Profile Of Psychologist & Nobel Prize Winner: Daniel Kahneman
Introduction (via IMF)
For Daniel Kahneman, one of the most moving episodes in the current global economic crisis took place when a humbled Alan Greenspan, the former chairman of the U.S. Federal Reserve, confessed before a congressional committee that he had put too much faith in the self-correcting power of free markets.
“He basically said that the framework within which we had been operating was false, and coming from Greenspan, that was impressive,” said Kahneman, who was awarded the Nobel Prize in Economics in 2002 for his pioneering work integrating aspects of psychological research into economic science.
But more to the point for Kahneman was how Greenspan, in his testimony, treated not only individuals but also financial institutions as rational agents. “That seemed to me to be ignoring not only psychology but also economics. He appeared to have a belief in the magic power of the market to discipline itself and yield good outcomes.”
Favorite Excerpt (Via IMF)
Kahneman has a number of takeaways from the current crisis.
- Need for stronger protection for consumers and individual investors. “There’s always been an issue of whether, and how much, protection people need against their own choices,” he argues. “But I think it’s now just become very, very difficult to say that people don’t require protection.”
- Failure of markets has much wider consequences. “Interestingly enough, it turns out that when uninformed individuals lose their money, it ruins the global economy—so the irrational actions of individuals have much wider effects when combined with the rationality of corrupt agents within the financial system, and very lax regulation and supervision.”
Additional Excerpts (Via IMF)
Kahneman goes to great pains to stress that, as a psychologist, he is an outsider in the field of economics. But he helped lay the foundation for a new field of research, called behavioral economics, that challenged standard economic rational-choice theory to inject more realistic assumptions about human judgment and decision making.
“Entrepreneurs are people who take risks and, by and large, don’t know they are taking them,” he argues. “This happens with mergers and acquisitions, but it also happens at the level of small-scale entrepreneurs. In the United States, a third of small businesses fail within five years, but when you interview those people, they individually think they have between 80 percent and 100 percent chance of success. They just don’t know.”
Prospect theory helps to illuminate experimental results that show individuals often make divergent choices in situations that are substantially identical but framed in a different way. Their paper became the second-most-cited article to appear in Econometrica, the prestigious academic journal of economics, during 1979–2000 (Kahneman and Tversky, 1979). The research has had an influence across a range of disciplines, including marketing, finance, and consumer choice.
Kahneman says little should be read into the theory’s name. “When we were ready to submit the work for publication, we deliberately chose a meaningless name for our theory: ‘prospect theory.’ We reasoned that if the theory ever became well known, having a distinctive label would be an advantage. This was probably wise.”