A psychological core for economics

Thinking of the mind as a network within and upon which our psychological process operates gives us a profound insight into the functioning of the mind and behaviour which fundamentally changes the way we think about economic behaviour. It allows us to integrate into a coherent whole all manner of quirks and oddments of human psychology and behaviour, and put them all at the core of our understanding of the economy.

At the dawn of the discipline of economics qua defined discipline, psychology was at the very core of economic analysis. Sylvia Nasar has recounted how the father of analytical economics, Alfred Marshall early in his career was considering becoming a gestalt psychologist. Indeed, as I have noted elsewhere, Marshall essentially defined the more important part of economics as psychological science in the famous opening of his Principles of Economics:

Political Economy or Economics is a study of mankind in the ordinary business of life; it examines that part of individual and social action which is most closely connected with the attainment and with the use of the material requisites of wellbeing.

Thus it is on the one side a study of wealth; and on the other, and more important side, a part of the study of man.

Luigino Bruni and Robert Sugden have documented how, for various reasons (but essentially because economists wanted to steer clear of the bitter controversies of early psychology) the discipline of psychology was banished from economics. A psychology of sorts remained in economics, variously a rather outdated one inherited from Francis Edgeworth’s Mathematical Psychics or heavily behaviourist one inherited from Paul Samuelson. The view was that individuals choose “rationally” that behaviour associated with the highest “utility” out of a constrained set of alternative courses of action.

Richard Thaler and Danny Kahneman in particular sparked the reengagement of economists with psychology by documenting critical differences between “rational choice” and actual behaviour. This, of course, is known as “behavioral” (contra behavioural, yes there is a difference) economics. The engagement, however, has hitherto been fairly piecemeal, largely building modifications into the basic “rational choice” model to account for this “bias” or that “heuristic”. This is an approach to integrating psychology into economics which Matthew Rabin has called “portable extensions of existing models”.

Peter Earl, one of my Doctoral advisors at the University of Queensland took a different view, and instead argued it was necessary to integrate psychology as a whole at the core of economic analysis. Economics ought proceed from a psychological model of individual behaviour, not merely integrate bits of psychology at the edges of an economic model of behaviour. He proceeded to do so in three remarkable books: The Economic Imagination, The Corporate Imagination and Lifestyle Economics.

In building the “UQ model” of economies as complex evolving networks formed by individuals acting on the basis of their psychology and social position, I took Peter Earl’s work and built on it using the power of mathematical analysis. What emerged was a coherent model of individual psychology which we can place at the core of models of the economy. All of a sudden the various quirks and oddments of human psychology and behaviour identified by the behavioral economists became not so, but rather reasonable aspects of the human mind.

If you can be patient with me and sit through what is of necessity a rather taxing essay by way of length, I promise you it will pay dividends by way of understanding human economic behaviour.

The mind as a network

How do you model something so complex and intricate and individuated as the human mind? The brain from whence it emerges is alone one of the most complex objects in the universe. We make sense of the mind by stripping it back to its most basic process.

On this, the philosophers are uniquely agreed, and many psychologists too. The basic mental process is the forming of a connection. Hume (in An Enquiry concerning Human Understanding) and Kant (in the Critique of Pure Reason) both speak of thought as a process of “association” and “connexion” between objects and events in the world; establishing their resemblance, their relation to one another, which is the cause and which is the effect. John Dewey in How We Think similarly talks of thoughts “inferring the unseen relations” between events and objects in the world. George Kelly in his Theory of Personality talks about thoughts as “channelled” by the way in which we “construe events”. The great economist Friedrich Hayek also wrote a particularly well informed book on psychology, The Sensory Order, in which he wrote of thoughts as classifying percepts by “filtering” them through neural networks.

Whenever we think, we construct connections. When we construe a relationship between two objects we are inferring the unseen relation between two things in the world, for instance, the physical object that is “my wife” and her name, or her beauty or my feelings for her. When we construe a relationship between two events we are inferring the unseen relationship between two occurrences in the world, for instance, the billiard ball striking another and causing it to move. We construe these in sequence too, connecting the objects that are the sound of an engine, then the engine as the cause of the movement of a vehicle.

A connection between two objects or events in our mind exists within a broader network of such connections weaving together a “map” of the world and the way it “fits together”. The Germans in their classically untranslatable manner call it a weltanschauung, a sort of “worldview”. We will call it simply our mental network.

The nodes in our mental network correspond to nouns, adjectives, subjects, objects, the symbolic descriptors of the objects and events in our world. The connections in this network correspond to connectors between those objects and events, the equivalents of symbolic “if, then, because, therefore, is, is not”, etc.

The mental network as a whole expresses the totality of our understanding of the world, the “stuff” in it and the relations we construe between that “stuff”. It expresses the totality of our knowledge of the world and our memory. It is what the psychological process operates within, and upon.

The psychological process within mental networks: perception, analysis, decision

We exist in a world full of information. Now I don’t mean that only in the internet-age sense of the world being full of information media, I mean that in the sense the quantum physicists do. The world itself is information manifest.

