More Defects of the Brain
This is the third of my four blogs on the brain. In my first blog, I outlined the main functions and features of both our conscious and unconscious minds. In the second blog and this one, I consider some of the biases and errors of the brain before in my fourth blog suggesting ways to minimise some of these defects. This article discusses the following cognitive errors: Loss Aversion, the Planning Fallacy, the Sunk Cost Fallacy, the Anchoring Effect, the Priming Effect, Framing Effect and the Halo Effect.
Our brains are hard wired to hate losing more than we love winning. We are more likely to act to avoid a loss than to achieve a gain. The golfer tries harder to avert a bogey and the loss of a par than to score a birdie. It has been calculated in several experiments that our loss-aversion ratio ranges from 1.5 to 2.5. To balance the risk of losing €100, most people need the chance to win at least €150 but some people won’t risk it unless they can have a chance to win at least €250. For the average person the fear of losing €100 is as intense as the hope of gaining €200. Consistent with loss aversion buying at a low price is a pleasurable event whereas buying at a high price is painful. Price increases are experienced as a loss and price decreases as a gain. A price increase of €5 has about the same emotional intensity as a price decrease of €10. The disadvantages of a change loom larger than its advantages, inducing a bias in most human beings for the status quo. Loss aversion is a powerful conservative force that favours minimal changes.
There are many consequences to our loss aversion. Negativity and escape dominate positivity and approach. Our sensitivity to threats means we pay more attention to opinions with which we strongly disagree. Bad information and emotions are processed more thoroughly than good. We are more motivated to avoid bad self-definitions than to pursue good ones. Long term success in relationships depends far more on avoiding the negative than on seeking the positive. A stable relationship requires good interactions to outnumber bad interactions by at least 5:1. A friendship that can take years to develop can be ruined by a single bad action.
Negotiations on the terms of an existing contract are difficult because of loss aversion. The concessions you make to me are my gains, but they cause you much more pain than they cause me pleasure. You place a higher value on them than I do. The same is true of the very painful concessions you demand of me which you do not appear to value sufficiently. Negotiations over a shrinking pie are especially difficult because they require an allocation of losses.
As initially conceived, reform plans almost always indicate many winners and some losers while on the way to overall improvement. If the affected parties have political influence, the potential losers will be more active and determined than potential winners. The outcome will be more biased in their favour and inevitably the reforms are less effective. Again and again attempted reforms fail because the losers fight far more strongly than the winners.
The intense aversion to loss and risk plays out in our laws. The legal ‘Precautionary Principle’ imposes the entire burden of proving safety on anyone who undertakes actions that might harm people or the environment. Many international bodies have said that the absence of scientific evidence of potential damage is not sufficient justification for taking risks. The precautionary principle is costly and when interpreted strictly paralysing. So many inventions would not have passed the test including airplanes, open-heart surgery and X-Rays.
Consistent with our aversion to loosing, the value people place on a change of probability (for example of winning something) depends on the reference point: people place greater value on a change from 0% to 10% (going from impossibility to some possibility) than from, say, 45% to 50%, and they place the greatest value of all on a change from 90% to 100% (going from high possibility to certainty). When the probability concerns losing something then the greatest value is placed on the 0% probability and the certainty of not losing anything.
However loss aversion has some advantages. It acts as a conservative force that helps to keep us stable in our community, our marriage and our job. One experiment showed that the brains of people who are engaged in punishing one stranger for behaving unfairly to another stranger experience increased activity in the ‘pleasure centres’ of the brain. More experiments conclude that our brains are designed to punish meanness more than to reward generosity. It seems we are more wired to maintain social order and fairness than to encourage innovation and creativity.
Traders are one group of people who have learnt through trading experience not to be loss averse. For them the pain of selling their goods becomes just the same as the pleasure of gaining something in return. Traders have learned to ask “How much do I want to have that product that I have compared with other things I could have instead?”
Somewhat contradictory to loss aversion, we are also over confident when we plan. The planning fallacy is our tendency to overestimate the benefits and to underestimate the costs of proposed projects impelling people to take on risky endeavours. People often take on risky projects (legal action, wars, building projects and starting small businesses) because they are overly optimistic about the odds they face. Anyone thinking of starting a new business should plan well. 65% of small businesses fail after 5 years in US. 60% of restaurants close after 3 years in US. Good planning is essential too in any type of building endeavour. In a 2002 US survey, remodelling kitchens was on average estimated to cost $18,658 when in reality they cost $38,769. The National Children’s Hospital in Dublin had an original estimate of €400 million but cost €2.4 billion – 6 times the original estimate. However every country can come up with proportionately even worse examples. In 1997, the new Scottish Parliament in Edinburgh had an estimated cost of £40 million but ended up being completed in 2004 for £431 – 10.3 times the original estimate. Faulty financial planning can have serious consequences for the economy of a whole country. The cost of staging the 2004 Olympics seriously hampered the finances of Greece leaving them with serious government financing problems and some abandoned sports arenas.
To explain our overconfidence in planning. Daniel Kahneman in his book “Thinking, Fast and Slow” created the concept he labelled “What you see is all there is (WYSIATI)”. His concept states that when the mind makes a decision and tries to make predictions it deals primarily with ‘Known Knowns’ - things it already knows about, that is primarily the most immediate threats and opportunities like funding. It ignores ‘Known Unknowns’ – things that it knows could be relevant but about which it has no information. Our conscious minds sometimes do not have the energy to do the hard slog of research but more often it is simply too lazy to research. One particularly common neglect is that planners do not research the base rates for their project i.e. the length and costs of similar projects comparable to the proposed project. Also planners find it hard to take a serious look at threats particularly the competition.
