The Mind of the Market
Evolutionary economics explains why irrational
financial choices were once rational
Since 99 percent our evolutionary history was spent as hunter-gatherers living in small bands of a few dozen to a few hundred people, we evolved a psychology not always well equipped to reason our way around the modern world. What may seem like irrational behavior today may have actually been rational a hundred thousand years ago. Without an evolutionary perspective, the assumptions of Homo economicus — that “Economic Man” is rational, self-maximizing, and efficient in making choices — make no sense. Take economic profit versus psychological fairness as an example.
Behavioral economists employ an experimental procedure called the Ultimatum Game. It goes something like this. You are given $100 to split between yourself and your game partner. Whatever division of the money you propose, if your partner accepts it, you are both richer by that amount. How much should you offer? Why not suggest a $90-$10 split? If your game partner is a rational self-interested money-maximizer he isn’t going to turn down a free ten bucks, is he? He is. Research shows that proposals that deviate much beyond a $70–$30 split are usually rejected.
Why? Because they aren’t fair. Says who? Says the moral emotion of “reciprocal altruism,” which evolved over the Paleolithic eons to demand fairness on the part of our potential exchange partners. “I’ll scratch your back if you’ll scratch mine” only works if I know you will respond with something approaching parity. The moral sense of fairness is hardwired into our brains and is an emotion shared by most people and primates tested for it. Thousands of experimental trials with subjects from Western countries have consistently revealed a sense of injustice at low-ball offers. Further, we now have a sizable body of data from peoples in non-Western cultures around the world, including those living close to how our Paleolithic ancestors lived, and although their responses vary more than modern peoples living in market economies do, they still show a strong aversion to unfairness.
The deeper evolution of this can be seen in the behavior of our primate cousins. In studies with both chimpanzees and capuchin monkeys, the Emory University primatologists Frans deWaal and Sarah Brosnan found that when two individuals work together on a task for which only one is rewarded with a desired food, if the reward recipient does not share that food with his task partner, the partner will refuse to participate in future tasks and expresses emotions that are clearly meant to convey displeasure at the injustice. In another experiment in which two capuchin monkeys were trained to exchange a granite stone for a cucumber slice, they made the trade 95 percent of the time. But if one monkey received a grape instead — a delicacy capuchins greatly prefer over cucumbers — the other monkey cooperated only 60 percent of the time, sometimes even refusing the cucumber slice altogether. In a third condition in which one monkey received a grape without even having to swap a granite stone for it, the other monkey cooperated only 20 percent of the time, and in several instances became so outraged at the inequity of the outcome that they heaved the cucumber slice back at the human experimenters!
Such results suggest that all primates, including us, evolved a sense of justice, a moral emotion that signals to the individual that an exchange was fair or unfair. Fairness evolved as a stable strategy for maintaining social harmony in our ancestors’ small bands, where cooperation was reinforced and became the rule while freeloading was punished and became the exception. Apparently irrational economic choices today — such as turning down a free $10 with a sense of righteous injustice — were at one time rational when seen through the lens of evolution.
Just as it is a myth that evolution is driven solely by “selfish genes” and that organisms are exclusively greedy, selfish, and competitive, it is a myth that the economy is driven by people who are exclusively greedy, selfish, and competitive. The fact is, we are both selfish and selfless, cooperative and competitive. There exists in both life and economies mutual struggle and mutual aid. In the main, however, the balance in our nature is heavily on the side of good over evil. Markets are moral and modern economies are founded on our virtuous nature. The Gordon Gekko “Greed is Good” model of business is the exception and the Google Guys “Don’t Be Evil” model of business is the rule. If this were not the case market capitalism would have imploded long ago.
February 5th, 2008 at 12:06 pm
Businesses arise not from altruism but only from a rational egoism. Altruism, by its own definition requires one to sacrifice a value for a non-value. An entrepreneur who intends to stay competitive so that he can maximize his long-run profits, must make deals that have the appearance of fairness to others, but require make no real sacrifice in his own values. Otherwise, what would be his interest in pursuing exchanges? An entrepreneur doesn’t get in business to help others, but that is the virtuous means to a rationally selfish end.
