WHY fear of losing keeps us stuck in euro rut
Thinking, Fast and Slow (Allen Lane 29)
Published 01/12/2011 | 05:00
GERMANY, a towering beneficiary of the euro, is perceived as sabotaging efforts to save the single currency. To understand why, pick up Daniel Kahneman's imposing new book, 'Thinking, Fast and Slow'.
Mr Kahneman, an influential Princeton psychologist who won a Nobel Prize in economics, doesn't discuss the euro debacle in this masterwork on intuition and decision making. He does, though, describe a human trait that has helped drive the sovereign debt crisis from Athens to Rome and on to Berlin: loss aversion.
The phrase is shorthand for an ingrained psychological quirk that surfaces in experiment after experiment. Simply put, people dislike losses more than they like gains. That instinct warps any negotiation, be it bargaining over labour contracts or deciding the fate of the European Union.
Germans, seen in this light, are primed by history and psychology to believe they have more to lose than to gain from euro bailouts.
"Loss aversion creates an asymmetry that makes agreements difficult to reach," Mr Kahneman writes. "The concessions you make to me are my gains, but they are your losses; they cause you much more pain than they give me pleasure."
This is only one slice of a highly readable and richly empirical study of our "mental machinery", as Mr Kahneman and his late collaborator Amos Tversky called it.
The book, a sweeping synthesis of Mr Kahneman's research and thinking, offers plenty of other intellectual meat to be savoured -- observations on hapless stock pickers and overrated chief executives, and an algorithm that predicts the future value of Bordeaux wines.
Yet I kept coming back to loss aversion, which is tripping up European ministers and keeping the bond vigilantes on their backs.
If Germany's chancellor Angela Merkel wants to save the beleaguered euro, she would do well to heed what Mr Kahneman and other pioneers of behavioural economics have learned.
Our cognitive equipment is composed, in Mr Kahneman's extended metaphor, of two systems that determine how we think and make choices. System 1 is fast, but runs on intuition and emotion: "Do we trust that Neanderthal with the baseball bat in the dark alley?"
System 2 is slower, more critical and more logical: "What's the product of 17 x 24?" No points for guessing which system has the upper hand in loss aversion.
Throughout our lives, we face choices that combine the risk of loss with the opportunity of gain.
Should you take that job in Dubai? Would you buy shares of Facebook in a private sale before the company goes public? In each case, you must decide whether to accept a gamble or reject it, Mr Kahneman writes.
He likens such choices to a coin toss. Tails, you lose $100; heads, you win $150. Though the expected value of the gamble is positive, most people dislike it, he says.
Their fear of losing $100 overpowers their hope of gaining $150. Many demand a potential gain of at least $200 to balance the possibility of losing $100.
Reading this book has deepened my appreciation of Germany's reservations. Germans are right to be vigilant about the moral hazard engendered by transfer unions.
Yet Germans would be wise to stifle their System 1 long enough to allow their System 2 to calculate the real value of saving or losing the euro. Is this a risky gamble? Yes. But Germans have far more to gain than to lose.
'Thinking, Fast and Slow' is available with free P&P from Independent Bookshop. Phone 01 405 9100 or visit independentbooks.ie.