Wednesday, February 8, 2012

Are Some of Us Just Plain Crazy?

Reality can be cold!

Have you ever dreamed of opening your own little bookshop? How about a restaurant or even a small coffee house? How would you rate your chances of success?

This is only one of many, many fascinating topics in Daniel Kahneman’s new book, Thinking, Fast and Slow. (Here is a synopsis by Jason Gots.) Time and time again, his research demonstrates that human beings do not make decisions by accurately assessing probabilities or even forecasting with reliability their own future satisfactions. Instead, we decide on courses of action and choose among alternatives with unwarranted confidence in our own judgment. Going into new projects, we overestimate our own abilities and skills and underestimate those of others. We have little idea what gives us a day-to-day sense of well-being. Our minds take the easy way out, retrieving easily available information and leaping to hasty conclusions; even in reflective mode, what Kahneman calls the “System 2” mind is generally only analyzing what the impulsive, get-‘er’done “System 1” mind came up with in the first place.

Let’s take just one of those weaknesses in our reasoning, overconfidence, and apply it to the business of business.

The chances that a small business will survive for five years in the United States are about 35%. But the individuals who open such businesses do not believe that the statistics apply to them. A survey found that American entrepreneurs tend to believe they are in a promising ine of business: their average estimate of the chances of success for “any business like yours” was 60% -- almost double the true value. The bias was more glaring when people assessed the odds of their own venture. Fully 81% of the entrepreneurs put their personal odds of success at 7 out of 10 or higher, and 33% said their chance of failing was zero [my emphasis added].

A third of the entrepreneurs said they could not fail, despite the fact that over two-thirds of the group will fail! Here it may be tempting to think that the failures were all in the two-thirds who admitted that failure was a possibility, but statistics do not bear this out. A very real advantage of optimism, on the other hand, is that an entrepreneur can survive repeated failure, always believing that he or she will be successful the next time around!

The 65% failure rate within five years is given for small businesses in general. What is the failure rate for independent bookstores? For restaurants (another dream business), 60% are out of business after only three years, and yet new restaurants open much oftener than new bookstores, a triumph of hope over—something! (Experience--that's the word I couldn't think of yesterday.)

Is overconfidence alone at work here? Kahneman says there is more to this failure of objective reasoning than emotion, that cognitive biases are at work, too. We focus on our own goals and plans, ignoring the base rate of success (he calls this the “planning fallacy”); focus on what we ourselves want to and can do, “ignoring the plans and skills of others”; think more about skill than about luck, so that we have the “illusion of control”; and, finally, we are overconfident because we focus on what we know and don’t take into account what we don’t know.

One of the charming traits of Daniel Kahneman as a writer and as a psychologist is that he is more than willing to tell stories on himself to make his points. Leading a group on a long-term education project in Israel, he began to wonder how long it had taken other groups to achieve their goals. (The goal was a textbook in the field.) His group thought they could complete their work in two to three years, but when Kahneman asked how other groups had fared, he was told that similar groups, when they had completed their work at all, had taken from seven to ten years. So what happened? His group stayed at their project without altering their time estimate. They took eight years to complete their project, which was never used.

For years, Kahneman says, when he told this story he was the hero, the only one who had thought to ask the question about other groups’ results. It took him a long time to see that he had failed in his leadership role, because having the facts changed no one’s beliefs, and the facts were not incorporated into the plan. “We should have quit that day,” he says now. Everyone on the project, he says, was taking the “inside” view, biased in their group’s favor; the “outside” view that showed a very different picture was ignored. All group members, including the leader, had the information, and all failed to process it.

Of course there is more to life than applying statistical algorithms, and the latter chapters of Kahneman’s book discuss happiness research: what makes people happy vs. what they think will make them happy, the surprising effects of the tiniest piece of luck (e.g., finding a mere dime planted by the researchers!) on mood and outlook, and how much our day-t0-day sense of well-being depends on where we focus our attention. How much money people need to be happy--barring poverty that makes every other crisis more difficult and dims ordinary pleasures—depends on individuals’ financial goals and how important money is to them, but even then, beyond a certain point (he says $75,000) happiness does not increase with income.

How much of any person’s day is spent in pleasurable, rewarding activities? How much time must be spent handling annoyances or crises? Are the surroundings harmonious or stimulating, confining or irritating? Much is in the eye of the beholder, but certain factors detract from anyone’s happiness—loud noise, pain and depression.

In one of Jane Austen’s novels, Northanger Abbey