People seem to do the craziest things when it comes to money. They chase stock market bubbles. They throw good money after bad investments, like a home that’s hopelessly underwater. They spend and spend while racking up crushing debt. They destroy their own businesses with dishonesty and deception.
Given all of this, the idea that individuals act rationally seems far-fetched. Only in the ivory-tower world does one find perfectly rational humans making judgments using all available information to satisfy their ends.
Michael Shermer explains in The Mind of the Market: Compassionate Apes, Competitive Humans, and Other Tales From Evolutionary Economics that behavior that is irrational today may have been perfectly rational a hundred years ago. That’s why, he says, you really need the work of evolutionary psychologists to explain human decision-making.
This book is your introduction to and overview of what this discipline contributes. And it is a substantial contribution that helps you understand why markets behave the ways they do.
As messy as human decision-making is, the spontaneous order that emerges from it leads to an extraordinarily productive economy. Shermer makes the case: “Just as living organisms are designed from the bottom up by natural selection, so too is the economy designed from the bottom up by the ‘invisible hand.’”
Shermer cites a number of experiments that show this:
- Most humans choose to avoid risks, instead of being perfectly rational. Folks will take a 50-50 chance only when the payoff exceeds double the potential loss. Humans are “twice as motivated to avoid the pain of loss as we are to seek the pleasure of gain”
- Groupthink is very powerful, with Solomon Asch’s studies showing that people will decide wrongly 70% of the time when influenced by a crowd. Studies of MRI brain scans confirm a correlation between decision-making and reward. Trust and social interactions are tested using the prisoner’s dilemma, while dopamine neurons are released when rewards are greater than expected
- Dopamine plays a prominent role with investors who take increasing amounts of risk to achieve the kick of gains made through speculation. Drugs and sex also feed the dopamine neurons, and so “do addictive ideas, most notably addictive bad ideas, such as those propagated by cults that lead to mass suicides (in the case of Jonestown and Heaven’s Gate), or those propagated by religions that lead suicide bombers to commit mass murder (in the case of Islamic militant extremists),” Shermer explains.
So are the bulk of humans acting irrationally at least some of the time because we can’t help it — or because our brains are wired that way? Or maybe there is no distinction between rational and otherwise.
Shermer contrasts two approaches to business. On one hand, there is Wall Street character Gordon Gekko and his “greed is good” speech and Enron’s tough, aggressive corporate culture. Good apples turn to bad ones in secretive, corrupt, aggressive corporate environments, according to Shermer, and this ultimately leads to the unraveling of those businesses.
On the other hand, there is Sergey Brin and Larry Page’s Google culture of “Don’t be evil.” This is to make their case that greed cannot sustain life on Earth and that “if market capitalism were winner take all, it would have collapsed centuries ago.”
An unfettered free market would lead to more entrepreneurs operating the Google way. It is government licensing and regulation that lead to the incestuous relationship of Big Business and Big Government — a crony capitalism exemplified by Enron and Wall Street.
In my view, Shermer places too much faith in democracy. He naively believes that science should be used to provide structure for government policies, but that these laws should be minimal.
Nevertheless, Shermer does write from a free-market perspective. He mentions the Austrian School specifically, and often quotes Ludwig von Mises, as well as Hayek and Bastiat. And while he doesn’t believe capitalism needs “apologists and propagandists, it does need a scientific foundation grounded in psychology and evolution.”
Science has proved that humans are capable of good and evil. So as Shermer quotes Mises, “People must fight for something that they want to achieve, not simply reject an evil, however bad it may be.” Shermer calls The Mind of the Market “an exercise in consciousness-raising for freedom.”
But Shermer’s work shows that science is on the side of Mises, who wrote that even a “mentally troubled person with whom there is still left a trace of reason and who has not been literally reduced to the mental level of an animal is still an acting being.”
And these troubled, acting beings are investing in the market every day. This book helps you make sense of what otherwise seems senseless.