A book about two psychologists who have altered the way we think about the way we think.
For many people, Michael Lewis is best known for his 2010 book The Big Short and the follow-up film, which describes the carryings-on of the financial sector in the American housing market which underlay the Global Financial Crisis. In fact he has written over a dozen books beginning with Liar’s Poker in 1989 which, by describing the culture in the New York finance industry, presaged the crash a decade later.
Many Americans know him best for Moneyball (2003), in which he describes how one of the poorest professional baseball teams was able to achieve high performance compared to richer teams. Oakland Athletics, which spent $US40m on salaries in 2002, outplayed the New York Yankees with their $US120m spend. Essentially Oakland selected their team by systematically purchasing undervalued players rather than by relying on the judgements of its talent scouts and managers.
There is an economic story here. It is normal to assume that businesses – like the All Blacks, big league baseball is a business – operate (near) efficiently, getting the maximum return on outlays. But Moneyball showed that the baseball industry did not. Perhaps this is a widespread problem throughout business; in which case quelle horreur! A fundamental assumption of how the capitalist economy is ruptured.
But Lewis did not appreciate then that lurking behind this failure was an even more fundamental question: why people were making poor quality decisions. Traditionally economics assumes that people act rationally. Do they?
In his latest book The Undoing Project Lewis explores this by tracing the lives of a couple of Israeli psychologists, Amos Tversky and Daniel Kahneman (who wrote Thinking, Fast and Slow), Kahneman was awarded a 2002 Nobel Memorial Prize in Economic Sciences. Tversky had died from cancer six years before and was not eligible – like Rosalind Franklin of the double helix. Had he survived he would certainly have joined his co-worker – as she would have.
In fact there are similarities between the Watson and Crick team and Kahneman and Tversky. Two very different personalities with differing backgrounds worked together brilliantly. I am not sure which team made the more profound discoveries.
(Lewis portrays the psychologists’ relationship as if it was a marriage – with no sexual overtones. It went through difficulties as marriages do, ending in a ‘divorce’. Three days later, Tversky rang Kahneman to say he had been told he had terminal cancer. Kahneman gave the eulogy at the funeral six months later – all very romantic.)
The book describes the research which led them to the conclusion that people do not always choose optimally and that the heuristics they instead use are not always near-optimal. They can even give contradictory answers. For instance, told that a particular surgical operation has a 90 percent of success one is likely to take it up; told that it has a 10 percent rate of failure the same person is likely to turn the opportunity down. The two statements are logically equivalent but the way the logic is presented affects the decision.
Because it is scientific research the experiments may seem artificial, but that is because they are designed to avoid ambiguity. Astonishingly, even experts can give poor answers. In an early study some surveyed statisticians gave wrong answers to elementary probability problems; how you, dear reader, can expect to get them right is uncertain. But by the end of the book you should be convinced that any rationality assumption for homo sapiens has to be used with the greatest caution.
This does not mean that it can never be used. For simple choices – such as oranges or apples – the assumption may be useful. For complex ones which involve future uncertainty – such as consuming and saving over time – the assumption of pure rationality is almost certainly misleading.
Lewis claims that the findings of Kahneman and Tversky and the other developers of behavioural economics are now well incorporated into economics. I am not sure this is true – at least not in New Zealand. For instance, there is no ‘nudge’ unit here which tries to apply the lessons to the practical interactions between government and the public. There are New Zealand university economists working in the area, but I do not get the impression that the majority of economics graduates are well trained in behavioural economics.
Some economists reject the approach. The older ones may not be up to speed. Keynes wrote that ‘in the field of economic and political philosophy there are not many who are influenced by new theories after they are twenty-five or thirty years of age, so that the ideas which civil servants and politicians and even agitators apply to current events are not likely to be the newest.’
Other economists have too much of their research invested in the rationality assumption to change their mind when the evidence says they should.
Some are ideologically fearful that abandoning the assumption of rationality justifies paternalistic interventions by the state. It need not, since those operating on behalf of the state are as prone to irrationality as those they are operating on.
We all suffer from the irrationality. Both Kahneman and Tversky admit that they make errors like everyone else. Tversky remarked that ‘[m]y colleagues study artificial intelligence; me, I study natural stupidity.’
Nor should we confine the impact of the findings only to economics. Kahneman has said that ‘[n]o one ever made a decision because of a number. They need a story.’ He is reporting on tightly designed experiments, but I think we are allowed to adapt his maxim to ‘no one ever made a decision because of a fact. They need a story.’
As the research shows the story need not be particularly attached to the fact(s) nor need it be coherent or consistent. Sounds like a lot of the support for Trump does it not?(To be balanced, those in other parts of the political spectrum can be equally irrational – the way some once supported the Soviet Union for example.)
If you read Thinking, Fast and Slow you would want to read The Undoing Project to enrich your understanding of the themes of the first book (plus there are some jolly good biographical stories – including their involvement in the Israeli military). And if you have yet to read Kahneman’s book you should, if you want to understand one of the major sources of unrest in public policy thinking – and why you and others (and I) sometimes make very stupid mistakes. Then on to Michael Lewis’s book.