TOPICS > Economy

Experts Examine How Brain Makes Economic Decisions

May 10, 2005 at 12:00 AM EDT

PAUL SOLMAN: An MRI of the human brain, cross-sectional images right through to the mind’s deep core to see what’s cooking inside — cooking not in sickness, but in health. This animation is a composite of normal brains made at UCLA’s Laboratory of Neural Imaging, one of dozens of labs where researchers are now trekking, “Fantastic Voyage”-style, to discover where specific thoughts and feelings arise.

And, as it happens, even economists are getting in on the action, asking how and where we humans think economically by seeing which parts of the brain are most active when we’re deciding what we want and how to get it. One lesson thus far: The brain isn’t quite as rational as the discipline of economics has long assumed, a finding that could have major implications right now given current economic uncertainty — the falling dollar, rising interest rates, stock market volatility.

SPOKESPERSON: This is for real money. They’re getting paid now.

PAUL SOLMAN: Now, economists usually start from the premise that we humans are up to the task of choosing the right investments for ourselves, be they CD’s, stocks and bonds, real estate, insurance. But when you look at how these investments are sold to us, you begin to wonder if the vendors really assume we can tell the good guy from the quacks or if, when it comes to financial decision-making, we mightn’t be driven by some rather more primitive urges.

Indeed, the GEICO gecko may be an especially apt image given the latest brain research summarized in a new book, “Mean Markets and Lizard Brains.” Author Terry Burnham is a former Harvard Business School professor who has taught both economics and evolutionary biology.

TERRY BURNHAM: Well, the lizard brain is a part of your brain, which we might call irrational. And I used the phrase “the lizard brain” because it has a deep evolutionary history that actually goes all the way back to lizards. So why is it “Mean Markets and Lizard Brains?” It’s because this part of your brain really gets messed up in financial markets. And so, if you rely upon the lizard brain to navigate your finances, you end up in a lot of trouble.

PAUL SOLMAN: Now, in fact, many of us think that, when we’re engaged in high finance, we’re making the most of our noodles using the highly evolved, reason-based prefrontal cortex.

JORDAN GRAFMAN: Where I’m pointing to is the prefrontal cortex of the brain.

PAUL SOLMAN: Jordan Grafman is chief of cognitive neuroscience at the National Institutes of Health.

JORDAN GRAFMAN: Now, this area, if we were to look at my head, comes all the way forward to my forehead, lies over my eyes and goes back as far as my ears.

PAUL SOLMAN: But as recent experiments at the National Institutes of Health have shown, financial decisions involve both the high-level cortex and the more primitive lizard, which comprises the rest of the brain. And surprisingly often, the lizard calls the shots, especially when reacting to a financial situation.

Here are subjects Nelly and Claire meeting for the first time via video, then playing a game electronically in which they choose to cooperate or compete. If they cooperate, making deals to split small pots of cash, they each earn more in the long run. If they compete and try to take as much as they can for themselves, each ultimately earns less in the end. In the first round, Nelly led off and, at Claire’s expense, tried to get more money right away. Second round: Claire led and did the same thing.

NELLY: I’m getting the idea that I, by being the first mover and I kind of screwed the first time, she didn’t like that. So, now, she’s doing it back to me.


CLAIRE: Yes. We’ve created a competitive atmosphere.

NELLY: For me, it wasn’t worth to try and work with her since it didn’t feel — she wasn’t going to cooperate with me. So, I kind of just followed her lead and went for the bigger payoff for myself, as she was doing.

PAUL SOLMAN: When subjects like Nelly and Claire are put into MRI machines and their brains scanned while they continue playing, both the rational cortex and the impulsive lizard brain light up, but the relative intensity depends on who goes first.

JORDAN GRAFMAN: So what I’m holding up here is an image of the brain that’s showing brain activation patterns.

PAUL SOLMAN: Neuroscientist Jordan Grafman runs the NIH experiments.

JORDAN GRAFMAN: The yellow signifies areas of the prefrontal cortex in particular that were highly active when the first decision maker was making a decision.

PAUL SOLMAN: So that’s — that’s Nelly, for example, deciding what her strategy is going to be with respect to her partner, Claire.

JORDAN GRAFMAN: Exactly, exactly.

PAUL SOLMAN: So, the first decision maker is scheming away with the front of her brain. And the second?

