Sunday, May 27, 2012

Der Spiegel Interview with Daniel Kahneman

This is four part series, with each part quite short. There are also illustrations that are part of the article, available separately.

Kahneman's work in behavioral economics is transforming the economics profession by calling in question many key assumptions, for example, the concept of rationality that underlies the notion of a representative rational agent and rational expectations hypothesis, which along with the presumption of individualism, form that basis of pursuit of maximum utility as the driving motivator of homo economicus.

Kahneman's conclusions, along with those of cognitive scientists, not only question those assumptions but suggest that they are not a true representation of how people behave. It is a confirmation of Keynes's "animal spirits," in a way, but more carefully articulated and backed up with data derived from experiments

Read it at Der Spiegel
SPIEGEL Interview with Daniel Kahneman
(h/t Kevin Fathi via email)

Kahneman summarizes his book,Thinking, Fast and Slow (2011), in which he reports on his life's work in studying behavior. Wikipedia summarizes the book here, too.

Of course, Kahneman has generated considerable controversy. Jim Holt gives an overview in The New York Times, Two Brains Running (Nov. 25, 2011).

Kahneman's basic thesis is that there are two selves within each of us, although he cautions that this is just a useful fiction representing different mental functions. The first, of System 1, is the experiencing self, and the second, System 2, is the remembering self. Life is essentially remembrance of the past and projection of the future based on it, so the mental aspect that most people identify with is the remembering self.

The remembering self functions very differently from the experiencing self, and it is this dichotomy that leads to cognitive-emotional biases when the remembering self uses heuristics instead of rigorous logical reasoning based on facts to come to quick conclusions, which most people do most of the time. Rather surprisingly, the remembering self interprets experiences non-factually and not always logical. It seems that heuristics are preferred, even through often inexact, for reasons are explicable in terms of evolutionary theory.

There has been a great deal of work done on cognitive bias of late. The major cognitive biases are summarized here. Be warned, there are a lot of them.

As Kahneman notes, Buddhist meditators (and I would add, many others) attempt to disentangle the experiencing self from the remembering self and to identify with the experiencing self, which lives in the present rather than the past and future. To this I would also add, that the object of meditation is to discern the aspect of mind that experiences by observing the distinction between experiencer as subject and experienced as object.

When this has been accomplished, the task is to discover the nature of the experiencer independently of an object of experience. Finally, the objective is to stabilize this state in activity, so that both experiencing self and remembering self are recognized as changing states of mind, while one's true nature is unchanging, which is the definition of "absolute" as distinct from relative.

Now that meditation has been popularized and many people have been practicing various methods for some time, cognitive scientists are studying them to discover what effects this may have on brain function, subjective experience, and behavior. This is incorporated in the nascent field of consciousness studies.

Note: Adaptive preference for heuristics, bounded rationality, and social (cultural and institutional) influences, in addition to "cognitive noise" arising from the interaction of mind and environment, challenge the presumption that human decision-makers use rationality chiefly for optimization (max u). Kahneman focuses on preference for heuristics, Herbert A. Simon is the developer of bounded rationality. Social factors are investigated by psychology, sociology, anthropology, evolutionary theory, and institutionalism.


Leverage said...

Why now is if the work on this field has been going for decades. Indeed the state of economics is sorry.

However, be careful with this subject as there is a lot of misunderstanding and lack of clarity or consensus in some concepts.

For example the rapid divide between 'rational' and 'unrational' and the use of heuristics or emotional feedback loops into the decision making process.

More times than not is correct and 'rational' even if it does not follow straight logic and is more likely of fuzzy logic or decisions under extreme uncertainty (where you can't basically assign probabilities to events). Is perplexing how complex our internal machines are, when dealing with this circumstances, if we just keep looking the cases that decisions go wrong we will extract wrong conclusions. But the fact is that these mechanisms we use on daily basis unconsciously work just fine and in fact we can't operate without them in a normal way (demonstrated by clinical cases).

Watch this lecture for some examples of what I'm talking about¨: Antonio Damasio: INET Keynote Address entitled Human Decisions

Tom Hickey said...

The problem is that the assumptions of neoliberalism don't allow for anything less than perfect rationality in its account of free markets as perfectly efficient mechanisms for price discovery. i.e., that markets can be trusted to always price goods and assets at their real value so that price is value.

Of course, changes in price with no apparent corresponding changes in underlying value question these assumptions. Neoliberalism denies that this divergence is possible, holding that genuinely free markets are never wrong and cannot fail by themselves, explaining bubbles and crashes in terms of external shocks or government meddling. the answer is then that mispricing either cannot be avoided due to "acts of God" or can be avoided by completely excluding government intrusion.

Neoliberals also hold that free markets require the rule of law and rigid enforcement protecting private property. So "free market" is an oxymoron by definition, since government is a requirement in the concept, and where there is government there is the possibility of influence and capture.

Cognitive bias arising from heuristics, bounded rationality, social influences and "noise" explains the discrepancy between nominal price and real value. Of course, traders have recognized this for years in trying to assess the balance between bulls (greed) and bears (fear), or as Buddhists might say, between desire and aversion.

Geoff said...

This is an excellent post. Having dabbled a bit in Eastern religions myself, I am familiar with the separation of the "experiencing" from the "remembering" self. Some might call it the separation of the ego. However, I had not previously considered how this relates to economics, and the "rational" school of thought. Very interesting stuff.

Anonymous said...

yes, i agree--excellent post!

but the problem with research in this area (cognition, consciousness) is it's tough to be "objective" when you're the "observer" and the "observed."

everybody wants to be just an observer and not the observed...