[Kabar-indonesia] 1 of 2: New Yorker: Money On The Brain: What Neuroeconomics Tells Us

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The New Yorker Magazine 
Issue cover dated September 18, 2006

Annals of Economics

MIND GAMES

What neuroeconomics tells us about money and the
brain.

by JOHN CASSIDY

Like many people who have accumulated some savings, I
invest in the stock market. Most of my retirement
money is invested in mutual funds, but now and again I
also buy individual stocks. My holdings include the
oil company Royal Dutch Shell, the drug company
GlaxoSmithKline, and the phone company British
Telecommunication. I like to think that I picked these
stocks because I can discern value where others can't,
but my record hardly backs this up. I invested in BT
in 2001, shortly after the Nasdaq crashed, when the
stock had already fallen substantially, only to watch
it slide another fifty per cent. I should have sold
out, but I held on, hoping for a rebound. Five years
later, the stock is trading well below the price I
paid for it, and I still own it.

I sometimes wonder what goes on in my head when I make
stupid investment decisions. A few weeks ago, I had a
chance to find out, when I took part in an experiment
at New York University's Center for Brain Imaging, in
a building off Washington Square Park. In the lobby, I
met Peter Sokol-Hessner, a twenty-four-year-old
graduate student, who escorted me to a control room
full of computers. Sokol-Hessner is completing a
doctorate in psychology, but he is currently working
on a research project in the emerging field of
neuroeconomics, which uses state-of-the-art imaging
technology to explore the neural bases of economic
decision-making.

Sokol-Hessner is particularly interested in "loss
aversion," which is what I was suffering from when I
refused to sell my BT stock. During the past decade or
so, economists have devised a series of experiments to
demonstrate just how much we dislike losing money. If
you present people with an even chance of winning a
hundred and fifty dollars or losing a hundred dollars,
most refuse the gamble, even though it is to their
advantage to accept it: if you multiply the odds of
winning—fifty per cent—times a hundred and fifty
dollars, minus the odds of losing—also fifty per
cent—times a hundred dollars, you end up with a gain
of twenty-five dollars. If you accepted this bet ten
times in a row, you could expect to gain two hundred
and fifty dollars. But, when people are presented with
it once, a prospective return of a hundred and fifty
dollars isn't enough to compensate them for a possible
loss of a hundred dollars. In fact, most people won't
accept the gamble unless the winning stake is raised
to two hundred dollars.

Why are we so averse to losses, even at the expense of
gains? At the Center for Brain Imaging, I removed my
belt and shoes and entered a room containing a big
metal box, which measured about six feet by six feet
by six feet, with a slim gurney protruding from one
side. It was a magnetic-resonance-imaging machine,
identical to those hospitals use to scan bodies for
lesions and tumors. "As blood pumps through the brain,
the oxygen it contains causes small changes in the
magnetic field," Sokol-Hessner explained. "The scanner
can pick up on that and tell us where the blood is
flowing. We get a picture of which parts of the brain
are being used."

I put on earplugs and lay back on the gurney.
Sokol-Hessner and two lab assistants placed some foam
around my ears and lowered a plastic grille over my
face. In one of my hands they placed a metal console
with two buttons on it. I felt my head and shoulders
sliding into a long, cylindrical hole about a foot and
a half wide. "Take a few deep breaths," Sokol-Hessner
said. There was a crashing noise—the sound of the
magnet warming up. Struggling to fend off
claustrophobia, I closed my eyes and counted to a
hundred while the scanner took a picture. "How are you
doing?" asked Sokol-Hessner, who had retreated to the
control room. "Fine," I lied.

My task was to consider a series of investment options
that were presented on a small illuminated screen over
my head. In each case, one of the options would be a
fifty-fifty bet and the other would be a sure thing.
The first scenario appeared on the screen: a possible
gain of four dollars and a possible loss of two
dollars versus a sure thing of zero, meaning that I
wouldn't win or lose anything. I had three seconds to
make my selection. Two dollars didn't seem like a lot
to lose, so I pressed a button on the console to
accept the bet. Somewhere in the next room, a random
number generator was deciding whether I had won or
lost. Then this message flashed on the screen: "You
won $4.00."

