SO MUCH FOR THE RATIONAL ECONOMIC MAN

Wade Roush has a nice partial summary of Daniel Kahneman's serious book on behavioral economics, Thinking, Fast and Slow, which I will summarize here.

1. The illusion of understanding: If we can fit past events into a satisfying story, we think we understand what really happened, and we can’t imagine things turning out any other way.

2. Outcome bias: Closely related to the illusion of understanding, this is the tendency to reward or blame decision makers for the performance of their organizations, even though the correlation between leadership quality and corporate performance is generally low.

3. The illusion of pattern: Kahneman thinks we’re too quick to ascribe meaning to events that are the product of pure chance.

4. Nonregressive explanations: An outstanding performance is likely to be followed by a mediocre performance. This isn’t backsliding: it’s usually just regression to the mean, the tendency of variables to gravitate around a historical average.

5. The illusion of validity, also known as the illusion of skill: We’re strongly influenced by the world in front of our eyes, and unwilling to admit that there’s much we don’t know—a phenomenon that Kahneman calls WYSIATI, for What You See Is All There Is.

6. The optimistic bias: Entrepreneurs know that the chances of success for a new business are low—only 35 percent of small businesses in the U.S. survive for five years. But they don’t seem to think the statistics apply to them, or they’d probably never start. Closely related to this is the planning fallacy, which leads decision makers to neglect historical data and rely on forecasts that are really more like best-case scenarios.

7. Overconfidence: The illusion of validity leads decision-makers to undertake bold programs based mostly on their insularity. “Declarations of high confidence mainly tell you that an individual has constructed a coherent story in his mind, not necessarily that the story is true,” Kahneman writes.

8. Competition neglect: Entrepreneurs usually act as if their companies will rise or fall based on their own efforts, while ignoring what their competitors are up to. “These bold people think their fate is almost entirely in their own hands,” Kahneman says. “They are almost surely wrong: the outcome of a startup depends as much on the achievements of its competitors and on changes in the market as on its own efforts. However, WYSIATI plays its part, and entrepreneurs naturally focus on what they know best—their plans and actions and the immediate threats and opportunities, such as the availability of funding. They know less about their competitors and therefore find it natural to imagine a future in which the competition plays little part.”

9. The focusing illusion: Business leaders are prone to many biases, but so are consumers—the people who ultimately buy the stuff entrepreneurs are selling. One is the focusing illusion, which can be reduced to the observation that, in Kahneman’s words, “nothing in life is as important as you think it is when you are thinking about it.”