Irrational Economist_ Making Decisions in a Dangerous World - Erwann Michel-Kerjan [4]
At the same time, and despite very important advances in economic theory that were made possible by the traditional view of economic man,7 there was a growing sense of unease among the general public and other social scientists as well as among policy makers that many economists had been unrealistic in their attempts to always rationalize how people, enterprises, and markets function.
Fortunately, the story did not stop there. Stimulated by creative conceptual, methodological, and empirical work by the more senior authors in The Irrational Economist and many others, including Amos Tversky, Daniel Kahneman, and Richard Thaler, the trickle of studies challenging traditional economic assumptions of rationality became a torrent. Nobel prizes in economics awarded to Herbert Simon in 1978, to George Akerlof in 2001, and to Daniel Kahneman and Vernon Smith in 2002 for their contributions toward understanding the behavioral dynamics of economic decisions further contributed to what has become a revolution in thinking.
Today, young scholars, and even those not so young, have become convinced that the secret to improving economic decision making lies in the careful empirical study of how we actually make decisions. New multidisciplinary fields have now emerged—many represented in this book by those who pioneered them—including behavioral economics, economic psychology, behavioral finance, decision sciences, and neuroeconomics, to integrate theories and results from economics, psychology, sociology, anthropology, biology, and brain sciences. Applied fields such as management, marketing, finance, public policy, and risk management and insurance are using this new knowledge today in significant ways.
We now recognize that the question “Are people rational or irrational?” is ill-formed. As human beings, we have intuitive and analytic thinking skills that work beautifully, most of the time, to help us navigate through life and achieve our goals, individually and collectively. But sometimes our thinking skills fail us.
The very modes of thought that are highly rational most of the time can get us into big trouble when the nature of the environment surrounding us, or the time horizon on which we make decisions, changes. We are also fundamentally influenced by short-term rewards, by what others do, and by what is at stake and how we feel when we make these decisions. Our emotions (known to economists as “affective feelings” or “affects”), including fear, anxiety, love, trust, and confidence, all of which help us assess risk and reward, are processed swiftly in our minds. These feelings form the neural and psychological substrate of what is important to us and guide many decisions, what economists refer to as “utility.” In this sense, reliance on feelings enables us to be rational actors in many important situations. For instance, if you were to see a venomous snake on your vacation trip, you would not pause to calculate the mathematical utility of all the possible harmful consequences multiplied by their associated probability (hard to calculate anyway) in order to decide what to do. Upon seeing the snake, you would act rationally: You would move away fast.
More generally, reliance on our gut feelings works when our experience enables us to anticipate accurately the consequences of our decisions—that is, when we have a good knowledge of the situation and (think we) fully understand our reactions today and in the future. But it fails miserably when the consequences turn out to be very different from what we expected—which is likely to happen quite often in an uncertain world. In the instance of surprise, the rational actor often becomes, to borrow the words of 1998 Nobel Laureate Amartya Sen,8 the rational fool.
This brings us back to two of our original questions: How might we behave in this new, uncertain, and more dangerous environment? Will our actions be rational or irrational? Our answer is: