The Exploration of Economic Irrationality

A Conversation with
Andrian Kreye [11.13.08]
Topic:

It was one of those watershed moments in science at which you would like to have been present. Last summer in Sonoma, three generations behavioral economists convened at a Master Class run by the Edge Foundation...If you are interested in getting your head around the current global economic meltdown, read through the transcript of this master class once more this autumn. You may not find direct answers, but you will certainly find elements of an explanation.

 

ANDRIAN KREYE is the editor of the Feuilleton of Sueddeutsche Zeitung in Munich. He is also an Edge contributor.

Andrian Kreye's Edge Bio 


It was one of those watershed moments in science at which you would like to have been present. Last summer in Sonoma, three generations behavioral economists convened at a Master Class run by the Edge Foundation. Behavioral economics is a field of science that analyzes market dynamics from the consumers' perspective. The three prominent lecturers were Daniel Kahneman, currently a professor of psychology at Princeton, also a Nobel laureate in Economics for his pioneering work in "behavioral economics"; his younger collaborator Richard Thaler, a professor of behavioral science and economics at Chicago, widely considered to be the "father of behavioral economics"; as well as Thaler's highly-regarded former student Sendhil Mullainathan, now a professor of economics at Harvard, who has applied behavioral economics and psychology to the phenomena of poverty.

Still more prominent were the students of the class itself, above all because Amazon CEO Jeff Bezos, early Googler and VP Salar Kamangar, Blogger founder and Twitter CEO Evan Williams, PayPal founder Elon Musk, former Microsoft chief technology officer Nathan Myhrvold, and Facebook cofounder and founding president Sean Parker, represented just four of the minds present who have shaped the successful part of the new economy. If you are interested in getting your head around the current global economic meltdown, read through the transcript of this master class once more this autumn. You may not find direct answers, but you will certainly find elements of an explanation.

That said, one should not place too much hope in a young science. The larger the number of people who cause an error on a vast if not global scale, the more difficult it is to find conclusive explanatory models. The larger the error, the more surreal the attempted explanation will be. In West Africa, for example, at the beginning of the nineties, a regional recession triggered a wave of superstition. In countries like the Ivory Coast, Burkina Faso and Senegal, the myth of the "voleurs du sexe" made the rounds. Black magicians, according to popular belief, robbed innocent men of their genitals, by chanting magic spells while shaking the hands of their victims. None of these cases of course were ever proven. However, the deadly side effect of the superstition were massive witch-hunts with angry mobs chasing alleged genital thieves across town, finally stoning them to death.

Some psychiatrists in Senegal found a perfectly sound explanation for this phenomenon. The reason for the recession had been a devaluation of the West African Francs, the regional currency strongly dependent on the French Francs and the goodwill of the Banque de France.

Most people of West Africa might have encountered hardship at one point or the other. But in most cases the underlying causes had been clear–drought, floods, or wars. An economic austerity measure such as the government mandated devaluation of a currency caused widespread confusion. The superstition engendered by this economic confusion could be explained in very simple psychological terms: Because the breadwinners had been de-empowered, i.e. emasculated, their angst turned into fears of castration that were taken out on alleged genital thieves who in turn were punished by lynching.

The West African genital thieves craze illustrates perfectly the discrepancy between belief and knowledge in economics. The rationale of Homo economicus remains a presupposition. Who hasn't observed how hysterically the market has reacted in recent months, who it lost its sanity a long time ago?

Behavioral economics, applying scientific evidence to the field of economics, comes to the conclusion that our impulses trump our reason. Even simple changes in the environment are sufficient to influence the behavior of economic players. Thus for example, in one experiment run by Richard Thaler, a computer, whose screen saver showed bundles of money, was placed in the corner of a room where participants were filling in a questionnaire. This was sufficient to make them more disposed to take a financial risk that was tied to a promise of great profits.

The aim of behavioral economics is to develop mechanisms that can enable what is called "nudging"—the psychological control of the Homo economicus. Behavioral economics is geared to deploying this technique in order to bring the irrational Homo economicus to reason, causing him to save money or at least pointing out to him the right purchasing decision. This definition is certain to immediately invite the critique that the so-called "nudge" is ultimately based on similar techniques, such as the reflexes in traditional behavioral research.

Until research in this field becomes more advanced, there will be widespread searches for culprits. But the economy wants to be a system characterized by market forces devoid of human actors to whom such anachronisms as guilt or failure could be attributed. Economics tends to fend off such inquiries or tries to deflect them. The head of the Deutsche Bank Josef Ackermann for example, in a speech he gave on the importance of Corporate Social Responsibility last June in Frankfurt, was already quite sure who the culprits are. "On the one hand, constant negative headlines in the media about companies and managers are not directly responsible confidence in the economy and to encourage managers. On the other hand, more importantly, in the face of increasing competition due to globalization, more and more people fear or have experienced failure." From this you could conclude that the genital thieves and their pursuers are themselves the culprits of the crisis—and not the product.