12th August 2011
Overconfidence (which I've looked at here) and
Belief in perfect hindsight
I've spoken to lots of people who know what the Bank of England should have done to avert the current financial crisis.
"If they'd done X", they tell me, "it would have been averted, or at least much less serious". The problem is, X is the unknown – sometimes it's raise interest rates, sometimes it's lower them, sometimes it's make ritual sacrifice, there's always something that would have worked and the person knows exactly what it was.
"As mentioned in the previous article, that arises partly from believing in the ability to control and predict events in a chaotic system. We can't and are overconfident that we can."
"But there's another reason we keep doing things that don't work, in the belief that they will work if we do them long enough.
Belief in perfect hindsight.
See if you can predict this:
Imagine you've got a large block of ice (a square block, an ice sculpture, anything). Given the topology and porousness of the surface, the temperature of the room and the dimensions of the block, calculate the size and shape of the pool of water that forms when it melts.
Whether you can predict it depends on your knowledge of thermodynamics, fluid mechanics etc. But it is potentially calculable.
Given the topology and porousness of the surface, the temperature of the room and the size and shape of the pool of water, calculate the shape and dimensions of the block of ice that formed it.
While you think, remember that the pool may not have been formed by melting ice but by a spilled bottle or a naughty puppy.
You can predict the ice from the pool and believe that you are right because nobody can prove you wrong. There are millions of possible shapes that lead to a single pool, just as there are millions of possible "legs of the trousers of time" that lead to the present.
Nobody knows which one we actually followed – because nobody knows all the chaotic events that were on the path.
We simplify when we look at the past. We want to understand, so we kid ourselves that we do – but we don't.
One reason we don't is that, contrary to popular belief, practice doesn't make perfect, it makes permanent.
If you start off really bad at something and practice enough, you'll become expert at being bad, but won't improve.
To improve, you need practice with feedback that allows you to correct what you are doing.
Imagine a tennis game. You serve, the ball goes in or out, you get feedback straight away so you can try to do better, or keep things the same if it worked
Imagine you invest. Your investment goes up. Was that your skill, or were you lucky? How do you know? What combination of chaotic events caused that?
Remember humans are subject to the Fundamental Attribution Error.
Basically, we believe that our success is due to genius and skill, our failure to bad luck. Other people's success is due to good luck or circumstances, their failure to congenital stupidity.
So if you are considering a course of action that hasn't worked, what happens?
You have a theory about what ought to happen. Say, you apply quantitative easing that "ought" to work in a particular way. But the economy doesn't do what you predict.
What actually happened – the QE effects lots of different factors in many ways, which interact with other factors to an extent that is totally incalculable. It might do what you predict for a while, then go into reverse, nothing might happen, things might get far worse. You don't know exactly why anything has happened or what the QE has actually done, if it has done anything at all. You don't get meaningful feedback and have no idea what to do.
What you believe happened – There is evidence QE is working (you know your ice shapes from extensive experience). There are other factors which prevent it working as you expected.
But it must be working, because that's what you started off believing. If you change policy, it is an admission that you were wrong. You cannot be wrong. You must persist.
To admit we don't have everything under control and can't understand the complexity or interpret the outcomes accurately is hard to bear.
So we stick with things that don't work – in our hearts we know they don't work, but we can't give up on our overconfidence of control, our belief that hindsight brings perfect understanding and that all that prevents success is lack of persistence.
Kim Stephenson is an occupational psychologist and trained financial adviser.
His website Taming the Pound is aimed at helping people get control of their thinking about money, so they can use their money – and avoid their money using them.
More from Kim on Mindful Money
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