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Idea Whose Time Has Come
;;thought the article by James Guszcza (“Rethinking Rationality,” July/August)
was very well done. Thanks to him for
writing it and to you for including it in
the magazine.
It is my belief that the economic
analysis based solely on rational choices
has run its course. Some of its adherents, however, are resisting the need to
evolve. Recognition of the importance
of both irrational and rational thinking
will lead to better understanding and an
avoidance of mistakes such as the overly simplistic “mark to market” rules for
valuing balance sheet items.
An interesting piece of trivia is that
in 1958 Merton Miller and Franco Modigliani published “The Cost of Capital,
Corporation Finance, and the Theory
of Investment,” a foundational paper of
finance and classical economics, while
professors at Carnegie Tech. They are
better known for their tenure at Chicago and MIT, respectively. Their work
might have been improved on had they
collaborated with a third colleague.
Herbert Simon was also a professor
at Carnegie Tech (now Carnegie Mellon)
in the 1950s and stayed there until he retired. For whatever reasons, his idea of
bounded rationality (and cognitive psy-chology/science more generally) has
been ignored by the homo economicus
crowd. Although his work did win a Nobel and is the foundation Amos Tversky,
Daniel Kahneman, Richard Thaler and
others built on, I wonder what might
have been different and better about the
study of finance had the irrational aspect
been blended in at an earlier point. If, in
the late 1950s, they all used the same
lunchroom, they must have eaten at different times (or tables).
Dick Herchenroether
Pittsburgh
A Profitable Nudge
;;have an insurance example of the strategic use of defaults (“Rethinking
Rationality,” July/August 2009).
During the early 1990s, I was responsible for the integration of a block
of business following an acquisition.
The new block was a near copy of one
of our existing products (or, who knows,
vice versa)—a universal life contract in
which the policyholder had a choice of
fixed investments, from money market
up to a 10-year guaranteed investment
certificate. Our product defaulted to
an investment period of five years. The
one we acquired defaulted to a money
market.
We didn’t have the ability to maintain
two defaults, so we had to make a choice
for both products going forward. Upon
review, we observed that the block with
the five-year default had dramatically
higher account values and company
profitability. Both the policyholder and
the company gained significantly by the
selection of that default.
Ed Freeman
New York
A Far-Fetched Scenario?
;he proposal in James Guszcza’s article (“Rethinking Rationality,” July/August
2009) that economists study human behavior to find ways to induce people to
act more rationally in their self-interest
brings to mind the following scenario.
Suppose sometime in the indefinite
future that some economist determines
it is irrational for workers to remain in
thrall to the owners of capital. And suppose this economist inspires political
leaders in some large countries, including the most populous, to adopt the
rational alternative of seizing ownership
of capital for the workers. And suppose,
in consequence, that 80 million people
are murdered and hundreds of millions
more condemned to lives of bleakness
and penury while the world sits on the
brink of nuclear war.
I know I will be accused of dredging
up a wildly preposterous scenario to discredit the wise economists who are only
doing their saintly best to make available
to the common man the benefit of their
superior knowledge and education. Let’s
just call it a black swan.
RICHARD THOMPSON
Eric Klieber
Cleveland
