[Paleopsych] Business Week: (Neuroeconomics) Why Logic Often Takes A Backseat

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Why Logic Often Takes A Backseat

The study of neuroeconomics may topple the notion of rational decision-making

The National Hockey League and its players wrangle over a salary cap. The
impasse causes the season to be canceled. Everybody loses. What went wrong?

According to the new science of neuroeconomics, the explanation might lie
inside the brains of the negotiators. Not in the prefrontal cortex, where
people rationally weigh pros and cons, but deep inside, where powerful
emotions arise. Brain scans show that when people feel they're being
treated unfairly, a small area called the anterior insula lights up,
engendering the same disgust that people get from, say, smelling a skunk.
That overwhelms the deliberations of the prefrontal cortex. With primitive
brain functions so powerful, it's no wonder that economic transactions
often go awry. "In some ways, modern economic life for humans is like a
monkey driving a car," says Colin F. Camerer, an economist at California
Institute of Technology.

Until recently, economists contented themselves with observing people from
the outside. Now, Camerer and others, teaming up with psychologists and
neuroscientists, are using a technique called functional magnetic resonance
imaging to look inside the skull. It's like watching Congress debate
instead of inferring what's going on by reading the laws that get passed.

Neuroeconomics, while still regarded skeptically by mainstream economists,
could be the next big thing in the field. It promises to put economics on a
firmer footing by describing people as they really are, not as some
oversimplified mathematical model would have them be. Eventually it could
help economists design incentives that gently guide people toward making
decisions that are in their long-term best interests in everything from
labor negotiations to diets to 401(k) plans. Says Harvard University
economist David I. Laibson, another leading researcher: "To understand the
real foundations of our behavior and our choices, we need to get inside the
black box."

Neuroeconomics could also give economics an alternative theoretical
framework. Since the early 1900s, economists have mainly assumed that
people have a stable and consistent set of preferences that they try to
satisfy. When faced with an apparently illogical outcome -- such as the
cancellation of the hockey season -- they try to explain it as the result
of a reasoned decision process. Such top economists as Gary S. Becker,
Milton Friedman, and Robert E. Lucas Jr., all Nobel prize winners, have
argued that discrimination, unemployment, and stock market gyrations can
have rational origins.

In recent years, the assumption of rationality has taken some hard shots as
economists have shown that people often lack self-control, are
shortsighted, and overreact to the fear of losses. But to date, these
attacks on rationality -- under the broad heading of "behavioral economics"
-- have seemed more like a grab bag of anomalies than a consistent
alternative theory. So the assumption of rationality survives.

By linking economic behavior to brain activity, however, neuroeconomics may
finally supply the model that knocks mainstream economics off its throne.
The new theory should fit better with reality, but it won't be as
mathematically clean -- because the brain is a confusing place, with
different parts handling different jobs. Says Camerer: "You are forced to
think about a brain which has many somewhat modular circuits."

One of the most fruitful avenues of neuro research is "time inconsistency."
When people decide about the distant future, they're roughly as rational as
economic textbooks assume. But when faced with a choice of whether to
consume something now or delay gratification, they can be as impulsive as
chimps. Harvard's Laibson coined "quasi-hyperbolic discounting" to describe
the behavior, but that was just a label, not an explanation.

So Laibson and others scanned people inside MRI machines and discovered two
parts of the brain operating in radically different ways. For decisions
about the far-off future, the prefrontal cortex takes a long-term
perspective. But for decisions such as whether to buy another chocolate bar
right now, the limbic system takes over and demands immediate
gratification. Last year the journal Science published the research by
Laibson, Princeton University neuroscientists Samuel M. McClure and
Jonathan D. Cohen, and Carnegie-Mellon University economist George

How does it help to know that you're literally "of two minds"? You could
arrange your affairs to make sure that your rational brain stays in control
-- for example, by committing now to saving a certain percentage of your
paycheck each month in the future. Many people already do that. Trouble is,
long-term commitments can be too rigid if circumstances change. Ideally,
you'd like to wait to commit to a savings plan until you see whether you
can afford it -- but not wait so long that your animal brain takes over and
you lose the will to save. The new research could help get that balance

A key tenet of standard economics is that making people happy is a simple
matter of giving them more of what they like. But neuroscience shows that's
not true. The brain's striatum quickly gets used to new stimuli and expects
them to continue. People are on a treadmill in which only unexpected
pleasures can make them happier. That explains why happiness of people in
rich countries hasn't increased despite higher living standards.

Neuroeconomics also challenges the notion that emotions can only corrupt
economic decision-making. Indeed, emotions grab people's attention and
motivate them to focus their rational brains on the issue at hand, says
Antonio R. Damasio, a University of Iowa College of Medicine neurologist
who studies brain-damaged patients. In his writings, he says that people
who feel no emotions are bad at making decisions.

The most controversial aspect of neuroeconomics is what to do with its
findings. Cornell University economist Robert H. Frank favors taxation of
conspicuous consumption, arguing that flashy spending simply raises
expectations, making the rich no happier and squeezing the middle class.
Laibson, in contrast, isn't willing to go much further than using
neuroeconomics to, say, improve the default choices in 401(k)s.

Neuroeconomics has its skeptics. Richard Thaler of the University of
Chicago, a leading behavioral economist, argues that it has yet to produce
a major, surprising finding. He says he prefers to leave brain research to
the neuroscientists. But he adds: "I am a big believer in letting all
flowers bloom."

Even believers in neuroeconomics aren't sure just how far to take it.
Should economic policy satisfy the farsighted prefrontal cortex? Or should
it sometimes indulge the impulsive limbic system? By peering into the
brain, economists are making discoveries that will keep them arguing for
years to come.

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