Brain dysfunction did not cause the recession
Ahead of a major conference, The Battle for the Economy, Stuart Derbyshire declares war on ‘behavioural economics’.
On Saturday 16 May, the Institute of Ideas is hosting a major conference in London: ‘Post-G20 Public Summit: The Battle for the Economy’. In the run-up to the conference, spiked will publish articles and essays by some of the speakers. Here, Stuart Derbyshire argues that we won’t find the answers to the economic crisis by studying bankers’ and consumers’ brains.
The Journal of Economic Psychology was launched in 1981. In the first article published in it, W Fred van Raaij explained that the aim of the journal was to encourage people away from studying the laws of interest rates, inflation, unemployment and the like (1). Instead of such traditional focuses, the new journal would support studies of ‘the behaviour of people who set the prices and whose actions bring about the higher or lower interest rates, inflation rates, or unemployment’. The editors of the new journal viewed economic problems, such as falling profitability, as not necessarily stemming from problems with production and distribution, but from problems with individual behaviour.
Today, the assumption that individual behaviour is responsible for the current economic crisis is widespread (2). A recent article, for example, argued that mania and a lack of self-control over debt are to blame for the crisis (3). Another argued that the crisis follows our inherent inability to see the world as it truly is (4). These arguments dovetail with a raft of psychological and neuroscience investigations that purportedly demonstrate human behaviour to be fundamentally irrational and driven by ‘stone-age’ needs hardwired into our brains (5).
There are many reasons why these arguments are problematic, but here I will consider just three. First, psychological investigations of economic behaviour tend to assume irrationality rather than demonstrate it. Behavioural data is mined and interpreted to support an assumed irrationality when other, more rational, interpretations are often available. Second, linking the supposed irrational behaviour to neuroscience through evolution provides some impressive sounding jargon, but does not advance the argument. At best such links are merely descriptive and at worst they are a series of just-so stories without any legitimate foundation. Third, whatever the merits of behavioural economics, analysing the economy through individual behaviour will provide no direction towards a more productive and rational economics.
Credit card debt in the UK amounts to £55.1billion, which is almost a third of all consumer debt; the situation is similar in the US. Consequently, every month millions of consumers receive a credit card statement requiring some payment. Almost all credit card companies recommend a ‘minimum payment’, which can vary, but must, at least, be enough to cover the interest charges to protect consumers from compounding interest.
A series of studies have demonstrated that the first presented price tends to create an ‘anchor’ that will yoke payment. For example, if I show you a pencil and tell you that its recommended retail price (RRP) is 10 pence and then ask you how much you will pay for it, you will tend to anchor your offers around 10 pence. If I tell you the RRP is 50 pence, however, then you will tend to anchor your offers around 50 pence (6). In this way, the same or very similar consumer item can attract quite different payments. If I am looking for a large LCD TV, for example, my expectations of what price I should pay will be driven disproportionately by the price of the first TV I see.
A recent report has demonstrated a similar phenomenon with credit card repayments. Consumers tend to anchor their payments according to the minimum payment requested (7). In an experimental setting, consumers paid more of the debt when no minimum payment was suggested. The implication is that consumers are irrationally attracted to the presented payment and that credit card companies should change the way they seek payments.
Assuming irrationality, however, is too hasty. If it is the objective of the consumer to pay down their debt more quickly, then it is obviously the case that paying more is the rational way to go. Similarly, if it is the aim of the credit card company to help you pay off your debt more quickly, then it may be rational for the company to avoiding providing a minimum payment suggestion, or to provide a range of minimum payment suggestions as a buffer against anchoring.
However, if it is the objective of the consumer merely to make a payment and stay within the rules, then paying the minimum is entirely rational. Similarly, if it is the objective of the company to keep you making payments to maximise profits, then it is entirely rational to suggest a low minimum payment. Of course, such actions may have negative outcomes for consumers and for society more broadly, but that does not show irrational behaviour. What that shows is the need for a discussion about the best way for consumers to use credit and the kind of credit we want to be made available.
Take another example, the apparent allure of ‘free’. Probably everyone has found themselves lured by ‘free’ and has bought something they perhaps did not entirely want because it arrived with something ‘free’. I have bought plenty of things on Amazon that weren’t entirely desired in order to make sure my purchases qualified for free shipping; I once bought a more expensive box of tea because it came with a free stuffed monkey.
