Are People Probabilistically Challenged? Book Review of Thinking, Fast and Slow by Daniel Kaheman:

Thinking, Fast and Slow is an excellent book. Thus far, behavioral economists did predominantly experimental work that uncovered discrete manifestations of people’s bounded rationality: representativeness, availability, anchoring, overoptimism, base-rate neglect, hindsight bias, loss aversion, and other misevaluations of probability and utility. This work has developed no causal explanations for these misevaluations. Kahneman’s book takes the discipline to a different level by developing an integrated theory of bounded rationality’s causes and characteristics. This theory holds that humans use two distinct modes of reasoning, intuitive (System 1) and deliberative (System 2), while systematically allowing their fast intuitions to supersede deliberation. These intuitions grow from familiar stereotypes, resemblances and emotions that oftentimes do not align with reality and take the person astray. The dominance of these untutored, and yet powerful, intuitions explains people’s various misconceptions in the domains of probability and utility.

Despite this advancement, I posit that the “bounded probabilistic rationality” thesis — the key component of Kahneman’s theory — remains unproven. Specifically, I argue that Kahneman and his collaborators have used an incomplete and unstable set of criteria for evaluating individuals’ determinations of probability. These criteria do not account for the differences between individuals’ rule-free “beliefs” and rule-based “acceptances” and fail to recognize a distinct — and perfectly rational — mode of probabilistic reasoning, known as causative or Baconian. Kahneman’s normative criteria also tolerate the presence of unspecified causality and malleable reference classes in experimental settings. As a result, his and his collaborators’ experiments do not reveal anything about the rationality of participants’ decisions. Indeed, my analysis of three flagship experiments, carried out by Kahneman and his collaborators, vindicates the participants’ appraisals of probability as perfectly rational. Policymakers therefore ought to put on hold the behavioral economists’ recommendations that urge the government to step in and fix people’s probabilistic decisions.

After I finish up my article on Harlan, and my work on black swan, I am going to make my piece on social cost into something about behavior economics. It’ll be hot.