by Bruce Hood
Even though each bonus was equivalent, Kahneman and Tversky pointed out that each twin would still be reluctant to switch. They called this ‘loss aversion’, and it is the reason that standard economic models fail under these circumstances.56 If two resources are equivalent in value, then they should be readily interchangeable. However, once established or owned, people do not treat them as such. Biases in the human mind need to be taken into consideration when reasoning about economic decisions. What is it about human reasoning that seems so fickle?
In his bestselling book Thinking, Fast and Slow,57 Kahneman argues that the human mind operates with two pathways to decision-making: System 1 operates fast and intuitively, often relying on emotional ‘gut feelings’, whereas System 2 is slow and ponderous, arriving at decisions much more slowly through rational logic and reasoning. We deploy both types of thinking, which often conflict when it comes to solutions. Standard economic models are based on the cold, hard logic and reason of System 2, but humans often succumb to their fast, intuitive biases of System 1, which is why our decisions can seem illogical when emotions are not taken into consideration. When you understand the difference between these two systems, the irrational aspects of ownership start to make more sense, as we will consider next.
BAD LOSERS
Imagine the following betting prospect. I will toss a normal coin and if it comes up heads, you will lose $10. How much would I have to offer you as a win before you took the bet? I expect you will want more than $10 otherwise there is no point in taking the bet. But how much would you require to be tempted?
On average, most people will not take the bet unless the potential win is at least $20. In fact, it doesn’t matter whether it is $10 or $10,000; most people want at least twice as much in return in order to take such a bet. Why? When it comes to losing, the prospect of a loss looms larger in our minds than the prospect of a gain unless that gain is substantially more. System 1 is at fault once again. This loss aversion is perverse when you think of the bets many members of the general public make when they play the lottery. The odds of winning are so much smaller than 50:50 as in a coin toss, but then the cost of a ticket is completely swamped by the prospect of a megabucks win. In most people’s minds, the unlikely chance to become a millionaire offsets the likely cost of the weekly lottery ticket. We are not very good at economic reasoning when it comes to taking risks, which is why national lotteries have been called an ‘idiot tax’.
It’s not idiocy, but rather System 1 operating. People love to dream about becoming rich, which is one of the reasons they gamble. And for many, a big win promises a better life that will make them happier. Clearly poverty is neither preferable nor desirable, but wealth does not always deliver the anticipated happiness we think it will bring. In a classic study of wealth and happiness back in 1978, researchers interviewed twenty-two lottery winners who had won prizes ranging from $50,000 to $1 million.58 The relatively random nature of lottery wins provides an opportunity to assess the value that significant amounts of money contribute towards enhancing well-being without factoring in work and effort. Winners were asked to rate how happy they were before their big win; how happy they were at the present moment; and how happy they expected to be in the future. They were also asked to rate how much pleasure they derived from everyday activities such as talking with friends, watching TV, getting a compliment or shopping for clothes. For comparison, the same questions were asked of their neighbours who had not won the lottery. Not exactly losers, but not winners either. Despite their windfalls, the lottery winners were no happier than their neighbours but reported significantly less enjoyment in daily activities.
The lottery winner study, now forty years old, was so influential and counterintuitive that it continues to stimulate further research and controversy. The most recent study (published in 2018) of over 3,000 Swedish lottery players who had won significant amounts of money appears to contradict the original claim that money does not increase happiness.59 When asked how life was for them at least five years after their windfall, they reported significantly higher levels of overall life satisfaction compared to those who had not won. This was mainly due to the fact their financial worries had been removed. However, as we noted earlier in Kahneman’s study of rising salaries, satisfaction is not the same as happiness. In terms of happiness and mental health, there were no significant increases as a result of winning a large amount of money.
Gambling also reveals something interesting about the ownership of choices. People are reluctant to change their minds if they are the ones making the decision. Just after placing bets, racing punters are more confident of their horse’s chances than they are immediately before laying their bets.60 Choices generate an illusion of control,61 where participants are reluctant to exchange lottery tickets that they have selected compared to ones that have been allocated. They believe they are more likely to win if they have made the choice. Even when players are offered a bonus for exchanging tickets, they don’t.62 It’s not so much that they magically think they have luck, but rather they report that they would feel much worse if they swapped a ticket and lost than if they stuck with it and lost.63 Again, emotions are ruling the decision.
Most of us do not like to take risks because of our fear of losing. It’s not just humans who are risk averse. When the stakes are high, even the simplest organisms develop strategies to avoid risk. Deep in our evolutionary history, we developed a bias against taking chances. For most animals, the proverbial bird in the hand is worth more than two in the bush. However, avoiding all risks is also not a good strategy. Just like in the economic games we encountered earlier, you need to balance risk against the potential advantage of gains, so strategies have to evolve to be flexible enough to be passed on to future generations as adaptations.
