Tuesday, January 13, 2009

The Logic of Life

The Logic of Life
- The Rational Economics of an Irrational World
by Tim Hartford

logic of life

Tim Hartford is the author of the book The Uncovered Economist. He is a new style economist who looks at everyday phenomenon from the economic angle. The stories in that book cover a few things which we take for granted, but Tim Hartford vividly reveals the underlying economics, much to the surprise of the readers. His new attempt the Logic of Life goes a step further and suggests that there is logic in many life decisions.

Contrary to his observation of a life logical, life actually seems illogical at times. Many people do illogical things such as taking drugs, mugging others on the street. Even love sometimes looks irrational; similarly so does divorce. To Tim Hartford, many of these seemingly illogical or irrational actions are being done as a rational choice of the persons. Drawing on statistics, there is a change in the pattern of people doing illegal things whenever the laws, incentives or the environment change. People do accept calculated risks in many areas where we normally consider as irrational behaviour. This concept is in sharp contrast with the book Fooled by Randomness I recently read. In that book, the author shows that there is randomness in our everyday life. Quite often, things will turn out in the most improbable way. A famous phenomenon known as the black swan effect which will catch anyone by surprise, will eventually occur no matter how improbable, at an unexpected time. To this end, Tim Hartford explains that the behaviour of people is governed by their rational choices. However, a rational choice does not mean a probable outcome. Although behaviour is rational, outcome is random.

Many may find it illogical that our bosses are always overpaid, and many talents in the office go unrewarded. Tim Hartford explains that the problem of the office stems from the lack of information about who is talented, who is honest and who is hardworking, and pay them accordingly. Different from the measurement of output by piece work or by sales return to the company, office work cannot be measured accurately, particularly under a subjective performance appraisal system. He says managers are just lying weasels. Just look at how many Very Effective appraisals are awarded to EO. The scenario of a large pool of office workers with blurry appraised performance which look very similar to each other is not conducive to work motivation. Thus encouraging any effort at all is going to require a large disparity between what the winners get. Absurdly high pay and perk for the bosses is a logical way to motivate the subordinates. This may not be entirely true for government workers whose pay and perk are largely regulated. But many such examples are found in the commercial world.

Another observation is the distribution of household in Washington DC which displays a scenario of racial difference by an artificial demarcation of neighbourhood of blacks and whites. The author introduces an experiment devised by Thomas Schelling, a game theorist. Suppose there are two groups of people; Schelling calls them the greens and the purples, but this can apply to black and white, rich and poor, Christian and Catholic, or fat and slim. They are not discriminatory to each other. In fact, they are comfortable with some others living in their neighbourhood. They can tolerate a few, and even to be slightly outnumbered. However, if anyone finds that more than two-thirds of her neighbours is of the other colour, she will become unhappy and move.

Schelling arranges these green and purple households by colour on a chessboard. First, there is the utopia situation where the coloured chess pieces are arranged in alternate order. This is a perfect situation where the two colours are perfectly integrated with an optimum number of mixed coloured pieces in the neighbourhood of each piece.



He then randomly takes away twenty pieces from the chessboard, and randomly replaces five pieces to the empty spaces. When the utopia situation is disturbed, some pieces have to move elsewhere where it is not so overwhelmed by the other colour. This in turn affects the other pieces. After a few generations of movement, the pieces reorganize themselves into clusters of greens and purples.



One may think that in this free world, discrimination is becoming a lesser and lesser problem and neighborhood will gradually integrate. The experiment shows that there is logic and rational choice behind the phenomenon of automatic and voluntary segregation. People make rational choices, but the outcome may not be favourable.

There are arguments that people do not always make rational choices. In this world, there may be irrational people who make decisions out of intuition and gut feeling. This is also the argument against game theory which makes prediction on decisions made by rational people, that there are irrational people who do not play by the rule. However, in a macro sense, when the aggregation of many events is taken into account, it is possible to identify the choices made by people and the logic and reasons behind them.

The book has many more case studies expanding on the proposition that there is logic in many life decisions. It is reassuring to know that people consciously or subconsciously do things rationally. However, it is sad to learn that rational decision does not automatically lead to a happy ending. Life is unpredictable after all.

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