Why people believe weird things about money
Evolution accounts for a lot of our strange ideas about finances.
By Michael Shermer
January 13, 2008
Los Angeles Times
Would you rather earn $50,000 a year while other people make $25,000, or would
you rather earn $100,000 a year while other people get $250,000? Assume for
the moment that prices of goods and services will stay the same.
Surprisingly -- stunningly, in fact -- research shows that the majority of
people select the first option; they would rather make twice as much as others
even if that meant earning half as much as they could otherwise have. How
irrational is that?
This result is one among thousands of experiments in behavioral economics,
neuroeconomics and evolutionary economics conclusively demonstrating that we
are every bit as irrational when it comes to money as we are in most other
aspects of our lives. In this case, relative social ranking trumps absolute
financial status. Here's a related thought experiment. Would you rather be A
or B?
A is waiting in line at a movie theater. When he gets to the ticket window, he
is told that as he is the 100,000th customer of the theater, he has just won
$100.
B is waiting in line at a different theater. The man in front of him wins
$1,000 for being the 1-millionth customer of the theater. Mr. B wins $150.
Amazingly, most people said that they would prefer to be A. In other words,
they would rather forgo $50 in order to alleviate the feeling of regret that
comes with not winning the thousand bucks. Essentially, they were willing to
pay $50 for regret therapy.
Regret falls under a psychological effect known as loss aversion. Research
shows that before we risk an investment, we need to feel assured that the
potential gain is twice what the possible loss might be because a loss feels
twice as bad as a gain feels good. That's weird and irrational, but it's the
way it is.
Human as it sounds, loss aversion appears to be a trait we've inherited
genetically because it is found in other primates, such as capuchin monkeys.
In a 2006 experiment, these small primates were given 12 tokens that they were
allowed to trade with the experimenters for either apple slices or grapes. In
a preliminary trial, the monkeys were given the opportunity to trade tokens
with one experimenter for a grape and with another experimenter for apple
slices. One capuchin monkey in the experiment, for example, traded seven
tokens for grapes and five tokens for apple slices. A baseline like this was
established for each monkey so that the scientists knew each monkey's
preferences.
The experimenters then changed the conditions. In a second trial, the monkeys
were given additional tokens to trade for food, only to discover that the
price of one of the food items had doubled. According to the law of supply and
demand, the monkeys should now purchase more of the relatively cheap food and
less of the relatively expensive food, and that is precisely what they did. So
far, so rational. But in another trial in which the experimental conditions
were manipulated in such a way that the monkeys had a choice of a 50% chance
of a bonus or a 50% chance of a loss, the monkeys were twice as averse to the
loss as they were motivated by the gain.
Remarkable! Monkeys show the same sensitivity to changes in supply and demand
and prices as people do, as well as displaying one of the most powerful
effects in all of human behavior: loss aversion. It is extremely unlikely that
this common trait would have evolved independently and in parallel between
multiple primate species at different times and different places around the
world. Instead, there is an early evolutionary origin for such preferences and
biases, and these traits evolved in a common ancestor to monkeys, apes and
humans and was then passed down through the generations.
If there are behavioral analogies between humans and other primates, the
underlying brain mechanism driving the choice preferences most certainly dates
back to a common ancestor more than 10 million years ago. Think about that:
Millions of years ago, the psychology of relative social ranking, supply and
demand and economic loss aversion evolved in the earliest primate traders.
This research goes a long way toward debunking one of the biggest myths in all
of psychology and economics, known as "Homo economicus." This is the
theory that "economic man" is rational, self-maximizing and efficient in
making choices. But why should this be so? Given what we now know about how
irrational and emotional people are in all other aspects of life, why would we
suddenly become rational and logical when shopping or investing?
Consider one more experimental example to prove the point: the ultimatum game.
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 each get to
keep your share. If, however, your partner rejects it, neither of you gets any
money.
How much should you offer? Why not suggest a $90-$10 split? If your game
partner is a rational, self-interested money-maximizer -- the very embodiment
of Homo economicus -- he isn't going to turn down a free 10 bucks, is
he? He is. Research shows that proposals that offer much less than 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 hard-wired into our brains and is an
emotion shared by most people and primates tested for it, including people
from non-Western cultures and those living close to how our Paleolithic
ancestors lived.
When it comes to money, as in most other aspects of life, reason and
rationality are trumped by emotions and feelings.
Michael Shermer is the publisher of Skeptic magazine, a columnist for
Scientific American and the author of "The Mind of the Market: Compassionate
Apes, Competitive Humans, and Lessons from Evolutionary Economics."
We believe our relationship with money is
rational and enlightened by reason (Second Order Intelligence). But
rational Second Order Intelligence is hardly more than 10,000 years old - and
the first coins were only minted as recently as 700 BCE, not even 3,000 years
ago. How many of our other relationships are actually driven by
First Order Intelligence while we pretend to behave rationally?
