The Mind of the Market: through chapter five

While reading Michael Shermer's The Mind of the Market: Compassionate Apes, Competitive Humans, and Other Tales from Evolutionary Economics, I suddenly realized that the terms Shermer was teaching readers about in chapter five were mostly familiar terms from psychology and probability.

Some of them I learned at MIT, but I also read about many of these terms in a book this year or last year -- and I can't remember what book and it's driving me crazy! Maybe it was Tim Harford's The Logic of Life: The Rational Economics of an Irrational World? Or Michael Mauboussin's More Than You Know: Finding Financial Wisdom in Unconventional Places? Or Marshall Goldsmith's What Got You Here Won’t Get You There: Discover the 20 Workplace Habits You Need to Break?

I just don't know, so I thought I would write a bit about each chapter of The Mind of the Market -- since the whole purpose of starting this blog is to help me remember what I've read and what I've learned from reading.


So here we go...

I've already summarized the prologue, Economics for Everyone, and chapter one, The Great Leap Forward, so let's start with chapter two, Our Folk Economics. Chapter two feels like a book report on the history of free market economics. The books mentioned through chapter two include:

• On the Origin of Species: By Means of Natural Selection by Charles Darwin
• Atlas Shrugged by Ayn Rand
• Human Action: A Treatise on Economics by Ludwig von Mises
• The Origin of Wealth: Evolution, Complexity, and the Radical Remaking of Economics by Eric Beinhocker
• Socialism by Ludwig von Mises
• The Wealth of Nations by Adam Smith
• Mutual Aid: A Factor of Evolution by Pyotr Kropotkin

I'm not complaining -- I didn't know much about the free market theory and I've only taken a handful of economics courses between high school and college so I found it very educational.

Still, chapters one and two feel like a two part introduction to the book (three parts if you include the prologue) and sets up Shermer's argument that economies are "complex adaptive systems" (CAS) -- "systems in which individual particles, parts, or agents interact, process information, learn, and adapt their behavior to changing conditions" -- and that we all owe our faulty economics instincts to our species' rapid evolution.

Chapter three, Bottom-Up Capitalism, continues with the book report -- William Paley's Natural Theology, Adam Smith's The Theory of Moral Sentiments and Frederic Bastiat's The Petition of the Candlemakers -- and again I'm thankful for the education on the history of free market theory. Shermer teaches us that Charles Darwin (Origin of Species) was arguing with William Paley (Natural Theology), who was arguing against Adam Smith (The Wealth of Nations), who was arguing against the mercantilists ("the belief that nations compete for a fixed amount of wealth in a zero-sum game"). This reminded me that I'd like to read Robert Wright's Nonzero: The Logic of Human Destiny (click here to view the table of contents and excerpts).

Anyway, the mercantilists of Smith's time believed in reducing or eliminating competition from foreign producers. Today we call that "fair trade" or the "favorable balance of trade" add the government uses a myriad of ways to intervene in the economy:

• tax favors for businesses
• tax subsidies for corporations
• regulations: to control prices, imports, exports, production, distribution, and sales
• licensing: to control wages and protect jobs
• taxes: through terms like "duties," "imposts," "excises," "tariffs," "protective tariffs," "import quotas," "export quotas," "most-favored nation agreements," "bilateral agreements," and "multilateral agreements"

Chapter three also discusses the Sherman Antitrust Act of 1890 -- which I hadn't thought about since taking AP US History as a high school junior -- which allows the government to indict individuals and companies on one or more of four crimes:

1. price gouging: charging more than the competition
2. cutthroat competition: charging less than the competition
3. price collusion: charging the same as the competition
4. monopoly: having no competition

The story of Charles Martin Hall's Aluminum Company of America (founded as the Pittsburgh Reduction Company and now known as Alcoa), which produced aluminum through a process far cheaper than otherwise available at the time. Hall found that aluminum was produced as byproduct of passing an electric current through a bath of cryolite and aluminum oxide. The Justice Department charged the company's directors with 140 criminal counts, including excessive prices when Alcoa in fact lowered prices dramatically.

