I’ve been fascinated by behavioral economics for a long time. As presumptuous as it may sound, understanding how people behave adds an important dimension to the understanding of markets. It certainly has for me. In fact, the book I recommend the most when people ask me for finance book recommendations is The Behavioral Investor by Daniel Crosby.
When I first discovered behavioral economics, I was stunned at the pathetic creatures we humans are. I memorized a laundry list of biases and made arrogant proclamations that people are stupid, much like everyone else. But the more I read, the more apparent it became that this truism that people are biased and irrational is incomplete.
The development of behavioral economics was a paradigm shift in the history of modern finance, but then it kinda started losing its way. Many behavioral researchers became more preoccupied with discovering supposed biases, finding cute little effects, and party tricks. Over time, the sheen around behavioral economics started wearing off. First, the field has been facing a massive replication crisis [1, 2, 3] as study after study failed to replicate in different settings. As if that wasn’t bad enough, there have been massive scandals. A few months ago, two superstars of the field who studied dishonesty were accused of being, wait for it, dishonest!
Despite all this, I’m in the camp that behavioral economics can be useful. It’s a valuable tool in the toolkit of investors, regulators, policymakers, and governments. But coming back to the point, as I read more about behavioral economics, it started becoming obvious that there’s more to the notion that people are biased and irrational, but I didn’t know what it was. The aha moment for me was when I discovered this paper a few years ago.
In sum, the notion that human judgment is fundamentally flawed appears to have been flawed itself. When we observe humans in adaptively relevant environments, we can observe impressive design of human judgment that is free of irrational biases. Because of trade-offs in error costs, true biases might also prove to be more functional than one would think at first. Some genuine cognitive biases might be functional features designed by the wisdom of natural selection.
The premise of the paper was that the so-called biases are not flaws but rather evolutionary adaptations that helped humans survive for over 200,000–300,000 years. If we were so useless, how did we make it to the 21st century? Of course, this isn’t a novel argument, but I was too dumb and slow to discover it. Evolutionary theorists have been making these arguments since the 1950s and 1960s. Gerd Gigerenzer has been a vocal critic of mainstream behavioral economics and has been making the case that many of the so-called biases are not irrational but ecologically rational for decades. But I hadn’t explored the literature on evolutionary rationality in detail.
A week ago, I started writing an article, and I had to dive deeper into the evolution of human rationality. While I was exploring the evolutionary literature, I came across this talk by the erudite and famed neuroscientist Robert Sapolsky. I knew of him because I had bought his book Behave, which has been lying unread on my bookshelf for a while now. The talk was just wonderful. Listening to Robert Sapolsky was like listening to a scintillating poem about the biology of the human brain. I hadn’t heard anything that left such a deep imprint on me in a long time.
I want to highlight a few wonderful parts from the video:
The single strangest example of violence I’ve ever heard of—and this is one having to do with Indonesia in the 1960s—is when a coup overthrew the government and instituted a right-wing military dictatorship for the next thirty years. In the year afterward, approximately half a million Indonesians were killed by right-wing death squads. The writer V.S. Naipaul was traveling through Indonesia at the time and kept hearing this crazy story about how sometimes these death squads would show up at a village to kill everyone and bring along a traditional Indonesian gamelan orchestra. One day, he runs across one of these old, grizzled veterans of one of these death squads. He’s talking to the guy, who is proud to brag about all the villagers and civilians he killed, claiming he was saving the nation. Naipaul finally said, ‘You know this crazy thing about how sometimes you people would bring like gamelan orchestras to these massacres?’ The guy said, ‘Oh yes, yes, whenever we could, we would bring an orchestra along.’ Naipaul said, ‘Why would you do that?’ In one sentence, the guy looked puzzled and encapsulated everything that’s weird about our violence. He said, ‘To make it more beautiful, of course.’
The duality of human nature:
There is no other primate on Earth that could make sense of our violence when we’re bringing along orchestras to make it more beautiful. Now, the single most complicated thing about us as this miserably violent species is that, at the same time, we’re the most altruistic, most cooperative, and most empathetic species on Earth. And we’re getting better at it. Consider that every single thing up here was invented in the last century – all these ways in which we are extending a sort of umbrella of empathy and protection in all sorts of unlikely directions. How do we begin to possibly make sense of the biology of us at our best and worst?
This is my favorite part of the video on what it takes to understand human behavior:
Now, one of the things that is absolutely clear with that is that you’re going to get nowhere in understanding these features of our behavior if you decide that here is the part of the brain that explains everything that’s going on or here is the hormone, or the gene, or the childhood experience, or the anything, or the whatever that explains everything. Instead, if we’re going to make any sense of these complex, context-dependent behaviors of ours, we have to look at many layers. So, one of these behaviors happens – it’s wonderful, it’s appalling, it’s ambiguously somewhere in between. And we ask the biological question: why did that behavior just happen? And when we do that, we’re actually asking a whole array of questions: what went on one second before in that person’s nervous system that instructed those muscles to do that good, bad, or in-between behavior? But we’re also asking what was going on seconds to minutes before in the sensory world that triggered those neurons, and we’re also asking what was going on with hormone levels hours to two days before that made that organism more or less sensitive to certain sensory stimuli that caused that. And then back to adolescence and childhood, in fetal life, and back to when you were just a fertilized egg, and then back to what sort of culture your ancestors came up with, and what sort of ecosystems, and what evolutionary forces sculpted all of that. If you want to get a sense of it, you’re going to have to ask that question on all of these levels.
