Thinking, Fast and Slow

by Daniel Kahneman

“Risk” does not exist “out there,” independent of our minds and culture, waiting to be measured. Human beings have invented the concept of “risk” to help them understand and cope with the dangers and uncertainties of life. Although these dangers are real, there is no such thing as “real risk” or “objective risk.”

Democracy is inevitably messy, in part because the availability and affect heuristics that guide citizens’ beliefs and attitudes are inevitably biased, even if they generally point in the right direction. Psychology should inform the design of risk policies that combine the experts’ knowledge with the public’s emotions and intuitions.

Resistance to stereotyping is a laudable moral position, but the simplistic idea that the resistance is costless is wrong. The costs are worth paying to achieve a better society, but denying that the costs exist, while satisfying to the soul and politically correct, is not scientifically defensible. Reliance on the affect heuristic is common in politically charged arguments. The positions we favor have no cost and those we oppose have no benefits. We should be able to do better.

The classic experiment I describe next shows that people will not draw from base-rate information an inference that conflicts with other beliefs. It also supports the uncomfortable conclusion that teaching psychology is mostly a waste of time.

Subjects’ unwillingness to deduce the particular from the general was matched only by their willingness to infer the general from the particular.

But even compelling causal statistics will not change long-held beliefs or beliefs rooted in personal experience. On the other hand, surprising individual cases have a powerful impact and are a more effective tool for teaching psychology because the incongruity must be resolved and embedded in a causal story.

success = talent + luck great success = a little more talent + a lot of luck

The objections to the principle of moderating intuitive predictions must be taken seriously, because absence of bias is not always what matters most.

When a venture capitalist looks for “the next big thing,” the risk of missing the next Google or Facebook is far more important than the risk of making a modest investment in a start-up that ultimately fails.

Our comforting conviction that the world makes sense rests on a secure foundation: our almost unlimited ability to ignore our ignorance.

Leaders who have been lucky are never punished for having taken too much risk. Instead, they are believed to have had the flair and foresight to anticipate success, and the sensible people who doubted them are seen in hindsight as mediocre, timid, and weak. A few lucky gambles can crown a reckless leader with a halo of prescience and boldness.

“Let’s not fall for the outcome bias. This was a stupid decision even though it worked out well.”

The amount of evidence and its quality do not count for much, because poor evidence can make a very good story. For some of our most important beliefs we have no evidence at all, except that people we love and trust hold these beliefs. Considering how little we know, the confidence we have in our beliefs is preposterous—and it is also essential.

In other words, people who spend their time, and earn their living, studying a particular topic produce poorer predictions than dart-throwing monkeys who would have distributed their choices evenly over the options.

But ease and coherence do not guarantee that a belief held with confidence is true.

The clinicians’ predicament was less extreme than the zero-validity environment of long-term political forecasting, but they operated in low-validity situations that did not allow high accuracy.

However, optimism is highly valued, socially and in the market; people and firms reward the providers of dangerously misleading information more than they reward truth tellers.

One of the lessons of the financial crisis that led to the Great Recession is that there are periods in which competition, among experts and among organizations, creates powerful forces that favor a collective blindness to risk and uncertainty.

To a psychologist, it is self-evident that people are neither fully rational nor completely selfish, and that their tastes are anything but stable. Our two disciplines seemed to be studying different species, which the behavioral economist Richard Thaler later dubbed Econs and Humans.

The idea of loss aversion, which surprises no one except perhaps some economists, generated a precise and nonintuitive hypothesis and led researchers to a finding that surprised everyone—including professional golfers.

Loss aversion is a powerful conservative force that favors minimal changes from the status quo in the lives of both institutions and individuals.

A basic rule of fairness, we found, is that the exploitation of market power to impose losses on others is unacceptable.

The firm has its own entitlement, which is to retain its current profit. If it faces a threat of a loss, it is allowed to transfer the loss to others. A substantial majority of respondents believed that it is not unfair for a firm to reduce its workers’ wages when its profitability is falling.

Employers who violate rules of fairness are punished by reduced productivity, and merchants who follow unfair pricing policies can expect to lose sales.

Altruistic punishment could well be the glue that holds societies together. However, our brains are not designed to reward generosity as reliably as they punish meanness. Here again, we find a marked asymmetry between losses and gains.

“This reform will not pass. Those who stand to lose will fight harder than those who stand to gain.”

“My clients don’t resent the price hike because they know my costs have gone up, too. They accept my right to stay profitable.”

Many unfortunate human situations unfold in the top right cell. This is where people who face very bad options take desperate gambles, accepting a high probability of making things worse in exchange for a small hope of avoiding a large loss. Risk taking of this kind often turns manageable failures into disasters. The thought of accepting the large sure loss is too painful, and the hope of complete relief too enticing, to make the sensible decision that it is time to cut one’s losses. This is where businesses that are losing ground to a superior technology waste their remaining assets in futile attempts to catch up. Because defeat is so difficult to accept, the losing side in wars often fights long past the point at which the victory of the other side is certain, and only a matter of time.

Consistent overweighting of improbable outcomes—a feature of intuitive decision making—eventually leads to inferior outcomes.

A rational agent will of course engage in broad framing, but Humans are by nature narrow framers.

In the presence of sunk costs, the manager’s incentives are misaligned with the objectives of the firm and its shareholders, a familiar type of what is known as the agency problem.