Friday, November 25, 2005

Economics and the Believing Mind

Two excellent articles this week focus on people's belief systems and how they affect economic decision making. Arnold Kling, taking a cue from Paul Bloom's Atlantic article on the neurological origins of religious faith, posits that the same bifurcation of cognitive patterns applies to economics - and why most people hate it.

"the separateness of these two mechanisms, one for understanding the physical world and one for understanding the social world, gives rise to a duality of experience. We experience the world of material things as separate from the world of goals and desires.

...We have what the anthropologist Pascal Boyer has called a hypertrophy of social cognition. We see purpose, intention, design, even when it is not there."
-- Paul Bloom, writing in The Atlantic

Paul Bloom's essay "Is God an Accident?" in the latest issue of The Atlantic, suggests that humans' belief in God, Intelligent Design, and the afterlife is an artifact of brain structure. In this essay, I am going to suggest that the same artifact that explains why people are instinctively anti-Darwin explains why they are instinctively anti-economic.

Bloom says that we use one brain mechanism to analyze the physical world, as when we line up a shot on the billiard table. We use another brain mechanism to interact socially, as when we try to get a date for the prom.

The analytical brain uses the principles of science. It learns to make predictions of the form, "When an object is dropped, it will fall toward the earth."

The social brain uses empathy. It learns to guess others' intentions and motives in order to predict their reactions and behavior.

The difference between analytical and social reasoning strikes me as similar to the difference that I once drew between Type C and Type M arguments. I wrote, "Type C arguments are about the consequences of policies. Type M arguments are about the alleged motives of individuals who advocate policies."

Type C arguments about policy come from the analytical brain and reflect impersonal analysis. Type M arguments come from the social brain. In my view, they inject emotion, demagoguery, and confusion into discussions of economic policy.

As a shortcut, I will refer to the analytical, scientific mental process as the type C brain, and the emotional, empathic mental process as the type M brain. What I take from Bloom's essay is the suggestion that our type M brain seeks a motive and intention behind the events that take place in our lives. This type M brain leads to irrational religious beliefs and superstitions, as when we attribute emotions and intentions to inanimate objects.

We need our type M brains, but in moderation. Without a type M brain, one is socially underdeveloped. In extreme cases, someone with a weak type M brain will be described by Asperger's Syndrome or autism. On the other hand, as Bloom suggests, there are many cases in which we over-use our type M brains. For example, social psychologists have long noted the fundamental attribution error, in which we see people's actions as derived from their motives or dispositions when in fact the actions result from context.

Economics is an attempt to use a type C brain to understand market processes in impersonal terms. We do not assess one person's motives as better than another's. We assume that everyone is out for their own gain, and we try to predict what will happen when people trade on that basis.


I think that Kling draws a valid parallel between religious and economic belief systems. This confusion of impersonal market forces and personal social forces is behind, I believe, the continued appeal of socialist economic and political theories. It is hard for most people to imagine that economic interactions, which are interactions between personal actors, can take on a level of complexity where they cannot be centrally directed and commanded to result in desired outcomes.

Holman Jenkins addresses the same issue from a slightly different angle, that of how we make decisions based on limited information.

A handy idea for making sense of the modern world is the idea of an "availability cascade." It employs economics to explain how people come to hold faddish beliefs, even when those beliefs are at odds with other beliefs they hold or information they possess.

You can see this dynamic in Washington's lowbrow burlesque over gasoline prices. The idea is also known as rational herding. Senators in the recent grilling of energy CEOs couldn't have made it plainer that they were flinging charges of manipulation not because they believed them but because they believed their constituents believe them. Senators also let it be known they were perfectly prepared to enact unwise policies rather than argue with constituent misperceptions.

Said Republican Pete Domenici: "Polls show that our people have a growing suspicion that the oil companies are taking unfair advantage of the current market conditions to line their coffers with excess profits . . . My constituents think that somebody rigs these prices, that in the process somebody is getting ripped off."

Said Democrat Byron Dorgan, explaining why he was forced to introduce a bill confiscating the "windfall" profits of oil companies: "A consumer says to us, 'You know, Mr. and Mrs. Politician, what I see are big economic interests getting rich here.'"

This hand-washing is the essence of childishness but the political class is far from the helpless sock puppet of an ignorant or misinformed public. The same voters, in any poll, would happily affirm that the world is running out of oil, that the supply is controlled by unreliable foreigners. Yet let gasoline rise to $3.00 a gallon, and suddenly they believe that only the ruthless profiteering of oil companies stands between them and cheap and abundant gasoline.

The public doesn't adopt beliefs directly at odds with its other beliefs without help. In the latest instance, help came from state attorneys general who, at the first sign of a spiking gas prices, ran to the nearest TV cameras and proclaimed crackdowns on price gouging. It came from the media and politicians declaiming against Exxon's quarterly profit of $10 billion as aberrant and suspicious -- never mind that at 10% of sales, Exxon's profit margin was hardly out of line with those of other industries.

'Availability cascade" is a term coined by Cass Sunstein and Timur Kuran in an important 1999 Stanford Law Review article. Their work follows distinguished prior work on informational cascades (when people knowing little about an issue take their cue from others) and reputational cascades (involving the rational incentive to go along with the crowd). All owe a debt to the Nobel Prize-winning work of Daniel Kahneman and Amos Tversky, who coined the term "availability bias" for people's willingness to judge the odds of a given event occurring based on how readily an example comes to mind.

