Neuroeconomists tackle the irrational

Some economists believe they can explain why we make bad financial decisions. Should we be afraid?

By Andrew Leonard
Published February 2, 2007 10:49PM (EST)

In Paul Krugman's masterful essay on Milton Friedman in the current New York Review of Books, he includes the following useful paragraphs.

For most of the past two centuries, economic thinking has been dominated by the concept of Homo economicus. The hypothetical Economic Man knows what he wants; his preferences can be expressed mathematically in terms of a "utility function." And his choices are driven by rational calculations about how to maximize that function: whether consumers are deciding between corn flakes or shredded wheat, or investors are deciding between stocks and bonds, those decisions are assumed to be based on comparisons of the "marginal utility," or the added benefit the buyer would get from acquiring a small amount of the alternatives available.

It's easy to make fun of this story. Nobody, not even Nobel-winning economists, really makes decisions that way. But most economists -- myself included -- nonetheless find Economic Man useful, with the understanding that he's an idealized representation of what we really think is going on. People do have preferences, even if those preferences can't really be expressed by a precise utility function; they usually make sensible decisions, even if they don't literally maximize utility. You might ask, why not represent people the way they really are? The answer is that abstraction, strategic simplification, is the only way we can impose some intellectual order on the complexity of economic life. And the assumption of rational behavior has been a particularly fruitful simplification.

This passage caught my eye, not because I am someone who has been known to make fun of economists and their marginal utility, but because earlier in the day on which I read Krugman's article I had made a note to learn more about something called "neuroeconomics." Neuroeconomics, as defined by one economist, is "the study of how the embodied brain interacts with its external environment to produce economic behavior." Or, more bluntly, the study of what is physically happening in a person's brain when he or she makes a (potentially irrational) decision. If Krugman, in the passages above, is defining "economic man" as a useful abstraction, or strategic simplification, then neuroeconomics is an attempt to remedy that ambiguity: to move from the abstract to the neurochemical; to represent people as they really are and structure legal and economic theory around it.

If this sounds like spooky science fiction, well, it's not. I consulted with a professor of neuroscience I happen to know personally -- oh, all right, I e-mailed my Mom -- and was informed that the experiments that neuroeconomists are basing their theories on are indeed bedrock neuroscience. We are learning an extraordinary amount about brain function, and in some ways, we've hardly gotten started.

The best summary of the current state-of-the-art in neuroeconomics that I've been able to find is an October 2006 article by Joshua Lehrer in Nature. To cut right to the chase: One classic problem that has befuddled economists is why people are wont to act imprudently in the present (by, say, blowing a wad of cash in Vegas) instead of investing that cash for long-term reward in the future. State-of-the-art neuroscience, via functional magnetic resonance imaging of live brains, suggests that two different parts of the brain are associated with making such decisions. A region associated with emotion takes over when presented with the prospect of immediate pleasure, while a different region is linked to the dispassionate contemplation of some future event or reward.

This may all seem a very convoluted way of saying, well, Duh! Just last night, I went through quite a struggle with my pleasure center, aka my midbrain dopamine system, which was demanding some immediate short-term reward to celebrate an invigorating morning spent attending the announcement of Berkeley's Energy Biosciences Institute. More rational neighborhoods of my brain -- the prefrontal cortex -- were informing me that I was never going to lose 20 pounds if I drank a six-pack every time I was super-satisfied with a blog post. On this particular occasion, in a surprise decision unanticipated by longtime observers, the prefrontal cortex was declared the victor. But there was certainly nothing unusual or out of the ordinary about the struggle itself. Most of us struggle with the tradeoff between immediate gratification and long-term reward; the fact that we do, some might even say, is refreshingly human. We are not automatons whose behavior can be predicted at every juncture. We're full of surprises.

At least I like to think so. But I've always been infatuated with my irrationality. My mother hates this.

The potentially troublesome question concerning neuroeconomics, it seems to me, boils down to this: Once economists have figured out our decision-making processes, once they have pinned down the true nature of "Not-so-Economic Man," what do they intend to do with that information? I read today a mildly alarming paper by Terrence Chorvat, Kevin McCabe and Vernon Smith titled "Law and Neuroeconomics" that calls for "incorporating the insights from neuroeconomics into legal studies."

The goal which is intended to be achieved from this study is not merely the arcane knowledge that a particular perception occurs in a particular region of the brain, but rather an understanding of the brain mechanisms used by individuals as they address economic problems and how these mechanisms affect behavior. From this inquiry, we can hope to understand the nature of the limits of law to alter behavior, how the alterations that can be achieved can be accomplished more effectively, and perhaps more importantly the nature of what it means for a law to be optimal.

Why do I find this alarming? It's not just that the field of "law and neuroeconomics" is an intentional offshoot of the school of "law and economics," an enormously influential body of theory that I once described as warping "the entire legal profession far too much toward a perspective that emphasizes pseudo-quantitative economic analysis at the expense of concerns for social justice and equity."

I will concede that there is much I do not yet understand about exactly how law and neuroeconomics enthusiasts would restructure our legal system -- let's consider this post as a first stab at opening up that conversation -- but it is questionable to me whether society will benefit if the intellectual heirs of Milton Friedman (for, make no mistake, that is who these people are) start rejiggering our legal and economic structures according to the images generated by an fMRI scanner. There is a deterministic aspect to basing policy on neuroanatomy that gives me the willies.

As my mother noted in her review of an article introducing the concept of neuroeconomics that I sent her: "The only thing lacking is mention of individual differences. People differ tremendously in where they strike the balance and how they value the different outcomes, probably because of a combination of innate differences and experience in shaping orbital frontal cortex."

People differ tremendously. Vive le difference. Embrace the irrational.

Andrew Leonard

Andrew Leonard is a staff writer at Salon. On Twitter, @koxinga21.

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