Finally, it appears oblivious to the ‘Unknown Unknowns’. People do not take in account the constantly changing and evolving nature of events and the role of fate and luck in so many endeavours, assuming too often when planning that the future will mirror the past. The coherence of the story it constructs from the Known Knowns is all that matters. The amount and quality of the data are largely irrelevant. When info is scare our subconscious easily jumps to conclusions.
Kahneman does offer one practical suggestion to mitigate some of the planning fallacy. Companies should implement a pre-mortem before starting a project. The project committee should convene a brief session where every member is asked to imagine a year into the future and the project failing. Everyone takes 10 minutes to write the story of the failure. This procedure brings out threats that were not considered.
Sunk Cost Fallacy
The Sunk Cost Fallacy has similarities to the Planning Fallacy. Rather than taking a hard and often painful look at the odds of success of investing further in a losing enterprise, some people tend to ‘throw good money after bad’ and continue to invest in projects that have already consumed significant resources. If they have invested heavily in a plummeting stock, investors tend to invest further in that stock rather than investing in another stock. The Germans and Japanese continued to fight on in WW2 well past the point when they could reasonably expect to win. The sunk cost fallacy keeps people too long in poor jobs, unhappy marriages and unpromising research projects.
The Anchoring Effect
The anchoring Effect: If people are given a certain value for an unknown quantity before estimating that quantity, their estimates will stay close to the given value. This effect reveals how we tend to be influenced by irrelevant numbers and subconscious elements. If shown higher or lower numbers we tend to give higher or lower responses. Most people when asked whether Gandhi was more than 114 years old when he died will provide a much larger estimate of his age at death than those who were asked whether Gandhi was more or less than 35 years old at death.
Probably the most significant subconscious anchor is the environment we are in at any particular moment. As we have seen in the first blog, our subconscious is working away, unknown to our conscious self, moment by moment constantly scanning our environment. These subconscious stimuli influence us much more than we know or want. You are likely to drive too fast coming off a highway onto city streets especially if you are talking with someone as you drive. The teenager often fails to meet the parent’s demand to play music at a reasonable volume as both teenager and parent are operating from two different anchors. The parent has a low anchor and the teenager a high anchor.
Similar in ways to Anchoring, Priming, or, the Priming Effect, occurs when an individual's exposure to a certain stimulus influences his or her response to a subsequent stimulus, without any awareness of the connection. These stimuli are often related to words or images that people see during their day-to-day lives. Exposure to a word causes immediate and measurable changes in the ease with which many related words can be evoked. If you have recently seen or heard the word EAT you are temporarily more likely to complete the word fragment SO_P as SOUP than as SOAP. If you are primed to think of old age, you would tend to act old, and acting old would reinforce the thought of old age. Money primed people are more independent, more selfish and have a greater preference for being alone. The portraits of the national leader in authoritarian societies lead to a reduction in spontaneous thought and independent action in those societies.
The framing effect has echoes anchoring and priming. It is the concept that choices are effected by the way the choice is framed or expressed. In an experiment subjects were asked whether they would opt for surgery if the survival rate was 90% while others were told the mortality rate was 10%. The first framing increased acceptance even though the situation was no different in both expressions. Unless there is an obvious reason to do so, most of us passively allow the way a question is framed to unduly influence our decision making. We rarely have the opportunity to discover the extent to which our preferences are frame bound rather than reality bound.
The Halo Effect is the tendency to like or dislike everything about a person including things you have not even observed. It increases the importance of first impressions sometimes to the point where subsequent information is ignored. So articulate, good looking, stylish, athletic and strong people do proportionately way better than others at interviews despite the fact that these attributes are not key skills required for most jobs. The handsome well-dressed man with the beaming smile bounds up onto the stage. We are all psyched to love him before he even opens his mouth.
The halo effect is present in other less obvious ways. The first question an exam marker scores has a disproportionate effect on the overall grade. Exam markers should read each candidates papers question by question unaware of the mark given to the previous question, not whole paper by whole paper
The anchoring, framing and priming effects reveal how we tend to be influenced by irrelevant numbers and subconscious elements. Many of our preferences are anchor, frame and prime bound rather than reality bound. The halo effect is a warning not to judge people on first impressions.
Loss aversion is a powerful conservative force inducing a bias in most human beings for the status quo. The disadvantages of a change loom larger than its advantages. It’s good in that it that it keeps our community, marriages and jobs stable. It’s bad in that it discourages innovation and creativity. Too many great reform proposals never see the light of day because the forces likely to lose fight harder than the ones likely to gain. We favour keeping things rather than letting them go. However along with hating to loose, we also hate to admit defeat. We stay too long in poor jobs and unhappy marriages. We are reluctant to let go of so many things that do not serve us anymore. We are also over confident in our own entrepreneurial abilities. And we are blind to many of the signs of the looming clouds of future threats.
In summary, we should at any moment be prepared to sacrifice what we are for what we should become. We should ruthlessly cease with activities that are not serving us well. We should courageously take on more calculated risks. Traders, entrepreneurs, explorers, artists and mystics display these traits. The shrewd stock trader knows when to sell non performing stock and she regularly takes calculated risks on new trending stocks.