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Applied Behavioural Economics- A Case

The recent India-Pakistan conflict provides rich data on individual human behavior that makes perfect sense within behavioral economics. Behavioral economics studies individual behavior using an eclectic mix of economics, psychology, sociobiology, neuroscience, and other behavioral sciences, within a mathematically rigorous framework.

The public in both countries has access to almost identical public information through electronic and print media. Yet, purely by an accident of birth that determines one’s citizenship, most of 1.3 billion Indians and 0.2 billion Pakistanis choose to believe in mutually incompatible narratives of events. For instance, whether an F-16 was shot down, the number terrorists killed, and the number of Indian aircraft lost. Why do such mutually inconsistent beliefs persist and why does each side appear to completely discount the beliefs of the other? While the Pakistani narrative is silent about the role played by it in cross border terrorism, the Indian narrative is silent about the role that it played in alienating a large chunk of the Kashmiri population. Each side is persuaded in the objective and moral correctness of its own view.

Theories of financial markets assume that individuals quickly update their beliefs in an identical manner when they observe common public information (e.g., dividends or earnings announcements) and immediately learn from each other’s beliefs and actions. Behavioral economics shows that this assumption is as incorrect in finance, as it is in many other contexts.

Below I draw on my 2016 book in offering some insights into these questions [Dhami, S. (2016) Foundations of Behavioral Economic Analysis, Oxford: Oxford University Press].

Henri Tajfel was a Polish Jew studying Chemistry at the Sorbonne in France at the time of World War II in which he lost his entire family in concentration camps. He switched to social psychology to discover the nature of human prejudice. His work gave rise to social identity theory. The main insight is that humans classify others into ingroups and outgroups and favour ingroups over outgroups. Examples include attempts by corporate entities to inculcate a corporation-specific culture and armed forces that try to inculcate a military identity relative to a civilian identity. On the negative side, social identity gives rise to social discrimination, prejudices, and the need for affirmative action.

Experiments in behavioral economics show that minimal group identities, in which individuals are classified into blue and red groups, is sufficient to elicit ingroup favouritism. Social identity becomes highly salient at times where one perceives that the ingroup is engaged in conflict with an outgroup. Propaganda has been historically used to prime social identity and to paint the ingroup position as a just cause, while characterizing the outgroup position as unjust, untrustworthy, and malicious.

Once suitably primed, otherwise peaceful individuals view any ingroup member killed in a military conflict as a martyr and celebrate the valour of their forces in killing the enemy, yet in each case a human life is lost. Indeed, many humans engage in this behavior automatically, without engaging in conscious deliberation, which suggests that social identity has evolutionary origins. While most humans find it comforting to associate with the ingroup narrative, some do challenge it, which typically invites a hostile reaction, particularly in times of heightened social identities. Joseph Goebbels, the German Reich Minister of Propaganda in World War II, understood this very well.

The media, in both countries, has played its role in sharpening social identities on the just cause/malicious intent divide. If it has a good understanding of this mechanism, and if it wishes to play a socially responsible role, then it must proceed with great caution.

So why is it difficult to alter one’s prior beliefs and mental models about the world, given that they might have arisen from social identity or other considerations in the first place? This bit of the puzzle is solved by invoking a very robust feature of human behavior–confirmation bias. I use the following definition from p. 1391 of my book which deserves to be read in full: “…there is considerable evidence that people tend to interpret subsequent evidence so as to maintain their initial beliefs. The biased assimilation processes underlying this effect may include a propensity to remember the strengths of confirming evidence but the weaknesses of disconfirming evidence, to judge confirming evidence as relevant and reliable but disconfirming evidence as irrelevant and unreliable, and to accept confirming evidence at face value while scrutinizing disconfirming evidence hypercritically. With confirming evidence, we suspect that both lay and professional scientists rapidly reduce the complexity of the information and remember only a few well-chosen supportive impressions. With disconfirming evidence, they continue to reflect upon any information that suggests less damaging “alternative interpretations.” Indeed, they may even come to regard the ambiguities and conceptual flaws in the data opposing their hypotheses as somehow suggestive of the fundamental correctness of those hypotheses. Thus, completely inconsistent or even random data¬¬¬¬–when “processed” in a suitably biased fashion–can maintain or even reinforce one’s preconceptions.”

Social identity first locks down our beliefs into country-specific narratives and then confirmation bias simply confirms our initially held beliefs and models, independent of the strength and the quality of the evidence that we observe. The result is separate, parallel, incompatible narratives.

Behavioral economics sometimes finds it useful to draw a distinction between System 1 (quick, reactive, impulsive, automatic part of the brain associated with the limbic system) and System 2 (slow, deliberative, conscious, long-term decision-making part of the brain associated with the prefrontal cortex). One of the great personal challenges for all humans is to ensure that when the occasion demands, we use System 2 to rein in System 1, which is responsible for the confirmation bias and for automatic conformity with social identity. This can be terribly difficult, but it is also an opportunity to demonstrate human character of a high order, which has also been observed in this conflict. Herein lies real hope.

By Sanjit Dhami
Professor of Economics at University of Leicester, and a Fellow of Munich University and the Kiel Institute for the World Economy.; Former faculty at SRCC

This article, retitled here, originally carried by Business Standard, March 15, 2019—“The Recent Indo-Pak Conflict: A Behavioural Economics Perspective”.
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