When we say that economies are complex evolving networks formed by individuals acting on the basis of their psychology and social position, this is what we mean by acting on the basis of our “social position”. Our social position is a literal position in spacetime which contains information in its locality, in particular social information. Our response to that information is what informs our behaviour, in particular our buying and selling, producing and exchanging — our economic behaviour.

Before we can respond to our environment, we need to transform raw information in the worlds into some representation of that information in our minds. That is the function of perception. Perception takes information in the environment of our social position and transforms it into those nodes in our mental networks which symbolise the various objects and events which manifest that information. Perception is the process by which the “dots” in our mental network “light up”, alerting us to “what’s going on” in our environment. It is what we are doing when we (literally) “see” something.

For instance, if we are walking around a shopping mall (temples of capitalism indeed) or a high street (the bucolic English variant) we are nearly drowned by information which will inform our economic behaviour. In this environment we perceive (or don’t) various shops, various people, and various things we can buy from them (increasingly also the labour we can sell to them).

The basic objects of economic activity are not the only things we will perceive. Two great Australian economists, Duncan Ironmonger and Kelvin Lancaster, would remind us that we will also perceive various attributes of the goods and services we are considering. For instance, we would perceive the smell, colour, texture and other properties of various foods and soaps and clothes and such like as well as of the shops in and the people by which they are sold. Ulrich Witt, one of my intellectual heroes, would remind us that we will also perceive the elicitation of various wants and needs. George Loewenstein and another of my Doctoral advisors Michelle Baddeley would remind us that we would observe the emotions elicited by this environment.

But these objects and events don’t really make “sense” to us; actually they mean nothing, unless we can connect them together and form an understanding of their relation. This is the function of analysis. Analysis is the process by which we take the connections contained in our mental networks between the various percepts of our environment, and apply them to construe the relations between the objects and events in our environment.

By this we arrive at an understanding of our situation, the relations between the various objects and events within it. We apply our accumulated knowledge of the world to come to knowledge of a particular situation. From our “map” of the world emerges a “model” as Hayek put it in The Sensory Order.

So, in our shopping mall or high street, by applying our mental networks, our knowledge, we connect the various foods and soaps and clothes and such like with their attributes (their smells, colours, texture etc.) and these in turn with the shops in which and the people by which they are sold. These attributes of goods and services, the people who sell them, and the places in which they are sold are in turn connected with various other objects both present and expected in the future, and finally to the wants, needs and emotions they satiate.

Our analysis of the information in our environment becomes our knowledge of how and why to engage in various courses of action. Applying our knowledge informs us of the how and why to buy and sell, produce and exchange.

This knowledge has a feeling endowed by the consciousness, and feelings always have aesthetic qualities. Aesthetic qualities are what allow us to establish that we prefer certain things to others. That means we can say that certain subsets of our knowledge of the outcomes of economic behaviour are more or less preferable than others.

There is a truth to the idea that we do what we think is best, and it is that our knowledge guides us in deciding upon that course of action associated with the most preferable expected outcomes. With respect to economic behaviour, that means we buy and sell, produce and exchange in such a manner which satisfies our needs, desires, and emotions in the most preferable way given our knowledge of how and why to act in the world. Note the individuality of this statement, it doesn’t suppose the existence of some universal morality, it says that people act according to their own personal knowledge of how and why to act in the world.

This is what Friedrich Hayek and the “Austrian” economists mean when they speak of the economy as a system of knowledge which coordinates individual actions. Our perception, what we “see” makes sense only in light of our knowledge, what we “know”, and it is this knowledge which informs our economic behaviour as individuals, because it informs all our behaviour.

Note well the significance of the whole of this process. Information is perceived, that perception is analysed, and then that analysis informs behaviour. If we change the basis for that analysis, our knowledge of the world, we change the way people behave. If we change the information in the environment, or even merely the way that information is presented, we change the way people behave.

Seeing the mind as a network structure reveals behaviour to be mutable and changeable, even without allowing the structure to evolve. With this psychological basis for economic behaviour, the economy becomes a mutable and changeable system, at its very core an evolutionary system.

The psychological process upon mental networks: evolution

The reality is that our mind, the way we think, changes over time. Our mental networks evolve as we accumulate new knowledge and memories, and they fade away as memory decays. The manner in which our minds evolve are subject to quite well documented processes.

The “indispensable intellectual” Arthur Koestler in The Act of Creation argued that all creative thought was the creation of “bisociations” in the mind between hitherto unconnected concepts. New ways of stringing words together to write new types of literature, new ways to pass a brush along a canvas to create new types of art, new ways of sequencing tones to create new types of music, they are all new ways of connecting things together. Joseph Schumpeter brought this into the quotidian world of economics in the Theory of Economic Development by realising that creative thought was a means by which we develop new techniques of combination in production processes.

