Well, first we define Irrationality. To use a technical economic term, humans are expected to be ‘rational’, i.e. they are expected to choose those actions that take them towards their expected objectives.
Declaimer: This article written was originally in October 2011 and some of the data points may be outdated.
So are these objectives ‘rational’? Well, there are rules to define such objectives. First is the objective of self-preservation. Long long ago, when we were still alligators, we decided that WE mattered more than any other (alligator). That got us an id, i.e. the original word for (self)- identity. As this id started to gain some intelligence, it started to go from me to mine. That got us the concept of wealth, society, children, even caste, creed, religion, nationality, party affiliations, and organizational loyalty.
Similarly, there were other manifestations of the Rational Objective, i.e. the herd instinct, for example. From your school/ college to your political party, your country, and your professional association, you seek to congregate in herds.
So then what is an irrationality
So then what is an irrationality? That happens when we have a certain ‘rational objective’, which in turn is embedded in our anthropological construction, BUT we indulge in behavior that negates the achievement of that objective. For example, one of the manifestations of our instinct of self-preservation is the presence of “risk aversion”, where we put a premium on the absence of losses, as compared to profits. So “a Bird in hand is worth two in the bush” because we hate pain more than we love pleasure.
Yet, we push ourselves into pain again and again, in a blind desire to avoid pain ahead of (or more than) others in the same boat. We will rush out of an exit, struggling through a stampede that ensures that a cinema hall on fire takes 50 minutes to vacate when it would normally vacate in 5 minutes (remember “Uphaar” Cinema).
This kind of behavior manifests itself again and again and challenges Darwin’s theory that physical construction/ mutation and happenstance decide survivability. Individual behavior plays an additional role in (economic) survival, at least.
So now let’s get on with the Glossary:
- Have money, will spend: humans are incapable of sitting on cash. This is particularly manifested in companies (a.k.a. groups of individuals). We see this in markets, especially in bear markets, when people rue their inability to sit on their cash. They will look back on the shares they sold, sometimes correctly, and how they could not wait to get into the next share, which has wiped out all their Bull Market gains.
Companies, too, are simply incapable of sitting on cash. The peak of a bull market or an economic cycle is made by the excessive optimism that pervades a population, with almost nobody who is left out of the investment binge that predominates.
- My Dick Is Bigger Than Yours: if only we could get over this, a large part of the luxury car industry would disappear. Almost all discretionary expenditure happens because we have this yearning for ‘relative wealth’. It does not matter what we earn/ get, as long as it is more than others.
Many experiments have shown up this irrationality. The root cause is hidden in Darwinian rules of natural survival: a sense of the shortage of all life-giving resources, which is why “I, me & mine” has got preserved in us as instinct. Not only do I want to survive, I want to do it at the expense of my competitor.
A logical extension of this is the concept of ‘relative wealth’, which kicks in, the moment we cross our threshold of basic needs. Maslow called it ‘ego’. As we move up the chain of discretionary expenditure, we can extract large savings from switching our minds to not caring much for this ‘relative wealth’. You will save money on cars, houses, travel, social expenditure, etc. Almost all your Credit Card expenditure will go to zero.
- Power Leads to Arrogance, which Leads to Ignorance: this, like the principle of mathematical Induction, is a ‘trend rule’ very similar to ‘all good things must end’. The first clause is obvious, the second is derived. Arrogance prevents learning and often leads to the learner having learned something, followed by the belief that something is everything, followed by the subsequent discovery that everything was not good enough to prevent disaster.
This is found again in big companies and is the reason why they periodically fall into knowledge booby traps. A company will get into a new business, and make a few mistakes. If it does not get killed by such mistakes (which, mind you, has a ‘survivorship bias’ in it), then it will ‘look successful’ till it gets into the next new business. And so on, till it makes its last final mistake….
Like Tata Tea bought Tetley, then painfully paid its way through, then the Tatas moved onto Corus and JLR, and they will keep doing it, till it finds its own “ABN Amro” (what ABN + Fortis did to RBS recently).
- Power Compounds, More Than It Corrupts: this is a very important ‘trend rule’ of human behavior. The balance of power in any human relationship compounds, i.e. if you are half a neck ahead of someone in a power balance, you will (over time) be 3 necks ahead of him. Those of us who have been married long will know this, of course, but good companies know this too. They use their (market) power insidiously, pulling ahead of others by consistent use of their bargaining position.
Warren Buffet’s axiom that the time to sell a good company is never, comes from this rule. A company that can build sustainable market power, and then uses it effectively, will create value over a very long period.
Most businesses are designed to capture relative (market) power, but few businesses know how to compound it. For that, you need to know what your power is, why it is there, and how to compound it, i.e. how to use it to build other differentiators.
- Fear is a Bigger Motivator Than Greed: this is a restatement of the earlier aphorism about pain aversion. We react more to pain than to pleasure and therefore, we fear more than we crave greed. That is why market bottoms are steep and long, while market tops are built over long, jagged curves.
We say very often that actions done under conditions of fear are thoughtful + humble and produce better results than decisions done under conditions of extreme optimism. That is what creates the business cycles, which are counter-cyclical to the ‘feel good’ factor.
I am building this Glossary as an educative tome. These are observations that by themselves lead to no conclusion, but an understanding of these patterns can help a person build a ‘to do’. If you can locate these patterns within yourself, that realization would itself be a help; more important, if you have an understanding of the predictive power of these rules, you will be able to take advantage of other people’s foibles.
I invite readers to contribute to this Glossary. My area of interest in ‘trend rules’ is for their predictive power, as also a ‘how to’ for the rules of success. As we negotiate our lives through the minefields of (other) people’s behavior, it would be a good Dictionary to have.