Sokol-Hessner's thesis advisers are Elizabeth Phelps,
a professor of psychology and neural science at
N.Y.U., and Colin Camerer, an economist at Caltech who
helped found neuroeconomics. This spring, I visited
Camerer at his office in Pasadena, California. He is a
stocky man of forty-six, with a large, bald head and
blue eyes. His office was cluttered with textbooks and
academic journals, and on one wall there was a
whiteboard covered with equations. It looked like
every other economist's office I've visited, except
that on Camerer's desk there was a plastic model of
the human brain.

While we were speaking, Camerer picked up the model
and gave me a quick tour, starting at the front, with
the prefrontal cortex, a structure that helps us
perform complicated mental tasks, such as logical
reasoning and planning. Then he pointed to the
parietal cortex and the temporal lobes, regions that
are also involved in deliberative decision-making. All
these areas are much larger in humans than in other
animals; scientists think that they were the last
parts of the brain to evolve.

The model was made of layers of interlocking pieces.
Camerer removed a piece from the top layer, exposing
the so-called limbic areas beneath, including the
insular cortex and the striatum. These structures date
to the earliest period of human evolution, and
neuroscientists believe that they help us process
emotions. Camerer was particularly eager to show me
the amygdala, a pair of almond-shaped structures that
also play a role in the processing of emotions. "They
are in here somewhere," he said, removing more pieces
from the model.

Camerer was a child prodigy. He grew up in Baltimore
and entered college at Johns Hopkins at the age of
fourteen, majoring in mathematics. He spent a lot of
time at a local racetrack, betting on horses, a hobby
that got him interested in risk-taking and
decision-making. In 1981, when he was twenty-one, he
obtained a Ph.D. in economics at the University of
Chicago Graduate School of Business. Camerer also
found inspiration outside his field.

In 1979, two Israeli psychologists, Daniel Kahneman
and Amos Tversky, published a paper in the economics
journal Econometrica, describing the concept of loss
aversion. At the time, few economists and
psychologists talked to one another. In the nineteenth
century, their fields had been considered closely
related branches of the "moral sciences." But
psychology evolved into an empirical discipline,
grounded in close observation of human behavior, while
economics became increasingly theoretical—in some ways
it resembled a branch of mathematics. Many economists
regarded psychology with suspicion, but their
preference for abstract models of human behavior came
at a cost.

In order to depict economic decisions mathematically,
economists needed to assume that human behavior is
both rational and predictable. They imagined a
representative human, Homo economicus, endowed with
consistent preferences, stable moods, and an enviable
ability to make only rational decisions. This sleight
of hand yielded some theories that had genuine
predictive value, but economists were obliged to
exclude from their analyses many phenomena that didn't
fit the rational-actor framework, such as stock-market
bubbles, drug addiction, and compulsive shopping.
Economists continue to study Homo economicus, but many
recognize his limitations. Over the past twenty-five
years, using methods and insights borrowed from
psychology, they have devised a new approach to
studying decision-making: behavioral economics.

One of Camerer's mentors, Richard Thaler, was among
the first economists to cite Kahneman and Tversky's
work; beginning in 1987, he published a series of
influential articles describing various types of
apparently irrational behavior, including loss
aversion.

Acknowledging that people don't always behave
rationally was an important, if obvious, first step.
Explaining why they don't has proved much harder, and
recently Camerer and other behavioral economists have
turned to neuroscience for help. By the
mid-nineteen-nineties, neuroscientists, using MRI
machines and other advanced imaging techniques, had
developed a basic understanding of the roles played by
different parts of the brain in the performance of
particular tasks, such as recognizing visual patterns,
doing mental computations, and reacting to threats. In
the mid-nineties, Antonio Damasio, a neurologist at
the University of Iowa, and Joseph LeDoux, a
neuroscientist at N.Y.U., each published a book for
lay readers describing how the brain processes
emotions. "We were reading the neuroscience, and it
just seemed obvious that there were applications to
economics, both in terms of ideas and methods," said
George Loewenstein, an economist and psychologist at
Carnegie Mellon who read Damasio's and LeDoux's books.
"The idea that you can look inside the brain and see
what is happening is just so intensely exciting."

