Where do great ideas come from? A popular notion among creativity experts is that recombination of preexisting ideas in a new context is the form that most if not all creativity takes. One more datum: Courtesy of my lovely wife, it seems that George Lucas may have been voguing, so to speak, when he came up with one of his most iconic images.
I just saw a recent article in the Chronicle of Higher Education on the emerging field of neuroeconomics. Unlike behavioral economics, where ideas from psychology have been ported over to economics to explain various individual “anomalies” in choice behavior, in neuroeconomics much of the intellectual traffic has gone in the other direction–economic modeling tools are helpful in understanding psychological processes (including where those processes deviate from classic economic theory). The axiomatic approach to choice makes it a lot easier to parse out how the brain’s actual mechanisms do or don’t obey these axioms.
An important guy to watch in this area is Paul Glimcher, who mostly stays out of the popular press but is a hardcore pioneer in trying to create a unified (or “consilient”) science encompassing neuroscience, psychology, and economics. I’ve learned a lot from reading his Foundations of Neuroeonomics (2010) and Decisions, Uncertainty, and the Brain (2004): why reference points (as in prospect theory) are physiologically required; how evolutionary theory makes a functionalist and optimizing account of brain behavior more plausible than a purely mechanical, piecemeal, reflex-type theory; why complementarity of consumption goods presents a difficult puzzle for neuroscience; and much more.
An article in today’s New York Times highlights a dramatic increase in the price of generic ointments over the last few years — generics have gone up 6 to 7 times their 2008 prices. Here is a chart showing the climb in prices for a few products. Before you say, this is clearly fallout from the new healthcare law, the article doesn’t point to any change in legislation covering ointments. In fact, there is a certain amount of puzzlement over why prices have gone up so much.
They note that doctors are not price sensitive when they write prescriptions and patients do what doctors recommend — that’s nothing new.
It turns out that regulation for generic skin treatments is more stringent than other generics because they must demonstrate that products are absorbed as well as the original treatments. This, more costly process creates higher entry barriers for generic ointments Read the rest of this entry »
For an economist studying business strategy, an interesting puzzle is why businesspeople, analysts, and regulators often don’t seem to perceive the fungibility of payments. Especially in dealing with bargaining issues, a persistent “optical illusion” causes them to fetishize particular transaction components without recognizing that the share of total gain accruing to a party is the sum of these components, regardless of the mix. Proponents of the “value-based” approach to strategy, which stresses unrestricted bargaining and the core solution concept, ought to be particularly exercised about this behavior, but even the less hard-edged V-P-C framework finds it difficult to accommodate.
- There’s been some noise lately about U.S. telecom providers cutting back on the subsidies they offer users who buy smartphones. None of the articles address the question of whether the telecom firms can thereby force some combination of a) Apple and Samsung cutting their wholesale prices and b) end users coughing up more dough for (smartphone + service). The possibility that competition among wireless providers fixes the share of surplus that they can collect, so that cutting the phone subsidy will also require them to cut their monthly service rates, is never raised explicitly. There is a pervasive confusion between the form of payments and the total size of payments.
Last week I had the great good fortune to attend the Max Planck Institute at Leipzig’s first conference on Rigorous Theories of Business Strategies in a World of Evolving Knowledge. The conference spanned and intense four days of presentations, exploration, and discussion on formal approaches to business strategy. Participants were terrific and covered the scholarly spectrum: philosophers, psychologists, game theorists, mathematicians, and physicists. Topics included cooperative game theory, unawareness games, psychological micro-foundations of decision making, and information theory. It was heartening to see growth in the community of formal theorists interested in strategy and my guess is that the event will spawn interesting new research projects and productive coauthoring partnerships. (Thanks to our hosts, Jurgen Jost and Timo Ehrig for organizing and sponsoring the conference!)
If one had to pick a single, overarching theme, it would have to be the exploration of formal approaches to modeling agents with bounded rationality. For example, I presented on subjective equilibrium in repeated games and its application to strategy. Others discussed heuristic-based decision making, unawareness, ambiguity, NK-complexity, memory capacity constraints, the interaction of language and cognition, and dynamic information transmission.
