The World Development Report is on cognitive economics this year!

JDN 2457013 EST 21:01.

On a personal note, I can now proudly report that I have successfully defended my thesis “Corruption, ‘the Inequality Trap’, and ‘the 1% of the 1%’ “, and I now have completed a master’s degree in economics. I’m back home in Michigan for the holidays (hence my use of Eastern Standard Time), and then, well… I’m not entirely sure. I have a gap of about six months before PhD programs start. I have a number of job applications out, but unless I get a really good offer (such as the position at the International Food Policy Research Institute in DC) I think I may just stay in Michigan for awhile and work on my own projects, particularly publishing two of my books (my nonfiction magnum opus, The Mathematics of Tears and Joy, and my first novel, First Contact) and making some progress on a couple of research papers—ideally publishing one of them as well. But the future for me right now is quite uncertain, and that is now my major source of stress. Ironically I’d probably be less stressed if I were working full-time, because I would have a clear direction and sense of purpose. If I could have any job in the world, it would be a hard choice between a professorship at UC Berkeley or a research position at the World Bank.

Which brings me to the topic of today’s post: The people who do my dream job have just released a report showing that they basically agree with me on how it should be done.

If you have some extra time, please take a look at the World Bank World Development Report. They put one out each year, and it provides a rigorous and thorough (236 pages) but quite readable summary of the most important issues in the world economy today. It’s not exactly light summer reading, but nor is it the usual morass of arcane jargon. If you like my blog, you can probably follow most of the World Development Report. If you don’t have time to read the whole thing, you can at least skim through all the sidebars and figures to get a general sense of what it’s all about. Much of the report is written in the form of personal vignettes that make the general principles more vivid; but these are not mere anecdotes, for the report rigorously cites an enormous volume of empirical research.

The title of the 2015 report? “Mind, Society, and Behavior”. In other words, cognitive economics. The world’s foremost international economic institution has just endorsed cognitive economics and rejected neoclassical economics, and their report on the subject provides a brilliant introduction to the subject replete with direct applications to international development.

For someone like me who lives and breathes cognitive economics, the report is pure joy. It’s all there, from anchoring heuristic to social proof, corruption to discrimination. The report is broadly divided into three parts.

Part 1 explains the theory and evidence of cognitive economics, subdivided into “thinking automatically” (heuristics), “thinking socially” (social cognition), and “thinking with mental models” (bounded rationality). (If I wrote it I’d also include sections on the tribal paradigm and narrative, but of course I’ll have to publish that stuff in the actual research literature first.) Anyway the report is so amazing as it is I really can’t complain. It includes some truly brilliant deorbits on neoclassical economics, such as this one from page 47: ” In other words, the canonical model of human behavior is not supported in any society that has been studied.”

Part 2 uses cognitive economic theory to analyze and improve policy. This is the core of the report, with chapters on poverty, childhood, finance, productivity, ethnography, health, and climate change. So many different policies are analyzed I’m not sure I can summarize them with any justice, but a few particularly stuck out: First, the high cognitive demands of poverty can basically explain the whole observed difference in IQ between rich and poor people—so contrary to the right-wing belief that people are poor because they are stupid, in fact people seem stupid because they are poor. Simplifying the procedures for participation in social welfare programs (which is desperately needed, I say with a stack of incomplete Medicaid paperwork on my table—even I find these packets confusing, and I have a master’s degree in economics) not only increases their uptake but also makes people more satisfied with them—and of course a basic income could simplify social welfare programs enormously. “Are you a US citizen? Is it the first of the month? Congratulations, here’s $670.” Another finding that I found particularly noteworthy is that productivity is in many cases enhanced by unconditional gifts more than it is by incentives that are conditional on behavior—which goes against the very core of neoclassical economic theory. (It also gives us yet another item on the enormous list of benefits of a basic income: Far from reducing work incentives by the income effect, an unconditional basic income, as a shared gift from your society, may well motivate you even more than the same payment as a wage.)