Of course the example we all know of is the Microsoft Internet Explorer antitrust suit (bundling Internet Explorer with Windows and partnering with AOL, IBM, Intel, Compaq and others which "compelled Netscape to stop charging for Navigator).

The Wal-Mart tidbits from chapter three were also interesting:

By employing 1.3 million people (about as many as the military), and keeping retail prices low through quantity purchasing, a McKinsey & Company study estimated that Wal-Mart alone accounted for a whopping 13 percent of U.S. productivity gains in the second half of the 1990s. As the savvy social commentator and political analyst George Will noted, for every fifty retail jobs that Wal-Mart caused to be lost among its competitors, it created a hundred new jobs at Wal-Mart, making it "about as important as the Federal Reserve in holding down inflation."

I still haven't figured how I feel about Wal-Mart (especially after learning about the massive subsidies Wal-Mart receives from local and state governments) but I'd like to learn more about the economics of Wal-Mart.

Also in chapter three, Shermer quotes Nobel laureate economist Edward C. Prescott that the government's job is "to provide the opportunity for people to seek their livelihood on their own terms, in open international markets, with as little interference from government as possible" and not "to protect U.S. industry, employment, and wealth against the forces of foreign competition." Prescott's research found that "those countries that open their borders to international competition are those countries with the highest per capita income" and that open economic borders are "the key to bringing developing nations up to the standard of living enjoyed by citizens of wealthier countries" (the Treaty of Rome -- originally France, Italy, Belgium, West Germany, Luxembourg and the Netherlands -- and the subsequent increase in productivity compared with Denmark, Ireland and the United Kingdom).

Chapter three closes with the thought that anarcho-capitalism (the belief that political systems will eventually fall into disuse) and other free-market extremists are impractical as:

we need political states based on the rule of law, with property rights, a secure and trustworthy banking and monetary system, economic stability, a reliable infrastructure, protection of civil liberties, a clean and safe environment, and various freedoms . . . a robust military for protection of our liberties from attacks by other states . . . a potent police force for protection of our freedoms from attacks by other people within the state . . . a viable legislative system for establishing fair and just laws . . . and an effective judicial system for the equitable enforcement of those fair and just laws.

The best politico-economic system to date is a liberal democracy and free market capitalism, or democratic-capitalism. In a system of democratic-capitalism, social liberalism and fiscal conservatism is a synergistic marriage that leads to the greatest prosperity, the greatest liberty, and the greatest happiness for the greatest number.

In case you couldn't tell, I liked chapter three -- I'm not sure I agree with Shermer on all his points but I still found it educational.

Chapter four, Of Pandas, Products, and People, starts out with Shermer's ode to cycling -- Shermer uses the massive changes in cycling technology during the mid-1980s through today to discuss how markets change. Also in this chapter Shermer explains many economics and evolutionary terms:

• path dependency: "where markets become dependent on the paths they are already in"
• historical lock-in: where markets "become locked into the channels in which they are operating"
• bandwagon effect: where customers "gravitate toward products that they think will most likely become readily available"
• network effect: "when producers and retailers, anticipating the bandwagon effect, produce and stock up on the products that they think will be most in demand by consumers"
• Nash equilibrium: where "two or more players reach an equilibrium where neither one has anything to gain by unilaterally changing strategies"
• Pareto efficient: allocation of resources is Pareto efficient when markets reach an equilibrium where an optimum level of win-win and win-no-lose trades (versus win-lose and no-lose-lose trades) is reached (where no further trades could be made without someone losing)
• Evolutionary Stable Strategies: a strategy that when adopted by a population of individuals consistently outcompetes alternative strategies
• exaptation: "a feature that originally evolved for one purpose is later co-opted for a different purpose"
• continuities:"a contiguous and constant connection to the past, as change occurs gradually over time"
• discontinuities:"breaks from the past as change occurs suddenly and dramatically over time"

Shermer's discussion of the QWERTY keyboard is fascinating. We've all been told that QWERTY was designed to slow down 19th century typists (who would jam the typewriters if they typed too fast). And (according the Shermer), more than 70% of English words can be produced with the letters DHIATENSOR but most of these letters are not in a "strong striking position" (home row struck by the strong first two fingers of each hand) and all vowels are removed from the strongest striking positions. Only about 100 words can be typed exclusively on th home row and the (typically weaker) left hand is required to type over 3,000 words alone (without use of the right hand). And the home row includes the alphabetic sequence DFGHJKL (minus the vowel I).

