Economic Psychology

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Economic Psychology

How and why markets aren't rational. Navigational tips for charting the Bermuda Triangle of human economic behavior.

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ⓒ Sara Wedeman, BECG, LLC

No, it's not "GPS for Human Behavior:" Keeping BE real.
It should be self-evident that financial behavior is a subset of human behavior, and - as such - it is rich with nuance and meaning. Certainly, it is self-evident that most of that meaning lies unplumbed, or at least, unarticulated.

When I first stumbled on the field now known as behavioral economics (BE), or economic psychology (EP), it did not yet have a name. This is not to imply that it did not exist: it has always existed, but not as a respectable field of academic inquiry. That began to change in 2002, when psychologist Daniel Kahneman, and colleagues, won the Nobel Prize in Economics for their work on decision making under uncertainty.

... Which brings me to the comment alluded to in the title of this post: A tweet by Richard Thaler:

Recently, Behavioral Economics has become a meme, which means that it has been reduced to an easily-transmissible idea-unit, shorn of its depth and complexity. One reason for its current popularity, I fear, is its ease of use as a gimmick. Frequently, I am contacted by people/companies that want to use BE~EP knowledge to more effectively manipulate others to do what the user wants them to do. Although many of those I speak with believe they are influencing people to do things that are "good for them,"* others' goals are anything but pro-social, from convincing consumers to apply for credit cards that charge above-market interest rates to "nudging" contractors into accepting reduced compensation. The use of BE in marketing is all the rage, or so it would seem. I'm not suggesting that market is evil or that an understanding of the drivers of financial behavior should not increase a company's effectiveness: it's just that there is so much more to this field than meets the eye. For example, the research shows that social influence techniques work best when implemented ethically (with one exception: when you lie about whether you like or admire someone, it still works).

In short, the knowledge generated by centuries of inquiry and experimentation in multiple disciplines should not be reduced to a list of mental quirks that can be used to influence behavior. One more thing: nobody should claim, or allow themselves to be described as, "the father of behavioral economics." First, this begs the question: Who's the mother? Second, BE~EP, or whatever one calls it, has many ancestors. It is not new - it is newly respectable. The field's respectability is a wonderful thing, which should open it - to further inquiry, to diverse points of view, and to voices not hitherto included in the conversation.

* A contemporary version of "the white man's burden?"

 Plus ça change...
Plus ça change...
Source: Macalester College

Amuse-bouche: My answer(s) to: "What are some mind-blowing facts about behavioral economics?"

Perfectionism: A Blessing and a Curse
I have always believed it is good to have high standards.

A long time ago, a not-wildy-competent coworker in a position of authority said to me that the 'secret' to his 'success' was that he "never sweats the small stuff." I barely knew how to respond, because all I could think was:
  1. You think you're successful?!
  2. What, in your view, constitutes "small"?
  3. I feel sorry for the people who have to depend on you. 
I also believe that intelligence is largely a matter of effort. We are all born with innate talents and weaknesses, but the willingness to expend energy on something that challenges us is a choice. Intelligence exists not just in the cranium, but everywhere in the body. If our muscles have brains, our brains are like muscles, which - if used - get stronger, better, and more courageous. If unused, they molt and turn to cardboard.

I have no time for people who don't extend themselves to learn and to put that learning to use in the real world. Thinking, writ large, takes energy - but it creates its own momentum. Most of the time, even when one turns out to be dead wrong, the learning is worth it. I speak from experience, with the partially-healed bruises and long list of yet-to-be-written apologies, to prove it.

That said, I tend to err in the other direction. This is not in any way to imply that it is a superior direction: au contraire.  While I'm busy researching everything I say to make sure it can be corroborated empirically, via multiple sources, I am a) driving myself nuts; and b) working so hard to protect myself from being wrong that I am missing out on learning from others, and on the thrill of discovery.

