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Jun 22, 2018

Anthropology and Markets

We don’t live in Adam Smith’s world. We live in Darwin’s. So here’s an anthropological view of economics, human behavior and working with our evolutionary faults.

First, a disclosure: While I once spent eight years studying and working in anthropology before veering away to study financial markets, I’m no longer a professional anthropologist. But once you become familiar with a subject you never quite leave it, so I find I still carry an anthropologist’s perspective with me as an asset manager. Someday I’ll research the cultural significance of the phrase “knows just enough to be dangerous.” So, with that out of the way, what does this background bring to my work in asset management? Here are a few lessons I think I’ve learned.

Why look from an anthropological perspective, and how does this relate to economics and markets?

Evolutionary anthropology digs deep: It aims to explain why we became us, how we emerged from the animal kingdom and how to extrapolate reasons for our present-day behavior—to figure us out from the floor up, so to speak.

At an elemental level, the connection between anthropology and economics rests on the fact that we’re still more or less the same animals, with the same motivations and fears, that we’ve been for almost 200,000 years. There have been some evolutionary changes in Homo sapiens since our species first emerged, like some disease resistance and toleration of lactose post-childhood, but nowhere near enough to quantify a species or even sub-species level redefinition of what we are.

How are we unique in the animal kingdom? The defining feature of modern humans relative to other primates is brain size, which has been stable in our kind for about 200,000 years at approximately 1,300 cubic centimeters. Theories differ about why selection favored the big-brained and gave rise to us. The Economist provides a succinct run-down:

“The ultimate cause of human brain expansion thus remains unknown. Toolmaking is one explanation. A more intriguing theory is that human brains are the equivalent of brightly colored plumage in birds, permitting the sexes to show off to each other what good mates they would make. Yet another idea, the Machiavellian-intelligence hypothesis, is that big brains enable people to manipulate others to their own advantage—a trick that the invention of language would also assist. Nor need manipulation be malevolent. Collaboration is also a form of manipulation. These ideas are not, of course, mutually exclusive. Any or all of them may be correct.”

The human brain grew in response to natural, selective pressures, and as it grew it was able to advance its evolutionary ambition in new and multifaceted ways not available to other animals: advanced language. Culture. Art. Markets.

Although we have come to possess these advanced tools, our use of these tools varies and is often imperfect. In order to fulfill its need to perpetuate, an organism will decide on its best course of action in any given moment based on what will return the most evolutionary benefit for the cost involved. But because perfect knowledge doesn’t exist—contrary to the espoused characteristics of homo economicus—an organism is taking what it perceives to be its highest percentage shot, given what it can and does know.

Consequently, the gaps in our knowledge can be vast; our behavior reflects our evolutionary interests, even if that behavior seems to occur in contradiction to information science shows us is true. Our belief systems are built around evolutionary success, not objective truth. Some presently unbelievable sounding belief systems have emerged, and that is because they have often greatly facilitated our evolutionary ambition. A person can quickly come to believe the world is flat, for example, if one determines that membership in a group that holds flat-eartherism as a tenet is aiding one’s security, well-being and prosperity. For humans, social inclusion is wonderful and social exclusion is extremely painful. If believing that fossil fuels are indefinitely the global economy’s best and only real source of energy is a badge you need to wear to belong to your group, you’ll do it.

Investing and decisions made in markets are clearly extensions of this evolutionary ambition. In other words, markets do not exist in a silo; they are not just a series of moving prices, but a system that is connected to other biological, social, environmental, economic systems. To succeed as long-term investors, we need to keep the broader picture in mind as we make decisions.

Homo economicus vs Homo sapiens

 Classical economics ignores evolutionarily ingrained elements of human nature that explain our behavior, and in some ways are now leading us down a destructive path. To both avoid peril and generate opportunity, we first need to understand that we are not simply the highly rational people that economists have made us out to be. Instead, we are a complex, short-term oriented, tribalistic species. Only once we understand humans from this angle can we find ways to productively align with, rather than work against, our evolutionary propensities.

 The “rational man,” or Homo economicus, of classical economics, is assumed to have continual, perfect awareness and be consistently, narrowly self-interested with respect to accumulating and preserving wealth.

 Homo economicus is an example of a good idea assembled with the incomplete information available at the time, in this case before evolution and natural selection were known to exist. In that context, rational man is rightly recognized as brilliant explanatory theorizing from greats like Adam Smith, who died 19 years before Darwin was born, or John Stuart Mill, who was a contemporary of Darwin’s but whose seminal economics text Principles was published 11 years before On the Origin of Species.

