If you’re a reader of this column you are regularly presented with an implicit understanding of behavioral models. As an economics student I learned quickly its foundations. Not least among them were the models of behavior that explained markets, market systems, instruments, and human behavior under circumstances. A secure understanding of behavior aids decision-making across all roles. Thus, a learned approach to things prepares advantages uncommon to those who can only react to their circumstances.
Some have taken to measuring behavior in scientific ways to quantify and clarify its motivational roots, both for predictability and successful decision-making. The essentials of the field of behavioral economics better inform the decision-making process and better prepare market participants for battle in the marketplace. From time to time I pause briefly to study the elements of behavioral economics (BE) to reset the methodology necessary to market success in service to stakeholders like you.
Recently, we considered “the illusion of understanding” in an effort to quantify the stories we prepare in characterizing the marketplace. Today, we’ll consider “loss aversion,” another of the elements of BE that may be the most significant contribution of psychology to the field of behavioral economics.
It would appear from the experience of those before, as well the study of loss aversion, that humans and animals are designed to give priority to bad news. Perhaps for good reason, the inborn tendency improves the chances of survival by raising the threat mechanism in us, thus paring vital seconds of response time when in crisis.
We have already learned that the narratives we prepare to inform our understanding of things are more often imputed with fallacies than not, leading to conclusions qualified randomly rather than logically. This model tracks the view of a subconscious that knows little distinction between a real and imagined experience. When not encouraged to succeed by an internal mainspring, we are seldom the progenitor of it. Alternatively, when we prepare ourselves with attributions (I can learn physics if I have to), then we are more likely to achieve the goal at hand.
If we see threatening things more quickly and easily than its obverse cousin, our senses drive us more quickly to action and the negative biases of our narrative fallacies. Who can forget, in the movie “My Cousin Vinny,” Marisa Tomei’s rant on the porch of a rented cabin, stomping out the cadence of her biological clock as she implored her beau to move on his promise to consummate their betrothal in marriage? She reacted to the threat of missing the child-bearing years; he to the distraction it imposed on his strategy forming over the case under trial; each responding to their inner fears.
Simply, threats of a worsening economy turn consumers into simplifiers, saving more of their money to drive expenses down, and many playoff athletes to sub par performances over the threat of losing so much more than a regular season game. Perhaps, for the same reasons, pro golfers putt more accurately for par than for birdie … at the same distance.
Loss aversion, the initiation of alternative action when threatened with loss, is a simple measure of psychological indices and tendencies to avoid and defend rather than to approach and advance. The negative dominance is so strong in us that a fly will completely ruin the appeal of a bowl of soup we otherwise enjoy. Even the success of marriage, it has been concluded, has far more to do with avoiding the negative than finding the positive. This veridical reality embarrasses the self-reflective among us.
So, how do we inform a marketplace to greater achievement, especially during a time of economic threat? Loss aversion creates an asymmetry that values loss greater than gain. Consequently, when attempting to inform another of opportunity it is better to reduce the sense of loss he may feel in the transaction-“You’ve got nothing to lose since our product sells itself, returning your investment after a single sale.” Get the picture?
In both human and animal worlds, the tendency to protect is strong. Since potential losers will be more aggressive and tenacious than potential winners, institutions and bureaucracies such as government will produce results more biased in the negative and more costly and less effective. The good news is that this is a conservative force whose reference point helps stabilize systems and keeps us closer together.
We do well to consider the principles above in preparing ourselves for the selection of the next administration. Radical changes such as short-term monetary policy and government growth increase the numbers who will fight to protect their subsidies and bias recovery. “A house divided” may eventually fall, but the evidence of failure is clearer to those understanding of the mechanisms of behavioral economics.