Making better decisions

  • Business
  • Saturday, 20 Feb 2010

The Irrational Economist: Making Decisions in a Dangerous World Editors: Erwann Michel-Kerjan and Paul Slovic Publisher: Public Affairs

FOR centuries, economics has been derided as a dismal science. But if economics is indeed a science, what exactly does it teach?

Apart from demand and supply, monetary policies, globalisation and capitalism, the integral proposition of economics is the notion that free markets are inherently rational and efficient.

What this means is that prices of stocks and financial securities reflect all available information about them.

If new information about a company becomes available, its stock price will quickly change to reflect this.

Further, it also asserts that irrational asset prices should not occur as market is rational and quick enough to adjust its overblown prices in accordance to their intrinsic values.

But is this proposition more theoretical than empirical? If it is true, why did we have the recent asset bubble? And why do we always succumb, yet again, to herd madness and end up purchasing stocks that we know are overpriced?

Or that we never seem to be able to overcome our irrational exuberance which makes us dive into the stock market even though it is irrational and we know the chances of it falling soon are high?

Such irrationality is the focus of behavioural economics, which appears to be gaining greater credibility among economists after the bubble burst in 2008.

Such, too, is the focus of The Irrational Economist, a timely compilation of articles contributed by a selected group of renowned scholars and Nobel Laureates on their views and discoveries about how to make the right decisions in an uncertain world.

But what seems like a book on irrationality and economics – as the title suggests – turns out to be anything but economics.

Although the 2008 financial turmoil was used as an example in a number of articles, it was done more under a social context rather than an economic one and it is on this premise that the concept of irrationality is being examined.

The most rewarding part of the book is the introduction.

Here, the editors write about the perils of an interconnected world, and how in a world that is full of surprises, a person who acts rationally based on his knowledge and experience often becomes a rational fool.

Such an intriguing introduction naturally gives the impression that the same can be said about the ensuing chapters.

Unfortunately, what follows is a series of academic papers that repetitively, and dully, delve more into psychological aspects of irrational decision-making.

This results in less insights as to how individuals can make the best out of the uncertainty in today’s new era by navigating both rationally and irrationally between risks and rewards.

Written by thinkers from the fields of economics and social sciences, these articles are actually quite readable if they appear individually rather than collectively.

Because it lacks a central theme to tie these articles together, the book becomes fragmentary and unsystematic.

Take, for instance, the articles titled Environment Politics, which is sandwiched between the section on the financial crisis and risk management.

Readers (myself included) reading in this order become frustrated, helpless and confused.

In addition, I find some of the articles to be repetitive and some of the issues discussed are more beneficiary to policymakers rather than ordinary folks.

For example, the subject of insurance appears in a number of articles, yet it is more about consumers’ behaviour towards insurance purchasing and policy reform, rather than the benefits insurance gives to consumers.

That said, the importance of these articles and this book is undeniable but only to policymakers, academics and management of financial institutions.

With virtuosic insights so earnestly written and thoughtfully collected, this book is a handy guide for people sitting in the ivory tower making complex business and policy decisions.

General readers who want a glimpse of the complexity of issues at play must read with unwavering patience and curiosity.

In the face of boundless wealth that has allowed extravagant spending, humans have become heedless, greedy, reckless, and their actions irrational and unpredictable.

Lest we make the same mistake again, coalescence of behavioural science into economics does seem to make a lot of sense.

However, it must not be done in a piecemeal format the way the editors Erwann Michel-Kerjan and Paul Slovic have.

With their vast experience in risk management and their forefront involvement in decision research, Michel-Kerjan and Slovic should be able to write a popular book of their own on the subject of irrationality.

The main introduction of this book and the five shorter sectional introductions that they both have written show a swift and straightforward prose that is potentially pleasing to a general audience.

An economist and a psychologist, respectively, Michel-Kerjan and Slovic hit the nail better than any of their contributors combined.

The time has come for the need to understand how people can make better decision because, despite our cerebral development, we have been acting for millions of years as irrational, unpredictable, illogical and dangerous creatures.

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