Sunday, June 1, 2014

Nudge Economics: Has Push Come to Shove for a Fashionable Theory?

Tim Adam of the UK's Observer has a long essay on, "A rival psychologist[who] has published a book [Risk Savvy: How to Make Good Decisions] debunking the behavioural economics of Daniel Kahneman and the men behind Nudge, who, along with the authors of Freakonomics, were once the PM's pet thinkers."

Here's the meat of his report:
Though nudge-economics remains seductive, what once seemed like a panacea has come to look a bit more like a series of sticking plasters. Earlier this year the nudge unit was removed from direct government control, partly sold to the Nesta innovation charity run by New Labour guru Geoff Mulgan, a move which seemed to suggest the prime minister no longer viewed it as quite so central to his philosophy. That move has coincided with a backlash, or at least a critical analysis, of some of the tenets on which its brand of behavioural economics is based.

Cameron would not have seen it in these terms but in his freakonomics moment over the NHS he was also confronting an extremely crude version of one of the most heated academic debates of the last two decades: the question of whether purely rational decision-making is feasible in the real world. That has been part of an ongoing argument between the "godfather" of behavioural economics, Kahneman, and his most serious opponent, a psychologist named Gerd Gigerenzer, director of the Centre for Cognition and Adaptive Behaviour at the Max Planck institute in Berlin. The substance of this argument concerns the best way for human beings to make decisions.

It is generally possible to judge the depth of an academic disagreement by the way the two principal opponents address each other in the footnotes of their life work. In Kahneman's hugely influential Thinking, Fast and Slow he notes that "a prominent German psychologist has been our most persistent critic" and goes on to list the references to articles in which those criticisms have been made (a list that cumulatively makes Gigerenzer seem a little obsessive, a behaviouralist stalker). Back at the turn of the millennium, when Kahneman was not yet an academic superstar, he admitted to being troubled by the feud to one interviewer. "It was embarrassing, the level of hostilities," he said. "Gigerenzer speaks very well. Even when he's completely wrong, it's hard not to be impressed… "

The shorthand of Gigerenzer's criticism then and now was that Kahneman presents "an unfairly negative view of the human mind". Or, as Gigerenzer himself explained it when I spoke to him on the subject in London last week, "in concentrating only on fallacies and biases Danny [Kahneman] pushes the idea that people are dumb." That shorthand – that because of various provable fallibilities in reasoning when making decisions, human beings are incapable of choosing the best outcome for themselves – is the basis of the philosophy behind nudge economics.

Gigerenzer thinks Kahneman is wrong. People are not stupid, he argues, just ill-educated in "risk literacy". Gigerenzer does not, for his part, mention Kahneman's name once in his new 320-page book, Risk Savvy, though arguably the entire volume is dedicated to a dismantling of some of the tenets of Thinking, Fast and Slow.

In an increasingly complex and specialised world, Gigerenzer preaches a gospel of greater simplicity. He suggests that the outcome of decisions of any complexity – a complexity of, say, trying to organise a successful picnic or greater – are impossible to accurately predict with any mathematical rational model, and therefore more usefully approached with a mixture of gut instinct and what he calls heuristics, the learned rules of thumb of any given situation. He believes, and he has some evidence to prove it, that such judgments prove sounder in practice than those based purely on probability.

"This is not," Gigerenzer concedes, "an easy message to convey to economists, who have been trained in optimisation techniques or to managers in corporations who believe that one can maximise every decision." There are, too, plenty of people who have a vested interest in preserving the idea that the future is complex but calculable, even if in most cases they know that the illusion of certainty that they present is untrue.

In Gigerenzer's view this group includes much of the medical profession, most financial analysts and advisers, and, of course, many academics. The desire for ever greater complexity in the process of decision-making, driven by ever greater access to data, in practice produces what he calls risk-averse "defensive decision-making", or covering your backside. You don't do what your instinct and experience tells you is right: you find the data to support an inferior, but less personally risky choice.

Gigerenzer believes above all in the power of simple rules in the real, unfathomably complex world. "Probability theory is the best thing in a world where you can measure the risks exactly and the parameters are not too complicated. But for most problems it provides another illusion of certainty, and becomes part of the problem," he argues. His favourite example is that of Harry Markowitz, who won a Nobel prize in economics for creating a formula to produce maximum gain from an investment portfolio, in a sophisticated mathematical weighting of gain and risk. When it came to investing for his own retirement, however, Markowitz didn't bother with that his formula – which Gigerenzer proved to be certainly effective only over a 500-year period – he simply divided his investment equally among a given number of assets. He used the heuristic of "not putting all his eggs in one basket" because he knew that would probably be good enough.

Gigerenzer often talks with investment analysts and bankers who, despite the illusions of sophisticated risk management they sell to their clients, tell him that more often than not they tend to rely on similar rules of thumb when it comes to placing their own bets. Politicians, he observes, also routinely trade on our inability to gauge competing risks, not least in exploiting anxieties over terrorism to erode civil liberties.
Read the full essay here.