Jocelyn PixleySchool of Social Sciences and International Studies

The University of New South WalesSydney

AUSTRALIA

Emotions and Economic Choice

Emotions and decisions

• formal rationality vis à vis risk and uncertainty

• Weber and capitalist calculability • decision models - compare to risk

assessment • attribution theory• time orientations

Conventional view

• Decisions via formal rationality excludes emotions

• Decision-maker - only faces RISK - not dangers

• calculations of probabilities (or odds) of likely outcomes

• EMOTIONS = irrational + trivialise decisions

Emotions and rationality: MY ARGUMENT

• most economic decisions: we do not know the outcomes

• Risk models: ‘standard deviation’ and ‘risk assessment’ - help make chance ‘inescapable and controllable’

• Construct decisions around same, step-by-step decision framework as the model for risk

• Risk calculations = procedures or cognitive and emotional ‘scripts’ - comforting

• rationalise away the necessity of emotions

Why study these comforting scripts?

TENDENCIES IN FINANCE WORLD TO:• minimise perceptions of vulnerability• acknowledge uncertainty only in the

ceteris paribus escape clauseResearch on how financiers decide: when

they refuse to accept uncertainty and its related need for trust:

• prompts more or less than prudent levels of risk-taking

• i.e. money ‘contracts or expands’ because of bankers’ anticipations

Uncertainty & its social institutions

• beyond Keynesian uncertainty = irrational to deny the unknowability of the future √

• ALSO rational to hope that ‘things’ might stay the same

• rational to rely on various emotions (trust, distrust, not mere animal spirits)

SINCE no-one can predict when ceteris paribus might fail to hold - or which ‘things’ must stay stable rather than other ‘things’

THEREFORE trust (in numbers, in institutions, in organisations), and political battles are unavoidable.

ARGUMENT - social institutions to ‘cope’ with uncertainty:

1. Use of implicit models - scripts: cognitive and emotional = anticipations that ex ante prompt decisions

2. Reactions to outcomes ex post attribution struggles (show precisely how a mania or panic gets started)

3. lead to ‘business cycle’ - of money ‘expanding and contracting’ over a cycle

4. Time orientations: institutionally driven and also have effects

What struggles?modernity’s major social conflicts:Labour - capital preserve value of money!Creditor - debtor allow inflation! & vice

versa, and industrial versus bank etc…INSUPERABLE QUESTION FOR LEADERS - How to

‘control’ business cycles?the state – usually central bank or treasury –

restores the convention that the future will validate, not the past since no-one can do that, but expectations made in past

restore the ‘state of business confidence’ yes BUT - depends on current state of attributions………… ‘trust’ … or

Emotions in Finance: Distrust and Uncertainty in Global Markets

(Cambridge University Press 2004)

• uncertainty and vulnerability prevails• emotions of trust and distrust, fear and anxiety therefore

unavoidable

WHAT EMOTIONS, WHEN? eg risk assessment:1. ‘objective probability’ when probabilities can be

assigned, the process seems rational BUT involves the thrill of a ‘flutter’, even when knowing the odds or alleged ‘risk/return ratios’

2. ‘subjective probability’ (i.e. one’s preferences, ordered and calculated): decision needs trust and waiting induces a blasé attitude, arrogance, bravery or even sleepless anxiety

Emotions and Economics

• People most readily accept that emotions arise in politics all the time

• economics with honourable exceptions (Adam Smith), associates emotions with irrationality

• distinction is completely inconsistent with Keynesian uncertainty emotions REVOLUTIONARY

POST-KEYNESIAN MODEL

• process leading to expectations• stress on knowledge, creativity and the

role of confidence √ relative to how much uncertainty is

perceived - more or less ‘confidence’

Figure 1. Dequech ‘Determinants of the state of expectations’

Copyright @ 1999 by M. E. Sharpe Inc. Reprinted with Permission (in Pixley 2004: 69)

Problems with Post-Keynesian model:

•too individualistic•assumes set traits - cf. public persona•Dr Pangloss, eg, in the face of uncertainty and disasters•cf. learning occurs - somatic markers•not dynamic - feedbacks•DESIGN OF FOLLOWING PIXLEY MODEL (improved from Pixley 2004:70) By JAMIL YAMANI, College of Fine Arts, University of NSW, Sydney

