Wednesday, April 30, 2003

Falsifiability

Jane Galt and USS Clueless both have recent posts on "falsifiability", which tangentially touch on why humanities students seem so stupid and out of touch with reality so often. I assume that some of this comes out of the deep cognitive splits laid bare by the recent war with Iraq, and also with the observation that commentators who were wrong before haven't seemed to factor that into their most recent prognostications.

It is a fact that people do not automatically seek disconfirming evidence. To do so requires a deeper understanding of underlying premises than most of us have time for and is of dubious value if the (incorrect) rules of thumb we live with are good enough. A natural side effect is that this tendency makes it easy to live in a fantasy world, particularly in realms where our decisions have no real consequences.

I am well aware of how deeply my time at Chicago has influenced the way I think. Chicago-school micro is very powerful, and it is easy to see how it can displace other, flabbier, modes of thought. But it is helpful, in the spirit of falsifiability, to see what could undermine these beleifs. At its heart, if you had to sum it up, microeconomics believes that people respond to incentives, ie. they want what is best for themselves, their family, and their friends. All else flows from this -- you get demand curves that slope downwards (people buy more as stuff gets cheaper), supply curves that slope upwards (people produce more as prices rise) etc. etc. So I guess to disconfirm micro, I'd need to see demand curves that slope upwards, supply curves the slope downwards, and people willing to sell you an apple for $5 and instantly agree to buy it back for $10.

Kahneman, Taversky (Nobel prize last year) and Dick Thaler (Chicago) show that this can happen in lab settings.

And I don't know of any better way to attract attention at Chicago than provide evidence for upwards sloping demand curves and (broken) transitivity.

I'm taking a class with Thaler now, and it has me seriously thinking about where markets reward rational behavior and where the human mind can enjoy its biological idiosyncrasies without having to whip out a calculator to see if a hunch makes any sense.

Noting the payoff structure in academia, I think Thaler is dead wrong on the consequences and applicability of his findings (although I believe his results are real). He has a paper called "Save More Tomorrow" where he shows how some simple changes to a savings scheme increases savings rates dramatically. I would argue that it is so difficult to know what the right savings rate it is, that it is impossible to know whether Thaler's changes have made people better off or not. Nonetheless, you can't get around that fact that people's savings rate can change dramatically given how the system (not the incentives) are structured, so who's to say that the initial savings rate was any less artefactual?

I don't think this has the ramifications people think it does (including Thaler). I hope to discuss this with him before the term ends, but it does seem to me that you would expect these behavioral effects to be more pronounced when it is less costly to make wrong decisions. Far from limiting the ability of markets to make optimal decisions, this suggests the limits of democratic central planning.

For example, people naturally assess probability of an incident by how frequently they can recall such an incident happening. This works fine when the two are similar, but does poorly when the two are not. For example, most people think more people die of car accidents than colon cancer, but the opposite is true. Public policy decisions made on assuaging public fears will tend to overinvest in things which are rare but people panic about, and underinvest in things which are common but don't get media attention. So we spend $2,000,000 per life saved in nuclear power, and $140,000 per life saved on motorways. This is another way of saying that we, as a society, choose more people dead over less people dead, for equal cost.

But this does not give way to the libertarian dream of complete freedom with complete consequences either. The more we understand about how the brain's natural wiring leads us astray, the better we can figure out how to best make which different kinds of decisions. But given that these are still people out there who don't believe that it is inimical in human nature to want the best for ourselves, our family, and our friends (or understand what that neccessarily implies) it's going to be a long journey.

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