An individual’s stance on politics largely depends on his view of the capacity of humans to exercise reason. It is no exaggeration to say that the ideas of freedom and democracy are premised on the notion that people can act rationally. Think of any political decision of any importance. Should Britain be in the European Union? Who should be president of the United States? What economic policies would serve the public best? The case for opening these questions up to public debate, and putting them to the vote, is premised on the notion of human rationality.
Of course, even today, anti-democrats are generally a little wary of attacking democracy or human rationality directly. Instead they typically work on the implicit assumption that only the technocratic elite is fully capable of rational decision-making. The rest of us are seen as impaired in our ability to act rationally. They think we are a bit stupid but they are often guarded about saying so in public.
This is where the field of ‘behavioural economics’ comes in. Contrary to the label, it has little to do with economics – at least in the conventional sense of the study of how production and consumption are organised. It is better seen as an ostensibly scientific assault on the rational capacity of human beings. The main reason ‘economics’ is included as part of the name is that the discipline is conventionally seen as embodying rationality. Mainstream economics is presented by the critics as exemplifying what they see as the erroneous assumption that people tend to behave rationally.
Behavioural economics goes far beyond discussions of how to understand the material world. It is premised on the idea that the psychological evidence shows that humans have severe cognitive limitations. As a result, it assumes that people are prone to making serious mistakes.
Michael Lewis’s The Undoing Project provides a useful account of how these ideas developed. His great gift is to outline difficult ideas in an accessible way. Many of his books, often on relatively obscure financial topics, have become hugely popular sellers. Some of them, such as Moneyball and The Big Short, have also provided the basis for Hollywood blockbusters.
Behavioural economics has little to do with economics. It is better seen as an ostensibly scientific assault on the rational capacity of human beings
The unlikely precursors to what has since become known as behavioural economics were two Israeli psychologists who started work in the 1950s. Daniel Kahneman, who was to win the Nobel Prize for economics in 2002, spent most of his childhood years in France. He probably only escaped death at the hands of the Nazis because his father worked as a chemist for L’Oreal, the giant French cosmetics company. Kahneman senior was allowed to live as his work was deemed useful to the war effort.
Amos Tversky, Kahneman’s professional collaborator, was born in what was then British mandate Palestine but later became the state of Israel. He was far more of an extrovert than Kahneman, but they shared a common interest in human psychology. Tversky died in 1996 so, although he was well known in professional circles by then, he did not enjoy the huge public recognition Kahneman has had in recent years.
Although Michael Lewis does not labour the point, he does a good job of describing the peculiar circumstances in which Kahneman and Tversky developed their ideas. They were working shortly after the Holocaust and in the midst of a nation that was in a permanent state of war. In such circumstances it is not surprising they developed a keen interest in how people think and that their conclusions were often negative ones.
A large part of Kahneman and Tversky’s working method was to shut their office door behind them before obsessively debating psychological phenomena. In Lewis’s telling they were as close as, if not closer than, a married couple. Another important part in their work was quizzing people on various puzzles they posed to them. The main conclusion they reached was that people have systematic cognitive biases. They don’t just make mistakes; their errors are also predictable and often point in a particular direction.
Their first big idea became known as the availability heuristic. This is essentially a mental shortcut that relies on immediate examples of what comes to mind. For example, they asked a group of students in Oregon about the frequency of letters in the English language (excluding words with fewer than three letters). Typically students said that they thought the letter ‘k’ was twice as likely to appear as the first letter of an English word as the third letter. But in reality the opposite is true. The letter ‘k’ appears twice as often as the third letter than as the first letter in English words.