Economics: a social science

When fear gets the upper hand in today’s stock market, people start losing money. When people expect to lose money they start acting in an irrational manner: they start selling their shares like crazy.

 

Now why exactly is that?

Kahneman, Knetsch, and Thaler (1990) came up with a theory called Loss Aversion[1].

Loss aversion implies that one who loses $100 will lose more satisfaction than another person will gain satisfaction from a $100 windfall. Loss aversion is a concept of Social Psychology as much as economics. It is not the reality of loss that matters but the perception. The pain of loss is two and a half times stronger than the gain of the same. 

 

In other words, were are willing to walk a mile to earn $ 100 and we are willing to walk 2,5 miles if it prevents us from losing the same amount. That’s why we act so swiftly or take enormous chances when we have the illusion that we can stop losing money.

 

So, when Steve Jobs catches the flu, people start selling their Apple shares. When a rumor would be spread that Steve just ran the New York marathon in 2 hrs flat, nothing would change.

Nations have gone to war until their doom because of loss aversion. It simply means you refuse to admit you made a mistake. “Once we have committed a lot of time or energy to a cause, it is nearly impossible to convince us that it is unworthy”[2].

The real question is “How bad do your losses have to be before you change course?” In stocks this is called capitulation, in war it’s called surrendering.

 

So what could stop us from being so irrational? What do we need in order to change the tide and start having some confidence in the future again?

 

It’s leadership.

 

And what kind of leadership have we witnessed in the past decade? Well, the kind of leadership that made us feel ashamed that we were stupid enough to put our trust in them. And, as explained above, that betrayal hurts us two and a half times more than the gain of trust.

The collapse of Enron (and with them accounting firm Arthur Andersen which was convicted of obstruction of justice for shredding documents related to its audit of Enron), WorldCom and most recently, the collapse of Lehman Brothers tells us that something’s rotten in today’s world. And when the Bush administration convinced us that weapons of mass destruction were stashed away in Irak, well, we know the story. If we can’t trust government officials, who can we trust?

 

So, to get ready for the new era ask yourself this question, dear leaders of the future:

 

“Why should anyone  want you to be their leader?”

 

If your answer is without terms as: ethical behavior, respect, care, role model, management by example or servant leadership start looking for an another way to fill your days. The new generation of global citizens will not tolerate you much longer.

 

The new era will not be about ‘having’ it will be about ‘being’.

Ponder that for a while!

 

 

 

 

 


[1] Kahneman, D., Knetsch, J., & Thaler, R. (1990). Experimental Test of the endowment effect and the Coase Theorem. Journal of Political Economy 98(6), 1325-1348

 [2] Social Psychology Fourth Edition, Aronson et al., p. 175

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