In 1997, Loewenstein and Camerer hosted a two-day
conference in Pittsburgh, at which a group of
neuroscientists and psychologists gave presentations
to about twenty economists, some of whom were inspired
to do imaging studies of their own. In the past few
years, dozens of papers on neuroeconomics have been
published, and the field has attracted some of the
most talented young economists, including David
Laibson, a forty-year-old Harvard professor who is an
expert in consumer behavior. "Natural science has
moved ahead by studying progressively smaller units,"
Laibson told me. "Physicists started out studying the
stars, then they looked at objects, molecules, atoms,
subatomic particles, and so on. My sense is that
economics is going to follow the same path. Forty
years ago, it was mainly about large-scale phenomena,
like inflation and unemployment. More recently, there
has been a lot of focus on individual decision-making.
I think the time has now come to go beyond the
individual and look at the inputs to individual
decision-making. That is what we do in
neuroeconomics."

When people make investments, they weigh the possible
outcomes of their decisions and select a portfolio of
stocks and bonds that offers the highest possible
return at an acceptable level of risk. That is what
mainstream economics says, anyway. In fact, people
often have only a vague idea of the risks they face.
Consider my investment in BT. Back in 2002, there was
no way that I could have predicted how much profit the
company would make in 2006, let alone in 2010 or 2020.
I bought the stock, nonetheless, convinced that it
could only increase in value.

As imaging technology gets more sophisticated and
easier to use, it may become possible to monitor
investors' brains while they trade stocks at their
offices. For now, however, economists are restricted
to laboratory experiments, in which they pay
volunteers to play simple games designed to imitate
situations that people experience in daily life. In
one study, Camerer and several colleagues performed
brain scans on a group of volunteers while they placed
bets on whether the next card drawn from a deck would
be red or black. In an initial set of trials, the
players were told how many red cards and black cards
were in the deck, so that they could calculate the
probability of the next card's being a certain color.
Then a second set of trials was held, in which the
participants were told only the total number of cards
in the deck.

The first scenario corresponds to the theoretical
ideal: investors facing a set of known risks. The
second setup was more like the real world: the players
knew something about what might happen, but not very
much. As the researchers expected, the players' brains
reacted to the two scenarios differently. With less
information to go on, the players exhibited
substantially more activity in the amygdala and in the
orbitofrontal cortex, which is believed to modulate
activity in the amygdala. "The brain doesn't like
ambiguous situations," Camerer said to me. "When it
can't figure out what is happening, the amygdala
transmits fear to the orbitofrontal cortex."

The results of the experiment suggested that when
people are confronted with ambiguity their emotions
can overpower their reasoning, leading them to reject
risky propositions. This raises the intriguing
possibility that people who are less fearful than
others might make better investors, which is precisely
what George Loewenstein and four other researchers
found when they carried out a series of experiments
with a group of patients who had suffered brain
damage.

Each of the patients had a lesion in one of three
regions of the brain that are central to the
processing of emotions: the amygdala, the
orbitofrontal cortex, or the right insular cortex. The
researchers presented the patients with a series of
fifty-fifty gambles, in which they stood to win a
dollar-fifty or lose a dollar. This is the type of
gamble that people often reject, owing to loss
aversion, but the patients with lesions accepted the
bets more than eighty per cent of the time, and they
ended up making significantly more money than a
control group made up of people who had no brain
damage. "Clearly, having frontal damage undermines the
over-all quality of decision-making," Loewenstein,
Camerer, and Drazen Prelec, a psychologist at M.I.T.'s
Sloan School of Management, wrote in the March, 2005,
issue of the Journal of Economic Literature. "But
there are situations in which frontal damage can
result in superior decisions."

Not long ago, I drove to Princeton University to speak
to Jonathan Cohen, a fifty-year-old neuroscientist who
is the director of Princeton's Center for the Study of
Brain, Mind, and Behavior. Nine years earlier, while
he was teaching at Carnegie Mellon, Cohen attended the
conference that Camerer and Loewenstein organized. "I
had never taken any economics courses; I had no idea
what they did," he recalled. "I thought it was all
about setting interest rates."

Since then, Cohen has collaborated with economists on
several imaging studies. "The key idea in
neuroeconomics is that there are multiple systems
within the brain," Cohen said. "Most of the time,
these systems coöperate in decision-making, but under
some circumstances they compete with one another."