Pixley BASIC model - Uses sociology and economics (Keynes 1937, Shackle 1972 and Myrdal (in Shackle 1967), Kemper 1978, and Luhmann, 1979

OUTCOMEOUTCOME

FailureSuccess

AttributionStruggles

EXPECTATIONImagination/Hope

PRESENTToday’s ‘NEWS’:

ConfidenceLack of Confidence

Feedback Loop

Feedback Loop

DECISIONTrust/Leap of Faith

Retrospective:PessimisticOptimistic

Retrospective:PessimisticOptimistic

PAST

PAST

BASIC MODEL

Approaches in orthodox economics:

Behavioural economics: • ‘many people’ willingly violate rational

axioms - anomalies and ‘irregular perceptions’

• Mark Twain - from gullibility to subversion: a mine = ‘a hole in the ground with a liar standing next to it’

• behaviourists maintain that predictions are possible with the correct human behaviour

Approaches in orthodox economics:

Neuro-economics: • tries to explain this irrationality: focus on the

human brain• Either - the hormone ‘oxytocin’ bonding,

love & trust - reduces aversion to loss

• Or people with brain damage to emotional regions bigger gambling risks

Recipe - hormones for more emotions or lobotomies to remove them

Emotions in organisations:

Uncertainty is not conquered within organisations, and nor are emotions

• ‘Rational organization, if anything, produces emotionality of a heightened sort. At the same time, it paradoxically structures itself to portray emotionality as aberration and neutrality as the norm’ (Gibson 1997: 229)

Formal rationality and uncertainty

• Knight and Keynes • uncertainty is very different from risk • Risk must comprise a set of known

chances to be measurable• Anything unmeasurable is a true

uncertainty (Knight 1964)

• the weather is ‘only moderately uncertain’ compared to finance (Keynes 1937)

Statistical probability

‘objective’ and ‘subjective’ probability:• ‘objective’ = dice or two-up - invariant factors• probability distribution - to each outcome,

known in advance• subjective’ probability - expected utility

maximisation theorem• Utilities = subjective preferences: agents can

evaluate; and can render judgements about the probability of each future outcome

• Probability measures one’s confidence in a likelihood estimate

cognitive script for probability rules …

Statistical Probability

Huge number of

OBSERVATIONS of each Subset’s past behaviour:

RELIABILITY - differences cancelled out

Huge number of OBSERVATIONS of each Subset’s past behaviour:

RELIABILITY - differences cancelled out

PAST

PAST

PRESENTCases must be SIMILAR -

Classification/StandardisationVALIDITY - gather & verify data

Cases must be SIMILAR - Classification/Standardisation

VALIDITY - gather & verify data

EXPECTATIONVALIDITY - Stability assumed!

Extrapolate the future from past experience.

VALIDITY - Stability assumed!Extrapolate the future from

past experience.

DECISION

OUTCOMEOUTCOMEClaim these are “KNOWABLE”

Claim these are “KNOWABLE”

EX ANTEKNOWN

EX POSTKNOWN?

Statistical probability - problems?

• huge number of past observations = reliability

• all cases must be the same = validity+ the past must continue exactly the same

into the future - extrapolateeg. ‘the American economy’s stability allows

for inferences from the past to the future’• NOT ‘as if’ rational decisions were being

made: transforming uncertainty into risk … depends entirely upon a ‘social capacity’: that is, stable institutions make economic calculations possible

Weber’s formal rationality

• social stability (capitalist institutions) is a condition of calculability

• a firm’s orientation is to profit (not subjective ‘preferences’ or utility)

• rationality ‘presupposes the battle of man with man’

conditions for rational capital accounting: ‘appropriation of the means of production’ by ‘property’; conflicts in the market, eg ‘shop discipline’ or domination; the whip of hunger = worker productivity predictable

Outcomes - calculable• ‘decisively influenced by the ability of

persons who are more plentifully supplied with money to outbid the others, and of those more favourably situated for production to underbid their rivals on the selling side’ (Weber 1978:93).

• exchange of ‘an expected future’ … the action is rational where ‘both parties expect an improvement in their position’

BUT - what if expectations prove incorrect all round even if they are formed through rational self-interest?

