Risk, Altruism and A Monkey Economy Like Ours
The â€œscienceâ€ of economics has for most of its history relied on theory more than experimentation, which is quite literally the testing grounds of all â€œrealâ€ science.
The birth of behavioural economics in the 1970s permitted economists to start testing theory rigorously, by borrowing empirical methods from psychology and other social sciences to lift the veil behind what makes us, and markets, really tick. How do incentives work?
This 10 minute fly by of economic research on the topic by the Freakonomics team examines a core tenet of economics â€“ utility maximizing. It shows that self-interest is not the only utility that people seek to maximize. Though they may be able to do better on their own, time after time, research shows that people gravitate towards acting as a community when given the opportunity, both giving and taking.
That doesnâ€™t mean our instincts our altruistic either, but â€œAltruism isnâ€™t irrational, because if it were, the only rational people would be sociopaths.â€
That quote comes from an article entitled Altruism in Economics, which discusses an interesting hypothesis: that working together provides an evolutionary advantage.
To see just how short that evolutionary path is, take a look at psychologist Laurie Santoâ€™s Ted Talk, A Monkey Economy as Irrational As Ours (It’s at the bottom of this article in a fascinating investment magazine, Seeking Alpha. Worth a troll.)
Observing a group of chimpanzees she had trained to use currency to trade for food, Santos found monkeys donâ€™t like to save. They often steal from one another and from the market â€œsalesmanâ€. And they display a tendency towards greed. Sound familiar?
Thereâ€™s more, and it speaks profoundly to just how much expanding markets are prone to increasing risk. Confronted with complex decisions we make mistakes, panic and revert to basic instincts. One such instinct is a bias towards thinking in relative, not absolute terms. Another is a bias towards loss aversion. Both lead to a simple and troubling truth: Humans donâ€™t like to lose anything of value that theyâ€™ve obtained, and will actually take on more risk at times in a misguided attempt to save what they already had.
The research gives the lie to the notion that markets are so rational that they can be predicted with computer models. And it sheds important light on ways to reduce risk and improve performance.
I have to say with a bit of humour, I have always been attracted to the movie series, Planet of the Apes, and it ain’t due to the cool costumes.
One of the points I would make, the computer models at least the algorithms I have studied a bit are not actually predicting. They are more of less trying to very very very quickly respond to the irrationality of the markets. If it were merely prediction on good info, they would not require the super computers that many of the traders are using these days. (see RCP i knew my supercomputer stuff would come in handy, actually that is what led me into the study of super computing, wondering why traders needed such cpu power)
The are taking a whole bunch of noise, and matching up clusters of general trading behaviour, and I would posit not a lot of that behaviour is what I would call modelling. Hence the need for the ultimate cpu beasts by traders, who ever can climb atop the behaviour modeling of the moment, gains the edge. Quite sad actually as these algorithms are hogging trillions and trillions of limited precious computation time of some super computing machines, which as I indicated in my article on Super Computing, being used for new ground breaking research in health and food science. The end result is pushing the costs of CPU time on these machines skyward.
This all boils down to exactly your point, Armine, the markets are not rational like theory suggests. Theory as a whole can but paint the faintest abstract water colour of what is being practiced.
Yet theory serves as hard core gospel over practice, and the wealth that controls the status quo, reaps massive returns. Just look at where we are not three years after the biggest finanical disaster in 70 some years. Not a single person who created the disaster is locked up, instead there they are right back at it, markets just about back to where they were. No responsiblility for the massive upheavals caused by the financial disaster, more starvation, less security, austerity and who knows how many hurt by such austerity, how many hospital beds closed, how many workers laid off, how many lives destroyed, how many communities imperiled, and finally how much progress for the planet?
Yet here we are again the same theory and the new anger safely funnelled into tea parties and austerity in the developed “free world’ and revolutions and massive change in some of the “less free” countries of the world. The irony is just such a massive wonder of our age, it truly will go down in modernity by historians as a bookmark for later review.
The main question I have, we are flying like a junky who found another stash and feel safe and quite secure in our massively ecstatic high, for the moment. But this junky has not eaten a real meal in thirty some years and what happens when we fall next time? Will another hit save us, or will the system just finally implode on us. Truly that is a question that not enough sane people are asking. The phracking reinforcements came easily off the package in 2008, just look at the lunatic fringe and how much traction they gained and the power they have. What happens next time?
Personally, I question the standard economic definition of “rationality” involved in utility maximizing. When we find that real people don’t behave according to economic “rationality”, that may be less a comment on people’s rationality and more a comment on the irrationality of the economic definition.