Over the course of the conference, it struck me just how offensive so many of my colleagues find the rationality assumptions so commonly used in economic theory. Of course, rational expectations models are the most demanding of their agents and, as such, seem to generate the greatest outrage. What I mean to convey is the sense that displeasure with these kinds of modeling choices go beyond dispassionate, objective criticism and into indignation and even anger. If you are a management scholar, you know what I mean.
Thus, at a conference such as this, we spend a lot of time reminding ourselves of all the research that points to all the limitations of human cognition. We detail how humans suffer from decision processes that are emotional, memory constrained, short-sighted, logically inconsistent, biased, bad at even rudimentary probability assessment, and so on. Then, we explore ways to build formal models in which our agents are endowed with “more realistic” cognitive abilities.
Perhaps contrary to your intuition, this is heady stuff from a modeler’s point-of-view: formalizing stylized facts about real cognition is seen as a worthy challenge … and discovering where the new assumptions lead is always amusing. From the perspective of many management scholars, such theories are more realistic, better able to explain observations of shockingly stupid decisions by business practitioners and, hence, superior to the silly, overly simplistic models that employ a false level rationality.
I am not mocking the sentiment. In fact, I agree with it. Indeed, none of the economists I know dispute the fact that human cognition is quite limited or that perfect rationality is an extreme and unrealistic assumption. (This isn’t to say there aren’t those who believe otherwise but, if there are, they are not acquaintances of mine.) On the contrary, careers have been made in game theory by finding clever ways to model some observed form of irrationality and using it to explain some observed form of decision failure. If this is the research agenda then, surely, we have hardly scratched the surface.
Yet, as I thought about it during the MPI conference last week, it dawned on me that our great preoccupation with irrational agents is misdirected. That animals as cognitively limited as us often, if not typically, fail to achieve rational consistency in our endeavors is no puzzle. What else would you expect? Rather, the deep mystery is how agents so limited in rational thought invent democracy, create the internet, land on the moon, and run purposeful organizations that succeed in a free market. Casual empiricism suggests that the pattern of objective-oriented progress in the history of mankind is too pervasive to ascribe to dumb luck. Even at the individual level, in spite of their many cognitive failings, the majority of people lead purposeful, productive lives.
This leads me to remind readers that economists invented the rational expectations model precisely because it was the only option that came anywhere close to explaining observed patterns in economy-level reactions to changes in government policies. This, even though the perfect rationality assumption is axiomatically false. There you have it.
Which leaves open the challenge of identifying which features of human cognition lead to persistent patterns of success in highly unstable environments. I conjecture that our refined pattern recognition abilities play a role in this apparent miracle. Other candidates include our determination to see causality everywhere we look as well as our incredible mental flexibility. Social factors and institutions must be involved — and, somewhere in there, a modicum of rationality and logic. After all, we did invent math.
I’m seeing more and more work using Mechanical Turk as a subject pool. Here’s another piece discussing some of the features, advantages and problems with Mechanical Turk – Rand, D (2011), The promise of mechanical turk: how online labor markets can help theorists run behavioral experiments, Journal of Theoretical Biology.
Combining evolutionary models with behavioral experiments can generate powerful insights into the evolution of human behavior. The emergence of online labor markets such as Amazon Mechanical Turk (AMT) allows theorists to conduct behavioral experiments very quickly and cheaply. The process occurs entirely over the computer, and the experience is quite similar to performing a set of computer simulations. Thus AMT opens the world of experimentation to evolutionary theorists. In this paper, I review previous work combining theory and experiments, and I introduce online labor markets as a tool for behavioral experimentation. I review numerous replication studies indicating that AMT data is reliable. I also present two new experiments on the reliability of self-reported demographics. In the first, I use IP address logging to verify AMT subjects’ self-reported country of residence, and find that 97% of responses are accurate. In the second, I compare the consistency of a range of demographic variables reported by the same subjects across two different studies, and find between 81% and 98% agreement, depending on the variable. Finally, I discuss limitations of AMT and point out potential pitfalls. I hope this paper will encourage evolutionary modelers to enter the world of experimentation, and help to strengthen the bond between theoretical and empirical analyses of the evolution of human behavior.