Given this history, it’s unsurprising that classical economics defines us too narrowly and gives us too much credit for knowing what’s going on. Economics and behavioral finance have begun to uncover ways in which the rational man theory is incomplete, adding that we are not always rational due to cognitive and emotional factors. Behavioral finance, in particular, has discovered that we fear losing money more than we enjoy gaining it. We get identity involved in our investments, so it is hard for us to accept when we have made a bad investing decision, which makes us susceptible to using baseless information to support what we want to believe. Clearly, we’re not as rational as Smith had it, or as we might like to believe.

What does a Darwinian perspective show us about humans that a Smithian perspective doesn’t?

From the organism’s point of view, an evolutionarily successful strategy will have far more considerations than counting wealth. By explicitly considering ecological variables including competitors, prey, predators and myriad other factors like disease burdens, we come to understand much more about our faults that do not exist in the hypothetical, narrowly interested, endlessly rational human.

For one, we are tribalistic—sometimes for better, but more often for worse. This is the output of eons of multi-level selection acting upon our ancestors, human and pre-human. Our self-interest in accumulation and our more general ambition is present in the individual, extended to the family and tribe, and maybe on a good day stretched to an abstract concept like a nation. Some scientists have calculated that in humans, the extent of our self-interest is limited to a group not much greater than 150 individuals, on the basis of present-day observation and limits of the sizes of our ancestral social units. I think if the organism believes benefit exceeds cost for whatever behavior is available, that it will still go ahead and do it, so 150 is a soft number. As tech writer Jag Bhalla has put it, “Economics is in our nature. But it is not, as most economists promote, the narrowly self-interested kind.”

Our tribalism and common propensity to blame others when things go wrong are always present, and there can always be some trigger that causes neighbor to turn against neighbor. Thinking that we are past that or having the hubris to think that we have biologically evolved, for example, since the horrors of the Second World War, is naive and ahistorical. The wetware we’ve been running for 200 centuries is running perfectly. Our job then is not to change that, but to understand it and work with it.

We are also short-term opportunists, meaning we have never been good at long-term planning. Our greatest evolutionary rewards have always come from solving today’s problem today. We now know that we would be better served by being at the forefront of solving long-term problems, but nevertheless, we generally don’t, so we suffer from status quo bias and resist positive and negative change. Tribalism and short-termism together incline us to focus on the reality TV aspects of who’s up and who’s down, or whether or not we’re going to build a wall, when these things are actually just ephemera in the scheme of long-term human success.

Tribalism combined with short-termism ensures that we always fixate on “we” versus “them,”’ when in the face of looming threats like climate change, there’s really only just us. The way we’re managing the political economy of the world is presently leading us to meet our fate together. But are we capable of redefining “we” and “them” as “us”?

 What’s the way out of this mess?

To have any shot at a plan for a better, more successful, more abundant tomorrow we need this scientifically based, inclusive perspective of what we are and why we do what we do. Trying to enact macro-scale, structural changes on our economies and civilization with incomplete models of what those things are, is more likely to fail than more informed approaches. Now that we’ve become an organism with global power to effect change on an environmental level, but seemingly without real agency to establish global policy or to do anything else about it, it is time to understand our fundamental drivers and faults so we can take steps to effectively address our greatest risks.

Any problem is solvable. Failure arises when humans come to solutions too late; it is failure to adapt to change that becomes an existential problem, and today change is upon us more than ever before in human history. We need to adapt equally. If the problem we are trying to solve is how to create a dynamic economy based on innovation that enables us to thrive over the next 20 or 30 years, if not indefinitely, we need to recognize and control our biases. The idealized realization of this would be a zero-risk economy, one not under threat from large-scale, systemic risks, with sufficient abundance that everyone felt able to (consciously or not) pursue an evolutionary beneficial strategy, and where our propensity for tribalism is thus minimized.

Benefit must exceed cost, as ever, so we must align our need to solve big problems with our programmed ambition. Our drive for evolutionary success will not evolve out of existence, but we can try to direct it toward problem solving as a means of evolutionary ambition satisfaction. We can and will embrace innovation, apply new tools and reach for new levers. This requires our capital to be pointed in that direction, and for capital thus invested to create wealth.

We’re not going to get anywhere trying to change what we have been for 200,000 years. There’s no pushing against it; by and large, we are what we are. What we have to do is understand and work with our nature, leverage it to align our evolutionary and thus tribal interests to result in more favorable outcomes for us, and for our descendants.

In the context of long-term investing, this means looking for productive innovation, for new and powerful tools of change and adaptation, and for solutions to the large-scale risks which the nature of our own selves has given rise. How is it possible to invest with all of that in mind? Our answer at Green Alpha Advisors is a thesis we call Next Economics, and its practical application, Next Economy Portfolio Theory.

Thanks for reading. Look out for our next post here on Worth on the changes emerging in supply-side economics. Spoiler: it’s not all about voodoo.

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