Kahneman Says Overconfidence Drives Capitalism

There is an interesting article "Questioning a Chastened Priesthood" at IMF website profiling the psychologist Daniel Kahneman, a winner Nobel Prize in Economics.

Here are some key excerpts:

Delusional optimism, he says, is one of the forces that drive capitalism. Many people don’t understand the risks they are taking, says Kahneman—a theme echoed in a book by Nassim Taleb called The Black Swan (2007), which points out that people fail to take into adequate consideration the possible impact of rare but earth-shattering events that prove wrong their assumptions about the future.
“Entrepreneurs are people who take risks and, by and large, don’t know they are taking them,” he argues. “This happens with mergers and acquisitions, but it also happens at the level of small-scale entrepreneurs. In the United States, a third of small businesses fail within five years, but when you interview those people, they individually think they have between 80 percent and 100 percent chance of success. They just don’t know.”

And here are some takeaways from current crisis:

Failure of markets has much wider consequences. “Interestingly enough, it turns out that when uninformed individuals lose their money, it ruins the global economy—so the irrational actions of individuals have much wider effects when combined with the rationality of corrupt agents within the financial system, and very lax regulation and supervision.”

Limits of forecasting. “The tremendous volatility in the stock markets and financial system tells us something about the amount of uncertainty in the system and the limits of forecasting.”

Delusional optimism...