This is a blog drawing on a lecture at the LSE with Professor Richard Layard in discussion with Nobel winner Daniel Kahneman!
Kahneman has essentially done a demolition job on the idea that people have consistent and stable preferences. In this one hour discussion with Richard Layard, the focus was on two main areas - both of which are covered in Thinking Fast, Thinking Slow. First the concept of brain clock speed and rationality, second issues to do with well-being and misery.
* What is the answer to 2 + 2? The answer will be immediate!
* What is the answer to 17 x 28? Most people need some time and effort to get to the answer (or somewhere close)
Attention and effort are both limited resources!
Kahneman makes a distinction between System 1 and System 2 responses to calculations, decisions, choices et al
System 1 Processes: System 1 involves automatic thought processes (fast) - basic intuition - System 1 operates all of the time providing rapid-fire suggestions, responses, and emotions. Once learned we know how to drive walk, swim. Skilled musicians can read new pieces immediately by sight. Most of us can glide around a supermarket and do the shopping quickly and efficiently without even thinking! Others have an unerring ability to recognise moods by listening to people’s first words to us and we are also pretty good at quickly finding an appropriate distance to stand between two people when having a conversation.
Most of these decisions require little cognitive effort because we are skilled. And skilled behaviour becomes automatic. Kahneman argues that most of what we do day to day is skilled and just fine. It serves us well by and large - but System 1 can sometimes trip us up - it produces mistakes when questions and tasks arise to which we don’t have a skilled answer. And these trip ups can be costly both in the short term and over a longer time horizon.
Try this example:
“Mo was able to read fluently by the age of 3 - what do you think his average US grade score was through high school and university?”
Most people, given this prior information, will immediately estimate that Mo’s grade scores will be high - perhaps somewhere between 3.2 and the maximum possible of 4 - they will over-estimate the value of grade scores because of an anchoring effect. In fact, there is little strong correlation between the age that someone can read fluently and their academic grade scores.
Or this one:
How much would you be willing to pay for travel insurance of £100,000 in case of death for any reason?
How much would you be willing to pay for travel insurance of £100,000 in case of death from being involved in a terrorist incident?
Emotions play a role, people fear getting involved in the latter (that is the nature of terror) and are therefore willing to pay more as a result - which of course is absurd! Because of the risk of dying from any cause must by definition be much higher than being the victim of a terror attack (which of course is always included in the first option)
System 2 Processes: These are described as slower, more deliberative, logical processes requiring effort and time - they need computation - system 2 exerts control over behaviour - it monitors system 1 loosely and translates in behaviours.
The idea of this distinction has now taken hold in psychological research. Much of the discussion in the lecture room was possible applications to policies including those focusing on welfare and well-being.
By the way ...... Kahneman recommends an entertaining book Moonwalking with Einstein (Joshua Foer) about entering the US memory championships. Memory is terrible at storing lists, it is superb at storing routes through space. The power of verbal mnemonics has been around for a long time but the Foer book considers techniques used widely by classical rhetoricians such as Cicero.
* Kahneman dislikes the words rational and irrational - people are basically reasonable and skilled who occasionally make mistakes
* Should we add in absurd realities of the human mind as part of our list of potential market failures? (externalities, asymmetric information etc).
* He argues that the notion of rationality as used in economics is a non-starter, the assumptions governing the consistency of preferences and our ability to look perfectly into the future are impossible and thus devoid of real meaning or importance.
“To a psychologist, it is self-evident that people are neither fully rational nor completely selfish, and that their tastes are anything but stable.” (Quoted in Vanity Fair, December 2011)
* In a world of bounded rationality and different brain speeds, ordinary well-meaning and sensible people need protection against their own mistakes, and they need protection against predators who hide relevant information in the small print (how many of us ever read the small print of contracts - lots of damaging things can be put in there and often are!)
* If we better understood the problems of making judgements about people then public policy would improve. We are too beholden to the views of experts (expert bias) institutions have relied too heavily in the past on face-to-face student interviews which can prove to be wildly inaccurate and a dangerously poor predictor of someone’s ability to perform a job or fill a role. This is especially the case when interviewer makes the final selection judgement. The LSE has abandoned student interviews by and large, will Oxbridge follow suit?
The Well-Being Debate
This is an area for which Layard has many years of well-detailed work. Kahneman has in the past talked persuasively about different aspects of our personality for example our remembering self and the experiencing self. See here: The riddle of experience vs. memory
Kahneman argues that the clunky levers of government policy will not make a huge difference to our well-being - there are limits to the power of nudge or nudge squared! If anything, the government ought to focus on reducing misery rather than promoting happiness - misery is painful (and that includes commuting!) and misery is misery, it is not susceptible to a grade of meaning, whereas there are many different ways of achieving well-being. The main determinants of well-being in any case are hereditary!
This was a new concept for me. According to the Chicago School, people make a decision now and are committed to it because they are assumed to know all of the consequences. Behavioural economists have a completely different view about this, people often take decisions without reference or full understanding of what the possible effects will be when a choice is made.
The people who committed themselves to sub prime mortgages were making a mistake and the people selling them were taking advantage and this could have been prevented with better / stronger regulation. Agents who can take risks and are rewarded for taking these, then large risks will be taken - this is not unexpected - expressed simply, the financial crisis was simply a principle-agent problem on a massive scale. And it was the consequence of a bias in behaviour towards over-confidence, for example financial traders who have an exaggerated belief in their own abilities as investors when share prices are rising.
This was a fascinating session in the company of an academic colossus - a man who has greatly enhanced our understanding of behavioural biases and heuristics, and the lecture at the LSE was free - the Royal Institution are charging £10 for a ticket for a similar event in London the next day!
Bloomberg Business Week Book Review: Book Review: Thinking, Fast and Slow by Daniel Kahneman
Vanity Fair: The King of Human Error
The Guardian (highly recommended article): Daniel Kahneman: ‘We’re beautiful devices’
Add these revision guides and worked answers to your essential revision resources for AS & A2 Economics exams this summer. Our revision guides are brand new and bring your tired old...