Yet the Dvorak Simplified Keyboard (DSK), which is supposedly much better, has never quite caught on. Historical research (according to Shermer) says that the inventor of QWERTY (Christopher Latham Sholes) designed his typewriter to separate keys whose type-bar letters (frequent letter pairs like T and H) were close to each other underneath the typewriter carriage. Shermer argues that "QWERTY may be suboptimal, but it is no less so than its erstwhile competitors."

Chapter five, Minding Our Money, is all about psychology and probability terms.

• cognitive dissonance: "mental tension created when a person holds two conflicting thoughts simultaneously" (Shermer uses the example of rationalizations that doomsday cults make when their prophecies don't come true)
• inattentional blindness: when attending to one task, many of us become blind to dynamic events (the gorilla suit during a basketball game is the typical example used and Shermer uses it)
• blind spot bias: when people recognize the existence and influence of biases in others but fail to see those same biases in themselves
• introspection illusion: how "people trust themselves to employ the subjective process of introspection but do not believe that others can be trusted to do the same"
• self-serving bias: "we tend to see ourselves in a more positive light than others see us"
• attribution bias: the tendency to accept credit for good behavior but to allow the situation to account for bad behaviors
• framing: that whether choices are "framed" as penalties or rewards affects one's decisions
• representative fallacy: "an event is judged probable to the extend that it represents the essential features of its parent population or generating process"
• availability fallacy: "we assign probabilities of potential outcomes based on examples that are immediately available to us, which are then generalized into conclusions upon which choices are based"
• anchoring fallacy: how once an initial value is set, we are biased toward that value (so don't be afraid to be the first to throw out a number during a negotiation)
• hindsight bias: "the tendency to reconstruct the past to fit the present knowledge"
• law of small numbers: "we tend to believe that small sample sizes are representative of the larger population"
• law of large numbers: "if the numbers are large enough, the probability is that something weird is likely to happen"
• Monty Hall problem: Whether you should change your choice on the classic television game show Let's Make a Deal (three doors with a brand new car behind one door and goats behind the other two doors) after Monty Hall opens one of the doors you did not choose and unveils a goat -- you should but most people would not
• mental accounting: where we put monies into different categories depending on the frame or context
• Wason Selection Test: thought experiment "designed to test symbolic reasoning" (four cards, each with a letter of the alphabet on one side and a number on the other side, with two cards showing numbers and two showing letters such as M 4 E 7; test the rule "if there is a vowel on one side, there must be an even number on the other side" by turning over just two cards -- the answer is E and 7 but most people choose E and 4)
• endowment effect: bias toward the status quo (what you already have and must give up in order to change) versus what you might have once you choose
• sunk-cost fallacy: how "we hang on to losing stocks, unprofitable investments, failing businesses, and unsuccessful relationships" based on our past costs and not wanting to sacrifice our sunk costs
• confirmation bias: "where we seek and find confirmatory evidence in support of already existing beliefs and ignore or reinterpret disconfirmatory evidence)"
• loss aversion effect: "shows that people tend to fear losses about twice as much as they desire gains"

Whew, that took longer than I expected . . .

I will write more about the other chapters later . . .

Happy Halloween!

The Happiness Hypothesis: The Divided Self, Changing Your Mind, Reciprocity with a Vengeance, The Faults of Others

I've read the first four chapters of Jonathan Haidt's The Happiness Hypothesis: Finding Modern Truth in Ancient Wisdom and so far I'm not sure whether I like it better or the same as Authentic Happiness: Using the New Positive Psychology to Realize Your Potential for Lasting Fulfillment by Martin E. P. Seligman.

First, in Chapter One, Haidt discusses the weaknesses of the theories of rational choice and information processing in psychology. But last month I enjoyed reading The Logic of Life: The Rational Economics of an Irrational World by Tim Harford and was convinced by Harford's rational economics explanations of seemingly irrational choices (gambling, the teenage oral sex craze, crime) that are in fact logical and rational. Harford also shows that individual rational behavior doesn't always lead to socially desired outcomes.

