Economic Myopia

One of the first articles I read as part of the Marketing Management course curriculum at IIMB was ‘Marketing Myopia’ an HBS article written in 1960 by Theodore Levitt. An influential article in its time it suitably impressed the novice me as well. The theme of the article is that companies should look beyond the obvious (their existing narrowly defined markets) and look for more opportunities by looking ahead in future and defining the markets as broadly as possible.

Being a student of Austrian Economics I was amused that the idea of looking beyond the obvious while readily accepted by the Marketing profession was shunned by the entire economist community (aren’t we all Keynesians) when in fact the idea was conceived much earlier in the field of economics (http://en.wikisource.org/wiki/That_Which_Is_Seen,_and_That_Which_Is_Not_Seen)

Almost all the post mortem analyses of boom and bust cycles are focused on the asset class where the bubble burst, despite the fact that in each boom and burst situation it was a different asset class which tanked. There is no problem with such analysis, if and only if it is seen as a starting point. But without exception most of the economic commentators stop short at understanding the reasons why the particular asset class suffered (CDOs/Tech Stocks/Emerging Market Bonds/Oil etc) or even worse why a particular financial institution sank #.

Such concretization is not very useful as there are thousands of asset classes (and new financial instruments keep emerging) and if the economists keep their understanding limited to what went wrong with a particular asset class at a particular point of time in history the realisation that had it not been mortgages, the cheap money would have found its way to create some other asset bubble would never dawn upon them.

What is the solution to this economic myopia? The traditional and boring one is to think in terms of abstracts, which I think is a bit difficult because “theory is not really tangible and concrete”. I am tempted to add how much I hate such proud platitudes as “economics is all gas; you need to look at the real data” and why concretized thinking is the core problem in economics, but I will not.

A more colorful solution and this comes from a person who himself doesn’t believe much in economic theory but despite his ignorance of economic theory he is still to an extent immune to economic myopia because of his habit of visualizing ‘alternative histories’, the habit of not looking at a ‘realized outcome’ without reference to the ‘unrealized outcomes’.

But again, colorful as it may seem his is not the best way to prevent economic myopia. Precisely because there is no enquiry into the underlying factors which lead to the one ‘realised outcome’, the fact that he doesn’t proceed any further, choosing rather to label the ‘generator’ unfathomable. I guess the reason is his nihilistic approach to acquisition of new knowledge, his popperian view of the world.

# I however do concede that such specific enquiries into the causes of busts have a certain value, the same value that reading history has. Barnett Hart’s thesis on the failure of CDOs is the most coherent historical account of the 2007 depression that I have come across so far - http://www.hks.harvard.edu/m-rcbg/students/dunlop/2009-CDOmeltdown.pdf

The Elevator Thumb Rule

I have been witness to an interesting social experiment for the last 6 months. It has made me realize that we are living in a society full of idiots who are surviving only because the world around us doesn't require them to think for survival.

The setting:

I stay in a multi-storey building, so you have a lift in it. Now as usual there are two buttons – one pointing up or inverted V shaped (I’ll call it UP) and the other below it pointing downwards or V shaped (I’ll call it DOWN). There is no written instruction about which one to press for going up or down. The location of the lift can be seen in the display.

For a person operating the lift for the first time there are two possible ways of going up from the ground floor – you either press UP - ‘I want to go up’ or you press DOWN - ‘I am calling the lift down’.

The elevator is indeed programmed to operate as per the first rule and not the second. However, because the lift can not read your mind it will open up in front of you no matter which button you press.

So even if a person on 5th floor presses the UP button when he wants to go to ground floor the lift will nevertheless come to 5th floor if the lift is at a lower floor and is stationary or going up. It may then continue to move upwards if it was already moving in that direction (Even if the person on the 5th floor instructs it to go down to the ground floor, quite logically) or wait for the 5th floor person’s instructions.

The observed data:

I have made close to 500 observations so far of more than 100 different people operating the lift and in more than 80% of the cases the buttons were pressed incorrectly. That is:

1. When on the ground floor, people always press the DOWN button to go up and
2. When on their respective floors, people always press the UP button to go to the ground floor (when the lift is on a floor below them)

The data as provided is completely objective with if any only a minor error of estimation.

My reactions:

At first I was plain disgusted at this stupid behavior. But later I realized that probably they are operating the lift for the first time and so haven’t yet figured out the right way to do it. But even after a few months the behavior wasn’t changed a bit, if only the incorrect behavior became more prevalent over time. Now I was perplexed – How can all the people be fooled all the time when there is no one to fool them?

From the little knowledge I have gained* about the use of heuristics by acting men, I think people form thumb rules and work according to those till the established norms are challenged by an ‘adverse event’. An equivalent of the ‘adverse event’ in a purely logical process would be – a contradiction. However, as opposed to a contradiction which may be trivial yet by its very existence sufficient to falsify a hypothesis, the ‘adverse event’# has to be significant enough to force a rethinking of the thumb rule.

So I kept condoning these little illogical acts witnessed everyday assuming that even if people operated the lift incorrectly it did not affect their lives in a significant manner. That bounded rationality saves them from overusing their brains. That their brains are hardwired to tolerate minor inconsistencies in the otherwise extremely regular workings of a lift (an artificial thing) as their forefathers had no regularity of events in their lives (except for the dawn and dusk and seasonality in climate).

But then one fine morning as I entered the lift to go down from the 9th floor to the ground floor the other occupants of the lift, a 5 yearish boy and his mother looked quite agitated. The mother addressing me complains, “As it is we are getting late, why then did the lift have to come up instead of going down!” And then it hit me, if this wasn’t an adverse event what would be? The same evening while going up from the ground floor the lift stopped on one of the floors and after the gentleman entered in, the elevator’s upward journey visibly shook him. Not to mention the realization did not dawn on him.

So after all, the ‘adverse event’ did not result in a change of heuristic. Why? After much thought I realized that it is possibly because people are not aware they are using a heuristic. The analogy in the logical/scientific process would be this – a hypothesis can only be tested using evidence if the hypothesis is identified as contingent – contingent on its validity (or invalidity/falsification). If the assumption is not recognized as an assumption and is taken to be axiomatic there is no way for the reasoning to be tested in light of a contradiction.

So what is happening here in this bizarre building is people have formed an extremely sticky heuristic which no amount of confusing behavior by the lift is able to change. Because people are not conscious of their reliance on heuristics.

Nice, neat and clean conclusion. But wait a second! What explains the high incidence of use of the incorrect heuristic?

If people are relying on heuristics which have no basis, shouldn't there be an equal incidence of correct and incorrect behavior? Why this bizarre tilt towards incorrect behavior? I had to grapple with this paradox for a few days till the eureka moment** came to me a yesterday. The high incidence is linked to the gradual increase in prevalence of incorrect behavior mentioned earlier - People were pressing the wrong button simply because others were too !! The heuristic has remained stikcy because everyone is following it at the same time notwithstanding the sporadic occourances of 'adverse events'.

So people are in fact aware of the use of heuristic ('Calling the lift'), they are either unable or unwilling to recognize the 'adverse events' as contradictions - I don't know which one!

*I have no formal knowledge of heuristics; all of it is just refined first hand observation.

# I have another term for the ‘adverse event’ – the ‘tongue burning experience’, I think this term is easier to visualize and connect.

** Personally I prefer to call moments of such revelation 'aqaba moments'. Remember the scene in Lawrence of Arabia when T.E. Lawrence spends the entire night cogitating till early morning when the crossing of Nefud desert occors to him.