Loss aversion and politics

I was thinking this week about political economy and status quo bias, specifically how cognitive biases could fit into Mancur Olson-style models of bargaining. Well, there is a literature on everything, per Cowen’s second law, and sure enough here’s a paper by Alberto Alesina and Francesca Passarelli on loss aversion in politics. Here are some key bits:

The basic idea

We present a model of unidimensional political choice where the voters differ in their evaluation of the relative costs and benefits of different levels of such policy. We assume throughout the paper that the reference point is the status quo. This seems realistic, since benefits and costs of political reforms are normally assessed relative to the current situation for given existing policies. Without loss aversion, the policy chosen would be the one preferred by the median voter, and the status quo is irrelevant. With loss aversion the status quo matters. For any initial policy level, a mass of voters would vote for the status quo, even if their rationally preferred policy differed from it. In fact changing policy implies losses and benefits, but the former weigh more. This generates a sort of political endowment effect: once the policy chosen by the majority becomes the new status quo, a larger majority of voters does not want to change it.

p. 2

Loss aversion as an explanation of incrementalism and a check on polarization

With this framework it is possible to prove a moderating effect. When individuals are loss averse, the distances among their ideal policies are lower: those who demand more p weigh the increases in cost; this dampens their demand for a policy expansion. On the contrary, those who would like to reduce p weigh the loss benefits; thus they desire to reduce the policy by a lesser amount. As individuals become more loss averse, the number of those who prefer the status quo increases, thus further dampening polarization.

p. 10

Once a bill passes, it becomes harder to undo

The second part of the Proposition is what we call the political endowment effect. The idea is the following. If the shock at time 2 is sufficiently large, the policy changes. But only the bare majority of voters cast votes in favor. All voters to the left of the median would prefer a lower policy. All those to the right prefer a higher one. Once the new policy has been set up and a certain amount of time has passed, this policy becomes the new reference point. The latter shapes voters’ preferences. Specifically, some voters to the left and to the right of the median change their minds and start considering this new policy their most preferred one. This means that, if no other big shocks occur, that same policy would beat any other alternative with more than the simple majority cast votes in favor. The political endowment effect hinges on the fact that a change in the policy yields a change in the reference point for subsequent periods, and the latter yields a change in voters’ (reference dependent) preferences. It might help explain why reforms that had hard time to be approved, gain popularity amongst people sometime later

p. 11

Do generations differ in how they approach losses vs. gains?

Here’s where things get a bit weird, but fascinating. They extend the model across time in a way that seems to me to reach conclusions that are right but for the wrong reasons. As you’ll see, they predict generational conflicts. But I’m not sure the psychology quite fits; a big part of the cognitive bias literature is not really thinking clearly about the future, which I think might undermine their analysis. They incorporate that in the model, but not in a way I find all that convincing.

This part is hard to find parts to copy from. They assume that we get used to changes faster than we think we will, which seems right. But they posit that older generations are less likely to think a policy will be worth the wait so to speak. If you think it’ll take you a decade to get used to a new arrangement, older people will find that less appealing since they’ll live to see less of the benefits of the period after having adjusted. This strikes me as trying to overly rationalize these biases, but your mileage may vary.

This implies that there are less young voters entrenched in the status quo, compared to old voters. It may happen that the majority of young voters want a change in policy, but the majority of old voters do not. The reason does not rely on differences in material interests. It is instead a psychological reason: the old do not want to bear the psychologically costly commitment to a change today, because their future horizon in which to enjoy the benefits of that commitment is shorter. The policy outcome depends on the population shares: older societies, where the share of young people is low, are more likely to remain with the status quo.

p. 16

Loss aversion vs status quo bias

The main result is that loss aversion translates into a preference for the status quo. They show later on that that’s not necessarily the case when risk is involved. I won’t try to excerpt this one; it starts on page 18.