Click here to read an excerpt from The Logic of Life from the Random House website, or click here to read a review by the NYTimes Book Review or here to read a review by the Economist.

So the first few pages of chapter one of The Happiness Hypothesis made me skeptical. But the rest of chapter one, The Divided Self, is about how the mind is divided into parts - in four ways - that sometimes conflict:

• Mind vs. Body - The Autonomic Nervous System (ANS) controls many bodily functions. The ANS is part of the peripheral nervous system and is a network of nerves that controls the organs and glands of our bodies. The ANS is independent of voluntary or intentional control. In addition, the Enteric Nervous System or "gut brain" is a network of more than 100 million neurons that processes all the food we eat and makes decisions on its own and continues to function even if the vagus nerve (which connects the "gut brain" to the brain) is severed.
• Left vs. Right - The human brain has two separate hemispheres joined by the corpus callosum, the largest single bundle of nerves in the entire body. The corpus collosum allows the brain's two halves to communicate and coordinate their activity. The left hemisphere receives nerve transmissions from the right half of your body and sends out commands to control the right half of your body; and the right hemisphere deals with the left half of your body. The left hemisphere is specialized for language processing, analytical skills, and detail-oriented activities. The right hemisphere is better at processing patterns in space particularly the face.
• New vs. Old - the limbic system emerged in the first mammals and includes the hippocampus (specialized to coordinate basic drives and motivations) the amygdala (specialized for emotional learning and responding)and other parts of the brain that a variety of functions including emotion. The frontal cortex is newer (in terms of evolution) and help us to make new associations and to engage in thinking, planning, and decision making. Those who have suffered damage to their frontal cortex are often hypersexual and aggressive. However those who have suffered damage to their limbic system become unable to make simple decisions or to set goals -- despite performing normally on tests of intelligence and knowledge of social rules and moral principles -- since their "emotional brain" can not guide them to make instant and automatic decisions and they must analyze the pros and cons of every decision.
• Controlled vs. Automatic - Controlled processing is limited since we can only think consciously about one thing at a time but automatic processes run in parallel and can handle many tasks at once. Controlled processing requires language and words to analyze and plan so is much newer (in terms of evolution) than automatic processes.

The analogy Haidt prefers to use is that our divided mind is like a rider on the back of an elephant, based on this quote from Buddha:

In days gone by this mind of mine used to stray wherever the selfish desire or lust or pleasure would lead it. Today this mind does not stray and is under the harmony of control, even as a wild elephant is controlled by the trainer.

Haidt also tells us that when you tell yourself to "not" do something (for example, "don't make a fool of yourself") this triggers automatic processes that monitor your "not" doing something (for example, finding signs of foolishness). I found this very interesting since it feels true; I have often felt that when I'm more worried or afraid that I'll embarrass myself that I'm more likely to do something embarrassing and I find that things tend to work out better when you're confident and happy.

Chapter Two, Changing Your Mind, starts with these two quotes:

The whole universe is change and life itself it but what you deem it. - Marcus Aurelius

What we are today comes from our thoughts of yesterday, and our present thoughts build our life of tomorrow; our life is the creation of our mind. - Buddha

Yes the quote from Buddha was one Haidt already used in the Introduction. But the crazy part of this chapter is the theory that we each have a like-o-meter that's always running and subconsciously decides what we like and dislike. We've all heard about the 1980s research on affective priming that showed that Americans of all ages, classes, and political affiliations react with a flash of negativity to subliminally flashed photos of black faces (as opposed to white faces).

But what I hadn't heard about what Brett Pelham's research that one's like-o-meter is triggered by one's own name!

• People named Dennis or Denise are slightly more likely than people with other names to become dentists.
• Lawrence and Laurie are more likely to become lawyers.
• Louis and Louise are more likely to move to Louisiana or St. Louis.
• George and Georgina are more likely to move to Georgia.
• And People are slightly more likely to marry people whose names sound like their own, even if the similarity is just sharing a first initial.