But how do we get from “that was a bad idea” to “Reed Hastings doesn’t understand what business he’s in?” When internet commentators see odd behavior that they don’t understand, why do they assume that the most parsimonious explanation is that management must be a bunch of drooling morons?I mean, Reed Hastings did manage to build this rather large and successful business that killed off one of the most successful retail operations of its day. It’s possible that he just sort of did this by accident. But is this really the most likely explanation? That he didn’t understand the first thing about how people watched movies, or how to run a business?The available evidence seems to indicate that at some point, Reed Hastings was a smart guy. Smart enough to count to twenty with his shoes on. Smart enough read pages 1-15 of the kind of introductory strategy text where they solemnly tell you to figure out what business you’re really in. Smart enough to grind Blockbuster into a pile of gleaming blue-and-white sand while launching a streaming service so popular that it now accounts for something like 20% of peak-load internet traffic. If you want to write an article on how he’s a big fat idiot who couldn’t find his ass with both hands in the dark, then you should probably have a theory of the transition between these two states of Reed Hastings. Did he suffer a stroke? Start dating distractingly gorgeous supermodels? Has he been licking the paint chips in his gloriously restored Victorian mansion?
I too have been guilty many time at looking in the rear-view mirror and wondering what the executives were smoking? Megan’s point is that we are not giving the executives the benefit of the doubt – that these decisions are sometimes made with a limited choice set and very limited information. On the other hand I wish we could put data flight recorders in the C-Suite – this way we would know for sure that a problem was preventable and avoidable and entirely based on bad human judgement and decisions making –> case-in-point the Air France 447 disaster.
This morning, my colleague Josh Gans and I sat in on a general audience talk by Daniel Kahneman about his new book Thinking Fast and Slow. It was interesting to see how the research agenda has progressed and evolved over the past couple of decades. This idea explored in this book, and in the talk, is that cognition can be broken into two “systems” — one that responds instantly and without effort and another that responds with will and effort. The example given to distinguish between the two was being asked to answer the following questions: (a) what is 2 + 2? and, (b) what is 17 x 24? The first comes unbidden and effortlessly to mind. The second requires conscious effort (which has several physiological traits associated with it, such as significant pupil dilation).
Kahneman is a terrific speaker and these issues are inherently fascinating. One of the examples raised a puzzle in Josh’s mind. The example is asking air travelers whether they want to buy insurance. When asked how much they are willing to pay for $100,000 worth of life insurance for an upcoming flight covering death due to any reason, subjects report a number. When asked how much they are willing to pay for $100,000 worth of insurance for death due to a terrorist attack (only), they report a substantially higher number. The reason given for this is that the “fast” system associates terrorism with fear and fear motivates higher willingness to pay for insurance.
The puzzle is: why do insurance companies specifically exclude terrorist acts from life insurance policies? Presumably, a”slow” thinking group of insurance executives could cash in on the “fast” thinking bias of travelers by inducing impulse purchases of terrorist insurance at ticket kiosks at the time of check-in. Yet they don’t. Having recently had some problematic insurance company dealings, Josh’s “fast” thinking answer was that insurance company execs are not very skilled decision makers. I am open to a more rational reason, though I cannot think of what it would be.
The latest issue of Strategic Management Journal is a special issue on “behavioral strategy.” The special issue has a piece on “neurostrategy” by Thomas Powell, Dan Levinthal discusses whether there’s even an alternative to behavioral strategy, Chris Bingham and Kathy Eisenhardt write about “rational heuristics,” Bardolet, Fox and Lovallo develop a behavioral perspective on corporate capital allocation, etc. Check it out.