Bounded Rationality and Our Failure to Recognize Our Own Incompetence

Who makes the best decisions for you? You? Are you sure? When you were young, you most probably had dreams of growing up and becoming successful in your chosen field, but did you always make the decisions that best maximized your chances of achieving that? Let’s say you wanted to grow up to be a doctor, did you always do your biology homework and study hard for all your exams or did you have to rely on threats of being handed detention by your teacher or grounding by your parents? Now going back to the opening sentence, who makes the best decisions for you? Still you? Some of you might argue that with the previous example; you were too young and immature to make optimal decisions for yourself. If you believe this, then may I propose the following question: Do you wish to have a financially secure retirement? If yes, how likely are you to adequately save enough during your working life for your pension if government-enforced social security schemes didn’t exist? The empirical studies of this suggest that it would be unlikely.

Two key issues arise here. The first stems from the actions described above where decisions are inconsistent with one’s goals; we discover from this that rationality is bounded. We are not as rational as economics textbooks may suggest, in fact, we are rarely ever perfectly rational. If a rational person wishes to pursue a certain career or have adequate savings for retirement, then why don't they take steps every day towards achieving that? If you simply look at how much you procrastinate, you will quickly begin to question if there is any rationality in you at all.

The second issue relates to how we, in light of this bounded rationality, don’t take steps to counteract it. This is because we are unaware of it or are ‘doubly cursed’ as espoused by American psychologist David Dunning. This ‘double curse’ arises not only through own incompetence, but through obliviousness to that incompetence. Our beliefs of our own performance can often be worlds apart from the objective reality of it. This ignorance of our own incompetence is what prevents us from taking measures to achieve optimal outcomes for ourselves (as defined by ourselves) in light of our bounded rationality.

The solutions to this overall conundrum lie in a relatively young academic discipline known as Behavioural Economics. This is a ground-breaking field pioneered by Richard Thaler that combines traditional Economics with an unlikely companion – Psychology.
  
“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” 
Richard Thaler

“If you’re incompetent, you can’t know you’re incompetent. When you’re incompetent, the skills you need to produce a right answer are exactly the skills you need to recognize what a right answer is.”
– David Dunning

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