So Haidt concludes that life is what we decide it is, but we decide instinctively and unconsciously. But there's hope! And Haidt recommends three techniques for changing your mind:

• Meditation - A conscious attempt to focus attention in a nonanalytical way. This is more difficult than it sounds. But give it a shot. Sit still and focus your awareness only on your breathing, or on a word or phrase, or on an image, and let no other words, ideas, or images arise in consciousness. Meditation helps to change automatic processes and reduce attachments. It can reduce the frequency of fearful, negative, and grasping thoughts.
• Cognitive Therapy - This is one of the most effective treatments for depression and anxiety. Cognitive therapy works by teaching the client to be aware of their thoughts, naming the distortions, and finding alternative and accurate ways of thinking, thereby changing their automatic thoughts.
• Selective Serotonin Reuptake Inhibitors (SSRIs) - SSRIs include Prozac, Paxil, Zoloft, Celexa, and Lexapro. SSRIs can repair the minor neural damage to the hippocampus that occurs when people have high levels of stress hormones and research has shown them to be as effective as cognitive therapy. Hmm...

Chapter Three, Reciprocity with a Vengeance, starts with these two quotes:

Zigong asked: "Is there any single word that could guide one's entire life?" The master said: "Should it not be reciprocity? What you do not wish for yourself, do not do to others. - Analects of Confucius

What we are today comes from our thoughts of yesterday, and our present thoughts build our life of tomorrow; our life is the creation of our mind. - Rabbi Hillel, 1st Century BCE

I like how the one from Confucius has the same message as the often quoted "Do onto others as you would have them do onto you" from the Bible. It goes to show that the world's religions have more in common than is obvious.

Haidt says that tit-for-tat -- be nice on the first round of interaction, but after that do to your partner whatever your partner did to you on the previous round -- is built into human nature.

This chapter also teaches us that 100 to 150 is the "natural" group size within which people can know just about everyone else by name and face and know how each person is related to everyone else and that success in our ultra-social species is largely dependent on how good you are at being social ("It's not what you know, it's who you know.'").

Gossip allows us to keep track of people's reputations without having to witness them personally, which explains why we humans today live in groups larger than the "natural" size. In fact, Haidt would say that my writing this blog illustrates this idea -- that we all have an urge to tell friends and family about anything we learn that amazes or fascinates us. Gossip is overwhelmingly critical and primarily about the moral and social violations of others because it allows people to share their sense of what is right and what is wrong. Haidt believes that gossip is underappreciated and without it people would get away with selfish, rude and antisocial acts.

And finally Chapter Four, The Faults of Others, starts with these quotes:

Why do you see the speck in your neighbor's eye, but do not notice the log in your own eye? . . . You hypocrite, first take the log out of your own eye, and then you will see clearly to take the speck out of your neighbor's eye. - Matthew 7:3-5

It is easy to see the faults of others, but difficult to see one's own faults. One shows the faults of others like chaff winnowed in the wind, but one conceals one's own faults as a cunning gambler conceals his dice. - Buddha

So Haidt says that we are all hypocrites and that we enjoy condemning other's hypocrisy (gossiping) and thus compound our own. I suppose a recent example of this would be the scandal of Eliot Spitzer after he had built his career on morals and values and how outraged we all were by it.

And interestingly when Americans and Europeans are asked to rate themselves on virtues, skills, or other desirable traits (intelligence, driving ability, sexual skills, and ethics), a large majority say they are above average; but only a small majority in East Asian countries rate themselves as above average.

Similarly, Haidt discusses Roy Baumeister's theory of "the myth of pure evil" which states:

• Evildoers are pure in their evil motives - they have no motives for their actions beyond sadism and greed
• Victims are pure in their victimhood - they did nothing to bring about their victimization
• Evil comes from the outside and is associated with a group or force that attacks our group
• Anyone who questions the application of the myth is in league with evil

Hmm...this sounds a lot like the tactics used by our current President.

And Baumeister also concludes that violence and cruelty have four main causes:

• greed/ambition - violence for direct personal gain
• sadism - pleasure in hurting people
• high self-esteem - if it is unrealistic or narcissistic and easily threatened by reality
• moral idealism - the belief that your violence is a means to a moral end

Six more chapters to go!