A good way to illustrate Cohen's point is to imagine
that you and a stranger are sitting on a park bench,
when an economist approaches and offers both of you
ten dollars. He asks the stranger to suggest how the
ten dollars should be divided, and he gives you the
right to approve or reject the division. If you accept
the stranger's proposal, the money will be divided
between you accordingly; if you refuse it, neither of
you gets anything.

How would you react to this situation, which
economists refer to as an "ultimatum game," because
one player effectively gives the other an ultimatum?
Game theorists say that you should accept any positive
offer you receive, even one as low as a dollar, or you
will end up with nothing. But most people reject
offers of less than three dollars, and some turn down
anything less than five dollars.

Cohen and several colleagues organized a series of
ultimatum games in which half the players—the
respondents—were put in MRI machines. At the beginning
of a round, each respondent was shown a photograph of
another player, who would make the respondent an
offer. The offer then appeared on a screen inside the
MRI machine, and the respondent had twelve seconds in
which to accept or reject it. The results were the
same as in other, similar experiments—low offers were
usually vetoed—but the respondents' brain scans were
revealing.

When respondents received stingy offers—two dollars
for them, say, and eight dollars for the other
player—they exhibited substantially more activity in
the dorsolateral prefrontal cortex, an area associated
with reasoning, and in the bilateral anterior insula,
part of the limbic region that is active when people
are angry or in distress. The more activity there was
in the limbic structure, the more likely the person
was to reject the offer. To the researchers, it looked
as though the two regions of the brain might be
competing to decide what to do, with the prefrontal
cortex wanting to accept the offer and the insula
wanting to reject it. "These findings suggest that
when participants reject an unfair offer, it is not
the result of a deliberative thought process," Cohen
wrote in a recent article. "Rather, it appears to be
the product of a strong (seemingly negative) emotional
response."

Several explanations have been proposed for people's
visceral reaction to unfair offers. Maybe human beings
have an intrinsic preference for fairness, and we get
angry when that preference is violated—so angry that
we punish the other player even at a cost to
ourselves. Or perhaps people reject low offers because
they don't want to appear weak. "We evolved in small
communities, where there was a lot of repeated
interaction with the same people," Cohen said. "In
such an environment, it makes sense to build up a
reputation for toughness, because people will treat
you better next time they see you."

Unfortunately, some of the emotional responses that we
developed millennia ago no longer serve us well. As
Cohen put it, "Does it make sense to play tough with a
person you meet on a street in L.A.? No. For one
thing, you will probably never see that person again.
For another, he may pull out a gun and shoot you."
Obviously, we can't alter our brain structures, but it
may be possible to influence decision-making by
tinkering with brain chemistry. Last year, a group of
economists led by Ernst Fehr, of the University of
Zurich, demonstrated how this might be done, in an
experiment involving what economists call "the trust
game."

Trust plays a key role in many economic transactions,
from buying a secondhand car to choosing a college. In
the simplest version of the trust game, one player
gives some money to another player, who invests it on
his behalf and then decides how much to return to him
and how much to keep. The more the first player
invests, the more he stands to gain, but the more he
has to trust the second player. If the players trust
each other, both will do well. If they don't, neither
will end up with much money.

Fehr and his collaborators divided a group of student
volunteers into two groups. The members of one group
were each given six puffs of the nasal spray
Syntocinon, which contains oxytocin, a hormone that
the brain produces during breast-feeding, sexual
intercourse, and other intimate types of social
bonding. The members of the other group were given a
placebo spray.

Scientists believe that oxytocin is connected to
stress reduction, enhanced sociability, and, possibly,
falling in love. The researchers hypothesized that
oxytocin would make people more trusting, and their
results appear to support this claim. Of the
twenty-nine students who were given oxytocin, thirteen
invested the maximum money allowed, compared with just
six out of twenty-nine in the control group. "That's a
pretty remarkable finding," Camerer told me. "If you
asked most economists how they would produce more
trust in a game, they would say change the payoffs or
get the participants to play the game repeatedly:
those are the standard tools. If you said, 'Try
spraying oxytocin in the nostrils,' they would say, 'I
don't know what you're talking about.' You're tricking
the brain, and it seems to work."

