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Thursday, September 9, 2010

Secrets of the Moneylab

By Claus Vistesen: Copenhagen

Kay-Yut Chen and Marina Krakovsky have earned their colours as behavioural economists at Hewlett Packard in the HP Labs and in in their new book Secrets of the Moneylab they present the gist of their research in the past 20 years. The book is a run-through of the most salient aspects of behavioural economics and its applications and since behavioural economics is all about designing (clever) experiments, the book oftentimes presents itself as an experimental handbook and their main results. As such, this is not an academic book but more so a how-to guide for business practitioners on how to implement lessons (and even experiments) of behavioural economics in a business context. Yet, the book never descends to the lower levels of the 10 Steps to Business Success type of books and always steers clear of making pretentious profit promises for the eager business man. This is a welcome plus and means that the stories are presented in a credible way.

The book covers a number of classic results in behavioural economics and especially the chapter on fairness reveal some well known, but often forgotten, truths about human nature. For example; the tendency to punish others so that they don't get the better deal even though refraining from it would give you the best of two possible outcomes is a result that defies convention economic logic. The experiment is detailed in Solnick and Hemenway (1998) and involves participants from the Harvard School of Public Health who are asked whether they would prefer one of two options:

1. You earn $ 50.000 and the other earns $ 100.000

2. You earn $ 100.000 and the other earns $ 250.000

Even under the condition of identical price levels in both contexts half the participants chose option 1 which is a result traditional neo-classical economics using a homo economicus as the representative agent would have difficulties explaining. Another interesting passage concerns the collective intelligence and how tapping into it can lead to superior forecasts of market performance, demand figures, sales etc. Personally, I believe this is very important and while the collective intelligence is always noisy and contains a lot of dead ends, understanding how to harness it is becoming a key parameter for business success today.

However, all this has a catch.

Experimental economics and the study of human behavior is all well and good, but my feeling is that we still have too small an overall sample size to really be confident of its conclusions. The work of Chen and Krakovsky is of course a step in the right direction here, but does it matter whether you run experiment above in Denmark or the US, is there a difference across time or age groups of the participants etc. These questions essentially address the robustness of the results from behavioral economics and while some of the experiments have indeed been tested in many contexts, the replication of results is something I think is important as we move on from here.

Is it a Buy Then?

Behavioural economics is ultimately about what people do under a given set of controlled circumstances rather than what they should do given an idealized pre-determined model and I think economists would be wise to take this lesson to heart. The economic profession should take due note not only of the actual results, but also the implied shift in methodology which is a consequence of working with behavioural economics.

The nobel prize winning economist George A. Akerlof finishes his preface of the book stating that Secrets of the Moneylab is economics at its best. This is a tall order, but after having read it I am inclined to agree with him. Behavioural economics maps an important alternative way to do economics and Secrets of the Moneylab is a fine representation of this tradition.


Full Disclosure: If this reads as a plug, it is because it is a plug. However, please note that regardless of whether the book does well, poorly or somewhere in between I have no financial stake in it. The book goes on sale in Europe in October.