Libertarian economists such as Gary Becker have been aggressively promoting free markets based on a mathematical vision of rational decision making. Needless to say, this vision could only apply to ultra-logical people like Mr. Spock - the notorious Homo economicus. Becker and others have used this model to defend free markets and "colonize" other academic disciplines like political science and psychology. Needless to say, a well-deserved backlash was coming. And as backlashes tend to do, it went way to far. The discipline of behavioral economics looks at how real humBut rather than try to understand the rich and powerful thought processes of real humans, most behavioral economists tilt towards the opposite extreme. They pronounce humans as irrational and filled with hidden biases. Homo economicus has been replaced by Homo irrationalus. That's a decent way to score a zinger against Gary Becker, but a poor way to make scientific progress.
Case Study: The Endowment Effect
That's unfortunate because the real story of human nature is far more interesting than either extreme. Consider the case of loss aversion. In a classic experiment which has been replicated hundreds of times, students were randomly given free coffee mugs. The mug-less students were asked how much they would pay to get a mug and the students with mugs were asked how much they would want in order to sell their mugs. It turns out that students with mugs wanted an average of about twice as much as the mug-less students were willing to pay! This goes by the name of loss aversion, the endowment effect, and the status quo bias. It is labeled a bias because a self-respecting member of Homo economicus would think about how often he drinks coffee, how often he does the dishes, and how many mugs he currently has. Based on this analysis he would put a price on a new coffee mug. That price would not influence by whether or not he just got a mug for free. But in fact this behavior is rational.
The method behind our seemingly irrational madness is found in a classic problem in game theory - the game of hawks and doves. Hawk and dove are different strategies people can use when they are in a conflict over a prize. The prize could be anything. For butterflies it could be a sunlit leaf because male butterflies have more mating success when they occupy such a position. For feral horses it could be a pool of water (Herb Gintis reviews the literature in The Bounds of Reason). Doves are sharers. When two doves see a prize they will share it. When two hawks see a prize they will fight over it. When a hawk meets a dove the dove will yield the prize to the hawk. A world of all doves is basically a communist utopia where everyone shares everything. It is also efficient because people maximize the use of available resources (prizes). The problem is that it is not what biologists and game theorists call an evolutionary stable strategy. It can easily be invaded by hawks. The first person to switch to the hawk strategy will get the entire prize without cost wherever he goes. Over time more and more and people will play hawk. That's inefficient because the cost of fighting must be subtracted from the value of the prize.
We have a problem. A world with doves is efficient but unstable. A world with hawks is inefficient but stable. The evolutionary biologist John Maynard Smith found the answer - the bourgeois strategy. That means "play hawk when you own the prize and dove when someone else does." A world of bourgeoisie is efficient because it eliminates fighting as effectively as the dove strategy. It is also an evolutionary stable strategy that cannot be invaded by hawks. That's because hawks are basically parasites on doves - they need the free prizes to offset the cost of fighting. A necessary consequence of adopting the bourgeois strategy is that people will value prizes that they own more than prizes that other people own. That's the real reason for loss aversion. It is not a "bias" but an efficient and stable strategy that provides the strategic foundation for the rule of law. The cost of enforcing the law goes up with the number of people who are trying to break it. If people did not have a sense of loss aversion then there would be more useful trades - but there would also be conflict and fighting over prizes.
Further Reading
The endowment effect is merely one finding of many coming out of behavioral economics but virtually all of them have a rational basis. The accessible Gut Feelings by Gerd Gigerenzer is a great place to read more deeply. Gigerenzer has had a running debate with Kahneman and Tversky about the proper interpretation of behavioral economics and makes many points similar to the one's I've made above. It is the book that Blink should have been. See my review of Moral Sentiments and Material Interests for a defense of strong reciprocity against either altruism or selfishness.
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