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Why Johnson should worry about loss aversion

09 January 2020

Learning about behavioural economics is one of the best parts of being a pension journalist. This branch of social science endeavours to explain why humans often don’t make logical financial decisions.

There are many fascinating observations. There is, for example, the endowment effect: people value more the things they already own than the ones they could own. And the reason why the endowment affect exists is loss aversion.

Loss aversion captures our asymmetric attitudes to changes in wealth. As Richard H. Thaler says in his book Misbehaving: “People like gains but they hate losses more.”

In other words, people will feel more strongly about losing £100 than they feel about gaining £100. Thaler said: “Roughly speaking, losses hurt about twice as much as the gains make you feel good.”

Loss aversion helps to explain why gamblers double down: it offers a chance to erase that catastrophic feeling. But it should also concern the Prime Minister as he prepares to take the UK out of the European Union.

Unpicking 30 years of economic alignment with our largest trading partner is not going to be without pain. From an economic perspective, Brexit is an illogical decision: you erecting rather than erasing barriers to trade.

This project is both complex and risky. In a post written just after the election, trade specialist David Henig said: “Not a sector of the economy or constituency of the country will be unaffected, and this will all be put in treaty form, to bind the economy for years to come.”

In other words, Brexit has the ability to negatively impact each and every one of the UK’s citizens. If Johnson wants to keep the support of voters, he will have to minimise loss aversion.

That will be hard to achieve when the government is committed to leaving the customs union and single market. But the negative impact would be exacerbated by the government’s current rhetoric of wanting to break with EU alignment – the harder the deal, the more likely voters will feel loss aversion.

Johnson might hope to soften that blow through fiscal policy. It’s likely to be initially popular with voters who will want to “Get Brexit Done”. But there is strong chance of that support waning if those policy cushions fail to prevent loss aversion.

There are no easy choices for the Prime Minister. Whichever path Johnson chooses has a high chance of causing voters to feel loss aversion. His long-term success will depend on choosing the route which minimises this impact.

Charlotte Moore - post author

Charlotte Moore has been a freelance journalist since 2006, with a solid technical understanding of a broad range of financial topics along with a previous incarnation as an investment analyst. Along with journalism, she has experience of producing written material for corporates and is seeking to expand this part of her business portfolio.