Cruzonomics: Is Wall Street Rationality Deeply Irrational?
The problem with free market psychology
Posted Sep 30, 2013
Senator Ted Cruz is a fan of the classic model of economic decision-making: sometimes called the Rational Man* view. On this view, every one of your decisions is designed to maximize “utility” – which translates loosely into personal satisfaction. If it feels good now, or will make you feel good later, choose it! Advocates of this position believe that we are, in general, pretty facile at processing information, and at coming to shrewd self-serving decisions. If you read the book Freakonomics, the authors explain how even seemingly senseless decisions, like changing one’s occupation from computer technician to prostitute, or living at home if you are a drug dealer, are well explained by economic incentive structures. We are all, on this view, continuously operating like the high-roller in the movie Wall Street, who, while considering a shady deal, asks: “What’s in it for moi?”
Ask NOT what you can do for your country…
On this view, selfishness is not a bad thing. On the contrary, it is a virtue. The intellectual patron saint of free-market economics is Adam Smith, who argued that an “invisible hand” moves us toward mutually beneficial arrangements when everyone pursues his self-interest. For example, if consumers freely compare different fruit vendors at the market place, they will choose the one who charges the lowest price, but the price will not fall below the farmer’s costs of production, or he will go out of business.
But there are a few problems with the Rational Man view. One is that people often fail to act in ways that economists regard as perfectly rational. For example, there is a laboratory game called the Ultimatum Game. Imagine that an experimenter hands you $100 and instructs you to divide it between yourself and a stranger in the next room. You can divide it any way you want, but there is one stipulation: If the bloke in the next room doesn’t like your offer, nobody gets anything. What should you offer?
And if you happen to be the bloke on the receiving end of such an ultimatum, how low an offer should you accept?
If you are being completely rational, the answer is easy: When you control the deal, keep most of it for yourself, and offer the person in the next room a smaller portion – maybe $10. Why? Because if the person in the next room says no, they end up with $0; whereas if they say yes, they are $10 richer. So it would be dumb of that person to refuse any offer.
And yet, after watching thousands of subjects in countries all around the world play the ultimatum game, researchers find that players typically offer 40 percent of the pie (among American college students, a completely even 50-50 split is often the preferred choice). As Joe Henrich and his colleagues concluded after conducting ultimatum games in 15 different societies: “We found … that the canonical model – based on pure self-interest – fails in all of the societies studied.”
Not only do people in control typically make reasonably fair offers, but when the potential recipients are offered a small portion of the pie, they very often turn their nose up – walking away with $0 rather than taking the chance to make a free $10!
Unfairness is naturally anger-producing
In fact, the mind is exquisitely sensitive to unfairness, and economic injustice naturally triggers a lot of angry feelings. In recent years, behavioral economists like Henrich and his colleagues have begun studying the phenomenon of “costly punishment” – in which people spitefully give up their own rewards if doing so can take rewards away from someone else who is treating other players unfairly. All completely irrational! Why get angry instead of simply moving on to the next vendor in the market?
From an evolutionary perspective, there are interesting questions about how costly punishment evolves, but it is clear that anger in response to an unfair negotiator can be adaptive – it sends a message – do not try to cheat me again!
People’s anger at selfish negotiators helps us understand one rather ironic finding: Economics students at Cornell, who are trained in the rational self-interest model, do especially poorly in laboratory economics games (Frank, Gilovich, & Regan, 1993)! Why? Their selfishness pisses the other players off, and inhibits the cooperative spirit necessary to come to a mutually satisfactory deal.
Rationality and Irrationality in Political Negotiations
As Ted Cruz and the Tea Party have recently demonstrated, the rational model is alive and well in the political arena. The typical Tea Party member is, not unlike Mr. Cruz, male, white, over 40, and above average in education and income (not quite as many soccer moms as their husbands). To the Tea Party fellows, a businessman is simply being rational if he chooses not to offer health insurance to his employees, and pays them the lowest possible wage. A wealthy taxpayer is also being rational if he wants to avoid paying taxes, and irrational if he is eager to pay for someone else to get food stamps or medical care. And if the CEO of a corporation is able to increase his annual bonus by another few million dollars by closing a unionized plant in Michigan and opening another in the less regulated atmosphere of Shanghai, that’s rational too.
To those who get angry at such Rational tactics, there is more than philosophical and political justification for their feelings. Our minds are designed such that the market approach to decision-making only applies in a very small percentage of normal interactions – those with complete strangers from other tribes.
Free Markets are Strange Places
Psychological anthropologist Alan Fiske has argued that human beings the world over have several different models by which we calculate costs and benefits: Market thinking applies to dealings with strangers, but friends use a very different model (equality and turn-taking), whereas family members use yet a different mental ledger (from each according to his ability to each according to this needs). People in organizations use still another model (superiors offer leadership and protection, followers offer respect and dedication, contingent on leaders not misleading them).
My colleagues and I have taken this one step further, arguing that there are at least 7 different Economic Subselves – modular decision-making systems handling our different relationships. When you are thinking about your children, you do not ask what kind of a financial return you are going to get on your investment, for example. You give, and they ask for more – an arrangement that would lead you to terminate any business partnership in short order – and yet you continue to love those cute little financial liabilities, holding them in even higher esteem than the boss who prints your paycheck.
Exactly how all this works is still being investigated, but one thing is clear: In normal everyday life – people do most of their exchanges in a context of trust, and on the assumption that there is a future to invest in. Even in the business world, it is rare outside the arena of financial investments that you will fare better if you take a cutthroat self-centered approach. Southwest Airlines provided a lovely example of turning Market Economics and Home Economics around – instead of treating their employees and customers like strangers and trying to pinch them out of every penny – they tried to encourage an atmosphere more like a family or group of close friends. As a consequence, they kept their employees and their customers when many other airlines were going belly-up.
Will Ted Cruz and his gang of Free Market fundamentalists continue to be financially successful? Probably, unless they are run out of town on a rail. Will their threatening low offer win this round of the National Ultimatum Game? We will know soon, but the costs may not all trickle down for a while. On the other hand, if they were to trade in some of their Adam Smith style economic reasoning for a little reading on the evolutionary psychology of human decision-making, they would make fewer people angry.
-- Doug Kenrick is the author of The Rational Animal: How evolution made us smarter than we think, in which he joins marketing professor Vladas Griskevicius to examine human decision-making in evolutionary terms. Click here to see a 3 minute animated video.
*(Rational Human if you like, but if you really think about it, you might not want to be included).
My thanks to Steve Neuberg, who suggested this blog topic, and who (irrationally) fails to keep track of which one of us bought lunch last week.
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