Why Logic Often Takes A Backseat

The study of neuroeconomics may topple the notion of rational

decision-making

The National Hockey League and its players wrangle over a salary
cap. The impasse causes the season to be canceled. Everybody
loses. What went wrong?

According to the new science of neuroeconomics, the explanation

might lie inside the brains of the negotiators. Not in the prefrontal
cortex, where people rationally weigh pros and cons, but deep
inside, where powerful emotions arise. Brain scans show that
when people feel they're being treated unfairly, a small area
called the anterior insula lights up, engendering the same disgust
that people get from, say, smelling a skunk. That overwhelms the
deliberations of the prefrontal cortex. With primitive brain
functions so powerful, it's no wonder that economic transactions
often go awry. "In some ways, modern economic life for humans
is like a monkey driving a car," says Colin F. Camerer, an
economist at California Institute of Technology.

Until recently, economists contented themselves with observing

people from the outside. Now, Camerer and others, teaming up
with psychologists and neuroscientists, are using a technique
called functional magnetic resonance imaging to look inside the
skull. It's like watching Congress debate instead of inferring
what's going on by reading the laws that get passed.

Neuroeconomics, while still regarded skeptically by mainstream

economists, could be the next big thing in the field. It promises to
put economics on a firmer footing by describing people as they
really are, not as some oversimplified mathematical model would
have them be. Eventually it could help economists design
incentives that gently guide people toward making decisions that
are in their long-term best interests in everything from labor
negotiations to diets to 401(k) plans. Says Harvard University
economist David I. Laibson, another leading researcher: "To
understand the real foundations of our behavior and our choices,
we need to get inside the black box."

A GRAB BAG OF ANOMALIES?

Neuroeconomics could also give economics an alternative
theoretical framework. Since the early 1900s, economists have
mainly assumed that people have a stable and consistent set of
preferences that they try to satisfy. When faced with an
apparently illogical outcome -- such as the cancellation of the
hockey season -- they try to explain it as the result of a reasoned
decision process. Such top economists as Gary S. Becker, Milton
Friedman, and Robert E. Lucas Jr., all Nobel prize winners, have
argued that discrimination, unemployment, and stock market
gyrations can have rational origins.

In recent years, the assumption of rationality has taken some

hard shots as economists have shown that people often lack self-
control, are shortsighted, and overreact to the fear of losses. But
to date, these attacks on rationality -- under the broad heading of
"behavioral economics" -- have seemed more like a grab bag of
anomalies than a consistent alternative theory. So the
assumption of rationality survives.

By linking economic behavior to brain activity, however,

neuroeconomics may finally supply the model that knocks
mainstream economics off its throne. The new theory should fit
better with reality, but it won't be as mathematically clean --
because the brain is a confusing place, with different parts
handling different jobs. Says Camerer: "You are forced to think
about a brain which has many somewhat modular circuits."

One of the most fruitful avenues of neuro research is "time

inconsistency." When people decide about the distant future,
they're roughly as rational as economic textbooks assume. But
when faced with a choice of whether to consume something now
or delay gratification, they can be as impulsive as chimps.
Harvard's Laibson coined "quasi-hyperbolic discounting" to
describe the behavior, but that was just a label, not an
explanation.

So Laibson and others scanned people inside MRI machines and

discovered two parts of the brain operating in radically different
ways. For decisions about the far-off future, the prefrontal cortex
takes a long-term perspective. But for decisions such as whether
to buy another chocolate bar right now, the limbic system takes
over and demands immediate gratification. Last year the journal
Science published the research by Laibson, Princeton University
neuroscientists Samuel M. McClure and Jonathan D. Cohen, and
Carnegie-Mellon University economist George Loewenstein.

How does it help to know that you're literally "of two minds"? You
could arrange your affairs to make sure that your rational brain
stays in control -- for example, by committing now to saving a
certain percentage of your paycheck each month in the future.
Many people already do that. Trouble is, long-term commitments
can be too rigid if circumstances change. Ideally, you'd like to
wait to commit to a savings plan until you see whether you can
afford it -- but not wait so long that your animal brain takes over
and you lose the will to save. The new research could help get
that balance right.

A key tenet of standard economics is that making people happy is

a simple matter of giving them more of what they like. But
neuroscience shows that's not true. The brain's striatum quickly
gets used to new stimuli and expects them to continue. People
are on a treadmill in which only unexpected pleasures can make
them happier. That explains why happiness of people in rich
countries hasn't increased despite higher living standards.

Neuroeconomics also challenges the notion that emotions can

only corrupt economic decision-making. Indeed, emotions grab
people's attention and motivate them to focus their rational
brains on the issue at hand, says Antonio R. Damasio, a
University of Iowa College of Medicine neurologist who studies
brain-damaged patients. In his writings, he says that people who
feel no emotions are bad at making decisions.

The most controversial aspect of neuroeconomics is what to do

with its findings. Cornell University economist Robert H. Frank
favors taxation of conspicuous consumption, arguing that flashy
spending simply raises expectations, making the rich no happier
and squeezing the middle class. Laibson, in contrast, isn't willing
to go much further than using neuroeconomics to, say, improve
the default choices in 401(k)s.

Neuroeconomics has its skeptics. Richard Thaler of the University

of Chicago, a leading behavioral economist, argues that it has yet
to produce a major, surprising finding. He says he prefers to leave
brain research to the neuroscientists. But he adds: "I am a big
believer in letting all flowers bloom."

Even believers in neuroeconomics aren't sure just how far to take

it. Should economic policy satisfy the farsighted prefrontal
cortex? Or should it sometimes indulge the impulsive limbic
system? By peering into the brain, economists are making
discoveries that will keep them arguing for years to come.

By Peter Coy in New York