Did you know that in our brain there is a biological and psychological mechanism designed to prioritize bad events over good ones?
Psychologist Paul Rozin observed in an experiment that a single cockroach completely ruins the appeal of a bowl full of cherries, but that one cherry does not make a bowl full of cockroaches any better.
Similarly, it is proven that the face of an angry person stands out from a crowd of happy faces, while the reverse is not the case. And now, for less scientific and more routine examples, all you need to do is watch the news. Could it be that nothing good happens in the world? But that’s how we humans are. The negative hides the positive.
This mechanism, which acts in a generic way, has a specific expression -and well known by investors- in the so-called loss aversion. We know that losses weigh more on us than gains. How much more? For data lovers, I will tell you that several experiments have placed this loss aversion ratio in a range between 1.5 and 2.5 compared to profit.
This prevalence of negativity or bad events explains many of the economic headlines we see these days, such as “market losing streaks,” “persistent inflation” or that we are in a the consumers”.
But beyond the economic veracity of this news and the real impact on the investment field, this effect is of great interest in the field of innovation management and business development.
If, as a human being, I prefer to avoid loss to profit, I may tend to stay where I am. Behavioral scientists call this effect status quo bias, and it is one of the most powerful behavioral levers there is. The governments, the church and the NGOs know this. In the midst of the 2021 Income campaign, which ends on June 30, 2022, the status quo bias has its maximum expression in the famous “tax allocation”. This is neither more nor less than the possibility of devoting 0.7% of the full quota to the Catholic Church, for purposes of social interest, or to both. In other words, without paying another euro in taxes, money could be allocated to the Church and/or social purposes. By default (status quo), none of these boxes are checked.
But according to data from 2021, only 66% of Spaniards checked at least one of these two boxes. And the question is, is there any Spaniard who, leaving it completely free, would not want money to be allocated to people with special needs (educational, health, etc.)? Surely the percentage that he would want would be much higher than 66%. And this percentage difference is the status quo bias. We just tend to leave things as they are.
But as we said, in management and together with loss aversion, it also has enormous implications.
To begin with, it is a barrier to entrepreneurship or intra-entrepreneurship (that which occurs as an outside worker within a company). And this barrier must be broken down through concrete actions aimed at equipping workers with skills, opportunities and motivation.
Likewise, many managers find it easier and less committed to cut costs than to invest in order to experiment and build, for example, prediction models that help them understand the future behavior of their consumers. What if they’re wrong?
Also, not many managers like uncertainty either, but in innovation, uncertainty is necessary to create opportunity. Innovation is potential uncertainty.
And there is also the problem of data, which in innovation is usually not so reliable, for example, because of its novelty.
All these examples are the result of this structural mechanism of the human being.
But the status quo can also be a goal that we place in the future, and not reaching it can be our concept of loss to be avoided. This is the approach that managers must work with. Two economists from the University of Pennsylvania (Pope and Schweitzer) illustrated this with the example of golf. Each hole on the course must be played in a par-number of shots-determined. It is not reaching it that is a loss.
In conclusion, loss aversion is a mechanism that at the same time protects us, favoring the status quo – which would act as a gravitational force that holds a neighborhood, an institution or a marriage together. But it also ties us to a comfort zone, to what we already know even if it is not particularly good, thus avoiding the culture of innovation and experimentation.
To combat this pernicious side effect of loss aversion and the status quo, we can harness another effect that takes place in our psychology and decision making. Another of the most powerful: the availability heuristic. This assumes that people make judgments about the frequency of certain events based on how easy it is for us to remember examples of these.
So let us give examples of what we should remember. Good examples do not mean easy examples. If our communication media continually display models of success that do not seem to be based on effort, study, sacrifice, satisfaction and love for one’s own work and respect for others, etc… many may think that success is in a way that possibly does not correspond to reality.
This reminds me of what was written by the brilliant and unrepeatable Jorge Luis Borges, in his story “Death and the compass”: “You will reply that reality has no obligation to be interesting. I will reply that reality can dispense with that obligation, but not hypotheses”.
Hypotheses must be interesting! Experimentation is hypotheses come true! And fiction is a hypothesis, neither more nor less. And fiction has an obligation to be interesting. And in it we can free ourselves from all loss aversion. A book allows us to risk as much as we want. And assuming that risk, our status quo is undone word by word. That is why it is so important to read. So psychologically and economically important. Reading promotes responsible entrepreneurship. Reading encourages innovation. Reading improves management.
I celebrate that one more year the Madrid book fair returns. It will take place this week, from May 27 to June 12. Let’s give priority to this good event.
*Behavioral Economics Consultant at BEWAY.org