This is, BTW, a long-winded way of saying that I really enjoy thinking and writing about this field - whatever one chooses to call it. Behavioral Economics - Economic Psychology (BEEP), whatever.  I have something (err - more accurately, quite a few things) to say. It's time for me to step away from my current program - wherein I spent 96% of my time checking my facts - and to lurch into the public square.

Let's "dance!"


Looking Back, Looking Forward
I started this blog on December 19, 2002 - with a post entitled Episode one, where I decide to take the plunge. When I did so, I don't even think I knew that just two months beforehand, psychologists Daniel Kahneman and Amos Tversky (Tverky, posthumously), as well as experimental economist Vernon Smith, had just won the Nobel Prize in Economics, for the former's (empirical) work on judgment and decision making, and the latter's use of experimental methods to test economic hypotheses.

From the Nobel organization's press release announcing the award:
Traditionally, economic theory has relied on the assumption of a "homo œconomicus", whose behavior is governed by self-interest and who is capable of rational decision-making. Economics has also been regarded as a non-experimental science, where researchers – as in astronomy or meteorology – have had to rely exclusively on field data, that is, direct observations of the real world. During the last two decades, however, these views have undergone a transformation. Controlled laboratory experiments have emerged as a vital component of economic research and, in certain instances, experimental results have shown that basic postulates in economic theory should be modified. This process has been generated by researchers in two areas: cognitive psychologists who have studied human judgment and decision-making, and experimental economists who have tested economic models in the laboratory.
The breakthroughs recognized by the judges were twofold:
  1. Establishing, based on empirical evidence, that the assumption underlying western Economics (that human economic decisions are rational, focused entirely on self interest and the best available information) was tightly-bounded-to-baseless.

  2. That economic hypotheses can and should be tested using rigorous, empirical methods - rather than relying on external, existing measures, whose construct, content, and external validity had never been established.
I still think experimental economics has a very long way to go before it achieves an acceptable level of psychometric integrity (by which I mean: the test items measure what they intend to measure, do so consistently across time, space, and groups involved), but Vernon put the field on a path whereby such integrity is at least achievable.

Kahneman and Tversky - through careful, empirical, valid and reliable research - did the world a great service by demonstrating to a skeptical academic public that which anyone with reasonable powers of observation should have already noticed: people rarely, if ever, make economic decisions on a primarily rational basis.

In the next few posts, I'll discuss some of the ways in which Behavioral Economics/Economic Psychology (BE/EP) and blogging have changed since that day in 2002 when I decided to "take the plunge" - and my views thereof.

Time: Not a grid, but a wave, or - in this case - a vortex.
This opinion piece, from the Washington Post, missed the mark, and widely at that. The author, Dana Milbank, argues that Bernie Saunders may be right about the need for a revolution, but "As Sanders is learning, you can’t have a populist revolution without people."

Oh really? How soon we forget (viz, "Those who cannot remember the past are condemned to repeat it." George Santayana (1905) Reason in Common Sense, p. 284, volume 1 of The Life of Reason).

Remember the 'opiate of the masses'? The concept has a life of its own and a shape-shifting role. The Telecommunications Act of 1996, esp. Title 3  set the stage for the gutting of the news business and its takeover by corporate titans with a decided stake in keeping the people inert. It is the new opiate of the masses.

There's no accident here, nor is there any evidence that the human spirit has suddenly gone flaccid. Telecom 1996, which replaced the Communications Act of 1934, is in so many ways analogous to the Gramm-Leach-Bliley Act of 1999, which gutted Glass-Steagall - among other legal protections preventing crashes like those of 1929 and 2008. 

Who was behind Telecom 1996 and Gramm-Leach-Bliley? The constituency was/is one and the same: those who favor conglomeration of power and money to further their own ends. To be clear, I am suggesting that in the current era, corporate bosses either hire reporters blind to the bigger picture - or censor those who are not - to please advertisers like the Kochs. You don't really need that many actual human beings in a world where "corporations are people, my friend." Therein lies the rub.

Cartoon penned by Joseph Keppler and published in the January 23, 1889 issue of Puck

Plus ça change...