In an interview on Decision-Making

So, the next book you chose, Judgment under Uncertainty, is by, amongst others, Daniel Kahneman, the psychologist who won the Nobel prize for economics, despite, he says, never taking an economics course.

This is one of the most influential books in modern economics. But first of all, it’s just this list of incredibly clever experiments. They don’t use any fancy tools, there’s no microscopes or telescopes involved: Kahneman and Tversky just asked their undergraduates hypothetical questions.

So how much would a student want in return if they were betting $1 on the flip of a coin? You can’t get a simpler question to ask in a science experiment, and yet that very simple question eventually led to a thing called ‘loss aversion’. And this is now viewed as a very important phenomenon – with implications for everything from how taxi-cab drivers think, to how people act when they evaluate their stock portfolio. So what I like about this is book is how they took these very simple protocols – really just idle conversation with students – and transformed them into the first really hard proof that people consistently violate the expectation of rational agents. That we don’t think like homo economicus at all. That our behaviour, our responses to very simple questions, don’t look at all like what a rational person would do – there are these deep inconsistent flaws in the human mind. It makes no rational sense to have such a strong loss aversion, or to be so vulnerable to any one of the long list of biases that Kahneman and Tversky demonstrated. But across all the big-end, large sample sizes, this is the way people responded. So it’s an incredibly powerful piece of work that really showed that people aren’t just occasionally irrational, they don’t just act stupidly when they’re in the midst of a bubble. Irrationality is embedded deep into our operating system.

But this is quite an academic book?

Yes it’s a very academic book. But it happens to be about as accessible as a bunch of academic papers can be, simply because it’s just fun to go through and do the hypotheticals – these questions they’re giving to undergraduates at Hebrew University in the mid-1970s – and then testing yourself against them. And the collection does a very nice job of mixing together the original papers with subsequent results in the field of economics which then take, for example, loss aversion and apply it to the real world. So you can see how this actively influences the decisions of mutual fund managers, with very important negative consequences. And this book not only pointed out this core irrationality, but really changed the economics field as well.

I think the Nobel prize speaks of the importance of the work to economics. But doesn’t it show these biases affecting all sorts of things, including potentially life-and-death medical decisions?

That’s actually an offshoot of loss aversion. So there are different ways of framing a question, and one way to demonstrate loss aversion is that the ultimate loss is, of course, death. So if you go to doctors and ask them to choose between options, and one, the riskier option, is framed in terms of saving people, and the other in terms of people dying, most doctors will risk everything on the all-or-nothing approach. Even when it’s the exact same numbers, if it’s framed in terms of death, people are twice as likely to avoid that option. Because framing the question in terms of losses, making us even think about death, is so ugly, it feels so bad to us, that the person thinks, ‘Oh I’ve got to go for the risky approach.’ [Read a more detailed explanation of the experiment here] And Kahneman and Tversky argue that it does indeed affect the way doctors discuss, for instance, cancer treatments. You can get doctors who work in cancer wards to think very differently about treatment if you frame it as a five per cent chance of surviving, or a 95 per cent chance of dying.

And, as a patient dealing with cancer, you often do have to make decisions based on statistics you are given – doctors say there’s a five per cent chance of this if you do that, or a 10 per cent chance of that if you don’t do this, and it’s all very confusing.

Yes. We’re given all these statistics, but the human mind wasn’t designed very well to deal with statistics. What we’re left with is this feeling. A feeling of either fear – that’s a risk we’re taking – or that’s a potential gain I should pursue. A lot of it really is about these emotions which, in the end, drive our decisions. So simply by reframing the question one way or the other, you can dramatically influence these feelings. Human beings really aren’t rational agents for the most part, because we’re actually being driven by these emotions triggered by dreams of losses or gains.