Primary navigation:

QFINANCE Quick Links
QFINANCE Reference

Home > Blogs > Anthony Harrington > Kahneman’s “fast and slow thinking” sets a puzzle

Kahneman’s “fast and slow thinking” sets a puzzle

Kahneman’s “fast and slow thinking” sets a puzzle Anthony Harrington

The Nobel Laureate Daniel Kahneman is a world famous behavioural psychologist and author of Thinking, Fast and Slow. He won the Nobel Prize for economics in 2002, the only non-economist ever to win that prize.

In his latest book Kahneman calls “fast thinking” what most people mean when they say they did something “instinctively” or that they “followed their intuition”. Fast thinking is tremendously useful. It enables us to do things that we are well versed in, such as driving a car, while the bulk of our attention is on something else. Many drivers will have had the experience of finding themselves having driven from Point A to Point C, without much recall at all of how they got through Point B. Their “machine code”, as it were, took care of the driving while they figured out some issue or indulged themselves in some flight of fancy as they drove “on automatic”.

“Slow thinking” on the other hand, is what we do when we use logic and reason to rationally work out the answer to even a moderately complex problem. In an interview with CNBC’s Charlie Rose, Kahneman cites the example of, say, 27 x 17, as a problem that most of us would need to work through fairly laboriously to generate the correct answer. That is slow thinking for you. By way of contrast, 2 x 4 is an instance where “fast thinking” generates the answer without most people having to have recourse to their fingers, or even having to run through the 2x2 multiplication table. You just “know” that the answer is 8.

So we have two systems of thinking, the intuitive system, where practice and life experience provides instant answers, and the reasoning system. His point is that very often, in complex situations, the answer that is delivered by “fast thinking” is wrong, because the problems our intuition is providing us with a “lightening grasp of”, turn out to be counter intuitive – once they have been solved, that is, by the application of “slow thinking”. Here Kahneman cites a rather tortuous example.

Buying insurance, he points out, turns out to be a complex problem not suited to “fast thinking." Shortly after a major terrorist incident two samples of members of the public were asked how much they were prepared to pay for travel insurance. The question put to the one group was something like: “How much would you pay for a travel insurance policy that covered all forms of death for the period of your journey?” The other group was asked: “How much would you pay for a travel insurance policy that covered you for death caused by a terrorist incident?" What the survey found was that people in the second group were prepared to pay significantly more for their travel insurance than people in the first group.

This is a blatantly absurd answer, Kahneman points out, because the second question provides protection for only a tiny subset of all the possible causes of death during travel, while the first provides comprehensive coverage of all possible causes, including death through a terrorist incident.

The explanation for the absurdity is obvious. The greater willingness to pay more in the second instance is driven by fear. In other words, when you have a powerful driver like fear – and one can add greed to this, since fear and greed are what drive investors and markets  – then in the face of these powerful emotions, instinct takes over and can lead to demonstrably absurd decisions.

This will come as no surprise to any reader of Reinhart and Rogoff’s “This Time is Different,” which catalogues and analysis five centuries of financial disasters, all of which seem to be based on our ability to delude ourselves into believing that bubbles are not actually bubbles and that this time they won’t burst but will go onwards and upwards forever.

What is most noteworthy about the Kahneman interview, however, is not so much his new terms for instinct and reason, which one can take or leave, but his pessimism about our ability to use system two to correct the flaws in system one. Asked by Rose what we can do to reign in intuition, which turns out to be a rich source of false assumptions and prejudices, Kahneman says that we need to learn to subject its results to a more rigorous scrutiny by “slow thinking”.

Is there much evidence we are doing this, Rose asks?

“Not really,” says Kahneman.  “It is very difficult to do and I am very pessimistic about us succeeding.”

In the light of this, the though occurs: If we can’t do it one on one with ourselves, what hope of success can there be when it comes to regulating complex systems like the global banking system, for example? If the 2008 crash demonstrated anything it was that bodies like the FSA and the SEC were running on “intuition” and their intuition was telling them that the markets were pretty well perfect and light touch regulation was the way to go. Not exactly a happy picture of our ability to cope with complexity…

The most fulsome response that has been produced so far to that disaster of intuition, namely the global financial crash, has been the Dodd-Frank Act. It is a beast of such wondrous complexity that lawyers yet to be born will grow rich parsing its clauses. It seems that when we know intuition won’t work we invent labyrinths instead…

Further reading on regulation and complexity:

Tags: common sense , fast and slow thinking , instinct , intuition , Kahneman , logic , reason , regulation
  • Bookmark and Share
  • Mail to a friend


or register to post your comments.

Back to QFINANCE Blogs

Share this page

  • Facebook
  • Twitter
  • LinkedIn
  • RSS
  • Bookmark and Share

Blog Contributors