In its early days, one feature of the research into cognitive biases was the emphasis it placed upon the fact that “experts” were as prone to error as laymen. In Kahneman and Tversky’s classic Judgment Under Uncertainty, for example, David M. Eddy showed that doctors commonly misinterpreted diagnostic probabilities, whilst Stuart Oskamp wrote that “professional psychologists are no better interpersonal judges, and sometimes are worse ones, than are untrained individuals.“ And in Human Inference, Richard Nisbett and Lee Ross said:
Sadly, though, the point seems to have disappeared in the debased form in which George Osborne understands - I use the word loosely - behavioural economics. He seems to think that irrationality is something to which only the little people are prone, and that it can be corrected by politicians and experts who are above such imperfection.
This mistaken premise leads him to some silly ideas. He writes:
1. The case for government not intervening heavily in financial markets does not rest upon the view that individuals are “always entirely rational.” Instead, it rests on the problem that policy-makers are no more able to spot irrationality and bubbles than are market participants. As Alan Greenspan famously asked: "how do we know when irrational exuberance has unduly escalated asset values"? And, indeed, he spent much of the next 10 years showing just how tricky the question is.
2. It omits a crucial distinction. Markets can go wrong not (just) because people are irrational, but because they have limited knowledge. In particular, knowledge of the future - which is the key to pricing any asset - is, as Keynes said, “usually very slight and often negligible.” But it is slight and negligible for governments too. To believe otherwise is to commit the howling cognitive error of the optimism bias.
3. There’s a category error here. Prices of financial assets are better regarded not as the discounted present value of future cash flows but as state-contingent securities. But from this perspective, there’s no such thing as “intrinsic value.” Yes, with hindsight, it might look as if markets got it wrong. But this is no proof of irrationality. For example, were share prices low a year ago because markets had irrationally over-reacted? Or were they low because they were pricing in a (small?) probability of a disaster which might, but didn’t, occur?
Sadly, Osborne’s piece does not improve. As DK and Tim point out, the examples he gives of individuals’ irrationality are pathetically weak.
All we have is an ill-founded assertion - that government, somehow, knows better than us.
Still, I’ll say one thing in Osborne’s defence. His piece is not quite as arrogant and imbecilic as this.
There is no inferential error that can be demonstrated with untrained undergraduates that cannot also be demonstrated in somewhat more subtle form in the highly trained scientist.This has not been forgotten. More recently, Philip Tetlock and Gerd Gigerenzer have shown that experts in politics and medicine still get things wrong.
Sadly, though, the point seems to have disappeared in the debased form in which George Osborne understands - I use the word loosely - behavioural economics. He seems to think that irrationality is something to which only the little people are prone, and that it can be corrected by politicians and experts who are above such imperfection.
This mistaken premise leads him to some silly ideas. He writes:
The crisis has finally put to rest the assumption, which underpinned Labour's entire system of financial regulation, that individual behaviour is always entirely rational and that market prices always reflect intrinsic values.Now, even if we leave aside the straw man, there are three problems with this claim:
1. The case for government not intervening heavily in financial markets does not rest upon the view that individuals are “always entirely rational.” Instead, it rests on the problem that policy-makers are no more able to spot irrationality and bubbles than are market participants. As Alan Greenspan famously asked: "how do we know when irrational exuberance has unduly escalated asset values"? And, indeed, he spent much of the next 10 years showing just how tricky the question is.
2. It omits a crucial distinction. Markets can go wrong not (just) because people are irrational, but because they have limited knowledge. In particular, knowledge of the future - which is the key to pricing any asset - is, as Keynes said, “usually very slight and often negligible.” But it is slight and negligible for governments too. To believe otherwise is to commit the howling cognitive error of the optimism bias.
3. There’s a category error here. Prices of financial assets are better regarded not as the discounted present value of future cash flows but as state-contingent securities. But from this perspective, there’s no such thing as “intrinsic value.” Yes, with hindsight, it might look as if markets got it wrong. But this is no proof of irrationality. For example, were share prices low a year ago because markets had irrationally over-reacted? Or were they low because they were pricing in a (small?) probability of a disaster which might, but didn’t, occur?
Sadly, Osborne’s piece does not improve. As DK and Tim point out, the examples he gives of individuals’ irrationality are pathetically weak.
All we have is an ill-founded assertion - that government, somehow, knows better than us.
Still, I’ll say one thing in Osborne’s defence. His piece is not quite as arrogant and imbecilic as this.
"All we have is an ill-founded assertion - that government, somehow, knows better than us."
Which, as we all know, has been totally disproven by the current Govt.
Posted by: Rainer Unsinn | January 29, 2010 at 03:05 PM
Markets go wrong because governments believe that can improve their outcome. Hayek demolished this notion in his essay 'the Use of Knowledge in Society'' when he said that no one person knows everything, so it is better to disperse. Socialist planning is impossible because the planning committee can not know more than the millions of people who work in the market.
Posted by: Josh | January 29, 2010 at 03:46 PM
Markets go wrong because people, and particularly those in the "Finance Industry", are entirely ignorant of what money is.
They do not understand its composition.
http://realitymoney.page.tl/
Posted by: Stanley | January 29, 2010 at 04:19 PM
I am sure he would say the same of you Chris. :o)
Posted by: Cityunslicker | January 29, 2010 at 06:29 PM
I agree with you on Osborne, and I have no faith in the Tories at all. However, I would vote for a party comprised entirely of donkeys, nay even plankton, if it could conceivably unseat the unspeakable Gordon Brown and Labour.
Posted by: Fed up with Socialism | January 29, 2010 at 08:56 PM
Markets never go wrong. You might not like what they tell, you, but boo hoo - suck it up.
Osborne is the latest in a long line of arrogant fools who thinks he knows better.
Markets reflect the waxing and waning of crowd psychology - in that much, no, they are not at all rational - but there is no bigger crowd, no bigger consensus-following organisation than government itself.
Government *always* acts too late, solving last year's problem (think Maginot Line, the reintroduction of Glass-Steagall) and so invariably exacerbates the problem they propose to solve.
Posted by: ThousandsOfMilesAway | January 30, 2010 at 12:00 PM
"Markets go wrong because governments believe that can improve their outcome."
irrastional exuberance, anyone, anyone?
Posted by: John Terry's Mum | January 30, 2010 at 02:18 PM
To paraphrase an an old folk song "I don't know where I'm going, or who's going with me". See the 1945 film which involves an ancient curse.
Posted by: Demetrius | January 30, 2010 at 03:26 PM
"He seems to think that irrationality is something to which only the little people are prone, and that it can be corrected by politicians and experts who are above such imperfection."
He should be in the Labour Party.
Posted by: ad | January 30, 2010 at 04:23 PM
Blogging is all part (letting off steam harmlessly) of the system. Articulate and intelligent people write inconsequentially of injustices and stupidities, but DO nothing.....like the guy on the couch in front of the telly!
Stop being part of the problem (elections are decided by voters who are not bloggers)and unite with others to DO something.
Posted by: Trevor Brown | January 30, 2010 at 04:47 PM
So wait... experts in decision science tells us that experts often get it wrong... and this proves... whatever Chris wants it to prove?
Posted by: Metatone | January 31, 2010 at 10:19 PM
Well Osborne has read Nudge.
I can accept the libertarian paternalism argument that says people can be influenced by non-monetary factors and that this nudging is better than coercing.
My issue with all this is that it says 'how' but not 'why'. Where is the political ideology?
What are we trying to achieve once the no brainers like 'eat fewer pies' are done with.
Posted by: alanm crisps | February 02, 2010 at 11:43 AM