Tuesday, September 27, 2016

Tradeoffs in negotiations don't work. "Loss aversion" doubles the costs

In a perfect world, tradeoffs are straightforward.
I give up on X, you give up on return on some Y valued similarly. Simple. Rational. Easy.

Loss aversion destroys this logic.

Loss aversion - Kahneman and Tversky 197x - shows that people value losses vastly more than their natural value.

I'll do vastly more try preserve my existing girlfriend, than to chase her has she been single. I'll ask vastly more for what I have than how much I would've paid to buy it.

Back to negotiations.
Suppose the UK asks the EU to give up on X (day freedom of movement), in return for whatever. Let's assume that the deal makes rational sense. (We ignore the strategic issues, have theoretic math etc)

For the EU, giving up on something is a loss. Losses are valued? Double their nominal value.
Hence, EU will ask the UK double the value in return.

Let's assume the required thing is money - for simplicity.

Say the EU says. Ok. No freedom of movement, but give £10bn yearly to the EU budget.

Now, for the UK this extra £10bn is perceived as a loss. Valued at double at £20bn

This explains why negotiating tradeoffs is so tough and usually just doesn't happen.

I am told that this idea has already been developed in a chapter by Kahneman and Tversky about conflict resolution, but I can't find the reference right now


wiley cason said...

Interesting. But surely the psychology behind this changes when you 'go to market' with the intention of selling or buying something? Otherwise shopping and trading would always be hopelessly crippled and inefficient.

Ex: you like my couch, and try to buy it- I'll demand x2 of real value as you said. But if I have a couch that I've elected to sell on craigslist or whatever, my price will probably be about right. Same for $ that I've elected to spend, versus surprise deductions from my savings.

So maybe when negotiating, both parties should go through an exercise of preparing a list of compromises/things/money that they are willing to trade with ahead of time, and come to the bargaining table with only those things available in their wallet to trade. Perhaps we'd get a more reasonable valuation of our own things that way.

Jazi Zilber said...

right. Framing is a phantom psychological thing influenced by perceptions.

IF the deal is presented differently, it can feel like no loss aversion and weird multiplications (as in the post).

My post assumes a *default* framing. And in hot political settings, the focus on loses is quite common. Especially if you read the newspapers headlines.

IF parties are rational etc. there will be no problem to begin with. the rational calculations are not so secret

Thanks for the comment :) you can always come and have mango sticky rice on the house

Anonymous said...

thank you. I'll be back through eventually. hopefully sooner than later, but who can say. will look forward to sticky rice when I do. Same offer .. for starbucks or soemthing.. if you ever find yourself in the western US.


"In hot political settings, the focus on losses is quite common"

Yes, definitely true. Perhaps a good argument for expanding executive power to negotiate trade agreements and the like.

the US gives the president 'fast track' authority to negotiate trade deals and submit them to a single up/down vote of congress.

Even still we have an undue focus on losses (TPP will prob. fail) but I think it helps