Monday, July 23, 2007

On Psycho-economics

Tirta, a psychologist-in-training who knows a little quite a bit about economics thinks psycho-economics still have a long way to go before we can use it to dismiss conventional economics. He's in fact worried that psycho-economics is fast becoming an empty fad. - Manager

On Psycho-economics
by Tirta

Here's a provocative comment from Terry Burnham (which was emailed to me by our sociologist friend a while ago):

"At one level, the logic of economics is so rigorous, but it is built on a foundation of folk psychology that we would mock in other fields..."

To put things in context, the comment was made in response to a 2002 study by Andrew Lo and Dmitry Repin, the former finance professor, the latter neuroscientist. The two guys jointly discovered that heart beat, blood pressure, and skin sweat were crucial in predicting the behavior of stock traders. They went on to claim that there's a lot of irrationality and emotion going on in Wall Street and places alike, which were once thought by many economists to be full of heartless people.

Incidentally, it turns out that Burnham was the guy who did the recent testosterone study, which found that the more you have the masculine hormone, the more you will reject unfair offers in standard ultimatum games. Alpha males, in other words, are psychologically fond of equality and distributive justice (not necessarily through philosophical reflections though, as I've alluded here).

Guys like Burnham are commonplace today. These are people who apparently are not satisfied with standard economics models of rational agents. They resort to psychological constructs and colorful brain pictures for insights on how to explain some economic behaviors. They like discussions containing words like 'intuition' and 'emotion' more than those sticking with 'rational', and seem to think that these psycho-economics explanations are one step ahead closer to the truth of why we behave the way we do.

Well I'm a psychologist-in-training who happen to know a tiny bit about economics (at least this Cafe's version of it), and I don't think so. Here’s why.

Psychologists have only began to explore the workings of intuition and emotion in the 1990s. In the 1920, we were obsessed with the relationship between stimulus and response, which at best gave birth to learning and conditioning theories applicable mostly to rats. In the 1950s, we finally saw the light, and dared to open the black box -- namely, the mind -- and started to converse in terms of memory, thought, personality, attitude, and the likes.

But we didn't talk about emotion or intuition until only recently. Of all topics in psychology, emotion and intuition are among the most alien and under-researched.

Current psycho-economics explanations are mostly tautologies, because the mechanisms of the mental properties they are referring to are themselves subject to active investigation. Yes, emotions do influence traders and ultimatum game players, so they are not as rational as they were thought to be. But the questions shouldn’t stop there: How exactly do emotions exert their influence? Which emotions? Under what circumstances? How do they interact with cognitive-based judgements and decisions? And the list easily goes on.

Psychology still doesn’t have a sound theoretical basis as to how emotion and intuition work, and more importantly, how they both relate to cognition at large. As interesting as those colorful brain images (usually coupled with paragraphs consisting of those weird latin words familiar mostly to medical doctors) can be, we still have no idea on how to tie them all together to explain why we do what we do – and why we think what we think.

So it's ironic when some economists think that they are significantly advancing the field by referring to psychological concepts like 'emotion' and 'intuition', which have only been around in the psychology literature for a decade or so, and of which our understanding is clearly minimal.

I think psycho-economics are becoming more and more like an empty fad. Some scientists got a little bit too excited and make too much out of it. As do the journals, newspapers, and blogs.

Here's another example, which actually got this post started in the first place.

A few weeks ago, I sent this op-ed to some of the cafe's managers. Roland Fryer, a Harvard economist, recently suggested that rewarding money would make bad NYC students more diligent and studious. Barry Schwartz, a Swarthmore psychologist who wrote the op-ed, disagreed. He pointed out that this simple reward scheme would distort the many other motives that are inherent to learning.

Responding to Barry's piece, here is an economist friend of the Cafe:

"Probably due to my own bias, but I tend to side with the psychologist on this. I have seen a similar phenomenon at [my place of work] where people who focus on the financial incentives do not produce quality work relative to those who are interested in the work per se. I think multiple objectives do compete (which is why economists don't believe in corporate social responsibility), and this incentive will skew the objective of going to school."

It's true that humans have competing motives all the time, and yes, money is one of them. And going to school, surely, should be based on the noble motive of learning-for-the-sake-of-learning.

