By now, you may have figured out that my last few blogs were
inspired by the recent book Thinking,
Fast and Slow of Professor Daniel Kahneman, a trained psychologist and a
co-recipient of 2002 Nobel Prize in Economics.
The Prize citation recognized him "for having integrated
insights from psychological research into economic science, especially concerning
human judgment and decision-making under uncertainty."
Along with many researchers and thinkers, Kaheman has been
making significant contributions to the field of what is now known as Behavioral Economics that “study the effects of social, cognitive and
emotional factors on the economic decisions of individuals and institutions and
the consequences for market prices, returns and the resource allocation.”
You may wonder if main stream economists did not incorporate
the effects of social, cognitive and emotional factors, what was the economic
decision theory like and how good are they?
In his book, Professor Kahneman recalls how he got involved in the study
of decision making. It all started one
day in early 1970s when late Amos Tversky, Kahneman’s collaborator and close
friend, showed him an essay that started with the sentence “The agent of economic theory is rational,
selfish, and his tastes do not change.”
The statement is a concise summary of one key assumption of the dominant
neoclassical economics theory and rationality
in this context means “an individual acts as if balancing costs against
benefits to arrive at action that maximizes personal advantage.”
What is interesting is the ensuing “what?!” moment. As Kahneman recalls “To a psychologist, it is self-evident that people are neither fully
rational nor completely selfish, and that their tastes are anything but
stable. Our two disciplines seemed to be
studying different species....” A Nobel
prize-worthy work was then begun. Indeed
this story is a good illustration of why honest inter-disciplinary efforts can
be very productive that bring different perspectives and thus connect otherwise
isolated frames of mind.
In subsequent decades, Kahneman and other researchers have
brought further insights from psychology and injected more reality into economics
theory. Behavioral economics is now a significant scientific discipline
that offered more satisfactory explanations and predictions of human economic
behaviors.
One example Kahneman used in his book to illustrate the
inadequacy of classical models is fairly easy to follow. If utility
of wealth is indeed the deciding
factor as the classical theory postulated, then the following two games would produce
similar preferences. But intuitively,
you know it cannot possibly be the case.
1. In addition to whatever you own, you have
been given $1,000. You are now asked to
choose one of these options: 50% chance to win $1,000 OR get $500 for sure.
2. In addition to whatever you own, you have
been given $2,000. You are now asked to
choose one of these options: 50% chance to lose $1,000 OR lose $500 for sure.
With a 20/20 hindsight, you may wonder why did it take so
long for experts to amend flawed models and why so many experts were oblivious
to the obviously (to common men) erroneous implications when applying some
methods of classical decision theory to scenarios involving losses and risks.
Economics is certainly not the only field that suffers from the
ill effects of silo thinking. Researchers in all fields are often so absorbed
and entrenched in their research and are so comfortable with their training,
they accept the theory and rarely bother to revisit the critical
assumptions. Another distinct
possibility is that some theories were never really applied in practice nor produced
any serious consequences; thus there is no incentive to validate it. Worse yet, it is far easier to make incremental
enhancements to accepted theory than to establish something fundamentally
new.
In fact silo thinking is a systematic problem that does not
end at scientific explorations. It is prevalent in organization and business of
all kinds as well. A vast majority of us
devote most of our energy in digging inch by inch the very silo we live in that
provides us a comfortable “shelter”, the same reason why most researchers don’t
branch out from their familiar ground.
Whenever one goes out of his or her own silo once in a while,
good things happen. At a minimum, it
could be refreshing to see different perspectives. Sometimes, one may even enjoy an Eureka
moment like ancient Greek scholar Archimedes
did or a sudden enlightenment like Zen Buddhism calls it. As trained psychologists, Kahenman and
Tversky recognized the importance of the psychological
value of gains and losses in decision making that was missed by main stream
economists. Their introduction of the
concept of loss aversion has since been
considered the most significant contributions of psychology to behavioral
economics. Sounds pretty intuitive and
easy, isn’t it? You can make a
difference too if you think out of box once in a while!
Talk to you soon! Sign
off by this frog at this well on this day.
