PraisingÂ Maurice Allais as the father of behavioural economics rather than Kahneman andÂ Tversky, Â John Kay introduces us to some of Allais’ ideas while simultaneously providing one of the finest arguments against the simplistic view of behavioural economics as the study of irrationality:
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.Â [â€¦]
The [behavioural economics] 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”. [â€¦]
Allais was less concerned to show that our behaviour was irrational than to argue that the premises of rationality itself were irrational.Â [â€¦]
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. [â€¦]
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.
The example Kay uses is a bit glib but does serve its purpose.That last paragraph, however, is the crux of it all.Â As you may have guessed, this is the Allais that designed the Allais paradox — an experiment in behavioural economics that shows the above wonderfully.
In light of the ongoing debate with regards to the financial sector’s so-called ‘bonus culture’, economist John Kay looks briefly at the history of the bonus and why the idea of a ‘bonus culture’ is a “poor joke” (using the example of teacher and doctor bonuses).
At one time, the offer and receipt of a gratuity was a statement of social and economic superiority on the part of the giver, its acceptance a statement of social and economic inferiority on the part of the recipient. To be salaried â€“ to be trusted to do the job for which you had been contracted and paid â€“ was a mark of status. Contractually agreed performance-related pay â€“ commissions and piece work â€“ was widespread in shops and factories, but has now largely been abandoned.
The common outcome was that employees came to care more about the quantity of the product than its quality. The system polarised the conflict between the interests of the organisation and of those who worked in it. [â€¦]
Teachers and doctors strongly resist the introduction of a bonus culture: not just because they resent measurement of performance and accountability for their activities [â€¦] but because they oppose importing the culture of assembly lines. They fear an environment in which they would be encouraged to focus on narrowly quantifiable objectives at the expense of the underlying needs of clients.
Even if many teachers and doctors are incompetent and lazy, many others are seriously committed to the organisations for which they work, the subjects and specialisations to which they are devoted, and to a broader sense of professional ethics: and it is only people like these who establish the kinds of schools and hospitals we want as parents or patients.
My current read, The Truth About Markets/Culture and ProsperityÂ (UK/US title respectively), is a thoroughly enjoyableâ€”if occasionally dense and dryâ€”introduction to economic theories and applications. Published in 2003, it’s aged fairly well.
I felt the need to share this two-paragraph excerpt from a section discussing “large models purportedly descriptive of entire economic systems” (pp. 193-194):
The error of principleâ€”the reason these models will never be usefulâ€”is best exposed by Jorge Luis Borges’ story of mapmakers who competed to build the best possible map. They eventually understood that the most accurate map simply replicated the world. The search for realism destroyed the purpose of the map. A map is valuable precisely because it simplifies and omits. Economic models are maps for the market economy. A map can be false but never true. Our criterion for selecting among maps that are not false isÂ usefulness, and a map can be too detailed or not detailed enough. We seek the simplest map adapted to our purpose, and it is a different map if we are walking or driving: not better or worse, but more fitted for its use. The London Underground map is a brilliant design for its purpose but useless to pedestrians. The ‘little stories’, or economic models, of this book are to be judged in theÂ sameÂ way.
I once debated the relationship between the social sciences with some anthropologists. We adjourned to the pub, and someone bought a round of drinks: the discussion naturally turned to the reasons why. For the economists, the explanation was obvious: the practice of buying rounds minimized transaction costs, reducing the number of exchanges between the patrons and the bar staff. The anthropologists saw it as an example of ritual gift exchange and described the many tribes that had developed similar customs. I proposed a test between the competing hypotheses: did you feel cheated or victorious if you bought more rounds than had been bought for you? Unfortunately, the economists and the anthropologists gave different answers to that question.