Using computer simulations to model the reproductive success of risky behaviours over a thousand generations, it turns out that a preference for risk aversion only evolves in small populations, and especially in groups of 150 or fewer.64 This figure will be familiar to readers of evolutionary psychology as it coincides with Dunbar’s Number, named after evolutionary psychologist Robin Dunbar who calculated that 150 was the optimum size of a group of hominids living together.65 Moreover, the size of the loss aversion bias (the minimum number of birds in the bush there needs to be before you let go of the one in your hand) derived from mathematical models turns out to be 2.2 – a value that is remarkably close to the $20 most of us require in order to accept a bet with a potential loss of $10.
Not everyone is risk averse. Twin studies from Sweden, comparing up to 30,000 identical and non-identical twins raised together and separately, enabled researchers to establish to what extent behaviours were shaped by environments and childhood experiences and to what extent they were predicted by genes.66 When it comes to financial decisions that involve risk, such as investing in the stock market, these twin studies reveal that around a third (30 per cent) of the variation in risk-taking behaviour is related to our biology. Impressive as this may sound, it does mean that the major influence on risky behaviours (the remaining 70 per cent) is not controlled by our genes. Rather, it comes down to life experiences which interact with our biology.
Important choices regarding ownership are not simply System 2 mathematical equations we coldly calculate in our heads, but also System 1 activity that fires the emotional centres of our brains.67 To make decisions, our brains weigh up the likelihood of losses versus gains and these two sides of the same coin are processed in different circuitry. We may punch the air and feel the jubilant elation of a win, but that does not compare with the dull, sickening pain of loss that churns in our guts and seems to linger longer because remorse is a more powerful emotion than joy. When we anticipate making acquisitions at bargain prices, the reward centres of a region deep within our brain known as the ventral striatum light up, much as they do in anticipation of other positive experiences.68 However, faced with the prospect of a loss on a deal, the punishment and pain c
ircuitry, including the insula and amygdala, usually associated with painful experiences, is triggered.
Unless we are professional traders who cannot afford to get emotionally connected, then each decision we make is a neural trade-off in our brain between the potential pleasure of acquisition and the pain of paying for it. This explains why taking painkillers reduces the price that owners request when selling something.69 Brain imaging can even predict those who are more risk averse by the higher neural responses generated by prospective losses compared to gains.70 This emotional battle is exactly what traders are relying on as they try to sell us stuff that we really don’t need, which is why they know that purchases that appeal to the heart rather than the head are more likely to be successful.
Wanting is different from needing because it is more to do with the psychological fulfilment we seek through what we can own. But it is what we could lose that seems to be the dominant force in our decision-making. And when it comes to the things we own, then this loss is all the more potent for possessions that say something about us.
7
Letting Go
A BIRD IN THE HAND
As a young economics graduate in the early 1970s, Richard Thaler noted how one of his professors, a wine connoisseur, had two rules when it came to buying and selling. First, he would never pay more than $35 for a bottle of wine; and second, he would not sell a bottle unless he got more than $100. This strategy meant he was always going to make a profit, but it was also illogical. If you buy a bottle for $35 then you should sell it for any amount over your original purchase price, taking into consideration all the other factors that may have contributed to a change in valuation such as transport, inflation and so on. However, as Thaler observed, time after time, people put a much greater value on their possessions than others are willing to pay. This may seem obvious, but Thaler’s observation was to mark the beginning of the new field of behavioural economics, for which he would eventually be awarded a Nobel prize in 2017.
Behavioural economics is the application of psychological biases to economic decisions and it overturned the standard models of commerce by introducing the vagaries of human decision-making. In their ‘prospect theory’, Kahneman and Tversky articulated a set of psychological principles that shape the way that we reason when it comes to decision-making.1 Just like when calculating our social status and the time-limited joy we gain from purchases, our brains are biased. First, as discussed previously, evaluating any change in our circumstances is relative to some point. Whether we stand to gain or lose something depends on what we have had in the past. Our experiences are shaped by past events, from the sweetness of a drink to the boredom of watching a play for the umpteenth time. Remember the hedonic adaptation that we all succumb to? We compare all experiences against what we are used to. The second principle Kahneman and Tversky described is that any change is relative to the current value you have. So not only are past experiences relevant but so is your current position. A starving man is going to accept any handout even though he may have been rich in the past. Finally, and most importantly, the prospect of loss weighs more heavily in our minds than the prospect of gain. We want at least two birds in our bush before we let go of the one in our hand.
When Thaler read about prospect theory, suddenly much of human economic behaviour made more sense. People are not rational when it comes to ownership. They have an inherent bias to overvalue their possessions and it can be explained by loss aversion, as prospect theory predicted. Just like the simple gamble on the toss of a coin, on average, people must be paid twice as much to give up a possession than they are willing to pay to acquire it.2 This may seem to make good business sense – buyers and sellers both try to maximize their gains from a transaction – but the main reason comes down to ownership and the over-inflated sense of personal loss by the seller.
