The Frontal Cortex

Iraq and Loss Aversion

It sounds as if Bush has decided to “escalate” the war in Iraq by sending a “surge” of 20,000 more troops. I’m no military expert, but this certainly seems like a terrible idea, especially considering that the previous attempts to pacify Baghdad earlier this summer were so ineffective.

So what is Bush thinking? Why is he refusing to listen to the advice of his generals and the Joint Chiefs, who are against a troop surge? I think part of the answer is that admitting defeat and de-escalating the war (i.e., bringing the troops home) would simply be too painful a decision for Bush to make. Accepting failure sucks, especially when the failure is entirely of your making. While it might feel better to “double-down” in the short term – this allows Bush to postpone an admission of defeat for a little bit longer – this is most likely a foolish strategy, since it only increases the magnitude of the loss that will be incurred later on.

Psychologists have a name for this phenomenon: loss aversion. First identified by Kahneman and Tversky in the late 1970’s, loss aversion is best illustrated with a simple bet. When offered a gamble on the toss of a coin in which they might lose $20, most people demand a payoff of at least $40 if they win. (Most people would also refuse a bet in which they have an 85 percent chance of doubling their life savings and a 15 percent chance of losing it.) In other words, the pain of a loss is approximately twice as potent as the pleasure generated by a gain.

This simple psychological principle has all sorts of real-world implications. For one thing, it explains why people often make such foolish decisions in the hope of avoiding a loss. Take, for example, the behavior of investors in the stock market. As a study by Terrance Odean of UC-Berkeley discovered, investors evaluating their stock portfolio are most likely to sell stocks that have increased in value. Unfortunately, this means that they end up holding on to their depreciating stocks. Over the long term, this strategy is exceedingly foolish, since it ultimately leads to a portfolio composed entirely of shares that are losing money. (In fact, Odean found that the stocks investors sold outperformed the stocks they didn’t sell by 3.4 percent). Why do investors do this? Because they are afraid to take a loss, and selling shares that have decreased in value makes the loss tangible. We try to postpone the pain for as long as possible.

I’m afraid that the decision to escalate this war once again is just another example of loss aversion distorting the decision-making process. No president wants to lose a war. But sometimes, it’s better to take a painful loss than keep on pretending that there’s something left to win.

Comments

  1. #1 Dan K.
    December 29, 2006

    Interesting. I’ve totally made that stock mistake. Are there evolutionary reasons for loss aversion?

  2. #2 Roy
    December 29, 2006

    Bush wanted to be a war president. So he invaded Afghanistan and Iraq, and is thinking about Iran, North Korea, and Venezuela. Afghanistan was an obvious loss, but the public has forgotten about it. Iraq is a worse disaster, and it’s getting worse.

    Bush gambled away a budget surplus and has put the US trillions in debt. He gambled and lost nearly 3,000 US soldiers, which won’t bother him because they are meaningless cannonfodder to him. He won’t mind gambling more, or losing more. Losing trillions more won’t bother him because those trillions will not improverish him by a single cent. (In fact, war profiteering enriches him, his friends, and his cronies.) None of the dollar or death costs have any meaning to him. It’s not that he’s willing to pay any price, the prices are not real to him, they’re Monopoly money. He’s gambling with other people’s money and lives, which are all externalities.

    He still imagines that if he trusts his instincts he will come out of this a hero, that the whole world will praise him as the greatest leader of all time. In his mind this is a sure thing, since the prize will be huge, and the price for it will be zero.

    For a model, think of a gazillion dollar lottery, and you alone get as many free tickets as you like. You have nothing to lose and everything to gain, so why not play like crazy?

  3. #3 Barry
    December 29, 2006

    It’s actually quite rational. In January, 2009, Bush will hand over the war to his successor, and will retire. For the rest of our lives, we’ll hear sh*t for brains talk about how Bush didn’t lose the war, it was that ‘DemocRat _______’. I think that the JCS generals are realizing that they’re going to relive those post-Vietnam years of a broken Army and Marine Corps; that’s why they’re not happy.

  4. #4 Tyler DiPietro
    December 29, 2006

    I think Roy has a good point here. Just about every thing that Bush is doing is producing external costs only. None of what happens in Iraq is going to cost him a dime, no matter how many die or how much public money goes down the wartime rat-hole.

    So naturally, doubling down seems like a good option. The only thin he has to save is his historical reputation, which from the looks of it will not be good.

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