Economics has always been concerned with social
policy. Adam Smith published "The Wealth of Nations,"
in 1776, to counter what he viewed as the dangerous
spread of mercantilism; John Maynard Keynes wrote "The
General Theory of Employment, Interest, and Money"
(1936) in part to provide intellectual support for
increased government spending during recessions;
Milton Friedman's "Capitalism and Freedom," which
appeared in 1962, was a free-market manifesto. Today,
most economists agree that, left alone, people will
act in their own best interest, and that the market
will coördinate their actions to produce outcomes
beneficial to all.

Neuroeconomics potentially challenges both parts of
this argument. If emotional responses often trump
reason, there can be no presumption that people act in
their own best interest. And if markets reflect the
decisions that people make when their limbic
structures are particularly active, there is little
reason to suppose that market outcomes can't be
improved upon.

Consider saving for retirement. Surveys show that up
to half of all families end their working lives with
almost no financial assets, other than their
entitlement to Social Security benefits. Saving money
is difficult, because it involves giving up things
that we value now—a new car, a vacation, fancy
dinners—in order to secure our welfare in the future.
All too often, the desire for immediate gratification
prevails. "We humans are very committed to our
long-term goals, such as eating healthy food and
saving for retirement, and yet, in the moment,
temptations arise that often trip up our long-term
plans," David Laibson, the Harvard economist, said. "I
was planning to give up smoking, but I couldn't resist
another cigarette. I was planning to be faithful to my
wife, but I found myself in an adulterous
relationship. I was planning to save for retirement,
but I spent all my earnings. Understanding this
tendency stands at the heart of a lot of big policy
debates."

Laibson has collaborated with Loewenstein, Cohen, and
Samuel McClure, another Princeton psychologist, to
examine what happens in people's brains when they are
forced to choose between immediate and delayed
rewards. For a study the four researchers published in
Science, in 2004, they used an MRI machine to scan a
group of student volunteers who were asked to choose
between receiving a fifteen-dollar Amazon.com gift
voucher today and receiving a twenty-dollar Amazon.com
gift voucher in two weeks or a month.

The scans showed that both gift options triggered
activity in the lateral prefrontal cortex, but that
the immediate option also caused disproportionate
activity in the limbic areas. Moreover, the greater
the activity in the limbic areas the more likely the
students were to choose the voucher that was
immediately available and less valuable.

The results provide further evidence that reason and
emotion often compete inside the brain, and it also
helps explain a number of puzzling phenomena, such as
the popularity of Christmas savings accounts, which
people contribute to throughout the year. "Why would
anybody put money into a savings account that offers
zero interest and imposes a penalty if you withdraw
cash early?" Cohen said. "It simply doesn't make sense
in terms of a traditional, rational economic model.
The reason is that there is this limbic system that
produces a strong drive. When it sees something it
likes, it wants it now. So you need some type of
pre-commitment device to make people save."

Laibson and Brigitte Madrian, an economist at the
Wharton School, have studied one such "pre-commitment
device" for 401(k) plans, which deduct part of an
employee's earnings each month and invest them in
stocks and bonds. Because the plans are often
optional, many people fail to join them, even when
their employers offer to match a portion of their
contributions. Laibson and his colleagues have called
for people to be automatically included in the plans
unless they choose to opt out. At companies that have
adopted such a policy, enrollment rates have increased
sharply.

Reforming 401(k) plans is an example of "asymmetric
paternalism," a new political philosophy based on the
idea of saving people from the vagaries of their
limbic regions. Warning labels on tobacco and
potentially harmful foods are similarly intended to
keep subcortical structures in check. Neuroeconomists
have suggested additional policies, including warning
buyers of lottery tickets that their chances of
winning are practically nonexistent and imposing
mandatory "cooling off" periods before people make
big-ticket purchases, such as cars and boats.
"Asymmetric paternalism helps those whose rationality
is bounded from making a costly mistake and harms more
rational folks very little," Camerer, Loewenstein, and
three colleagues wrote in a 2003 issue of the
University of Pennsylvania Law Review. "Such policies
should appeal to everyone across the political
spectrum."   

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