Dan Ariely has performed a series of experiments examining the lure of ‘free’ (6). In one of his experiments, he offers a free $10 Amazon gift certificate or a $20 Amazon gift certificate for $7. Most people choose the free $10 certificate even though the $20 certificate for $7 yields a bigger net payoff ($13 versus $10). ‘Irrational!’ cries Dan. But not so fast.
If you were planning a purchase from Amazon costing $13 or more, then it would be rational to buy the $20 gift certificate. But if you were not planning a purchase, then the deal is quite different. You can spend nothing and have $10 to spend at Amazon on whatever takes your fancy, or you can spend $7 and have $20 to spend at Amazon on whatever takes your fancy. Given that there is nothing specific that you want from Amazon, then spending nothing is actually infinitely better, and more rational, than spending $7. If you have no desire to spend money, then not spending money is eminently rational.
I am not suggesting that consumers cannot behave irrationally, as doubtless they can, but assuming irrationality is often hasty, and conclusions of irrationality can easily be based on a lack of imagination. Take my box of a tea with a stuffed monkey inside. The difference in the cost of the monkey tea relative to my usual brand would probably have been enough for me to buy a stuffed monkey if I really wanted one and with a bit of change left over. But that would have been a hassle and I would have missed trying a different brand of tea and some fun with my kids as they wondered why there was a monkey in my box of tea. On the whole, the extra £2 seemed reasonably well spent.
Irrational evolutionary neuroscience
A common explanation for why consumers behave irrationally is because that is the way our brains were wired up by evolution. As I reported with my colleague Anand Raja a few weeks ago, John Naish ‘explains’ consumption because we have brains wired with a ‘want more’ instinct (8). The lure of ‘free’, presumably, taps into this instinct, which is what makes ‘free’ so alluring.
Writing in Scientific American last year, however, Michael Shermer explained that we may reject an offer of free money if we see the offer as ‘unfair’. This irrational rejection of free money is because the ‘moral sense of fairness is hardwired into our brains’ (5). A typical experiment demonstrating this will proceed as follows. Two random people will be asked to play a game of ‘ultimatum’ where they are offered a chance to win a certain sum of money. One of the players suggests how to split the money. The other player may accept or reject the offer. If accepted, both get the share agreed to; if refused, none of them receives any money. Rationally, the player doing the offering should offer very little (to maximise his return) while the player accepting should accept whatever is offered otherwise they both end up with nothing. In reality, offers that deviate beyond a 70:30 split are generally rejected and the offers tend towards a 50:50 split (9).
Brain-imaging experiments have shown that considering an unfair offer causes activity in emotional parts of the brain and parts of the brain associated with reasoning. If the emotional activity is greater then the offer is rejected; otherwise it is accepted. The interpretation is that unfair offers tap into a primitive ‘fuck you buddy’ response but also into a ‘hang on though, free money’ response. The emotional response is because fairness was important for maintaining social harmony in small bands of hunter-gatherers on the Savannah. Rationally we should always override it, but we can’t.
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There are many reasons to be immensely sceptical about this explanation of fairness. First, there is a lack of rigour and thought about the category of ‘fairness’. While it appears to be the case that there is an assumption of fairness and reciprocity amongst the largely white and middle-class students that take part in psychology experiments, there is no rationale for projecting those norms back through history. Free-market capitalism creates the need for implicit reciprocal contracts in a way that rigid, hierarchical and feudal societies did not. And although it might be reasonable to assume that Stone Age man needed reciprocity and fairness to survive, we have little to no idea about how those arrangements were organised and enforced.
Second, adding brain-imaging does not provide any further support for the theory. There is nothing surprising about the fact that an unfair offer causes an emotional reaction alongside reasoning. If these things did not happen then it would be questionable whether the offer was actually sensed as unfair. And so the activation of brain areas involved in emotion and reasoning is equally unsurprising. Brain activation does not provide an explanation, only a new level of description for what we already know is happening.
Third, there is a massively unsupported assumption of modularity. A function, such as thinking or an emotional response, is considered modular if that function is always elicited by a fairly specific set of inputs and the function itself is largely separate from other functions (10). A module for ‘fairness’, for example, would have to be sensitive to situations involving reciprocity and to signs of unfair exchange and would have to generate a spontaneous negative emotion in response. To be truly modular, the negative emotion would have to be insensitive to other considerations, such as the need for $5 right now regardless of the unfairness of the exchange. While there is good evidence that the human brain is organised modularly for low-level stimuli, so that we are tuned to pick out straight lines, edges, corners and so forth, there is very little evidence that the brain is organised modularly for higher-level functions (11).
