Oct. 27 (Bloomberg) -- Take a look at the photos of two pairs of eyes, and take note: Your heartbeat accelerated when you looked at the left-hand figure. In fact, it accelerated even before you could label what is so eerie about the picture.
After some time, you may have recognized the eyes of a terrified person. The eyes on the right, narrowed by the raised cheeks of a smile, express happiness -- and they are not nearly as exciting.
When the two pictures were presented to people in a brain scanner, each was shown for less than two one-hundredths of a second and immediately masked by a random display of dark and bright squares. None of the observers ever consciously recognized what they had seen, but one part of their brain evidently knew: the amygdala, which has a primary role as the “threat center” of the brain, although it is also activated in other emotional states.
Information about the threat probably traveled via a superfast neural channel that feeds directly into a part of the brain that processes emotions, bypassing the visual cortex that supports the conscious experience of “seeing.” The same circuit also causes schematic angry faces to be processed faster and more efficiently than schematic happy ones. Some experimenters have reported that an angry face “pops out” from a happy crowd, but a single happy face does not stand out in an angry crowd.
Bad Is Stronger
The brains of humans contain a mechanism that is designed to give priority to bad news. No comparably rapid mechanism for recognizing good news has been detected. Threats are privileged above opportunities, as they should be. Loss aversion is one of many manifestations of a broad negativity dominance in people.
In a paper titled, “Bad Is Stronger Than Good,” some scholars summarized the evidence: “Bad emotions, bad parents and bad feedback have more impact than good ones, and bad information is processed more thoroughly than good. The self is more motivated to avoid bad self-definitions than to pursue good ones. Bad impressions and bad stereotypes are quicker to form and more resistant to disconfirmation than good ones.”
John Gottman, an expert in marital relations, observed that the long-term success of a relationship depends far more on avoiding the negative than on seeking the positive. Gottman estimated that a stable relationship requires that good interactions outnumber bad ones by at least 5-to-1.
Some distinctions between good and bad are hardwired into our biology. Infants enter the world ready to respond to pain as bad and to sweet (up to a point) as good. In many situations, however, the boundary between good and bad is a reference point that changes over time and depends on the immediate circumstances.
Imagine that you are out in the country on a cold night, inadequately dressed for the torrential rain. When you find a large rock that provides some shelter, the moment is intensely pleasurable. But the relief will not last long; you will soon be shivering behind the rock, driven by your renewed suffering to seek better shelter.
Loss aversion refers to the relative strength of two motives: We are driven more strongly to avoid losses than to achieve gains. A reference point is sometimes the status quo, but it can also be a goal in the future: not achieving a goal is a loss; exceeding it is a gain.
Bogey vs. Birdie
The economists Devin Pope and Maurice Schweitzer, at the University of Pennsylvania, suggest that golf provides the perfect example of a reference point: par. For a professional golfer, a birdie (one stroke under par) is a gain, and a bogey (one stroke over par) is a loss. Failing to make par is a loss, but missing a birdie putt is a forgone gain, not a loss. Pope and Schweitzer analyzed more than 2.5 million putts to test their prediction that players would try harder when putting for par than when putting for a birdie.
They were right. Whether the putt was easy or hard, at every distance from the hole, players were more successful when putting for par than for a birdie.
Tiger Woods was one of the golfers in their study. If in his best years Woods had managed to putt as well for birdies as he did for par, his average tournament score would have improved by one stroke and his earnings by almost $1 million per season.
If you are set to look for it, the asymmetric intensity of the motives to avoid losses and to achieve gains shows up almost everywhere. It is an ever-present feature of negotiations, especially of renegotiations of an existing contract, the typical situation in labor negotiations, and in international discussions of trade or arms limitations. Loss aversion creates an asymmetry that makes agreements difficult to reach.
Negotiations over a shrinking pie are especially difficult because they require an allocation of losses. People tend to be much more easygoing when they bargain over an expanding pie.
In the world of territorial animals, the principle of loss aversion explains the success of defenders. A biologist observed that “when a territory holder is challenged by a rival, the owner almost always wins the contest -- usually within a matter of seconds.”
Losers Try Harder
In human affairs, the same simple rule explains much of what happens when institutions attempt to reform themselves, in “reorganizations” and “restructuring” of companies and in efforts to rationalize a bureaucracy, simplify the tax code or reduce medical costs. As initially conceived, plans for reform almost always produce many winners and some losers while achieving an overall improvement.
If the affected parties have any political influence, however, potential losers will be more active and determined than potential winners; the outcome will be biased in their favor and inevitably more expensive and less effective than initially planned.
When Richard Thaler, Jack Knetsch and I studied public perceptions of what constitutes unfair behavior on the part of merchants, employers and landlords, we found that the moral rules by which the public evaluates what companies may or may not do draw a crucial distinction between losses and gains. The basic principle is that the existing wage, price or rent sets a reference point, which has the nature of an entitlement that must not be infringed. It is considered unfair for the company to impose losses on its customers or workers relative to the reference transaction, unless it must do so to protect its own entitlement. Consider this example:
A hardware store has been selling snow shovels for $15. The morning after a large snowstorm, the store raises the price to $20. Eighty-two percent of participants in the survey rated the action unfair, though the hardware store was behaving appropriately, according to the standard economic model.
Participants evidently viewed the pre-blizzard price as a reference point and the raised price as a loss that the store imposes on its customers, not because it must but simply because it can. We found that the exploitation of market power to impose losses on others is unacceptable.
Rules of Fairness
Different rules governed what a company could do to improve its profits or to avoid reduced profits. When a company faced lower production costs, the rules of fairness did not require it to share the bonanza with either its customers or its workers. Of course, our respondents liked a company better, and described it as more fair, if it was generous when its profits increased, but they did not brand as unfair a company that did not share.
They showed indignation only when a company exploited its power to break informal contracts with workers or customers, and to impose a loss on others in order to increase its profit. The important task for students of economic fairness is not to identify ideal behavior but to find the line that separates acceptable conduct from actions that invite opprobrium and punishment.
More recent research has also shown that fairness concerns are economically significant. Employers who violate rules of fairness are punished by reduced productivity, and merchants who follow unfair pricing policies can expect to lose sales. People who learned that a merchant was charging less for a product that they had bought at a higher price reduced their future purchases from that supplier by 15 percent, an average loss of $90 per customer. The customers evidently perceived the lower price as the reference point and thought of themselves as having sustained a loss by paying more than appropriate.
The influence of loss aversion and entitlements extends beyond the realm of financial transactions. One study of legal decisions found many examples of sharp distinction between actual losses and forgone gains. For example, a merchant whose goods were lost in transit may be compensated for costs he actually incurred, but is unlikely to be compensated for lost profits.
The familiar rule that possession is nine-tenths of the law confirms the moral status of the reference point. If people who lose suffer more than people who merely fail to gain, they may also deserve more protection from the law.
(Daniel Kahneman, a professor of psychology emeritus at Princeton University and professor of psychology and public affairs emeritus at Princeton’s Woodrow Wilson School of Public and International Affairs, received the Nobel Memorial Prize in Economic Sciences for his work with Amos Tverksy on decision making. This is the third in a four-part series of condensed excerpts from his new book, “Thinking Fast and Slow,” just published by Farrar, Straus and Giroux. The opinions expressed are his own. See Part 1, Part 2 and Part 4.)
To contact the writer of this article: Daniel Kahneman at Kahneman@princeton.edu
To contact the editor responsible for this article: Mary Duenwald at firstname.lastname@example.org