Monday, November 03, 2003

When is a raven like a writing desk?

(Or when is a preference not a preference). Dennis Dutton writes a piece for the excellent arts & literature daily outlining how Darwinian evolution explains people's economic preferences. Given the amount of gibberish spewed on this subject in humanities departments, it's nice to see genetics and evolutionary biology start to shed real light on human cognitive function.

Dutton's point is that human nature was selected to maximize reproductive chances in a caveman world that is very different from today's world, but explains why we do the wacky things we do. He talks about Pinker's Blank Slate (which is very good) but it seems the topic is given a more complete treatment in Rubin's "Darwinian Politics: The Evolutionary Origin of Freedom" (which I have not read.) Rubin, by the way, is a Law and Economics professor, a type whom I tend not to trust because (in my experience) they like theory too much and never do the math, so I'm not sure how good his book will be.

Nonetheless, the thoughts here echo a short paper I wrote in Thaler's (U Chicago Behavioral Economist) class at school. We are asked to write about when loss aversion and mental accounting were useful heuristics, and I think were expected to jot a note about self-discipline, but I wrote about cavemen instead. So, first some background, then my note, and finally some thoughts.

1) Background

All else equal, a gain of $10 should be worth as much to you as not losing $10. In practice, losses loom larger than gains, and people prefer to forgo $10 new dollars over paying $10 old dollars out of pocket. People also use mental accounts, so they will create categories for expenditures and ignore the fact that money is fungible across categories. This leads to amusing anecdotes about people risking blizzards to see a play when they bought the ticket, but deciding the drive is not worth it if they were given the tickets as a gift. In standard Chicago school neo-classical economics, none of this should happen.

2) The paper (edited for length)
Question: Mental accounting, to the extent that it violates fungibility, is (according to economic theory) irrational. Do you think there are any circumstances where mental accounting makes people better off nonetheless? How?

Mental accounting (concave value gains, steeper and convex value losses, the endowment effect, transaction utility, and multiple accounts for purchases) might make people better off in a primitive "caveman" society characterized by subsistence living, zero capital formation, a barter economy, and no law except for trust and coercion within your small community.

In a subsistence society, individuals are essentially just one big mistake away from death. So while they will seek gains they will be unwilling to take big risks to do so and when faced with a potentially catastrophic loss, they may decide to gamble. This survival instinct may result in a value function where losses loom larger than gains, and individuals are risk seeking to avoid loss while risk averse in seeking gains.

An additional effect of subsistence living is that there are essentially no savings. An evaluation mechanism that evolved under these conditions would equate gains or losses from a transaction as being equivalent as gains or losses in wealth because they are, indeed, equivalent.

Similarly, in a barter economy with weak property rights it may be reasonable to underweight opportunity cost. Firstly, property that is not proximate may be easily stolen, and secondly, the risks and inefficiencies inherent in bartering make goods less fungible. The net effect would be to only count on property that you have for sure, and not anticipate changing that property into something you value more.

Subsistence living is also zero-sum, focused on redistributing wealth not creating it. In this environment, wellbeing is tied to tracking how much each group member is getting relative to each other. In this environment, it is important to track whether or not the transaction was fair, and assume that any individual gain came from another individual’s loss. The value of goods in this environment is essentially the cost to the seller (p*) since there no opportunity to add value through capital. Since the only competition is in distribution, not production, tracking transaction utility is most important.

Finally, it's worth distinguishing between two different kinds of self control problems. The first set essentially come from a mismatch between what was biologically optimal in a primitive society but is harmful today, with sugar, salt and fat being obvious examples. There is a mismatch between our biological desires and our "rational" cognitive desires. The second set of problems is where the optimal strategy is to cheat and avoid getting caught. For example, an unwillingness to indulge in luxuries, may reflect how in a primitive society individual survival is dependent on group cooperation, even though the group is made up of competitors. Therefore the individual needs to maintain the support and trust of the group, and desires to be seen as frugal, and conscientious. In this situation, people would be more comfortable indulging their luxuries in private, and only being public about luxuries that were given to them as gifts. A luxurious gift demonstrates how important others think you are and therefore furthers your reputation as a valued member of the tribe. The same mechanism of mental accounting that separates and controls private indulgence versus public thrift may have been recruited to handle the broader variety of tasks we need to juggle in our more complex world today.

If the systematic biases uncovered in behavioral economics are universal and have a genetic basis, then it seems reasonable to suppose they were selected for in an evolutionary context. One would therefore expect them to be optimal for the primitive existence that characterizes the bulk of human existence.
My grader (and good buddy, compadre, and general partner in crime) thought I was loony and said so in his comments.

3) Thoughts

In standard economic models, anything someone gives up money for is treated as a preference. If you give up money for ice cream, it means you have a preference for ice cream. If you give up money for a male colleague (by hiring him over a more talented female colleague) you have a preference for sexual discrimination. Preferences can be legitimate or illegitimate. For behavioral economics to show that people giving up money for stuff is irrational, they need to show that it cannot be simply thought of as a preference, and they do this by showing how framing effects, or circumstances, create choices that are, well, stupid.

Is it unfair to call them stupid though, as we all struggle through his modern world with our caveman minds? I don't think so, but that does not change the fact that we, as individuals or society, as traders or committee members, as elected officials or private citizens, put ourselves and our clan before others and act dumb.

Thaler used to say that once you spot a bias you should de-bias, and if you can't de-bias, re-bias. Dutton, Pinker, Rubin, Thaler, and yours truly (among others) are pointing out real biases that are probably biological, and I don't think that any degree of training will really rid them of us. Therefore, the de-biasing strategy is a non-starter, leaving only re-biasing to help correct these errors.


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