How does ‘Behavioral economics’ help us in understanding ourselves in an informed way?

“We are blind to our blindness. We have very little idea of how little we know.We are not designed to know how little we know”-Daniel Kahneman,Thinking,Fast and Slow

My first introduction to behavioral economics or rather my affair with economics started through the fellowship program that I was a part of last year. It was intended at policy design and it just blew by tiny box of thoughts/ideas wide open. I believe economics not just helps you in understanding societies but yourself in ways that even your therapists can’t. It helps us understand the choices we make and why we make them. Why does the need of the government arise where we as individuals can’t think rightly for the common good. How we inherently do not have the ability to think statistically but are highly motivated by our biases to make choices. Daniel Kahneman, an Israeli American psychologist and economist brilliantly explains this through his book‘Thinking,fast and slow’ which I have been currently reading.

The book breaks down our entire thinking into two systems-System 1 which is intuitive,based on heuristics and helps in understanding nuances in social institutions whereas System 2 is our system of core beliefs which builds upon our experiences and hence arises our biased nature, because all our experiences are unique to ourselves. System 2 is something that doesn’t naturally come to us but is a trained thought process and requires attention to comprehend. It basically helps us tackle‘present biasing’ or ‘hyperbolic discounting’ which most of us succumb to. These terms sound fancy but it broadly means that how we value the present more than the future and how in the world of Instagram, snapchat, tiktok and other numerous social media apps which exploit this weakness and satisfy our need of instant gratification. It also enables us to understand why so many people fail to invest at a young age even though people are aware of the magic of compounding. We prefer a reward now than the one in the future. This is how ‘present-bias’ plays role at a micro level but if this effect multiplied and none of us kept in check what our future selves would be like ,the world would be terrible place to live in.

At a macro-level policymakers intervene because as rational as we would like to think ourselves to be , we are in-fact not above our biases. Hence, this gives scope for government and private or public banks to think the better for us on our behalf  through their investment schemes. The employees’ provident fund scheme that aims at providing the employee with a lump sum amount which includes both self and employer’s contribution with interest on both, on retirement, essentially takes into consideration the idea of ‘hyperbolic discounting’. The Systematic Investment Plan(SIP) that debits a fixed amount automatically through the linked account nudges the idea of investment and how if we were given a choice to deposit manually per month, the scheme wouldn’t work as we focus more on the presence of money in the current moment in our bank account and not what we would have accumulated 15 years from now.

Since thinking beyond our biases is a System 2(effortful thinking) job, it is naturally more exhausting and hence why we rely on System 1 for most of our daily decisions. The book highlights a concept called ‘Law of Least effort’ which essentially justifies our need to procrastinate but in the economy of action, effort is the cost and if the cost is too high we are most likely not to pay. Therefore, nudges work. In a nutshell, nudge is an attempt to make judgements and choices easier but not in a coercive way. They make choices simpler and the time taken to comprehend (System 2 job) decreases. Swachh Bharat Mission has nudged people into better behavior by using the key ideas that are highlighted in ‘Prospect Theory’ by Daniel Kahneman ,which are , that people are ‘loss averse’ and by exposing people to the perils of not abiding by healthy sanitary practices and that ‘social pressure’ by making open defecation more ‘observable’ makes people more self aware of their actions. Along with this the ‘follow up’ and ‘plan forming’ by introducing Swaccgrahis to track the progress of toilet building helped in garnering momentum for the mission.

Another interesting concept under ‘Behavioral economics’ is ‘sunk cost fallacy’ which people in failed relationships/friendships will understand easily. It basically means where we follow through things just because we have invested time/money(sometimes both) in those things.That rings a bell, doesn’t it? Romantic relationships are a classic example of this as the longer we have been in it,the harder it is to break up even if we would like to get out of it.We stay longer in some or other commitment, professional or personal even if it no longer serves us, simply  because we could like to believe that we could somehow recapture loss but in the process we end up incurring an even bigger loss. At a macro level this could also be understood through the banking sector crisis that has been looming over us since the past year.It began with the Punjab and Maharashtra Co-operative bank debacle which used 21000 fictitious accounts to hide the bad loans. One of their biggest Non-performing asset (NPA) was due to the failure of Housing Development and Infrastructure Limited to whom they had been sanctioning loans despite their failure to repay because they had proved to be one of the biggest consumers in the past. The increase in NPAs which essentially leads to the failure of banks is a classic case of sunk cost fallacy along with other variable factors such as money laundering in the case of Yes Bank (post for another day).

Lastly, before I get back to reading, I would like to mention the concept of ‘peak end rule’. It is also by-far the most interesting one and a lot of us are already familiar with it but didn’t know it was called that. It is basically a cognitive bias that impacts how we remember past events. We remember mostly the ends and along with it some key emotionally intense moments of a experience and the rest of the memory of the experience is distorted along the lines of how we felt in the end or in those peak points. It aims at highlighting how biased we are as our beliefs which are shaped by these memories are in-fact so subjective to those key moments.We rarely have an accurate record of events. We also remember negative experiences more than the positive ones which is more of a evolutionary trait and not you being pessimistic , as we happen to perceive these negative experiences as threats. System 1(the intuitive part of the brain) heavily rules our judgement of an experience. A classic example of this could be how suddenly before the elections  landmark judgements are passed or how newer policies come into play just before that and how we would remember that more while voting rather than averaging out their performance over the span of 5 years.

Hopefully , the above-mentioned ‘behavioral insights’ help you in becoming more self aware of your thoughts and I would like to go back to reading now before my System 2 can’t comprehend more information for the day.