Behavioural Economics Gains Street Cred
An Anti-Discipline to Explain Where the Financial World Went Wrong
Oct 14, 2009
It's the kooky cousin, the one no one in their right mind would willingly invite to the dinner table. Behavioural economics has been dismissed by the more serious types as a bit 'new age' on the grounds that if human behaviour can't fit itself into economic models, then it has no place in the field. Imagine a blend of Harvard Business School professor and Hunter S. Thompson. Now there's a picture, but in this day and age, perhaps its time for classical economists to get down with the possibility that humans are fallible.
Where Human Irrationality is a Given
Richard Thaler and Cass Sunstein put it this way: "If you look at economics text books, you will learn that homo economicus (rational characters favoured by classical economists) can think like Albert Einstein, store as much memory as IBM's Big Blue, and exercise the willpower of Mahatma Gandhi." The problem seems to be that traditionalists assume human rationality and any deviation from it can be marked up to an aberration easily corrected by market forces.
Housing bubble aside, its a big ask for humanity and this is where behavioural economics diverges and quite markedly so. In this school of thought, human irrationality is a given. In his recent book, Predictably Irrational, behavioural economist, Dan Ariely says, "Moreover, these irrational behaviors of ours are neither random nor senseless. They are systematic, and since we repeat them again and again, predictable."
Behavioural Economics and The Things We Do
According to behavioural theory, humans have issues with rational decision-making. Choice is difficult and is often influenced by the context in which the choices are offered. Pervasive myths or stories within a society at a particular time can make decisions, which appear irrational in the cold light of day, seem logical, meaningful and even necessary. NOTE: Safe as houses, property always appreciates with or without inflation factored in and everyone needs as large a castle as the lending institutions will allow.
On top of this, anecdotal evidence shows that humans truly absorb knowledge through practice. Think of an elite athlete. It has more than likely taken years of practice for those enviable skills to kick in without too much gear-grinding, heavy-duty, on-the-spot decision making and yet most humans are required to make life's biggest decisions (like entering into a mortgage, how to save for retirement, choosing a university, deciding whether to marry or is credit card debt the devil), with very little training in these areas. It truly is exhausting.
It is no wonder that many people procrastinate and then rush into decisions at the last minute. It is also not surprising that people look to those around them as a way of weighing issues at hand. It should therefore come as no surprise that one irrational decision made by one person can be magnified into a decision made by many.
A Rational Discussion of Irrational Behaviour
Rationally speaking, now would not be the time to stick heads in the sand, however attractive denial may be. The tables just may have turned and that kooky cousin could become not just a cool dinner guest, but the equivalent of a chairman of the board. In behavioural economic terms, the story has changed due to the obvious limits of the one preceding it. Will it revert back? Almost certainly, that is, without the training needed to ingrain the new one.
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