But I'm not sure if I totally agree.

One may criticize economics, as I automatically did when I read the op-ed initially, for freakonomically assuming that everything -- learning and school included -- is about the right type and amount of incentive. Yet psychology, so far as it recognizes the many different faces of motives, intuition, and emotion, has no idea as to how these mental attributes really interact. We know that it’s not just about money. The problem is, we don’t really know what the rests are.

So here’s my question. When these bad students are already devoid of the intrinsic motives of learning, which I presume was what Fryer had in mind, which would you pick: play carrot-and-stick to at least feed their mind with something that is potentially useful, or leave them as they are on the street with no better mental arsenals to face the future?

I personally would opt to be pragmatic, simplify matters appropriately, and thus side with the conventional economist. At least for the time being.


  1. Tirta:
    If you've read Freakonomics, surely you remember the nursery experiment where parents are penalized a small amount of money for picking up their children late from the nursery. The penalty actually increased the number of tardy parents. Why? Because parents substitute monetary penalties for punctuality.

    The lesson from the experiment was that incentives do matter -- but which one? Are monetary incentives always dominant?

    More broadly, the real question is: Among the various incentives faced by individuals, statistically which one matters most on aggregate (for a particular problem)? And how does a policy intervention (like the one proposed by Fryer) influence them?

    So the skepticism of Fryer's proposal is neither about questioning (conventional economic) rationality nor the need to maintain "noble motive of learning-for-the-sake-of-learning". It's about questioning whether money is the most effective tool (read: incentive) for the job (of encouraging learning). As suggested by the nursery experiment, it often isn't.

  2. What about parents' motive in investing their kids to get some degrees, even for Master or PhD? Or, some scholarship foundations or corporations? Some Masters or PhDs writing books or journals could be for something. Two or three writers in a paper might have different motives among them. What motives might a 30y.o professor have? (better salary than assistant or associate prof?) Etc.

  3. arya:

    a minor quibble to start with: i have long found that ariel rubinstein had some reasonable doubts on the nursery study, as outlined here (on pages 6-8):

    nonetheless, i think it's a bit far fetched to extrapolate the results of the nursery study in israel (if they are indeed 'true' and replicable) to the learning problems faced by new york schools. the minds of israeli parents and new york teenagers work quite differently, i suspect, with respect to incentives. thus fryer's intervention will shed some direct light on the effectiveness of the monetary hypothesis.

  4. Tirta
    Surely you don't think I was extrapolating by my previous comment. I was merely using a study on incentives as to argue that monetary incentives may not always be the most effective means to affect (non-profit) motives.

    At any rate, I think you over-analyzed my jerk-reaction comment that you quoted in the post. It's a bit far-fetched to take it as signifying my rejection of conventional economics -- except , of course,if you think that conventional economics believes only monetary incentives matter.

    My initial comment was a hypothesis. I am hoping that Fryer's little 'experiment' would either prove me right or wrong -- and I'm happy either way!

  5. I really like this article, v interesting :)

    Tirta, I think you hit the nail on the head. If economists had a better way of generally modelling human decisions in a relatively simple manner they'd use it. I don't think homoeconomicus is something economists cling onto for dear life, but as you say, it's the best worst solution available.

    I think ppl are too focused on emotions and complicated psychological factors when modelling decisions nowadays. What about the influence of personal experience on decisions (information sets)? Something which has been around in economics for years.

  6. arya:

    "...except , of course, if you think that conventional economics believes only monetary incentives matter."

    of course not. but i do think that economics is most accomplished in talking about the monetary hypothesis. psychology is far behind in terms of elegant theories and models, despite a century of efforts looking at various non-monetary incentives.

    as for your over-analyzing remark, i heartily accept the rebuke ;-)


    i have nothing against economists taking emotion and intuition more seriously. the problem for me is the addiction of some in scanning as many brain as possible, without enough thinking about the theoretical basis of the two mental elements.

  7. "there's a lot of irrationality and emotion going on in Wall Street " not anymore, there's a "Circuit Breaker" now. any significant drop in one day the system will halt. in long term, irrationality and emotion may disappear. i hope so.