Creative thought is by its nature ex nihilo, without origin, by definition, for otherwise it would not be creative. But new connections may also be presented to us by information in the world, by perception. We may perceive apparent connections between objects and events in the world — indeed this is the source of a key disagreement between Kant and Hume. Kant argued that there was such a thing as “a priori synthetic statements”, what we would call creative thought, where Hume thought in his earlier work A Treatise of Human Nature that the only source of new mental connections was “sense-data”, what we call perception.

This latter source of new connections is the source of many scientific ideas. The experimenter observes that pure sodium in water dissolves and fizzes, suggesting to the experimenter a reactive connection between sodium and water. The strong performance of Google, a company which has an unusual “hands off” approach to management (see the book How Google Works), suggests a connection between a philosophy “let the smart people do their thing” and a strong company.

New connections alone, created or perceived, do not cause the mind to evolve unless they are assented to, to use the great phrase of Cardinal Newman in the Grammar of Assent. And the likelihood of we assent to, and incorporate connections into our knowledge is subject to the government of three laws.

1. The law of suggestion: Almost as a matter of logic, if we perceive a new apparent connection between objects and events, they are more likely to assent to that connection.

This is the idea behind teaching and conversation. Say I tell you the connections which comprise mathematical arguments such as 2+2+4=4+4=8 or political arguments such as “liberty is necessary for experimentation with lifestyles, experimentation with lifestyles is necessary to live a Good Life, therefore liberty is necessary to live a Good Life” or such like. I am much more likely to have you assent to those connections than if I left it to the vagaries of chance for you to discover them.

2. The law of resistance at the core: This is the corollary of George Kelly’s research on personality, and holds that the more the incorporation would change mental networks at their core (a well-defined concept in network theory), the less likely we are to assent to that connection.

George Kelly teaches us that not all “personal constructs” (sets of mental connections) are equal, there is a “core” to our personality. This core includes, but is not limited to, our moral code. It includes our knowledge of our closest relationships. Kelly (and later, incidentally, M Scott Peck in The Road Less Travelled) teach us that changing our minds is uncomfortable. Hence why it hurts so very badly to lose a loved one, or why someone is so utterly resistant to ideas which might change their basic morality — such connections would change the very core of our being.

3. The law of resistance to dissonance: This is the direct corollary of Leon Festinger’s famous Theory of Cognitive Dissonance, and holds that the more elicited connections in our mind a new connection contradicts, the less likely we are to assent to that connection.

I have written elsewhere on the dangers this poses in our political systems by in severe cases reducing our ability to persuade and debate to zero between political “tribes”. But it is also the reason being an entrepreneur is so hard. In the Theory of Economic Development Joseph Schumpeter noted the difficulty facing entrepreneurs who almost by definition challenge the way “things are done”. Leon Festinger shows us why: to challenge the way “things are done” is to create cognitive dissonance, and cognitive dissonance is deeply uncomfortable.

But knowledge does not only grow, memory decays over time as must all structures in the universe according to the entropy law.

4. The law of entropy, or memory decay: The strength (the “vividness”) of connections in mental networks will decline over time at a rate which is slowed the more often that connection has been elicited in the past, and which may only be reversed by the energy exerted in the eliciting of that connection.

Even as new ideas are incorporated into our mental networks, they begin to decay toward nothingness, unless like flexing a muscle we continually renew them.

So, again, when we see economic behaviour as governed by a psychology which can evolve, by knowledge which can evolve, our economies are revealed to be evolutionary systems at their very core. Over time our knowledge, our thinking, our minds evolve and change the basis upon which economic behaviour is decided, and as the basis for economic behaviour changes, so too does economic behaviour.

Conquering new realms of knowledge

This has already been a somewhat taxing essay. But let us conclude by casting an eye forward to the new realms of knowledge our model can conquer for us as a reward for our exertions. With this model in hand we can understand a wealth of new economic behaviour as part of a coherent whole which could previously be understood only in “Portable Extensions of Existing Models”.

For instance, one especial advance discussed in Foundations for Economic Analysis, the technical work which sets out the “UQ model” is the manner in which behaviour which results from non-substitutability can coexist with behaviour which results from substitutability. This is a fairly technical distinction which I hope to discuss more in the future, because in spite of its technicality it has profound implications for how we understand economic behaviour, and therefore profound implications for the way our economies form and evolve.

Other advances are elaborated in two technical works of mine which I hope to discuss further in the future. The argument of On Changing Behaviour in Fixed Psychologies is that we can reduce the vast array of differences between “rational choice” and actual behaviour identified by behavioral economics back to three quite reasonable and straightforward aspects of human psychology. I have written elsewhere in the context of the art of rhetoric about the argument of The Competition and Evolution of Ideas in the Public Sphere which relates to us how we can understand in an coherent manner all the various factors at play in the spread of ideas across a population, and the resulting evolution of knowledge which causes the evolution and development of the economy.

All these various aspects of human psychology can now be incorporated at the core of economic analysis. They are all various aspects of the same underlying model which arises from a view of the mind as a network within and upon which our psychological process operates. They are all various aspects of the mind which we can now put at the very heart of economic analysis, and by so doing understand the impact of the workings of human psychology on the formation and evolution of our economies.