Framing Costs and Losses - Joe Abittan

Framing Costs and Losses

Losses evokes stronger negative feelings than costs. Choices are not reality-bound because System 1 is not reality-bound,” writes Daniel Kahneman in Thinking Fast and Slow.

 

We do not like losses. The idea of a loss, of having the status quo changed in a negative way without it being our deliberate choice, is hard for us to accept or justify. Costs, on the other hand, we can accept much more readily, even if the only difference between a cost and a loss is the way we chose to describe it.

 

Kahneman shares an example in his book where he an Amos Tversky did just that, changing the structure of a gamble so that the contestant faced the possible outcome of a $5 loss or where they paid a $5 cost with a possibility of gaining nothing. The potential outcomes of the two gambles is exactly the same, but people interpret the gambles differently based on how the cost/loss is displayed. People are more likely to take a bet when it is posed as a cost and not as a possible loss. System 1, the quick thinking part of the brain, scans the two gambles and has an immediate emotional reaction to the idea of a loss, and that influences the ultimate decision and feeling regarding the two gambles. System 1 is not rationally calculating the two options to see that they are equivalent, it is just acting on the intuition that it experiences.

 

“People will more readily forgo a discount than pay a surcharge. The two may be economically equivalent, but they are not emotionally equivalent.”

 

Kahneman continues to describe research from Richard Thaler who had studied credit-card lobbying efforts to prevent gas stations from charging different rates for cash versus credit. When you pay with a card, there is a transaction processing fee that the vendor pays to the credit card company. Gas stations charge more for credit card purchases because they have to pay a portion on the back end of the all credit transactions that take place. Credit card companies didn’t want gas stations to charge a credit card surcharge, effectively making it more expensive to buy gas with a card than with cash. Ultimately they couldn’t stop gas stations from charging different rates, but they did succeed in changing the framing around the different prices. Cash prices are listed as discounts, shifting the base rate to the credit price. As Kahneman writes, people will skip the extra effort that would garner the cash discount and pay with their cards. However, if people were directly told that there was a credit surcharge, that they had to pay more for the convenience of using their card, it is possible that more individuals would make the extra effort to pay with cash. How we frame a cost or a loss matters, especially because it can shift the baseline for consideration, making us see things as either costs or losses depending on the context, and potentially altering our behavior.
Markets and Fairness

Markets and Fairness

Research from Daniel Kahneman’s book Thinking Fast and Slow may help explain some of the anger and anti-capitalism sentiment that has cropped up in the United States in the last several years. Senator Bernie Sanders is incredibly popular among a segment of the population and he is not afraid to categorize himself as anti-capitalist and as a socialist to a degree that would have been unthinkable just a decade ago. From my perspective, many people feel that they have been treated unfairly by markets, and this lack of fairness contributes to the Sanders support, especially among young people.

 

Kahneman’s writes, “a basic rule of fairness, we found, is that the exploitation of market power to impose losses on others in unacceptable.”

 

My experience is that people are feeling the forces of market power in many different areas, and becoming discontent with their own economic standing and with feeling as though they are being treated unfairly by large market players. It may be that most people can still afford to buy more than what they need and to live comfortably, but on a daily basis they are faced with a barrage of unfair market practices. There may not be anything legally wrong with a market practice, and the market practice may be adjusting for real value rather than just collecting rents, but nevertheless, the exploitation of market power still feels unfair.

 

I spend a lot of time thinking about healthcare in the United States, and for many years the costs of healthcare and health insurance has risen much quicker than employee wages. With employees feeling their wages stagnate, unfair exploitation of market power can become a major outrage. This has been seen with drug prices as some individuals and companies have specifically targeted pharmaceutical mergers and acquisitions with the intention of increasing drug prices. Some medications have risen dramatically in price at the same time that many deductibles for health plans have shot up beyond the savings levels of most Americans. Even though a drug may provide an incredible value like saving a life or dramatically improving the quality of a life, an increase in price while wages stagnate feels deeply unfair to people. This could be a basis for our discontent with markets and capitalism (at least on the healthcare front), and a source of support for Bernie Sanders and his socialism lean.