Economic rationality values gains and risks equally rather than being biased towards risk aversion. Is that rational? Well, we use money and because it’s counted in interchangeable units we act as if moving the same amount always has the same impact on utility. But it doesn’t. If I’m a middle class person living paycheck to paycheck or with small savings, a gain of say $50,000 might improve my quality of life–allow me to enjoy more entertainment, eat somewhat higher quality food, go on a vacation–while a loss of $50,000 could put me (and my family) on the street, homeless, hungry and despised, with terrible future prospects; clearly a much greater change in my utility. Economic rationality would claim that, if offered a coin toss where a win gains me $50,001 and a loss loses $50,000, I should go for it because the gain is greater than the loss. In reality I would be a moron to take such a bet.
Economic rationality also assumes decisions made with perfect information, infinite calculating ability, and as far as I can make out no confounding effects from other actors with conflicting motivations making their own calculations. Since the real world isn’t like that, it would be strange for people in the real world, no matter how rational, to behave according to what economic rationality calls for. Rather we would expect a set of “rules of thumb” that are reasonably well optimized for a broad set of circumstances. This is similar to the way many creatures use a fairly optimized search pattern for foraging. If they knew where the food was, they could rationally go straight to it. Their search pattern may well happen to lead them away from it. And it may turn out that the pattern they forage in doesn’t quite work right in terrain that’s different from what they would usually expect to find. But there you go: They don’t know where the food is, and they don’t have the computing power to come up with new patterns on the fly optimized for particular terrain, so they use a “rule of thumb” best searching practice. Overall, it’s the best thing to do given real-world constraints on knowledge and brainpower.
Now people may actually not be completely rational by any yardstick. And there are probably systematic differences between the challenges of most modern environments and those of hunter-gatherer bands where humanity evolved. So for instance, people may be more disposed to various kinds of altruistic and co-operative behaviour than is actually useful in a big-city environment where people you interact with may never meet you again or contribute to your reputation. But by the time you get to that kind of discussion, you’ve already left the “economic rationality” model in the ditch long ago. Which is IMO where it belongs. The problem is not just that “homo economicus” fails to accurately describe real people. Just as neoclassical economics is in general an attempt to fit reality into conveniently simple and ideologically useful math, the “homo economicus” model of rationality has no genuine philosophical or scientific basis; it defines rationality itself to fit the equations so that the model’s math can stay easy.
I recommend ‘Selfishness, Altruism and Rationality’ by Howard Margolis on this topic.
Margolis explains how substituting a utility function that values both public goods and private goods for the standard private only version can explain a number of phenomena that are inexplicable using standard economic models.
He also does a great job explaining the hidden assumptions that lurk inside most typical economics models.
Interesting topic. It seems to me that altruism whether in discussion about sociology, religion or politics, is by and large the de facto idea that has shaped our modern world – I sacrifice something for you to make you happy and in turn this makes me happy as well. I.E. spiritual wealth. It is the classic “do unto others…” approach that permeates every facet of our personal and professional lives. On the other hand, altruism has with overwhelming evidence throughout the course of history, NOT permeated the normal practice of economics I.E. capital wealth. There is little risk involved in practicing altruistic economics because my main objective would be insure that you are happy with my economic decisions in spite of my capital gain because it satisfies the “greater good” that altruism seeks to achieve. For example, if I have a lemonade stand and you have a lemonade stand, the people will decide which one they will buy based on personal tastes and the price that you and me are offering. Altruistic economics in this article would suggest that our evolved selves will want to act as a community or partnership to sell lemonade. Basically a mutual decision to merge the two lemonade stands would occur and our altruistic instincts will have us sharing in the endeavor to sell the best lemonade possible. A dose of reality will occur in the form of competition when a third lemonade stand comes to town and happens to have better tasting lemonade at a more affordable price. If the people flock to the third lemonade stand, what will our evolved altruistic economic selves do? Do we applaud the third lemonade stand’s efforts and shut down because he has satisfied the greater good or do we attempt to offer another merger? The final option, and road most traveled, of engaging in self-interest competition against the third lemonade stand is the model that we most often see today. Altruistic economics will be faced with the instinct for self-preservation. I also think that history will show that when markets engage in free unfettered self-interest competition, we find that the end result leads to the highest quality products and services for the consumer because we would always be trying to make a better lemonade stand than the previous one. So, we find a paradox with altruism. On one hand we want to do what is right for the greater good to our fellow man, but at the same time we have an instinct to protect ourselves and our capital because it provides for the individual and their families’ well being. So to sum up, you can take the monkey out of the jungle, but you can’t take the jungle out of the monkey. Altruistic economics is most absurdly practiced in our US government that insists it knows how to take care of people’s economic needs better than the free market economy does. In turn we see the result. More spending on government programs, more regulation on private industry, more corruption and more taxes to support it all, all under the banner of “providing for the greater good.” The truth is, people are hasty to outright vilify selfish corporate billionairs, but they are more than willing to let the government take 40 cents of every hard-earned dollar to pay for a government that makes sure the “greater good” is being adhered to at home and abroad. This altruistic investment has shown little return and obviously no profit. Altruistic economics works wonders between loved ones, friends, and even neighbors. Once it takes root in the greater private sector economy and government, it fails miserably and does greater harm than greater good.