Tuesday, May 08, 2012

Thinking, Fast and Slow (Book Review)

     Daniel Kahneman, Thinking, Fast and Slow (2011) Kahneman is an economics Nobel winner for his work on the effects of psychology on economic behaviour. That is, he (with his friend Amos Tversky) answered what should have been an obvious question: How do emotions, cognitive biases, etc, affect economic decisions? The answer is of course, "A lot." Essentially, we can no more avoid cognitive illusions than we can avoid visual ones. Knowing that we are seeing a visual illusion does not prevent us from seeing it: we must deliberately use tricks and methods to avoid the effects of misinterpreting what we see. Just so, we suffer from cognitive illusions, and we must learn tricks and methods that enable us to avoid the mistakes that these illusions would otherwise ensure.
     Kahneman describes the experiments he’s done to tease out these effects. At first he was merely interested in how humans actually make decisions, judgments, estimates, choices, and so on; only later did he apply his discoveries to economics. But economics is after all just another area in which we do all these things. What he’s proved is again what should be obvious: that we are anything but the logical, rational creatures that Friedman and his kind assume we are. It will take a generation or so for economics to become what it really is: a social science. Which means that the application of economic theory is more art than science.
     The average person distrusts economists for many reasons. The joke is that if you as three economists for their opinions you’ll get six answers. But a more serious criticism of economics as it is currently practiced is that it focuses almost exclusively on money, and fails to take into account that for most people the purpose of economic activity is not the amassing of money but the creation, distribution, and enjoyment of wealth. That being said, there’s no question that most people also have only the haziest concepts of what money is, what the various indicator numbers mean, and so on. The worst effects of this confusion are the superstition that money is wealth; that the financiers have some kind of esoteric insight into the economy. There is also the touchingly naive belief that accounting captures not just the truth, but the whole truth, about economic activity. Neither of these proposition is true.
     Read Kahneman. The book goes far beyond economics, and has sage advice about how to compensate for the inevitable cognitive biases and illusions. It's also a good read. ****

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