 

When I think about it, I see this type of market exploitation beyond the world of healthcare. Ice cream cartons continually get smaller, the fun-sized candy is a depressingly small size now, good quality razors seem to be unreasonably costly with the cheap alternatives being effectively useless. Outside of smartphones, most markets seem to be providing less value for higher costs, and it is not hard to understand the frustrations that so many people may feel with markets and market solutions, even if they can still afford to live a comfortable lifestyle. For any given firm, exploiting market power is a rational and reasonable thing to do, but for customers, this adds up to an untenable sensation of loss, and a deep feeling that markets are unfair and should not be trusted. In a global market sense, it is as if we face a universal tragedy of the commons problem, but instead of a habitable grazeland being decimated, it is our economic wellbeing that is destabilized as each player in the market flexes more market power to impose marginal losses on each consumer.
Why We Talk About Human Nature

Why We Talk About Human Nature

I entered a Master’s in Public Administration program at the University of Nevada in 2016. I started the same semester as the 2016 election of President Donald Trump. I was drawn toward public policy because I love science, because I have always wanted to better understand how people come to hold political beliefs, and because I thought that bringing my rational science-based mind to public policy would open doors and avenues for me that were desperately needed in the world of public administration and policy. What I learned, and what we have all learned since President Trump took office, is that politics is not about policy, public administration is not about the high minded ideals we say it is about, and rationality is not and cannot be at the heart of public policy. Instead, politics is about identity, public administration is about systems and structures that benefit those we decide to be deserving and punishing those who are deviant. Public policy isn’t rational, its about self-interest and individual and group preferences. And this connects to the title of this post. We talk about human nature, because how we can define, understand, and perceive human nature can help us rationalize why our self-interest is valuable in public policy, why one group should be favored over another, and why one system that rewards some people is preferable over another system that rewards other people.

 

In Daniel Kahneman’s book Thinking Fast and Slow, he writes, “policy is ultimately about people, what they want and what is best for them. Every policy question involves assumptions about human nature, in particular about the choices that people may make and the consequences of their choices for themselves and society.” The reason why we talk about human nature is because it serves as the foundation upon which all of our social systems and structures are built upon. All of our decisions are based in fundamental assumptions about what we want, what are inherently inclined to do, and how we will behave as individuals and as part of a collective. However, this discussion is complicated because what we consider to be human nature, is subject to bias, to misunderstandings, and motivated reasoning. Politics and public policy are not rational because we all live with narrow understandings of what we want human nature to mean.

 

Personally, I think our conceptions and ideas of human nature are generally too narrow and limiting. I am currently reading Yuval Noah Harari’s book Sapiens, and he makes a substantial effort to show the diversity and seeming randomness in the stories that humans have created over tens of thousands of years, and how humans have lived in incredibly different circumstances, with different beliefs, different cultures, and different lifestyles throughout time. It is a picture of human nature which doesn’t quite make the jump to arguing that there is no human nature, but argues that human nature is a far more broad topic than what we typically focus on. I think Harari is correct, but someone who wants questions to religion to be central to human nature, someone who wants capitalistic competition to be central to human nature, or someone who wants altruism to be a deep facet of human nature might disagree with Harari.

 

Ultimately, we argue over human nature because how we define human nature can influence who is a winner and who is a loser in our society. It can shape who we see as deserving and who we see as deviant. The way we frame human nature can structure the political systems we adopt, the leaders we favor, and the economic systems that will run most of our lives. The discussions about human nature appear to be scientific, but they are often biased and flawed, and in the end what we really care about is our personal self-interest, and in seeing our group advance, even at the expense of others. Politics is not rational, we have all learned in nearly four years of a Donald Trump Presidency, because we have different views of what the people want and what is best for them, and flawed understandings of human nature influence those views and the downstream political decisions that we make.
Capitalism and Externalities

Capitalism and Externalities

Capitalism has come under fire in the recent years in ways that I would not have predicted as I completed my college degree and entered the workforce. For so many years the idea of capitalism has been central to the American story and to American identity. It may not be perfect, but it has always been held above other economic systems as the best option available. However, recently, people have taken a new look at capitalism to ask if it can be maintained without the plundering of others. Can there be a reasonable sense of equity or equality within a system of capitalism? And in the United States, do we really have a meritorious system of capitalism, or is the American system of capitalism overrun with grift and graft?

