The Value of Extremist Economics

An article by Justin Fox in the June 1, 2009, issue of Time called my attention to the economic commentary and libertarian views of Peter Schiff, president of brokerage firm Euro Pacific Capital. (Justin Fox writes the column “The Curious Capitalist” for Time. The article I’m referring to was called “Excluding the Extremist” in the print magazine but is called “Why We Should Listen to Peter Schiff’s Bad News” in the online version.)

While most other economic commentators were trying to prop up the smiley-face view of the economic prospects during 2006 and 2007, Schiff was warning that the economy was heading into a serious recession because of too much debt and a broken banking system, and that the stock market was due for a crash.

Commenting as part of a panel for Fox News on 18 Aug. 2007, Schiff said the following:

The worst is yet to come, the fundamentals are not sound, they’re awful. If the fundamentals were sound we wouldn’t be having these problems.

This to the derisive laughter of the other Fox panel members. In the following video you can see fascinating clips of Schiff during that period going up against the prevailing optimistic wisdom of the time:

Even now in 2009, says Fox, Schiff has not changed his tune:

He thinks the “phony economy” of the U.S. is headed for even harder times. He believes that the crisis-fighting measures coming out of Washington are merely delaying the inevitable, debasing the dollar and loading future taxpayers with huge debts.

Doomsday prophecies aside, though, one of the most interesting aspects of Fox’s column is what he has to say about the value of diversity of opinion, even extremist views. Fox refers to the work of University of Michigan Professor Scott E. Page, an expert in complex systems, political science, and economics.

Including a diversity of views in a set of people working on a problem, writes Page in his book The Difference, increases the possibility that a crucial “savant” will be included in the group and that that is the person who will contribute the nugget that solves the problem:

If we sample widely, we’re more likely to find the one person who can solve the problem or who can make the key breakthough. We did not get the theory of relativity from a crowd. We got it from a diverse, novel thinker in a patent office.

Page’s book explains the research that backs up this assertion.

Some of our research at the Institute for Innovation in Large Organizations (ILO) jibes with what Page is saying. In our 2007 report “Effective Cross-Functional Innovation Groups,” we cited research by Harvard business professor Lee Fleming, who studied 17,000 patents. Fleming encountered an interesting tendency when studying the diversity of innovation teams:

The financial value of the innovations resulting from such cross-pollination is lower, on average, than the value of those that come out of more conventional, siloed approaches. In other words, as the distance between the team members’ fields or disciplines increases, the overall quality of the innovations falls.
However, he adds a big but:
But my research also suggests that the breakthroughs that do arise from such multidisciplinary work, though extremely rare, are frequently of unusually high value—superior to the best innovations achieved by conventional approaches.

The financial value of the innovations resulting from such cross-pollination is lower, on average, than the value of those that come out of more conventional, siloed approaches. In other words, as the distance between the team members’ fields or disciplines increases, the overall quality of the innovations falls.

However, he adds a big “but”:

But my research also suggests that the breakthroughs that do arise from such multidisciplinary work, though extremely rare, are frequently of unusually high value — superior to the best innovations achieved by conventional approaches.

We wrote:

Fleming comments that “when members of a team are cut from the same cloth,” as with a group of all marketing professionals, “you don’t see many failures, but you don’t see many extraordinary breakthroughs either.”

As an example, Fleming says that economists and physicists seem to be able to “team up and innovate efficiently and produce many moderate-value innovations, because their fields are fairly well aligned,” sharing “the common foundational tools of mathematics.”

However, as team members’ fields begin to vary, “the average value of the team’s innovations falls while the variation in value around that average increases. You see more failures, but you also see occasional breakthroughs of unusually high value.”

To me, this emphasizes the value of giving more extreme views a place at the table when tackling complex problems, rather than just laughing them off.

AB — 1 June 2009

 

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Do happy faces cause dumb investments?

Could an investor be prompted to make a more risky financial decision when exposed to positive, optimistic stimuli, such as a smile on the face of someone recommending or selling an investment?

That’s the implication of research by Julie L. Hall, a doctoral student in personality and social psychology in the Cognitive Science & Cognitive Neuroscience Program at the University of Michigan.

Hall and colleagues studied investment decisions made by 24 research subjects during a market simulation game. Some choices were high-risk and some were low-risk. Participants were shown pictures of happy, angry, or neutral faces before they carried out investment decison-making tasks.

Researchers also used fMRI (functional magnetic resonance imaging) during the tasks to see which areas of the brain “lit up” while participants were deciding which investments to follow.

Writing for New Scientist, Peter Aldhous describes how the game was set up (“Cheery Traders May Encourage Risk Taking,” April 7, 2009):

For every round of the game, the bond paid out $3. One of the stocks paid out $5 half of the time, while the other lost $5 at the same rate. At the start of the game, the players were told the rules but didn’t know which of the stocks was good and which was bad: that only emerged as the game unfolded. As with real-world investments, the good stock became bad at certain points during the game, and vice versa.

As Hall and colleagues anticipated, the positive stimuli caused increased activity in areas of the brain associated with anticipation of a reward and correlated with risky decision-making.

In introductory material to her March 23, 2009, presentation at the annual meeting of the Cognitive Neuroscience Society (“Put Your Money Where Your Heart Is: An fMRI Investigation of Affective Influences on Financial Investment Decisions,” Julie L. Hall, Richard Gonzalez, Oliver C. Schultheiss, Cognitive Neuroscience Society Annual Meeting Program 2009):

As predicted, participants showed greater NAcc activation and were more likely to make risky investment decisions after happy versus neutral face primes in both the subliminal and supraliminal presentation conditions. In addition, participants also showed greater anterior insula activation and made slightly less risky investment decisions after angry versus neutral face primes during supraliminal presentation conditions.

Hall concludes that

… facial expressions of emotion, even when they are not consciously perceived, can influence investment decisions and suggest that the inclusion of affect may lead to more accurate models of economic decision making, which better explain irrational financial behavior. They also suggest that affective states during pre-choice stages of the decision making process may alter the perception of benefits relative to costs, leading to changes in financial risk taking depending on whether the affective state is positive or negative.

Brian Knutson, a psychologist at Stanford University, has done similar research. He acknowledges, writes Aldhous, that “it is hard to determine the extent to which real financial markets are driven by similar emotional factors.”

However, Knutson has found that “the nucleus accumbens,” the brain area associated with risky investment decisions, “is activated when we are anticipating a reward.” For example, “showing men erotic pictures leads to similarly risky investment decisions.”

This fits with the Bubbleconomics proposition that infectious optimism contributes to economic bubbles and to the disastrous results.

Hall tells Adhous,

When risk-taking is a good thing, it’s good to be in a positive mood. When risk-taking is a bad thing, it’s not good.

AB — 7 April 2009