A few other interesting highlights, that blew my mind:
Dopamine is about reward, but even more so, it’s about the anticipation of reward. Remarkably, if you block the rise of dopamine, the organism doesn’t press the lever. It’s about the goal-directed behavior. It’s about the pursuit of reward rather than about reward itself.
Testosterone does not invent aggression; it exaggerates existing social patterns of aggression. It turns out that testosterone does something even more subtle than that. People are beginning to realize that what testosterone really does is make you do whatever you need to do to maintain your status when it is being challenged. For example, you can have an economic game where people get status by making generous offers and give people testosterone and they become more generous in the game. In other words, if you shot up a whole bunch of Buddhist monks with testosterone, they would run amok doing random acts of kindness all over the place.
Oxytocin doesn’t make us more pro-social and makes us more pro-social to people who feel like in us. If it’s a them, it makes us crappier and more xenophobic to them.
Your genes shape everything that happens in you, and the thing is your genes have no idea what they’re doing. Saying that a gene knows, for example, when it is going to regulate cell biology, saying that a gene knows what it’s doing is like saying that a cake recipe knows when you’re going to make the cake or decides when you were going to make the cake. Genes don’t regulate themselves; what regulates genes environment does.
The talk seems to based on this paper. Watch the video, you’ll love it.
What if the value of your money decayed over time, like potatoes? A fascinating history of a radical proposal for money that had an expiration date
Is his idea of an expiring currency any more absurd than the status quo we inherited? Perhaps his greatest contribution is to remind us that the rules of money can be reinvented, as indeed they always have. Money is a construct of our collective imagination, subject to our complacency, yes, but also to our inquiry, values and highest ambitions.
The Dutch dairy industry is a significant contributor to nitrogen pollution, which is harming natural habitats. The government wants to combat nitrogen emissions by shutting down dairy farms and asking farmers to downsize their herds. To none’s’s shock, the farmers don’t like the idea of losing their livelihoods. The country has been rocked by massive protests by dairy farmers. The far-right politicians have co-opted the protests to peddle conspiracy theories and xenophobia. Climate change is a societal problem as much as it is an existential one.
There may be no proposal that will satisfy dairy farmers. Any solution for reducing emissions will require either fewer farms, or existing farms to function differently, or both. No solution can guarantee that incomes will be unaffected. As environmental protections become more urgent, it is likely that some people will simply have to change the way they work, just as others might be forced to change how they travel or cook.
“The vast majority of content we consume when we’re on social media is by amateurs as opposed to professionals, and that’s a dramatic shift in terms of how we’ve gotten our media content over the years,” he says. “The notion of the amateur is that they’re doing it for love and not for money; they enjoy the creative expression, they have no ulterior motives. That has created the expectation in audiences that these folks are trustworthy, and that’s exactly what makes them valuable to then sell on behalf of marketers and corporations.”
To feed its manufacturing industry, and economic development more broadly, China became the world’s largest importer of fossil fuels and minerals. The black curves in Figure 1 clearly illustrates the relentless rise of Chinese manufacturing in terms of both exports of final goods and imports of inputs. Also visible in the figure is another, less publicised shock to the global economy: after joining the WTO in 2001, China quickly went from being a net exporter of agricultural products to being the world’s largest importer. China currently imports more than 10% of all internationally traded agricultural goods, and more than 5% of global agricultural production.
Now look: none of this seems to have resulted in actual cancellations. Yet. Netflix hit 247 million subscribers worldwide at the end of the last quarter, at least in part thanks to a crackdown in password sharing prompting new signups. But first-mover advantage only really holds so long as people don’t start questioning the value of their subscription. And with more price hikes, a greater effort to shift customers to ad-supported tiers, a notable slowing in the creation of viral phenomena like Stranger Things and Tiger King, and the rise of cheaper services like Peacock and AppleTV+ alongside the so-called FAST (free ad-supported streamers) channels, Netflix is, for the first time in its history as the streaming leader, facing real questions of whether or not it is worth what it costs to subscribe.
I loved this piece on reading.
Reading requires a lot of effort and practice. Hearing language versus reading it engages different mental processes. Reading forces you to move more slowly. If an author explains an idea to you, the constraints of natural conversation mean that you can’t just pause for 10 minutes while you think deeply about what he or she just said and then subsequently resume the discussion. Books enable you to do that. Of course, you can pause on audiobook and think about what the author just said. Often, though, listening to audiobooks is accompanied by other tasks, making it harder to devote 100% of your attention to the ideas being discussed or the story being told.