Thursday, May 17, 2012

Silo Thinking

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.

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