Monday, 19 January 2009

Darwin's lemmings

Behavioural scientists attribute the global financial meltdown to our herding instincts. Much like our primate ancestors, humans tend to form groups to tackle adversity — the phrase “safety in numbers” is drawn directly from our tendency to trust larger numbers of people, even if our instincts tell us to go against the grain. It's a cute paradox. We yearn for a competitive advantage, strive all our lives for knowledge, yet doubt our own opinions if they disagree with those of our peers. And so, despite incandescent logic burning in the back of the investor’s mind, schemes such as Bernard Madoff’s continue to wreak havoc. Double-digit returns, while countless other funds struggled with huge losses, certainly looked suspicious, but our hardwired inclination to follow the herd proved the greater draw.

And if all goes awry, there is plenty of solace in group-failure, says Paul Seabright.

"When the maths gets too tough we seek reassurance from the powerful groups to which we belong. If it is okay to them that is fine by us; the group will protect us if things go wrong. We have to trust someone: modern life would collapse if we did everything alone. So we trust those who seem most like us, which means we trust the folks they trust, and so on in another long chain that stretches our strategic reasoning capacities to the limit.

The big surprise of the last three months to economists has been that professional investors behave with as much of a group instinct as retail investors. But it would not have surprised Darwin: professional investors are just another primate population. If you want to change their behaviour you have to change the way it feeds back not just into their pay packets, but into the status competition and coalition formation in their chosen peer-group."

Speaking of Darwin, the coming celebration of his bicentenary will no doubt spur the age-old efforts to link his theories to the modern economic world. What would Darwin have made of modern capitalism — the global march of the biggest and baddest corporate monsters? Such a question misinterprets Darwin’s intention. His theory was indeed based on “survival of the fittest”, but to be “fit” did not necessarily imply size or power, it concerned dominance of the species “most responsive to change”. As Simon Calukin notes in the Guardian,

"The simplistic "might is right" case has been blown apart by the force of events. However it originated, the credit crunch is the meteorite that is causing the mass extinction of what now can be seen as financial dinosaurs. Suddenly the once mighty are so no longer — in the new credit-starved world, investment banks are extinct, by the end of the year most hedge funds will have gone out of business, and even Russian oligarchs are finding food hard to come by."

If Darwin is to be considered truly prescient, business success in the next decade will be determined by flexibility, not size.

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