Part 3 is a particularly bold addition: It turns the tables and applies cognitive economics to economists themselves, showing that human irrationality is by no means limited to idiots or even to poor people (as the report discusses in chapter 4, there are certain biases that poor people exhibit more—but there are also some they exhibit less.); all human beings are limited by the same basic constraints, and economists are human beings. We like to think of ourselves as infallibly rational, but we are nothing of the sort. Even after years of studying cognitive economics I still sometimes catch myself making mistakes based on heuristics, particularly when I’m stressed or tired. As a long-term example, I have a number of vague notions of entrepreneurial projects I’d like to do, but none for which I have been able to muster the effort and confidence to actually seek loans or investors. Rationally, I should either commit or abandon them, yet cannot quite bring myself to do either. And then of course I’ve never met anyone who didn’t procrastinate to some extent, and actually those of us who are especially smart often seem especially prone—though we often adopt the strategy of “active procrastination”, in which you end up doing something else useful when procrastinating (my apartment becomes cleanest when I have an important project to work on), or purposefully choose to work under pressure because we are more effective that way.

And the World Bank pulled no punches here, showing experiments on World Bank economists clearly demonstrating confirmation bias, sunk-cost fallacy, and what the report calls “home team advantage”, more commonly called ingroup-outgroup bias—which is basically a form of the much more general principle that I call the tribal paradigm.

If there is one flaw in the report, it’s that it’s quite long and fairly exhausting to read, which means that many people won’t even try and many who do won’t make it all the way through. (The fact that it doesn’t seem to be available in hard copy makes it worse; it’s exhausting to read lengthy texts online.) We only have so much attention and processing power to devote to a task, after all—which is kind of the whole point, really.

2 thoughts on “The World Development Report is on cognitive economics this year!

    • I’m really not impressed. Some of what it says is very useful and clearly explained, and the basic idea that debt drives short-run cycles while productivity drives long-run growth is definitely correct.

      But he starts by saying that the economy is a “simple machine”, which is totally wrong and probably what got us into this mess in the first place. No, the economy is an extremely complex nonlinear system. Some of its aggregate behavior can be modeled simply, but never for a minute think it’s because the whole thing is simple.

      He also doesn’t really seem to grasp what debt is, or how government debt differs from bank loans which differ from individual loans. He just calls them all “debt” and treats them the same. Individuals are constrained in the way he describes—what you loan out you no longer have, and if you aren’t paid back you lose that money.

      But banks really aren’t constrained in the same way—when they create credit they still have the deposits, so their total assets rise. If I have $1000 and loan you $500, I now have $500 in cash and could say I have $500 in loans to you, total $1000. But if a bank has $1000 and loans you $500, they now have $1000 in deposits and $500 in loans to you, total $1500. Banks really do create money out of thin air, and for some reason we allow them to call that money their own. (Actually it’s even a bit more complicated than that. Deposits are technically considered liabilities for the bank, so the accounts sort of still balance at $1000; but they know that they’ll never pay all that money out, and if they were ever asked to they’d come crying to the FDIC to save them.)

      Finally, governments aren’t constrained at all—their power over the money supply is unlimited, and it’s only a question of what consequences will arise from their manipulations. The Federal Reserve can just create $1 trillion whenever they choose, and Congress can add $1 trillion in taxes if they so desire. They even have the power to erase debts completely, or refinance them however they like. They rarely use this power, but I think it’s precisely because they buy into this stuff about how they are constrained in ways they actually aren’t.

      This is important because what Ray Dalio is basically trying to argue is that debt cycles are inevitable—he actually has the audacity to call them “human nature”, as though hunter-gatherer tribes 20,000 years ago suffered debt cycles—when that’s simply not the case. (I suppose hunter-gatherer tribes did use a form of debt, as Graeber points out. But I highly doubt they went through boom-and-bust cycles the way modern capitalist economies do.) You can’t borrow from the future, not in real terms. (Actually there’s one way: Environmental degradation. But that has nothing to do with debt.) You can only borrow from the future in financial terms, and finance is a human institution that obeys only the rules we set for it. What you’re really doing when you borrow money is redistributing the real resources that exist to new ownership and new applications. That’s why “overconsumption” can be bad; it means we’re spending all our resources making televisions instead of roads. But no, we aren’t consuming more than our economy can produce—if it wasn’t produced, we can’t consume it, period—and we don’t have to be committing ourselves to consuming less later on.

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