Read the following quickly A BIRD IN THE THE HAND. Many people who are asked to do this say “a bird in the hand”. Experimental psychologists use such exercises to demonstrate cognitive illusions. The mistakes that are identified are not random, but systematic. Very few people read “a bird in the the hand” when you have written “a bird in the hand”, but the converse misreading is very common.
But who is actually making the mistake? Doesn’t the fault lie with the experimenter who asks his subjects to parrot a meaningless phrase, rather than the subject who valiantly finds sense in nonsense? Many London taxi drivers display signs that suggest they believe London’s third airport is called Stanstead. Even Transport for London, which ought to know better, displays a sign to this effect at Baker Street Underground station – but no one has the slightest difficulty understanding what is meant. If you approached the staff and said: “I see the sign for buses to Stanstead Airport, but where do I find the buses to Stansted Airport?” you would rightly be regarded as a pedantic fool rather than a careful observer. The skill of piecing together sense from fragmented and inaccurate information is a central attribute of human intelligence. Literal interpretation, and insensitivity to context, are not marks of rationality but mental disorders.
If you ask people whether they would rather have $100 now or $110 a week from now, many people will plump for the $100. But if you ask if they would rather have $100 in 52 weeks’ time or $110 in 53 weeks, almost everyone prefers the larger sum. Yet 52 weeks from now, all those who postpone gratification could have had $100 in cash rather than $110 in a week’s time. Faced with just this situation a year ago, many chose the immediate $100.
But once again, the dumbhead is the experimenter, not the subject. You can count me among the irrational respondents: if you made me an offer like that, I would unhesitatingly trouser the $100 in cash. Anyone who has lived for long in the real world has learnt that “a bird in the hand” is a useful maxim, even if “a bird in the the hand” is not. The experimenter’s trick is to construct an artificial situation in which normally sensible behaviour gives what he thinks is the wrong result. The “mistake” is detected in a meaningless problem designed solely to elicit the “mistake”.
Behavioural economics is often sourced to Danny Kahneman and Amos Tversky, but credit should go to the earlier work of a Frenchman, Maurice Allais. Allais was less concerned to show that our behaviour was irrational than to argue that the premises of rationality itself were irrational. In fact, he suggested that they were part of an American conspiracy to deny the subtleties of how sophisticated people – such as the graduates of elite French schools – think. He may have had a point.
Allais’ most famous experiment showed that we often treat very high probabilities very differently from certainties, although “rational” individuals would regard them as almost the same thing. But very high probabilities often are different from certainties: very high probabilities are usually derived from calculations whose relevance and validity are themselves uncertain.
When the credit crunch hit in 2007, a Goldman Sachs risk manager famously claimed that we were experiencing a 250-sigma event – something unlikely to happen in the whole history of the universe. But that was not the explanation of what had occurred. The extreme events were not the result of an astounding freak of nature. The very low probabilities he described were derived from the bank’s particular models of risk, which did not provide a good description of the world.
Irrationality lies not in failing to conform to some preconceived notion of how we should behave, but in persisting with a course of action that does not work. Sometimes in modern economics and political life, there is a big difference.