Keynes, Minsky and uncertainty Minsky: instability arises from stability or

‘tranquillity’ of success impact on ‘permissible liability structures’ change from ‘an initially robust financial structure into a fragile structure’ or Ponzi situation

• Keynes: scientifically revolutionary • incompatible (dissimilar) and

unknowable futures cannot be weighed or compared

• MONEY allows organisations to defer making decisions: a deferred decision cannot be known by anyone Myrdal

Rational Emotions in expectations

Keynesian expectations = ‘imagination and hope’

Keynesian conventions = a price, if left undisturbed; or guessing what the opinion of a majority of fellow-speculators will be by the afternoon

• ‘convention’ not clear… few boundaries ‘between today’s opinion of what will be tomorrow’s opinion, and the actual prevailing opinion which has anticipated tomorrow by being generally adopted today’ (Shackle 1972:225).

Rational Emotions in expectations

‘anticipatory emotions’ (Kemper 1978):• optimism or pessimism = emotions

generated by past experience and conditions

• confidence and lack of confidence = from positive and negative indicators in the present.

• variations in anticipatory emotions = many • hope can emerge from high optimism

over past events, but a lack of confidence about present unattractive indicators can augment the dangers in hope …Basic Model

OUTCOMEOUTCOME

FailureSuccess

AttributionStruggles

EXPECTATIONImagination/Hope

PRESENTToday’s ‘NEWS’:

ConfidenceLack of Confidence

Feedback Loop

Feedback Loop

DECISIONTrust/Leap of Faith

Retrospective:PessimisticOptimistic

Retrospective:PessimisticOptimistic

PAST

PAST

BASIC MODEL

Attribution struggles:• Attributions are significant because

of the emotional feedback • inter-organisational factors –

whether an outcome is deemed a success or failure – are won and lost in a social context, not in ‘reality’

• if outcome expected ex ante - little search for causes

• Unexpected outcomes if disasters - colossal efforts

diverse agents & unpredictable impacts

• a chain of feedback loops to the organisation a ‘damn the torpedoes, full steam ahead’, or to flight

• credibility or trustworthiness is a social form and is socially contingent

• Diverse conflicts: claims and counter-claims; law suits to defend a reputation; analysts bestow praise; stock values rise and fall; hedge funds short a stock; private equity firms criticise takeover target and vice versa

Constant + the cause of booms and busts: when enough usually conflicting attributions coalesce into uniformity - but this is unpredictable ….

Hypothesis: time orientations

• whether the past, the present or the future is emphasised in an organisation’s outlook towards the future - neglected

• Possible dominance of ‘short-termism’ = even cautious bankers report a relentless pace, shortening the time frame is a common strategy

• Past orientation - common among central bankers, some firms

Past

Comparison of past and present time-orientations

PAST: stretches way back; negative and positive cases; is this 1929 or 1996?

a tendency to ‘cling to Nurse/for fear of finding something worse’ paralysis, or select activity only if competence

PRESENT: copies the cognitive rules of statistical probability

• Memories are short: or tranquillity from winning attribution struggles ; shorten time frame; potential gullibility, recklessness

Present

Comparison to future time-orientation

- prone to accept uncertainty- history only ‘tells us’ that there is

uncertainty- study of outcomes, short and long-term1 = publicly proposes precautionary

measures and regulation of global liquidity 2 = an implicit long-term future of large

financial firms becoming ‘too big to fail’

Future

What does this approach bring out?

Formal rationality is not possible - calculations cannot be made about the unknowable - cognitive wrappings around uncertainty and emotions of anticipations and reactions

-cognitive and emotional rules from attributions, from assessments of past, present and future

-neglect of uncertainty is a source of irrationality

Implications of attributions

everyday influence on decisions

- we only have debates and competing claims about the past outcomes, with which to face the future

IF/WHEN attributions coalesce, they play a major role in creating a boom or bust, but the timing of such unanimity cannot be predicted

ALSO - in time-orientations - more short-termism? Or, long-term future-oriented view in large firms - to moral hazard or precautionary policies?

Conclusion

• Emotions give direction and motive to decisive action, yet emotions not controllable nor predictable

• social institutions of uncertainty: attribution conflicts after unexpected outcomes; time-orientations which are unavoidably part of decisions, and the political struggles to control sources of unpredictability

• Squeeze uncertainty in some places and it pops up, unpredictably in others