Demonetization, Cognitive Bias, and Decision Making

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India’s demonetization exercise has taken the country by storm. Amid widespread support from the masses, there is now a growing body of criticism from citizens, political parties, and economists. Arguments range from bringing misery to people, slowing macroeconomic growth, to whether it will have any long-lasting impact on black money. We will know for sure in a year or two.

In this context, we can explore lessons on decision-making for leaders.

The Demonetization decision
It is clear this bold move will flush some black money from the system, but will it cage and destroy most of it? A few points arise from the landmark move:

• Will it disable the black economy and stop further generation of unaccounted wealth without structural changes in the economy and society?
 • Will it curb consumption for a year or two and slow down GDP growth? Were there other ways to debilitate illegal wealth?


• Could demonetization have been handled in other, more effective ways?

Surely, the Prime Minister and his Cabinet examined these consequences before making the move. But could they have been inadvertently affected by cognitive biases?  

Confirmation bias and demonetization 
We are susceptible to bias because much of our thinking is powered by the intuitive mind. Intuition helps us make sense of complex issues quickly and quite often correctly but it also makes us prone to errors of judgment. Were Modi and his leadership team affected by confirmation bias?

Confirmation bias occurs when we create a hypothesis, an assumption, and then belief before making a decision. We look for evidence that confirms our conviction. We passively or actively ignore disconfirming evidence. Was the Cabinet pre-disposed in favor of demonetization because they believed it would be good for the country? And in the process overlooked the costs and risks?
 

The trap of overconfidence
Did the Government accurately estimate the time it will take to remonetize the economy? Did they underestimate the difficulty?

Overconfidence is a pernicious bias that arises from optimism. It gives us sureness in our capability and leads to ignoring base rate of other similar exercises. The vast majority of large and complex projects are delayed everywhere in the world. But it doesn’t stop us from believing we can accomplish them quicker and better than all others. In the throes of this bias we tend to launch a strategy with inadequate preparation and resources.


Loss aversion and risky choice
Then there is framing effect. We are naturally loss averse and this causes us to sometimes choose risky options that may lead to far worse outcomes. It is crucial for BJP to win in the upcoming elections to the UP assembly. Did the Modi Government see demonetization as a strategic move that will gain BJP the support of the vast vote bank of the poor and rural folk? Did they inadvertently see choices as follows?

a) Fight the election on caste lines, or the usual plank of economic growth,OR
b) Contest it as true patriots and champions of the poor, by eradicating black money. And simultaneously destroy the coffers of other political parties.

Did loss aversion lead the Cabinet to the second, perhaps the riskier option?

Relevance for business leaders
Cognitive biases that may have affected Modi Government’s decision are emblematic of high stakes decisions CEOs sometime grapple with. How cognizant should they be of bias and consequent missteps? What can they do about it?

A large body of work in cognitive psychology and behavioral economics suggests that reflection and wide consultation usually helps neutralize bias. CEOs would do well to think deeply and actively solicit diverse, and especially dissenting views. They serve to open the mind’s eye to possibilities as well as pitfalls. Taking time over crucial decisions is a good thing.

There is no reason to believe Prime Minister Modi did not consult experts, or contemplate carefully before making the decision.

But consultation alone does not ward off bias, more so when several of them are at work simultaneously. It is extremely dangerous when advisers themselves suffer from Groupthink – collective confirmation bias.