February 7th, 2008 at 10:36 am
I read “Mind of the Market” in an abandoned copy of Scientific American last night on flight that was 3 1/2 hours delayed.
It brought to mind an interesting story I had heard recently about an experiment with resources and rats. One group of rats was provided just the amount of food they needed and they all lived together happily.
Then a second population (perhaps the same?) was provided with food far in excess of their needs and immediately the some rats started to hoard the excess food and to aggressively compete with each other for it and to deny access to others.
Is this true? If it is, the lesson for evolutionary economics would seem to be clear.
February 13th, 2008 at 12:11 am
Maybe market capitalism has imploded already though some delude themselves that it has not. When an American CEO receives 60 times the pay of an average worker who is not earning an affordable housing wage yet is considered rich compared to workers in other countries, market capitalism could be considered dysfunctional.
February 13th, 2008 at 11:01 am
You condemn what you don’t understand. Is it a vice or a virtue, that the ability of one to afford valuable property (ie. a house) is determined by his ability, ingenuity, and productivity? Is it a vice or virtue, that producing “average” work should be exchanged for “average” value?
February 15th, 2008 at 7:12 am
Projecting the concepts of Evolution onto other developmental processes in life (universal or holistic Darwinism), is interesting as a phenomenon in itself. It is becoming increasingly popular as a mainstream concept. However, there are still many inconsistencies as shown in the text above.
For example:
The monkey receiving the grape does not express concern for the others outrage which makes definite conclusions about ‘reciprocal altruism’ difficult. Other factors could be involved. But in both cases, we run the risk of projecting our own perceptions or emotions onto a primate. The monkey has no way of explaining to us that his reason for being outraged was ‘at the inequity of the outcome’. We don’t speak Capuchin.
“But isn’t it obvious from his response?” is simply not a scientifically sound argument. Extrapolating such emperical observations to an ‘evolution of morality’ is questionable. In my humble opinion, much, much more research would be required with many more counterfactual investigations.
Curiously, morality issues regularly present themselves in this area of research. But how would one define a ‘moral market’? What is a ‘modern economy’? Was the economy of nazi-Germany modern? Is the market of communist North-Korea modern? Is the military goods market a ‘moral market’? Was Enron evil? Or simply possible in this economy? What about the subprime mortgage crisis? Is Google’s method of collecting consumer data justified? According to the European Union it wasn’t.
In this respect ‘morality’ seems to be, again, a matter of perception.
Nevertheless, I purchased Dr.Shermer’s book and I will undoubtedly find it an interesting read.
February 17th, 2008 at 8:40 am
Mr. Moya, along with any other Randians dropping in, might try to answer this argument: It’s Not Your Money
February 17th, 2008 at 6:56 pm
The Ultimatum Game may shed light on our sense of fair play, but has little in common with economic free trade, where the parties to a trade agree on terms before trade occurs. Economic trade requires that the parties hold different relative values for the items traded to make the trades beneficial to both.
February 29th, 2008 at 3:11 pm
Response to WMR:
When you live in a rational society, where men are free to trade, you receive an incalculable bonus: the material value of your work is determined not only by your effort, but by the effort of the best productive minds who exist in the world around you. This is an observation misunderstood and therefore misrepresented in that article you linked, “It’s Not Your Money”. This is an argument in favor of capitalism, not against.
March 5th, 2008 at 4:23 am
Countries that are on the North side are more fairer and living there is easier, the reason they provide welfare, fair exchange, social security and all sorts of socio, political and educational stability. Their transaction even is termed ‘fair exchange’ where one party to an exchange don’t feel he overly enriched himself or the other feel he is overly cheated.
These sorts of arrangments makes western societies more livable than others. I believe it is the victory of reciprocal altruism in play in such societies and the citizen find it more convenient to live there than elsewhere.
March 6th, 2008 at 11:42 am
I agree with Michael Shermer.
