Strategy. Innovation. Brand.

Daniel Kahneman

Aristotle and Economics

He's back!

He’s back!

The Nobel economist, Robert Shiller, has an interesting assessment of economics in yesterday’s New York Times. Shiller is one of three economists to win the prize this year and they all have different opinions on rationality and economics.

Prizewinner number one, Eugene Fama, is a rationalist. Rational people making rational economic decisions can explain all of economics. You have to look closely, but it’s all rational. Prizewinner number two, Lars Peter Hansen, occupies a middle position, emphasizing mathematical models but also noting the importance of “animal spirits, … rare events, and overconfidence….”

Shiller (aka prizewinner number three) notes that he is “the most willing … to incorporate ideas about nonrational or irrational behavior from other social sciences….” I’ve written a bit about nonrational economic behaviors – like loss avoidance bias. Additionally, I know that I don’t always make decisions solely for the purpose of maximizing my income. In other words, they’re nonrational in the strictest sense of economic rationality. So, I’m probably in Shiller’s camp.

Ultimately, however, I think the debate goes all the way back to Aristotle who made a clear distinction between:

  1. Things that can never be other than they are, and:
  2. Things that can be other than they are.

Physics is in Category One. The speed of light won’t change, no matter how much we discuss it.  Thus, Aristotle proposes that analytics are the appropriate tools to study physics – and any other topic that falls in Category One. We analyze to understand, not to change things. By understanding, we may improve our ability to adapt to the world, but we’re not changing the world. (On  related topic, I worry that physics envy is leading economists astray. The economists are being nonrational).

On the other hand, Aristotle would put political science in Category Two. The way we govern ourselves can be changed and  improved. We need to analyze but we also need to come to a consensus. Aristotle codified rhetoric for this purpose. Rhetoric is the art and science of persuasion with the goal of reaching consensus on how we can improve the world around us. Rhetoric is not simply the art of winning an argument (that’s sophistry). Rhetoric helps us think clearly, reason together, and change what can be changed to build a better world.

I’ve been wondering recently whether economics fits into Category One or Two. If it’s Category One, all we can do is analyze it. We can describe economics but we can’t change it to build a better world – except in the sense that we can understand the world better. If economics is in Category Two, however, we could conceivably identify better ways to organize our economies and improve the world around us.

If economics is totally rational, then it seems to fit into Category One. We can only describe it. There’s no changing it (unless we can change human rationality, which seems improbable).

On the other hand, if economics has nonrational elements, then we could conceivably improve it. We could identify mechanisms that would help us balance rational and nonrational behaviors. As Shiller notes, he still advocates “a free market system, with innovations to make it work better.” I’m an optimist, so I’m hoping that economics fit naturally into Category Two. That’s why I’m lined up with Shiller (and Kahneman and others).

Aristotle has given us an interesting system to organize our thoughts. So what do you think? Does economics fit in Category One or Category Two?

Sinkholes, Icy Roads, and Chenesium

This is nothing. I'm much more worried about sinkholes.

This is nothing. I’m much more worried about sinkholes.

Last week a man was swallowed by a sinkhole while sleeping in Florida. This week, I’m more worried about sinkholes in Florida than I am about driving on icy roads in Colorado. Is that logical?

It’s not logical but it’s very real. Sometimes a story is so vivid, so unexpected, so emotionally fraught, and so available that it dominates our thinking. Even though it’s extremely unlikely, it becomes possible, maybe even probable in our imaginations. As Daniel Kahneman points out, “The world in our heads is not a precise replica of reality.”

What makes a phenomenon more real in our heads than it is in reality? Several things. It’s vivid — it creates a very clear image in our mind. It’s creepy — the vivid image is unpleasant and scary. It’s a “bad” death as opposed to a “good” death. We read about deaths every day. When we read about a kindly old nonagenarian dying peacefully after a lifetime of doing good works, it seems natural and honorable. It’s a good death. When we read about someone killed in the prime of life in bizarre or malevolent circumstances, it’s a “bad” death. A bad death is much more vivid than a good death.

But what really makes an image dominate our minds is availability. How easy is it to bring an instance to mind? If the thought is readily available to us, we deem it to be likely. What’s readily available? Anything that’s in the popular media and the topic of discussion with friends and colleagues. If your colleagues around the water cooler say, “Hey, did you hear about the guy in the sinkhole?” you’ve already begun to blow it out of proportion.

Availability can also compound itself in what Kahneman calls an availability cascade. The story itself becomes the story. Suppose that a suspicious compound — let’s call it chenesium — is found in the food supply. Someone writes that chenesium causes cancer in rats when administered in huge doses. Plus, it’s a vividly scary form of cancer — it affects the eyeballs and makes you look like a zombie. People start writing letters to the editor about the grave danger. Now it’s in the media. People start marching on state capitals, demanding action. The media write about the marching. People read about the marching and assume that where there’s smoke, there’s fire. The Surgeon General issues a statement saying the danger is minimal. But the populace — now worked into a frenzy — denounce her as a lackey of chenesium producers. Note that the media is no longer writing about chenesium. Rather, they’re writing about the controversy surrounding chenesium. The story keeps growing because it’s a good story. It’s a perfect storm.

So, what to do? Unfortunately, facts don’t matter a whole lot by this point. As Kahneman notes (quoting Jonathan Haidt), “The emotional tail wags the rational dog.” The only thing to do is to let it play out … sooner or later, another controversy will arise to take chenesium’s place.

At the personal level, we can spare ourselves a lot of worry by pondering the availability bias and remembering that facts do matter. We can look up the probability of succumbing to a sinkhole. If we do, we’ll realize that the danger is vanishingly small. There’s nothing to worry about. Still, I’m not going to Florida anytime soon.

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