We overvalue things as soon as they come into our possession. This bias, known as the ‘endowment effect’,3 is one of the most robust phenomena in behavioural economics. In short, we expect more money for selling an item than we would be willing to pay for acquiring the same item. There is always an imbalance between the vendor and the buyer, but more so if the item for sale is a personal possession.
Many manipulations can induce endowment effects. Bidding at an auction on an item that you have not yet acquired is more likely to lead to further bids – a ploy that most auction houses appreciate will lead to a bidding frenzy.4 Simply holding or touching a potential purchase is sufficient to trigger endowment.5 When the salesperson asks you just to try on a suit or go for a spin in the car, they are relying on the endowment effect – the first taste of ownership – to overcome the toughest barrier to a purchase.
Although common, the endowment effect is not universal. When researchers started to look at different societies and cultures, something remarkable was discovered: the individualist–collectivist dimension influenced the power of the endowment effect. In one remarkable cross-cultural study, social psychologist William Maddux and a team of international collaborators studied college students from Western and Eastern backgrounds in the US, Canada, China and Japan.6 Students were assigned to be either ‘buyers’ or ‘sellers’. The sellers were given a mug with their school’s logo on it and told that they owned it but to choose a price between $0 and $10 that they would be willing to sell it at. Buyers were asked how much they would pay for the same mug. As predicted, the sellers’ average price of $4.83 was twice the buyers’ average offer of $2.34. However, when the researchers looked at the cultural backgrounds of the students separately, sellers from Western backgrounds asked for more ($5.02) compared to the average buyer’s offer ($1.78). In contrast, students from Eastern backgrounds were much closer in what sellers requested ($4.68) to what buyers offered ($3.08).
Then, with another group of Chinese students, the experimenters manipulated the participants’ self-construal before the transaction. They asked the Eastern students to write either a brief essay about their friendships and camaraderie with other people, or an essay about their unique character and skills and how they might stand out compared with other people. When the students wrote about other people, the endowment effect was reduced, but if they wrote about themselves it was increased. Finally, the researchers manipulated the relationship between owners and their mugs by getting Eastern and Western students to write about how important the mug was to them, or how unimportant. In Western students, this meaningful manipulation increased the endowment effect compared to Eastern students, which produced the opposite effect. In other words, forcing Western students to focus on their possession made them value it more, whereas Eastern students valued it comparatively less. Clearly, the endowment effect is not inevitable but rather reflects the way we consider our possessions in relation to our self-construal, which is shaped by cultural norms of individualism or collectivism.
If the endowment effect is shaped by culture, can we show the seeds of this effect in children before culture kicks in? We decided to investigate the development of the endowment effect in very young children using priming of the self or others in how they value toys. Normally, the endowment effect is not observed in Western children until they are around five to six years old,7 so we targeted three- to four-year-olds. At this age, the concept of value is beyond the grasp of children, but if they place one toy on a smiley face on a scale and another on a face with a frown then we can assume the children prefer one toy more than the other, which is a kind of relative value.
Smiley scale used to elicit relative evaluations of toys by pre-schoolers
Sandra Weltzien and I began by getting the toddlers to place different toys on the smiley scale to show that they understood the game, and then gave them two identical spinning-top toys. If they placed them on the same smiley face, then it meant they thought they were of the same value. Sandra then gave the children one of the tops and asked them to draw a picture either of themselves, their friend or a farm scene. Afterwards she asked the children to rate the toys
again, including the two spinning tops. Just like Maddux’s adults, those children asked to draw themselves valued their spinning top more than the identical top that did not belong to them. In this experiment, therefore, we were able to induce an endowment effect at an age when it is not normally found by getting children to focus on their selves.8
If the bias to overvalue possession is related to self-construal, then the recent discovery that individuals with autism lack an endowment effect is consistent with this account.9 Their expression of self-construal differs from typical individuals. High-functioning individuals with autism spectrum disorder without language impairments have difficulty using the first-person pronouns ‘I’ and ‘me’10 and have impaired autobiographical memory.11 Maybe this different awareness of their psychological self is why they do not overvalue their possessions as most of us do.
The difference in self-construal across the independent–collectivist divide can also explain the cultural variations in the endowment effect. Consider again the Hazda tribe of Northern Tanzania, one of the last hunter-gather societies left in the world. As we saw in previous chapters, they tend to have few possessions and operate a demand-sharing policy whereby members of the tribe take things they need if they are not being used. It is no surprise, then, that when tested with trading experiments using culturally appropriate items, many of the Hazda do not show the endowment effect.12 Why is this?
One reason is that hunter-gatherers have few possessions other than those that are necessary to maintain their nomadic lifestyle. They simply cannot carry much stuff around and so possessions are not a priority for them. This is why they developed demand-sharing as a way of optimizing the amount of materials and resources they need to carry among themselves. However, there is one interesting exception to this – the Hazda who have been exposed to Western influence. When anthropologists studied this subgroup, they discovered evidence of the endowment bias in those who interacted frequently with tourists or had the experience of trading at markets. When forced to trade with Westerners, the Hazda develop biases too.