Don't assume that bankers, or delinquents, act rationally.

Wall Street melts down. The prime minister proposes tougher punishment of young offenders.

Two stories. Any connection?

Yes, there is. And no, I am not setting up a punch line about juvenile delinquents in investment banks.

The connection lies in how we think people think.

Very simply, most of us believe people think things through before they act. They consciously examine the evidence. They weigh their options. They make a decision. They act.

Most people would call this common sense. Economists call it "rational choice theory." Either way, it has major consequences.

Consider the crisis on Wall Street. It started with sub-prime mortgages that were bundled into complicated debt instruments and sold, re-sold, and sold again in the financial markets. The people involved were very smart. For a while, they made lots of money. Now, they are unemployed.

So what went wrong? Well, if you think like most economists think and you examine the wreckage, you will blame incentives and regulations.

These were smart people. They had lots of information. And yet, they loaded up on risky debt that needed constantly inflating house prices to keep from going bad. That's crazy. It's irrational. Or rather, it would be unless the people involved faced incentives that encouraged this dangerous behaviour and regulations that allowed it. Then it would be rational.

One of these conclusions fits the theory. The other doesn't. Guess which wins?

Listen carefully to the analysis and you'll hear plenty about incentives and regulations. The implicit assumption? Bad decisions were made for rational reasons. Change the incentives and regulations and Wall Street will make better decisions.
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Now consider Stephen Harper's call for tougher punishment of young offenders.

One could argue in favour of this proposal on the grounds of retribution -- that justice demands tougher punishment, whatever the practical effect of such punishment. That's an argument for another day. What matters here is the Conservatives are promoting this policy by saying "soft on crime does not work." Tougher punishment does.

Why? It's simple. Before a young person commits a crime, he has to decide to commit the crime. And he will only make that decision if he concludes --after weighing the potential benefits of the crime against the potential cost -- that committing the crime is in his best interest.

The solution is to change the incentives: Boost the punishment so the potential cost outweighs the potential benefit. That will change the fateful decision. Crime will be deterred.

For Mr. Harper, who is trained in economics, this is an obvious application of rational choice theory. For conservatives who are not, it's just common sense.

It definitely is common. But is it sensible?

No. Over the last several decades, cognitive science has discovered a great deal about how humans make decisions. We now know, beyond any doubt, that most people's thinking about thinking is wrong.

The most important discovery is that the conscious mind is not in sole command. It thinks it is. But that's an illusion.

"One of psychology's fundamental insights," writes Harvard psychologist Daniel Gilbert, "is that judgments are generally the products of non-conscious systems that operate quickly, on the basis of scant evidence, and in a routine manner, and then pass their hurried approximations to consciousness, which slowly and deliberately adjusts them."

We have an unconscious mind. It delivers snap judgments in the form of emotions, intuitions or hunches. We feel that something is true.
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Like the tortoise lumbering after the hare, the conscious mind can then get involved. Does this judgment make sense? Does the evidence support it? Is it in my interest? Is it rational? These are the questions the conscious mind can ask and when it does there's a good chance people will be as rational as economists expect them to be.

But that lumbering tortoise is also lazy. Psychologists have demonstrated repeatedly that when we have a strong feeling something is true, we do not think about it consciously and carefully. We just go with our gut.

This is true of pretty much everybody. Bankers. Juvenile delinquents. Everybody.

Thus it is foolish to simply assume the people involved are making decisions on the basis of rational calculation. And it is foolishness squared to make public policy on the same assumption.

But still we do it.

In conjunction with a book I published this year, I've been lecturing on risk and cognitive psychology to a wide array of audiences -- everyone from corporate executives to public officials, policy analysts, politicians and people who just happened to be wandering around the science centre the day I was there.

Time after time, people are amazed. I wish I could say it's my delivery. It's not. They are amazed at what cognitive science has discovered. They are amazed to learn that how they think people think is wrong.

Want a better understanding of the Wall Street meltdown, youth crime, or pretty much any other important subject involving humans making decisions? Pick up an introduction to psychology. And prepare to be amazed.

You can contact Dan Gardner at the Ottawa Citizen.
E-mail: dgardner@thecitizen.canwest.com

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