To put it slightly differently, if we can change the way we think about things so that we produce different responses, then the idea that we are being dictated to by modules programmed by evolution loses a lot of force. And, of course, we can change the way we think about things so that we produce different responses. In the ultimatum game you are free to decide to play the game in a more altruistic fashion to ensure that your partner doesn’t punish you. You can also decide that, even if you are playing with a total git, you will still take any money offered so that you walk away with something rather than nothing.
Changing individual behaviour will not affect the real economy
It is currently very fashionable to suggest that the current economic crisis is down to greedy bankers playing some sort of hardball version of ultimatum (3). They handed out debt to people with little ability to pay, took the commission and then bundled that debt up and passed it along to the next banker who could wring some money out of it, and so on. And then it all collapsed.
There is undoubtedly some truth in this story and the standard claim of irrationality is not without foundation. But that claim is not entirely satisfactory either. It is the job of bankers to make money from assets for their bank. There is an argument that even people unable to service a mortgage can still end up better-off by owning their property, so long as the value of their property increases faster than their compounding debt. In an inflated property market, bankers cashed in this possibility in order to turn a profit, which is entirely rational because that is what they are supposed to do.
The possibility to make money in this way arose, not because bankers are irrational and driven by Stone Age desires, but because of the deeply subservient nature of Western economies. With the share of the economy devoted to real, productive activity in long-term decline, America, and especially Britain, turned towards generating money off the backs of financial instruments. And as that got increasingly difficult, so the measures became increasingly absurd. As Sean Collins has pointed out on spiked, it was never entirely certain when the reliance on finance and expanding credit would reach its limit (12). But now we know it was the sub-prime market that broke the camel’s back.
Turning to the psychology of bankers fails to explain the source of this crisis, however, and fails to point towards a solution. Even if consumers and bankers are taught to watch out for the effects of anchoring, the lure of ‘free’ and the need for equitable exchanges, it is hard to see how that will do anything to improve the productive base of any economy. In fact, as Rob Killick has argued in his blog on Britain after the recession, attacking bankers is likely to make things worse, as bankers will back away from taking any steps to resolve the toxic debt problem lest they be accused of making money out of public misery (13). And all the talk of greedy bankers gets in the way of a proper discussion of what role the state could and should play in regenerating the economy and what new avenues of productive activity might open so that we don’t have to rely, again, on an inflated financial sector.
Behavioural economics is an essentially degenerate economic theory that focuses on largely irrelevant activity with dubious justification via neuroscience and evolutionary theory. Even if there are some merits to behavioural economics, ignoring the real economy can only mean not solving the real problems we face.
Stuart Derbyshire is senior lecturer in psychology at the University of Birmingham in England. He is speaking on the The Rise and Rise of Behavioural Economics at the Post-G20 Public Summit: Battle for the Economy on Saturday 16 May, Goodenough College, London, WC1N 2AB. Buy tickets here.
(1) W. Fred van Raij. ‘Economic Psychology’. Journal of Economic Psychology 1, 1981: 1-24.
(2) Beyond Conventional Economics: The Limits of Rational Behaviour in Political Decision Making. Edited by Giuseppe Eusepi, 2006; Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism. George A. Akerloff and Robert J. Shiller, 2009; Predictable Irrational: The Hidden Forces That Shape Our Decisions. Dan Ariely, 2008.
(3) Hope, Greed and Fear: The Psychology behind the Financial Crisis, Knowledge @ Wharton, 15 April 2009
(4) The Behavioral Revolution, New York Times, 28 October 2008
(5) The Mind of the Market, Michael Shermer
(6) Predictable Irrational: The Hidden Forces That Shape Our Decisions. Dan Ariely, 2008.
(7) ‘The cost of anchoring on credit-card minimum repayments’. Neil Stewart. Psychological Science, 2009, 20: 39-41.
(8) Enough is enough: learn to want less, The Times (London), 12 January 2008.
(9) ‘NeuroEconomics: An overview from an economic perspective’. P. Kenning and H. Plassmann. Brain Research Bulletin 2005, 5: 343-354.
(10) The Modularity of Mind: An Essay on Faculty Psychology. Jerry Fodor, 1983
(11) The Mind Doesn’t Work That Way: The Scope and Limits of Computational Psychology. Jerry Fodor, 2000.
(12) The ‘credit crunch’: another Great Depression?, by Sean Collins
(13) UK after the recession