant roles.
Of course, all science is subject to the same difficulties—experiments are imperfect replications of real life and so cannot be used as perfect predictors. This does not mean that the science is unable to provide insight; just that any insight must be accompanied by caveats. As it turns out, behavioral economists are quite good at neglecting these caveats.
As one can easily see, most of the studies in the Behavioral Economics literature are conducted by university professors on college campuses. This fact alone means that most of the experiments featured college students as their subjects, a sample that cannot possibly reflect the true make up of a population, especially in the realm of economics and decision-making. College students are notorious for their money problems, their willingness to try new things, and their libidinous inclinations. This alone means that the data are skewed in the direction of reckless behavior and poor decisions.
And yet researchers and writers fail to make note of this when arriving at their conclusions. After surveying a study conducted on the decision-making of students “in the heat of the moment”, for instance, Dan Ariely makes a conclusion about everybody in the world. “Our experiment at Berkley revealed not just the old story that we are all like Jekyll and Hyde, but also something new—that everyone of us, regardless of how good we are, underpredicts the effect of passion on our behavior.” In other words, because a number of traditionally irresponsible youths could not control themselves, everyone is incapable of doing so.
Throughout Daniel Kahneman’s Thinking, Fast and Slow, the author examines experiments, determining that a group of people acted a certain way under certain circumstances, and then claims that the findings apply to everyone in the universe, including the reader. An experiment described early in the book showed how a group of people were less helpful to others after being ‘primed’ by the concept of money. The conclusion was that the thought of money makes people less helpful to others.
Kahneman then says “You have no choice but to accept that the major conclusions of these studies are true. More important, you must accept that they are true about you. If you had been exposed to a screen saver of floating dollar bills, you too would likely have picked up fewer pencils to help a clumsy stranger.” Since some people were less helpful on average, then everyone must be, and to the same degree. Kahneman is not clear as to how exactly this translates. How is the reader supposed to react in the test? Will he pick up the same number of pencils that the average person picked up? The mean? The median? Why not the top or the bottom extremes? Why is it not possible for the reader to provide an exception to the rule?
What we have here is a simple whole-to-part fallacy. Kahneman argues that because people in a group were influenced by a certain prime that all people would be influenced by that same prime. The jump in logic cannot be defended. It is true that studies like this could indicate propensities of people within a similar group under similar circumstances, but there are variations within his sample and exceptions for the rule, and so absolute claims cannot be made with any kind of scientific authority.
Fallacies such as these can be found throughout the Behavioral Economics texts. For the most part, the experiments are fascinating and certainly provide insights into human thought processes—indeed, they show that people do some really bizarre and mysterious things. But thanks to ambiguity and loose adherence to scientific principles, the findings often become exaggerated and awfully illogical themselves. Most arrive at the conclusion that all human beings are irrational, and this simply goes too far.
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In response, a rigorous examination is called for. We need to really understand what it is that these experiments say about the human brain and the mind housed by it; we need to examine the inner workings of that brain and find out what the latest research tells us; and, foremost, we need to get to the bottom of the concept of rationality to make sure we are clear about exactly what people have the capacity for. This book is intended to be just such an examination.
What we find is that Behavioral Economics is really just a good representation of science in general and the course it has taken over the last fifty or so years. As a people, we love science. We can’t get enough of it—in school, at work, at home, on television, at stores, on the Internet, and in politics. We love abstract ideas and analysis; we love to find patterns and make sense of them; we love to find correlations and identify cause and effect. We praise our scientists and long for great scientific breakthroughs.
But this love affair with science has taken us to passionate extremes. We encourage it everywhere, even in places where it doesn’t belong, and we accept anything that slightly resembles science even if it defies the true Scientific Method on all counts. It has come to a point that we love science so much and believe anything it tells us, even if it ends up going against us, tells us that our thoughts are illusions, and that science itself is a pie in the sky. Behavioral Economics is a discipline in which practitioners consistently make these claims, and we just can’t seem to get enough of it. Seemingly, we love being told that we’re irrational and that we make idiotic choices because, of course, the data prove it!
This book is about the human mind, the science it creates, and what happens when that science turns back on its creator. Currently, the human mind and rationality in general are under attack. And the irony is that they are under attack by the institutions and constructs that they made possible. Science has gotten so powerful that it has been able to refute the intellect that brought it about. This book is an attempt to understand this uprising and counter it.
Behavioral Economics is perhaps the best example of this tragic drama, partly because it is so fresh in the collective consciousness, and partly because its contentions are so brazen. There is no more powerful antagonist to human rationality today than Behavioral Economics, and so there is no more relevant subject matter for a book about thought and action. Of course, the issue rests in science in general, and the big picture is the real focus.
This is the great paradox of modern science. In effort to better understand this paradox, let us examine the themes and methods of Behavioral Economics and the sciences in general, let us investigate the various experiments and mysteries of recent research to get to the bottom of it all. And in so doing let us employ the one mechanism that allows us freedom to think and imagine and create and innovate—human reason.