The key is to remember that acquiring information is costly and that people look for shortcuts. Imagine a situation in which gifts are being distributed in red and blue boxes. You don't know what the boxes contain but everyone in line is asking for a red box. Therefore, you ask for a red box too, assuming they must know something you don't and because you want to appear "in the know" too.

This is rational herding. Now consider that everyone was thinking just like you, and that the chain began only because a prominent individual was seen picking a red box.

Put aside the reliance on jargon: That even intelligent people are capable of holding passionate views on matters to which they have given little thought or study is hardly a revelation. A plausible explanation indeed is that such people model their beliefs on the apparent beliefs of others whom they presume to be better informed.


Of course, such is the material of which popular delusions and the madness of crowds are made. South Sea bubbles, Tulip-mainia, Dot-com fever: the examples are too well-known to modern economic man.

It is instructive that the author refers to this behavior as "rational" herding. On its face such unthinking conformism seems anything but rational. But if you think it through, it may just make some sense. Given that one cannot make an immediate, informed decision between two options, but one option is favored by the "herd", what are the costs and payoffs of either option?

If you choose with the herd and they are correct, then you benefit materially as well as socially - you stay with the herd. If you choose with the herd, and are incorrect, you do not benefit materially, but your misfortune is shared by the herd, so you do not lose any ground socially.

If you choose against the herd and you are correct, you benefit materially and the herd does not. But your benefit may raise the ire and jealousy of the herd, so your social position may be threatened. If you choose against the herd and are incorrect, then you lose both materially and socially - you are open to the ridicule and disdain of the herd for being a contrarian and for being wrong.

So, as much as it is popular for people to declare themselves to be individuals and not members of the herd, is there some deep seated instinct within us that dreads to be separated from it?

4 Comments:

Blogger Bret said...

Duck wrote: "On its face such unthinking conformism seems anything but rational."

Actually, on its face I think that "unthinking conformism" is probably rational and beneficial most of the time - even without taking into account the possible "social benefits".

Let's consider a common transaction. You need some item. The item has moderate cost, say $100 or more. You go to the nearest store that has that item, you walk in, pick up the item, take it to the counter, pay for it, and walk out with the item.

This is a type of rational conformism. You didn't attempt to bargain with the seller of the item and you didn't call other stores to see what their price for the item was. You conformed completely to the price set by the merchant and other shoppers who did take the time to price shop.

Yet, if you look at the cost of the effort to save the few percent that you might save on the item if you didn't conform to the price set by others, it's clear that you're usually better off just buying such items, without expending any extra effort to price shop. This is an example of what Jenkins means when he wrote "[t]he key is to remember that acquiring information is costly and that people look for shortcuts". Buying without price shopping is an example of one of those unthinking conformism shortcuts.

The other side of the "madness of crowds" is The Wisdom of Crowds. The crowd, in a situation where there's competitive aggregation of information, can usually greatly out perform an individual. Thus, it's often perfectly rational to follow the crowd.

That's not to say I disagree with the concept of there being social benefits of conforming. I'm just saying that even ignoring that, unthinking conformism is often beneficial.

November 25, 2005 11:08 PM  
Blogger Duck said...

Bret,
All good points. I guess you can say that the crowd is wise, except when it is not.

The $64,000 question is - how will you know when the crowd is heading off a cliff? What are the kinds of situations where the herd's instincts are inviting disaster? Can we classify them in some way?

Here are some of the worst herd decisions of all time:

* The southern states decision to secede from the Union.

* The German people's decision to elect Adolph Hitler.

* The Zimbabwe people's approval of Mugabe's campaign to chase out all of the white farmers.

How does the wisdom of crowds get so distorted in situations like these? What causes them to choose certain disaster?

November 26, 2005 6:41 PM  
Blogger Hey Skipper said...

Duck:

Steve den Beste wrote about this when discussing the "hive mind." (Unfortunately, I don't have a link).

The "competitive aggregation of information" is fundamental, but the phrase hides one important consideration: the situation is such that it prevents flocking to a perceived "correct" solution.

For example, if you and I were to go to a mall, say, and I was to ask 20 people to guess your weight and none of them had any idea what value the others guessed, then the average of all the guesses will almost certainly be within a pound of the actual value.

Unfortunately, many situations allow herding around a particular value, destroying the decentralized aspect of the hive mind.

Bret:

Internet operations like Expedia.com have eliminated the price stickiness available with rational conformism, and thereby have contributed to the airline industry's current travails.

Which reminds me, I have some writing to do ...

November 27, 2005 4:06 AM  
Blogger Brit said...

I think Skipper makes a valid insight.

Both the wisdom and the madness of crowds do exist, so they are not mutually exclusive.

The wisdom of the crowds is the result of many people making an individual, independent decision based on their own judgement. In other words, they don't know they're in a crowd.

The madness of crowds occurs when they know they're a crowd and all follow along the same path simply because everyone else is at it.

If the path turns out to the right one it could look like wisdom, but when it's the wrong one, as in the examples noted by Duck, then you get madness.

November 28, 2005 5:22 AM  

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