Decision Quality Blog

David Brooks is jumping, at least modestly, on the behavioral economics bandwagon in an editorial in today’s NYT.

Roughly speaking, there are four steps to every decision. First, you perceive a situation. Then you think of possible courses of action. Then you calculate which course is in your best interest. Then you take the action.

Over the past few centuries, public policy analysts have assumed that step three is the most important. Economic models and entire social science disciplines are premised on the assumption that people are mostly engaged in rationally calculating and maximizing their self-interest.

But during this financial crisis, that way of thinking has failed spectacularly. As Alan Greenspan noted in his Congressional testimony last week, he was “shocked” that markets did not work as anticipated. “I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms.”

So perhaps this will be the moment when we alter our view of decision-making. Perhaps this will be the moment when we shift our focus from step three, rational calculation, to step one, perception.

As someone who got hid first deep immersion into the finer points of decision making in 2001, I say welcome to the party.  The idea that we’re all “Econs”, to trade on a favorite diminutive of the Nudge guys, and that markets actually behave in reality like they do in theory, is so weirdly laughable it’s almost quaint.

The truth is, we humans are pretty awful decision makers, judging by both the way we go about it and the results we produce. The single biggest explanation is that we fall too easily into thinking traps or what psychologists call “cognitive biases.”  These mental short cuts and short hands cause us to wander off in all sorts of unproductive directions when it comes to making difficult decisions. Here’s a list of some common ones . . .

• Plunging in: Beginning to gather information and reaching conclusions without any thought to what problem you’re really trying to solve and what alternatives you should be considering.
• Frame Blindness: Working on the wrong solution because you didn’t take time to define the right problem.
• Frame Stickiness: We see our situations through one frame at a time. Once we lock into a frame, we tend to stay there. Most problems should be examined through more than one frame.
• Lack of Frame Control: Failing to proactively frame the problem in multiple ways; being duly influenced by the frames of others.
• Incrementalism: making small and often meaningless changes to previously considered alternatives and thinking it’s a new alternative.
• Jumping at the first possible solution.
• Over-valuing alternatives presented by others, particularly by “experts.”
• Overworking the problem so that when you finally get around to choosing, one or more of the alternatives are now gone.
• Sunk Costs: Protecting earlier choices, even if they were bad choices, even if the conditions under which they were good choices no longer exist.
• Intangibles: ignoring or giving undo weight.
• Neglecting the values of a key constituency.

For more on decision making, try some of these links

Tags: Nudge, Richard Thaler, Cass Sunstein, Alan Greenspan. Fooled by Randomness, Nassim Nicholas Taleb, Kevin Hoffberg