Behavioural Economics about Irrationality

Behavioural economics about irrationality

Introduction

The rise of behavioural economics persists. The phenomenon of nudging is increasingly recognised and applied. In the Netherlands the recently adopted Donor Law is an example: those who do not fill in a form, is considered to be a donor of organs. Those who don’t want to be a donor, must take action to prevent it. People are seen as comfort-seekers, but are doing it quite thoughtless. Behavioural cognitive psychologists consider these properties as difficult to change. By designing smart context structures, easy-going people are seduced to behave well, without any moral or legal rule. Great, isn’t it? However, not every ‘nudge’ is so innocent as it seems at first sight. A closer look is necessary.

History

Herbert Simon is generally considered founding father of behavioural economics. He turned against the orthodox neoclassical economics, which assumes perfect rationality. Unfortunately Simon did not make a clear distinction between perfect information and perfect rationality. He posed that our brains have a limited capacity to store information – a very orthodox economic idea! – and drew the conclusion that people are only rational given the information available: bounded rationality.

Neoclassical economists know how to counter this criticism. People are making estimations of what we can expect in the future. Sometimes they overestimate, and in other times they underestimate. Rational people have rational expectations and assume that all other people are rational too, and together form a stable system. It means that everyone bases its decisions on the trends, which are generally expected. The result is that everyone is making permanently mistakes. That’s the risk of life. But this risk can be calculated!

Policy economists regularly meet experts of other disciplines. Most of the time they do not accept this neoclassical apology. They observe problems, such as people who save little and lend much, people with unhealthy habits, such as drinking much alcohol and using cocaine to survive on the job. Many people are corrupt and fraudulous and many other people observe it without any comment.

Behavioural and cognitive psychologists have increasingly focussed their research by designing and executing experiments. Ariely (2017) discovered that many people buy a latte for 4 dollars, while it is not more than a few drops of coffee in a cup of milk. Many women protest, if they discover that men are earning more money for the same performance. Persons, who lost their cinema ticket were disappointed and went home rather than buy a new ticket; many people are not intelligent enough to see that marginal costs are not the same as average costs; all very irrational, of course. The result is a colourful collection of behaviour called irrational; irrationality as a container concept. It is time for a critical treatment of the theory behind this experimental work.

Modern behavioural economics

Behavioural psychologists interpret the human mind as a black box. We can observe impulses and their responses; but we cannot observe mental processes. Introspection gives unreliable results. Cognitive psychologists have made a model, describing the way rational persons store and retrieve information. Experiments show that the actual information processing systematically deviates from what is expected from the reference model; ergo, humans are irrational.

These psychologists are increasingly working together with neuro-scientists under the label positive psychology. It has led to important results. Kahneman distinguishes between system 1 and system 1. The first system processes information, that fits the existing structure, very fast. The second system processes information, that contradicts or at least does not fit the information stored, quite slow. Much energy is used to answer questions, such as: shall I store this or not? If yes, in which part of the brain does it belong? Irrationality means that system 2 does not work perfectly well. Information appears to be treated group-wise. If a neoclassically educated economist, listens to a story about the financial crisis 2008, he selects ‘facts’ that fits the neoclassical frame, and store them. Facts that contradict the neoclassical paradigm might not be stored at all.

Many psychologists turned away from their core business, which is the analysis of the mechanism that steers emotions and thoughts; in other words, the logic of the psyche or mind. Behavioural economics has adopted this reduction. Where neoclassical economics is based on the homo oeconomicus, does behavioural economics have no human image at all; it is reduced to a physical-chemical machine. We can imagine that we have a mind, but that is just consciousness. We can experience that we take decisions, but that is an illusion; we are just the spokesman of the material processes.

The unarguability of empiricism

Many modern scientists deny the importance of meta-physical phenomena, such as the idea of a human mind, being a reservoir of emotions, feelings and thoughts. Although metaphysical in nature, logic, and mathematics and stochastics, which are derived from it, are exceptions. The human experience of scarcity, which causes economic motivation, however, is not accepted. So with the experience of human rivalry and solidarity: it does not exist. The materialist ontology leads us to deny the existence of any type of explanation, which is more than correlation between empirical variables. No economic market mechanism, no social arena mechanism, where groups fight their status battles and exorcise non-loyal members, no mechanism of the mind; in the next section we will develop a psychic analysis and show how the mechanism of the mind works.

A test of a psychic analysis

Imagine a person, who is rich, prestigious and physically healthy. Nevertheless, he can experience typical psychic problems. To find out what is the essence of these problems, we need to make an analysis of the mind. It can only be a partial analysis, as is the case with our economic and social analysis.

