Saturday, January 29, 2011

Irrational Humanity.

It may be a product of overindulgence in my favourite pastime of reflection, but I sense these days that people seem to respond less to situations in a manner one would expect. In doing some reading for last week’s article, the thought struck me that perhaps human beings are not as rational as we think. I hesitate to use the term “irrational” because this implies a degree of mental instability, but at times it seems to border on that.

I have been struggling for some time to employ part time help from a large pool of unemployed in the area. After months of experimentation with better than average pay and amenable working conditions I have still not found the formula to counter a widely followed custom here where people work for a few weeks, perhaps even a month or so, and then take an extended, unannounced holiday.

The example is perhaps trivial and anecdotal, but it serves to illustrate the millions upon millions of transactional relationships that make up the global economy where, at the core, lies our understanding of each other and our definition of human nature. The conundrum is whether the behaviour itself is irrational or whether the expectation of a different behaviour is irrational. It should not be a surprise that very often our expectations of the other based on our understanding of human nature differs from the outcome. At the time of writing there were nearly 7-billion definitions of human nature.

The real question is how predictable are human beings? This is not an academic question. It has been the most important component of economics and social structures since the earliest days and strongly informed the writings of amongst many others, Adam Smith who is credited with being the father of Capitalism. Despite his intuitive genius and humanist motive, Smith arguably knew far less about human nature than we do today. More importantly, John Muth’s development in the 1960’s of the theory of rational expectations created the most important driver in economic modelling, which in turn shapes policies, systems, structures and measurements which affect our daily lives. Take away rational expectations and policy loses its grip while systems lose their efficacy.

Yet, it has become increasingly clear that we have only scratched on the surface in our understanding of human beings and of humanity itself. When we get it wrong, it can have some disastrous consequences. The case of Alan Greenspan deserves repeating. There are many, including a recent Federal commission report that put the blame for the 2008 financial meltdown squarely on his shoulders as Chairman of the American Federal Reserve. Time Magazine ranked him third amongst 25 people most to blame for the crisis. Most agree in retrospect that he kept interest rates too low and failed to regulate derivatives and excesses in the financial markets. This is all old hat by now, but the lasting legacy of that time and perhaps of Greenspan himself is the danger of preconceived beliefs about human responses. By his own admission, the flaw in Greenspan’s thinking was that “financial institutions didn't protect shareholders and investments as well as I expected”.

And perhaps more importantly: ``we cannot expect perfection in any area where forecasting is required. We have to do our best but not expect infallibility or omniscience.''

One can understand Greenspan’s frustration. It was natural to assume that given freedom to act in the interests of their investors financial institutions would follow the Buffett philosophy on long term sustainability. It is also too simplistic to blame it all on unbridled greed – some would argue that a measure of greed is an essential component of a Capitalist economy. As a product of the age of deprivation, Greenspan shares with many of that era a belief in prudence, modesty and a moral compass.

The problem is much deeper than greed: there has been an understandable and fundamental shift in human behaviour. The pace of life is so much faster today than it was in the days of my youth or even early adulthood. Despite greater prosperity, we have become more agitated and insecure. Horizons are shorter, so out the window go patience and prudence, making way for immediate self gratification and the quest for a “quick buck”. We don’t have to look much further than companies where reporting cycles and shareholder expectations have increasingly been focussed on short term profitability at the expense of long term sustainability. King III, sustainability reporting and the just announced “integrated reporting” are responses to that. They seem to have negligible effect so far.

It is also easier today to give effect to less rational consumption and acquisition. On line shopping, more seductive and broader advertising, quick and easy money transfers and easier credit, all create the conditions for greater impulse buying and quicker responses. I can remember a time when you needed a 25% deposit and a 36 month repayment period to buy a car. This automatically reduced an impulse buy, giving you time to move from a Porsche fantasy to a Volkswagen reality before committing yourself to a purchase.

The same goes for investments. The quick buck syndrome is the breeding ground for schemers and fraudsters, but even on a legitimate level it is easy to by-pass solid expert advice and to follow an irrational herd via on line trading and half baked, homespun networked views. One could argue that these are desirable features of a modern economy, but one could also argue that given the human behaviour it facilitates, it’s a bit like having well oiled wheels on a runaway truck.

The gap between expectations and reality is much wider than decades ago. Expectations may have been dampened somewhat by the meltdown but there are still symptoms of “irrational exuberance”. This makes them unpredictable and if you multiply them by the vast increase in the number of people, each with their own expectations and aspirations in a world where they can more easily express them, then you are dealing with a data base that no known model can capture for sensible and reliable assumptions.

Add to the mix, random events such as floods, earthquakes, strikes and social unrest, all of which have their own impact on the real economy as well as on human expectations, then current models are rendered more inaccurate and suspect.

The exciting thing is that this is being recognised and work is being done to develop a much more comprehensive and all encompassing model.

But in the meantime, the consistency we seek does not lie in computer models, measurements, structures and systems, but in a return to universal values that make us more trustworthy and reliable as human beings. They include honesty, fairness, care for each other, generosity and integrity.

Unfortunately, these are not things you can legislate for. You cannot force people to be generous – that’s taking not giving. You also cannot coerce compassion. That’s a contradiction in terms.

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