Tuesday, August 03, 2010
an actress, doing more stage acting and dancing than screen work. My brother is a musician. I dabbled in acting and singing for much of my youth, even heading up the University of Cape Town choir for a while when I was a student. Now why is this relevant? As a consequence of these affiliations and activities I occasionally end up watching programs like So You Think You Can Dance (which my brother-in-law did quite well in previously) and Idols. I explained to my students that these two programs create problems for economists and some of our theory. Why? I shall try to explain below.
Consider signalling theory and let's take the classic example of education. The idea here is that you try to create a set of incentives such that high ability individuals and low ability individuals self-select into groups such that high ability individuals get an education to signal that they are high ability because to get such an education would be too costly for low ability individuals (this is summarizing greatly). What this assumes is that people know their own abilities. But, as Idols and So You Think You Can Dance so readily exemplify, many people do not know that they have low ability. They believe, falsely, that they are high ability individuals. They are victims of illusory superiority..
Dunning-Kruger effect. The Dunning-Kruger effect exemplifies a cognitive bias by which individuals often think that their abilities are better than they are, that is people suffer from illusory superiority. Consider two people: one of low ability, another of high ability. If the Dunning-Kruger effect (and, specifically, illusory superiority for low ability individuals) holds, then the individual with low ability does not realise that they have low ability. This creates a problem for signalling theory. Why? The low ability person will lack the metacognitive abilities to evaluate their own cognition. Consequently, they may incorrectly evaluate the costs that they would incur to attend university (get an education). They might then attend university and fail at a cost to themselves and to society. The might also, by some fluke, get through university and send the signal of 'high ability'. But, once they enter the workplace, their employer might then discover that the signal was untrue and they are indeed a low ability individual, which undermines the credibility of the signal for others.
But, the Dunning-Kruger effect has another side. Intelligent, or high ability, individuals generally have the metacognitive abilities to evaluate their own abilities relative to others. Consequently, they are often better at measuring when they have high ability in one subject and low in another, but they are also often victims of incorrectly evaluating the incompetence of others: they take their own ability as representative of an average ability to complete a task, therefore underestimating their own abilities. This adds a second problem: imagine that a high ability individual, falsely believing that she is a low ability individual chooses not to attend university. This further complicates the signals for companies. A high ability individual who is hired and found to be a high ability individual undermines the 'low ability' signal of no education.
Signalling theory in economics consequently faces a host of problems, at least as far as it tries to grapple agents who suffer from cognitive biases, i.e. humans. I have simplified the problems here, but it does give us a first blush of some of the problems of reconciling actual human thought processes with economic theory.
[Note: I haven't ever read anything about Dunning-Kruger and Signalling theory together, it just struck me that the one contradicted the other, what I know about Dunning-Kruger and other cognitive biases is predominantly self-taught so I may have phrased things slightly loosely. My apologies.]
Images: denitza.wordpress.com, www.motivatedphotos.com