A guest review by Ian Bright
Emotions affect how people behave. People do not necessarily behave rationally as basic economic models suggest. As a result, individual transactions may not maximise utility and markets may not move towards or reach equilibrium. These statements are not controversial. Behavioural economics has been studying these effects and challenging standard economic theory for at least the past two decades.
David Tuckett argues this challenge does not go enough. He asserts (pages 12 and 13) that behavioural economics is limited. It “wants to improve the field of economics on its own terms, modifying one or two assumptions that are not central”. He argues: “A purpose of this book is to show that once uncertainty is properly included, just about everything changes.” Tuckett, a Professor of Psychoanalysis at UCL, argues: “Behavioural economists do not take anything from real life psychology and neurobiology that is relevant to the task of considering the impact on human agents, working in social groups, making decisions under uncertainty.” He focuses on financial markets, partly due to personal experience and topicality, and also because these markets are supposedly seen by economists as more rational than other markets - or at least that irrationality here can be exploited creating “a role for professional investors”.
So far, so good. But skip to page 184:
“The central implication of emotional finance is that, if the future is taken as inherently uncertain, conventional equilibrium modelling isn’t a useful way to start and, especially as far as understanding instability, isn’t helpful. Nonetheless, there may be possible ways to widen the framework of analysis to take account of my findings while still achieving a more general analytical framework. One potentially useful innovation in this area is agent-based modelling, derived from the attempts of physicists to predict the behaviour of very complex systems.”
This comes after extensive analysis of interviews with 52 international fund managers during the first eight months of 2007. Concepts such as groupfeel rather than groupthink are introduced. People and institutions are described as being in divided states, apparently as a way they try to rationalise what is actually happening with what they think should be happening. People develop stories to simplify complex decisions and cope with uncertainty. Furthermore, financial contracts have special emotional effects because they are intangible and can become ‘phantastic’ objects.
I am at a loss as to what is added by these observations. They appear to be essentially the same as well-known ideas such as herd behaviour, decision making by rules of thumb, and confirmation bias (seeking data that supports your ‘story’ and ignoring contrary evidence). And then after 180 pages, I’m anyway told that perhaps I should be reading about agent-based modelling, another familiar idea already used by a (small) number of economists.
I feel conned. Several aspects of the research approach and the argument make me uncomfortable.
Interviews can be difficult to interpret but I supposed the professor has an advantage given his professional training. Still, I was surprised to read (page 72) that only the last eight interviews were adjusted to take direct account of remuneration and performance assessment: “Because my main focus in the interviews was on describing decision making, at first I did not realise what I was seeing.” Apart from being concerned about the consistency of the “data gathering” associated with an interview technique when the questions can appear to change, I was surprised that pay was not central from the beginning.
The concept of ‘phantastic’ objects is also unconvincing. Financial products may be intangible and volatile but they are not the only objects that experience rapid price increases and declines – “bubbles” if you must. Physical items such as housing, wine, stamps and tulip bulbs have all experienced “bubbles”.
I am also concerned that Tuckett has inadvertently interviewed the wrong group of people. Fund managers were pawns in the latest financial crisis. I suspect they will be in the next as well. A more appropriate group would have been risk managers in banks and insurance companies who didn’t recognise the risks they were running, the financial engineers, derivatives traders and salespeople who made, traded and sold the complex products and the regulators and central bankers who dropped the ball. Now, there is a group for psychoanalysis.
For those who would like to hear more, the Institute for New Economic Thinking has a 15 minute video interview in which Professor Tuckett explains his ideas. It covers the main aspects of his book adequately.
I am writing in a personal capacity