JORDAN GRAFMAN: The blue areas represent decision maker two making a judgment about how to respond to the initial move by decision maker one.

PAUL SOLMAN: So, less prefrontal cortex activity.


PAUL SOLMAN: And more activity in the limbic system, the brain’s emotional center. What does this high-tech head game have to do with investing? Well, think about it. The front of the brain is where we learn rational rules of personal finance — to diversify, to buy low and sell high — but the lizard brain is often running the show, reacting to situations impulsively. Take this rather subtle example:

TERRY BURNHAM: Your lizard brain is built to find patterns in the past. So, the lizard brain, by its very nature, seeks to replicate things that have worked previously. It can imagine where it was built. If you threw a spear a certain way and you got food, guess how you’re going to try to throw it the next time? The same way.

PAUL SOLMAN: But think of what this means for picking a stock for your retirement.

TERRY BURNHAM: The stock that you fall in love with has four up days in a row. Must be a good stock, right? There must be some reason it’s gone up four days in a row. People are excited about it. They buy it. It plummets. At the bottom, they hate it, they can’t stand it. They — it’s called “puking it out” in the Wall Street lingo. You puke out the position. You get rid of it. You sell it at the low. This process pushes us to buy high and sell low, exactly the opposite of what we want to do.

PAUL SOLMAN: With the advent of brain scans, experiment after experiment is now showing exactly how much the lizard brain can cost you. For example, in a study published last fall, researchers at Princeton scanned people while asking them if they wanted $20 right away or $25 in a week.

TERRY BURNHAM: What goes on in the brain? The front of your brain does the calculation. “Hmm, that’s 25 percent in a week, that’s good.” The back of your brain says, “Take it now; take it now.” And you can see inside people the war between the two parts.

And they actually can measure who has more strength in the prefrontal cortex and who has more strength in the lizard brain. When the lizard brain wins, they say, “Give me the $20 now.” And when the prefrontal cortex wins, they say, “Give me the $25 in a week.”

PAUL SOLMAN: Humans boast the animal kingdom’s most highly developed prefrontal cortex…

TERRY BURNHAM: Right here at the end.

PAUL SOLMAN: …Especially this part, Brodman Area Ten, which, says brain expert Jordan Grafman, allows you:

JORDAN GRAFMAN: In real time to carry out events that maximize gain for you, whether it be in economics or social behavior or politics or any endeavor you choose.

PAUL SOLMAN: If the prefrontal cortex is kind of like top management trying to control the unruly rest of the brain, Brodman Area Ten is the CEO. Sadly, though, the cortex is the last part of the brain to mature, between ages 25 and 30, and the first to go, starting at age 50 or so.

PAUL SOLMAN: I’m 60. You now tell that my prefrontal cortex is fading fast.

JORDAN GRAFMAN: Slowly, slowly. Not as we’re speaking, but slowly.

PAUL SOLMAN: What should I be doing about my investments?

JORDAN GRAFMAN: You should be much more conservative. Whether you invest or not, I think the issue is to do it conservatively when you get older, that your ability to be taking chances — that’s what you want to be careful about because, since the prefrontal cortex is probably not functioning as effectively as it did when you were younger, you’re going to be more prone to that kind of impulsive decision-making.

PAUL SOLMAN: For our final words of advice, we return to author Terry Burnham.

TERRY BURNHAM: Step one is to know I am not the boss of the lizard brain. There are things driving my behavior that I’m unaware of and that I can’t control directly.

PAUL SOLMAN: A recent MIT study of professional traders confirms what Burnham’s saying. The least emotional were the most successful, which leads to step two.

TERRY BURNHAM: If you go through and you study the Warren Buffetts of the world and the people who are amassing capital in the world, who are making money in markets, those people have systems in place to not allow their lizard brain to bankrupt them. They don’t use impulse, they use quantitative analysis, they use discipline, they use team approaches, a whole range of tactics to constrain their instincts and their emotions.

PAUL SOLMAN: The problem is, the Warren Buffetts are the exceptions, not the rule. Most of us are all too vulnerable to the whims of our lizard selves, which, in the end, suggests that personal investing for the future, essential as it may be for both our ultimate welfare and that of the American economy as a whole, could entail some risks of which we’re only now becoming fully aware.