Every social animal is dependent on the society of its conspecifics to survive and flourish. Every social animal is faced with a dilemma that affects the survival of both the individual animal and the society. That dilemma involves the conflict between choices that benefit or harm the individual animal vs. choices that benefit or harm the group.
Some choices are clearly either good or bad for both the individual and the group; the rest involve some degree of conflict in which either the individual animal or the group is benefited or harmed at the expense of the other. This is the evolutionary basis of human morality as Michael Shermer indicates
March 10th, 2008 at 8:23 pm
The only thing the “Ultimatum Game” proves is how some scientists try to build experiences purposely made to prove their own “moral” point of view.
What if you were given $10.000.000 to split between yourself and your game partner? Is he also going to turn down free $100.000? Maybe what this research shows us is that proposals that deviate beyond a $70–$30 split are rejected because values under $30 tend to be insignificant for most people. Or maybe it’s simply showing us that an important percentage of people haven’t evolved yet to the point of being a Homo economicus…
The concepts of Fairness and Equality shouldn’t be so mixed up in the minds of people. Fairness is definitely hardwired into our brains, and we demand fairness on the part of our potential exchange partners in a sense that we want to gain something equivalent to our effort (rational egoism).
Equality only makes sense if the same cooperation effort was made by both partners. Since people normally have different capabilities, when they decide to cooperate, why should the result be shared in a equal way, approaching parity? People should cooperate only if they have something to gain that justifies their effort and shouldn’t worry if the other part gets more. From a moral point of view, that’s called jealously or, in other words, “reciprocal altruism”.
The fact is, we are usually selfish and very seldomly selfless. Choosing between cooperative or competitive behaviors depends only on our assumption of what generates a better gain/effort ratio, not on the existence of some moral definition of altruism hardwired in our brains.
The single reason why capitalism flourishes while other more “altruistic” concepts have failed is because capitalism is the most efficient way of maximizing the well being of each individual in a society by admitting our true nature (rational egoism), where individuals decide to cooperate using their own free will instead of being cohersed to cooperate, as it happens in low IQ societies existing in Nature where selflessness and altruism is a more common behavior.
March 17th, 2008 at 11:39 am
I can’t believe Shermer still thinks ‘selfish genes’ are genes that code for selfishness.
March 22nd, 2008 at 9:37 am
[…] March 22, 2008 Posted by tkcollier in Lifestyle. Tags: Psychology trackback the official site of Michael Shermer » The Mind of the Market Behavioral economists employ an experimental procedure called the Ultimatum Game. It goes something […]
March 24th, 2008 at 6:22 am
I’ll put in my “two cents”. Are we forgetting that money is the great medium of exchange that enables one to measure the value of what we give and what we get. Is it no accident that people refer to moeny as the root of all evil? Don’t lawyers always quote the phrase “the deal won’t work if its not fair to all parties”? Free markets where good old supply and demand reign is the core ruler. Isn’t irrational behavior in the eyes of the beholder?
March 24th, 2008 at 1:56 pm
From “American Mania: When More is Not Enough,” by UCLA Neurobiologist Psychiatrist Peter C. Whybrow, M.D.
Whybrow … p. 7 Adam “Smith’s economic philosophy was predicated on a dynamic balance between commercial liberty and a set of social structures that are rapidly eroding in America. Smith worried in his writings, as did many other thinkers of the time, that human envy and our tendency toward compulsive craving, if left unchecked, would destroy the empathic feeling and neighborly concerns that are essential to his economic model and a free market’s successful operation. In searching for the necessary counter-balance to this natural human avarice, Smith took comfort in the fellow-communities characteristic of the eighteenth century.
Given the social conditions that prevailed during his lifetime, Adam Smith was prescient in his judgment. Experience tells us that small markets do produce their own constraint and rational order, founded as they are on an interlocking system of self-interested exchange. However, Smith lived before the invention of the megacorporation, before instant communication with a global reach, and before the double cheeseburger and stock options.”