We propose the mind to be a partial and closed system with three elements (Keizer 2015, 2017b). In a later stage we can broaden the number of elements and open the system. In the first place, we have an ‘I’, which is the decision maker. Secondly, there is an actual self, which is the doer. It reacts relatively fast without much energy (Kahneman’s system 1). Thirdly, there is a true self, which is the conscience, advising the ‘I’ with respect to the long-term strategy. This true self uses its ratio to make the incoming and retrieved information logically consistent. The ‘I’ has an intuition at his disposable, which is the capacity to say yes or no when confronted with solutions to complex problems. Moreover, the ‘I’ can use willpower, which is the source of mental energy, to force the actual self to adjust to the decisions made by the ‘I’.

This mental model is necessary to interpret the results of neuroscience, as mentioned in section 3. Incoming information, which fits the existing structure of information is processed fastly by the actual self. Unknown information is rationalised by the true self, which is advising the decision maker ‘I’, who says intuitively yes or no to the advice. In case of yes the ‘I’ uses his willpower to influence the behaviour of the actual self. Neuroscience is unable to give an answer to the question of why the mind and the brain are operating this way. Our psychic analysis unravels the mechanism behind this behaviour. A person is in psychic balance if he respects his actual self completely. Some information is a threat to the self-respect of a person so severe, that it is not processed at all. This urge to protection of the vulnerable self is the source of irrational behaviour. The parallel with the philosophy of science of Lakatos and Kuhn is striking here. A full professor will almost never discover that the hard core of his research programme is quite unrealistic. If one of his assistants clearly shows why his programme is failing, he will be fired. The full professor behaves like an ostrich, and the refusal to store inconvenient truths shows the so-called ostrich-mechanism, which is responsible for the selection of information. The assistant is the scapegoat, and when fired the group restores its unity on the basis of a flawed hard core or paradigm; but it can continue the status battle wit other groups. This social mechanism is called the scapegoat mechanism.

New Behavioural Economics

When explaining human behaviour, we can distinguish three primary relationships: the economic relationship between human and nature, the social relationship between humans, and the psychic relationship between the ‘I’ of a person and his actual self. All relationships are under tension, which motivates humans to diminish it. Each aspect-system is responsible for the simultaneous operation of its mechanism. Although the three motivations drive human behaviour always and everywhere, the relative importance of the three differs according to place and time (Keizer, 2015, 2017a, 2017b).

 

New Behavioural Economics

Heterodox economics criticises this orthodox approach of partial and closed analyses. To transform them into a heterodox one, we must integrate the three parts and open this whole system, extrinsically as well as intrinsically. Extrinsic disclosure means that the exogenous variables are varying over place and time. Intrinsic disclosure means that all relationships are permanently changing – coefficients appear never constant and their changes do not contain any regularity. This starting point implies radical uncertainty, which is reduced by the development of institutions, especially group-wise. They create stability over a long period, making life more predictable. Only if remarkable events take place, people change their institutions; in other words, history plays a significant role. Unfortunately behavioural economics completely ignores heterodox economics. As a matter of illustration the following example might clarify this point. Ariely (2012) discusses an experiment in which Californian subjects must choose between to insurance policies, one Californian and one American. Many choose the Californian one, although the American is cheaper. Ariely calls this behaviour irrational. However, many subjects might trust their ‘own’ company more than they do trust the company faraway. Without any attention paid to the particular situation, and the motivations people have, it is impossible to draw far-reaching conclusions.

Alternative research strategy

To build up knowledge of the mind, introspection is an important source of information. People should learn to do it by themselves. Skills in terms of selfcontrol by means of growing self knowledge and the effective use of willpower, will lead to an important reduction in energy necessary for the implementation of long-term strategies. It might even lead to outright satisfaction: boss over your actual self means freedom and independence.

Neuro-linguistic programming leads to less aggressive language and a growing understanding of different (vocational) languages. Also multi-dimensional mindfulness can be very effective. A good example of introspective research is Kets de Vries (2006), who accompanied many chief executive officers in their discovery of their motivations when taking very important decisions.

Behavioural economics suffers so much from its material and empiricist reduction. New Behavioural Economics, which adds a serious analysis of the mind, leading to introspectively found facts, will turn out to be much more realistic.

Ariely, D. (2012), The (Honest) Truth about Dishonesty, New York: Harper Collins Publishers.

Ariely, D. (2017),Dollars and Sense, Dollars and Sense Magazine.

Keizer, P. (2015), Multidisciplinary Economics, A Methodological Account, Oxford: Oxford University Press.

Keizer, P. (2017a), Hoe de crisis het economische denken verandert, linkse en rechtse dogma’s ontrafeld, Amsterdam: Amsterdam University Press.

Keizer, P (2017b), A Multidisciplinary Framework of Analysis, Journal of Philosophical Economics, Vol.XI, Autumn.

Kets de Vries, M. (2006), The Leader on the Couch: A Clinical Approach on Changing People and Organizations, Chicester: John Wiley and Sons.

Piet Keizer, 15-05-2018

 

 

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