Psychologist Daniel Kahneman was awarded the Nobel Prize in Economic Sciences in 2002 for some of the work he did with Amos Tversky over many years on the study of human decision-making. Dubbed prospect theory, the part of Kahneman and Tversky’s research that led to a Nobel Prize identifies certain cognitive biases that cause actual humans to deviate in their decision-making from the mathematical rationality of expected-utility theory. In his fantastic new book, Kahneman (p. 282) discusses the three “cognitive features” underpinning prospect theory.
- We evaluate potential gains and losses in relation to a neutral reference point. Under expected-utility theory, $10 is always $10, and $20 is always twice as much as $10. It turns out that’s not really how we think about gains and losses. Prospect theory shows us that, to a real-live human decision-maker, the value of $10 and the magnitude of the difference between $10 and $20 depend on their relation to some prior reference point that shapes the decision-maker’s expectations. As Kahneman writes, “For financial outcomes, the usual reference point is the status quo, but it can also be the outcome you expect, or perhaps the outcome to which you feel entitled, for example, the raise or bonus your colleagues receive.”
- Our sensitivity to changes in wealth diminishes as values increase. “Turning on a weak light has a large effect in a dark room. The same increment of light may be undetectable in a brightly illuminated room. Similarly, the subjective difference between $900 and $1,000 is much smaller than the difference between $100 and $200.”
- We dislike losing more than we like winning. Psychologists call this principle loss aversion. As Kahneman reports, “When directly compared or weighted against each other, losses loom larger than gains. This asymmetry between the power of positive and negative expectations or experiences has an evolutionary history. Organisms that treat threats as more urgent than opportunities have a better chance to survive and reproduce.”
I first encountered prospect theory in graduate school, when Kahneman and Tversky’s groundbreaking article in Econometrica (pdf) was one of many required readings in an excellent course on organization theory taught by Jonathan Bendor. Most of my work since then has involved statistical analysis of cross-national data, so I haven’t had much cause to think about how these cognitive biases shape political behavior.
A couple of year ago, though, I wrote a book on democratic consolidation that uses game theory to help understand when and why attempts at democratic government usually fail. The formal model at the heart of that book construes those failures as the result of choices made by political organizations–rival parties and the military–in the face of uncertainty about future gains and losses and the likely actions of their competitors. Re-reading the outlines of prospect theory now, I can see a couple of ways that the cognitive biases it identifies might help explain some of the empirical patterns I observed in failures of democracy.
First and most interesting to me, I can see how loss aversion would strengthen the temptation for incumbent office-holders to diminish civil liberties and manipulate elections in order to preserve their power. Prospect theory teaches us that fears of large losses drive people to do all kinds of things to protect themselves against those losses, even when the costs of that protection seem to outweigh the expected gains. One of the two ways democracies usually fail is by executive coup, where the party that won the last election fixes the game to ensure it doesn’t lose the next one. (The other, of course, is military coup.)
It’s not hard to imagine situations where the spoils of power would tempt incumbent officials to try to lock themselves into office, but it’s also not hard to think of significant risks and costs associated with those efforts, especially if they fail: never-ending payoffs to cronies, loss of property, prison time, and so on. Prospect theory helps me see how the experience of holding power might reset actors’ expectations and then lead them to weigh the expected costs of losing power more heavily than the actual costs of trying to sustain it. In the world described by prospect theory, the spoils of power wouldn’t have to be all that grand, and the threat of losing the next election or being ousted in a military coup or rebellion all that large, to tempt incumbents to try to lock their status down. As Kahneman writes (p. 316),
When you pay attention to a threat, you worry–and the decision weights reflect how much you worry…The worry is not proportional to the probability of the threat. Reducing or mitigating the risk is not adequate; to eliminate the worry the probability must be brought down to zero.
In the context of democratic government, bringing the probability of a loss of power down to zero means breaking the democracy.
Second, I can also see how what Kahneman and Tversky call the possibility effect might increase the temptation to attempt a military coup. Military coups fail much more often than they succeed, so the puzzle here is why officers keep trying in spite of the long odds. Apparently, loss aversion doesn’t mean that people never chase long shots. Instead, psychologists have found that people tend to prefer big payoffs with long odds over smaller payoffs with much better odds in paired choices when the outcomes of the safe play is framed as a loss.
This cognitive quirk leads us to make decisions that rational-agent theory says we shouldn’t make, like chasing unlikely profits from business ventures into which we’ve already sunk a lot of money. Military leaders facing slashed budgets or loss of status and prerogatives confront a similar choice: stomach the losses associated with continuation of the status quo, or gamble on a coup bid that probably won’t succeed but might stem those losses if it did. Through the lens of prospect theory, we can see more clearly why they might pick Door Number 2, even if the expected payoff from that pathway is worse.
The possibility effect is connected to a pervasive human bias toward optimism. As Kahneman puts it (p. 255), “Most of us view the world as more benign than it really is, our own attributes as more favorable than they truly are, and the goals we adopt as more achievable than they are likely to be.” In addition to being overly optimistic about our own skills and prospects, we tend to reward other people who exude self-confidence, even when that confidence is unwarranted by past performance. As a result, “Optimistic individuals play a disproportionate role in shaping our lives. Their decisions make a difference; they are the inventors, the entrepreneurs, the political and military leaders–not average people.”
The reference to military leaders caught my eye when thinking about the risk of coups. Military leaders are not a representative slice of the general population. As Kahneman notes, they are more likely to be risk-seekers who overestimate their own skill and downplay the chances of failure. These traits probably serve them well in combat and make them appealing leaders, but they could also lower the cognitive barriers to making a grab for power in shaky democracies.
Those are two ways that prospect theory might deepen our understanding of the forces behind the two most common forms of democratic breakdown. Structural conditions might determine the size of the gains and losses political decision-makers can expect to realize under different future scenarios, but cognitive biases will affect how they weigh those gains and losses, and how they evaluate their chances of insuring against or capturing them. Prospect theory doesn’t “prove” anything about the causes of democratic breakdown any more than my own little model does, but it’s comforting to see that an informal application of the former to the latter seems to amplify rather than undercut the lessons we might draw about why democracy fails so often.