“In America, living with such an abundance of choice, we have discovered some disturbing facts about human behavior–facts that from knowledge of modern neurobiology are predictable and that confirm Smith’s worst fears. In times of material affluence, when desire is no longer constrained by limited resources, the evidence from our contemporary American experiment suggests that we humans have trouble setting limits to our instinctual craving.”
I will give you a quote from the last chapter page 239. “The key is relearning to focus one’s attention. The more demanding the commercial environment gets, the more essential it is to live in the moment, and to use that present moment effectively. It seems deceptively simple, but it works. I know: I’ve found the more I focus on the task at hand, the better are the choices I make. The alternative is to be overwhelmed and swept away by the maniacal excess that exists all around us–the excess of material goods, of food, of competition, and so-on.”
Jim Kawakami
April 2nd, 2008 at 3:42 pm
According to Brandon Adams, Behavioral Finance (which I would contend is a superset of evolutionary economics) is now the norm in academic economic circles:
http://www.amazon.com/Story-Behavioral-Finance-Brandon-Adams/dp/0595396909/ref=sr_1_1?ie=UTF8&s=books&qid=1207175730&sr=1-1
For a quantitive look at how evolution leads to altruistic/cooperative behavior, check out Martin Nowak’s tour de force:
http://www.amazon.com/Evolutionary-Dynamics-Exploring-Equations-Life/dp/0674023382/ref=sr_1_1?ie=UTF8&s=books&qid=1207175841&sr=1-1
And for a more comprehensive remaking of economic theory in light of the more general lessons of complex systems dynamics (of which evolution is just one part), Beinhocker:
http://www.amazon.com/Origin-Wealth-Evolution-Complexity-Economics/dp/1422121038/ref=pd_bbs_sr_1?ie=UTF8&s=books&qid=1207175986&sr=1-1
April 3rd, 2008 at 8:10 am
[…] financial decisions as well. But why so? For a simple reason: your brains are wired that way. Looking at markets and business through the lens of human cognition debunks a lot of popular myths, and provides a fresh perspective on why we act the way we do. […]
April 10th, 2008 at 11:35 pm
I’m supporting this idea all the way! I can not imagine who would disagree with it. On the whole – make posts like this more often.
April 15th, 2008 at 9:10 pm
I have always loved reading Michael Shermer, he is actually one of my heroes, but I have always known to take him with a grain of salt.
Despite his skepticism about religion, faith healers, UFos, and the like, he never manages to apply a skeptical mindset to economic theories. This is part of the larger phenominon I keep observing where self-describing lovers of science and skepticism never actually learn the need to apply the scientific method to society. Perhaps this is a failure of public relations on the part of sociology?
It is hard to believe that Michael Shermer still has faith in “free” market systems. I say this is a “faith” for 2 reasons:
1) Free markets do not exist. The term “free market” implies that markets are somehow natural and exist independently of government intervention. Nothing can be further from the truth. One of the main findings of the field of economic sociology is that markets are always products of society and cannot exist without laws and rules created by the government. The market is never natural or “free”; it is ALWAYS constructed. The system Shermer defends is not a “Free market” but actually a market that is regulated to redistribute wealth upward and concentrate power in the hands of a small ruling class. This is done either openly with corporate welfare, or more subtely with things like negative externalities or starvation wages.
2) There is very strong empirical evidence that the unregulated markets do not work. That is to say, the countries with the most unregulated capitalist economies tend to have lower standards of living, more inequality, and greater levels of poverty. We can look at data ranking industrialized nations based on percentage of GDP given to social programs. This data puts America near the bottom of the list, meaning we spend very little on welfare programs. Because of our low welfare spending, America also has one of the highest poverty rates in the industrial world. Coincidince? I think not.
July 29th, 2008 at 8:20 am
Mr Shermer has shown that he needs to be shown the door with that Article, for trying to peddle his own political views into a scientific magazine.
September 21st, 2008 at 8:08 am
Unfortunately, one must also consider the role of sex, sexual tension, and the libido – which altogether inhibits rational egoism/altruism and adds an element of unpredictability.