Ep70 "Why We Don't Just Say What We Mean - Part 2" with Steven Pinker

All Else Equal Podcast: Common Knowledge & The Mysteries of Money, Power, and Everyday Life – A Detailed Summary

Key Concepts: Common Knowledge, Levels of Induction, Rationality, Equilibrium Thinking, Taboos & Norms, Mosaic Theory, Insider Trading, Psychological Factors in Decision-Making, Plausible Deniability, Competition & Monopoly.

I. Introduction & Recap of Previous Discussion

Jules Van Binsbergen (Lauder Institute, University of Pennsylvania) and Jonathan Burke (Graduate School of Business, Stanford University) host this episode, continuing their discussion with Steven Pinker based on his book, When Everyone Knows That Everyone Knows: Common Knowledge, and the Mysteries of Money, Power, and Everyday Life. The previous episode established the concept of common knowledge – not just knowing something, but knowing that others know, and knowing that they know you know, and so on – and its explanatory power in human behavior. This episode expands on this, applying the concept to financial markets and broader societal dynamics. Initially, common knowledge was viewed as a modeling device rather than a primary driver of decision-making.

II. Defining & Understanding Levels of Common Knowledge

Pinker’s book clarifies the distinction between simply knowing something and knowing that others also know it. The hosts illustrate this with a landlord example: announcing a filter replacement requirement to all tenants (public knowledge) versus informing each tenant individually (private knowledge). The public announcement is more effective because it creates a shared expectation that someone will address the issue, whereas private information leads each tenant to believe they might be solely responsible.

A crucial point raised is the limited capacity of the human brain to process multiple levels of induction (“I know you know that I know…”). While theoretically infinite, individuals typically struggle beyond three or four levels. Pinker’s work demonstrates that higher levels of induction unlock greater informational value, but require significant cognitive effort.

III. The Spinach in Teeth Experiment: A Demonstration of Common Knowledge

Pinker’s example involving 12 psychologists and spinach in their teeth vividly illustrates the power of common knowledge. Three psychologists have visible spinach, but politeness prevents direct communication. When the department chair announces “at least one person has spinach in their teeth,” the three affected individuals immediately remove it after three repetitions of a signal (clinking a glass). This isn’t magic, but a result of iterative reasoning: each person, knowing others are observing, can deduce their own situation based on the lack of action from others after each signal. The hosts emphasize that this seemingly simple scenario reveals the complex cognitive processes underlying common knowledge. The example highlights how individuals can infer information based on the actions (or inaction) of others, given a shared understanding of the situation.

IV. Common Knowledge & Strategic Behavior: Avoiding Transparency

The discussion shifts to scenarios where avoiding common knowledge is advantageous. The example of being stopped by a police officer illustrates this. Directly offering a bribe creates common knowledge, risking arrest if the officer is honest. Instead, individuals employ “plausible deniability” – vague statements like inquiring about local procedures – to suggest a bribe without explicitly stating it. This allows for a face-saving exit strategy if the officer is incorruptible. The key is to ensure the officer knows a bribe is possible without knowing the individual is offering one. This is framed as “I know I’m bribing him. He knows I’m bribing him but he does not know that I know I’m bribing him.”

V. Common Knowledge, Competition, and Financial Markets

The conversation turns to the implications of common knowledge for economic competition and financial markets. Lack of common knowledge can be a barrier to entry, as uncertainty about competitor reactions hinders strategic decision-making.

Robert Aumann’s “Agree to Disagree” theorem is mentioned, suggesting that rational actors with differing private information are unlikely to converge on a shared assessment of value. This explains the irrationality often observed in speculative trading, where investors buy assets hoping for future price increases, but the underlying value is already reflected in the current price if it’s common knowledge.

The discussion then explores the “mosaic theory” in relation to insider trading law. Building a case based on numerous small pieces of public information (the “mosaic”) may not be illegal, even if the resulting insight is equivalent to that gained from direct insider information. The question is raised whether skilled traders can legally reconstruct insider information through diligent research and deduction.

VI. Rationality, Psychological Factors & Market Anomalies

The hosts delve into the psychological factors that deviate from purely rational economic behavior. They discuss the appeal of gambling and lottery tickets, even though they have negative expected value, attributing it to the psychological pleasure of anticipation. Similarly, they explore the role of reputation and social signaling in auctions and investments, suggesting that individuals may overpay to avoid appearing weak or easily intimidated.

The importance of avoiding unpleasant equilibria is highlighted. People may ignore the logical consequences of their actions to avoid confronting a negative outcome. Pinker’s work suggests that people often avoid fully considering the implications of common knowledge because it leads to undesirable conclusions.

VII. Taboos, Norms, and Academic Freedom

The discussion concludes with a consideration of taboos and norms, particularly in the context of academic freedom. Pinker’s willingness to “steelman” the argument for justifiable speech codes is praised. The hosts acknowledge the arbitrary nature of many taboos, comparing them to the coordination game of driving on the right side of the road.

The conversation explores the tension between upholding norms and pursuing truth. The hosts discuss the phenomenon of “cancel culture” as a public attempt to reinforce norms when they are challenged. They also acknowledge the need for a degree of “stealth technocracy” – allowing experts to make decisions on complex issues without direct public input – while recognizing the importance of transparency and accountability. The paradox of identifying a taboo is that the very act of naming it constitutes a violation of it.

VIII. Conclusion

The episode underscores the pervasive influence of common knowledge on human behavior, extending beyond economics and finance into social interactions, strategic decision-making, and even the pursuit of truth. Pinker’s work provides a framework for understanding how shared assumptions and expectations shape our actions and the world around us. The hosts emphasize the importance of “equilibrium thinking” – considering the broader consequences of one’s actions – and recognizing the limitations of human cognitive capacity in processing complex levels of induction.