 

Allowing people to flourish based on their own talents, allowing people to pursue their own interests, and to accumulate wealth can be a good thing, but it can also be done to excess. Like alcohol, chocolate cake, or Netflix, our pursuit of wealth can essentially be an addiction, and the costs can be born on all of society, not just on ourselves. Our actions and the systems and structures within which we operate have unintended consequences. These consequence, or externalities, can be positive or negative. Within capitalism, positive externalities include new technologies that improve our lives, more efficient markets which minimize waste, and hopefully more goods and wealth for everyone. But negative externalities related to capitalism include pollution, corruption, and extractive processes that harm individuals, communities, and environments.

 

In Letters From a Stoic, Seneca writes to his friend Lucilius, “I myself pray rather that you may despise all those things which your parents wished for you in abundance. Their prayers plunder many another person, simply that you may be enriched.”

 

Seneca is acknowledging that when one person gains resources, often times it is at the expense of another person. The goal of capitalism is for our economic system to be positive sum, meaning that everyone is better off in an exchange – a state known as a Pareto Efficiency. However, this is not always the case. Seneca sees exchanges, or maybe more precisely the accumulation of resources and wealth, as zero sum, meaning that there is a fixed amount of stuff, and that anything that one person accumulates is taken away from another person. This, in my opinion, is where so much of our discontent in the United States and across the globe with capitalism lies.

 

Seneca may not always be correct. There may be Pareto Efficiencies out there and there may be situations in which capitalism builds a positive sum economic system. But it does seem like moderation in our approach to capitalism and wealth accumulation is warranted. At a certain point, for us to have more necessarily mean that we are extracting wealth and resources from other places. Mining, logging, and cattle grazing can have damaging effects on local environments and communities, even if they do help develop industry or increase GDP in the places we take resources from. Beyond a certain level, continuing this trend is likely to make our lives marginally better, while potentially making the lives of others much worse. We should constantly ask ourselves if we are nearing that point, and try to limit our need for more stuff and more wealth when we are at sufficient level where the marginal gain for us is meaningless and effectively just plunders others for our own enrichment. It seems reasonable if we should ask whether limitless growth is really possible, or if capitalism ends in a state of plunder, in which nothing is left for a sustainable existence for everyone.
Hiding the Cost of Healthcare

Hiding the Cost of Healthcare

In the United States, our current system of healthcare coverage is hiding the cost of healthcare. Anyone who has to go to physical therapy, get an MRI, has a child that needs treatment for a disability, or ends up in an ER knows firsthand that healthcare is expensive, but many of them probably don’t realize just how costly our healthcare system truly is. For the most part, in our country we have a system that pulls a third party into every payment scenario for healthcare, and as a result, the cost of healthcare is not reflective of a true market.

 

Many argue that our current system creates too much of a moral hazard, with people living unhealthy lifestyles because they know they won’t face the full cost of care if they need it. Some argue that the current arrangement leads to unnecessary care or over-treatment because people don’t pay the full cost of care, so they seek more of it. At the same time, groups argue that insurance and healthcare coverage are still prohibitively expensive, and that the stress of possibly having to go to a doctor and spend thousands of dollars (even if one is insured) genuinely harms people’s health.

 

I think all of these are true in their own way, and I think they are relatable because they are things that people have seen first hand or can easily imagine, but there is still a deeper level of healthcare costs in America that we don’t discuss. Our system of taxes is also hiding the cost of healthcare. As Dave Chase writes in The Opioid Crisis Wake-Up Call, “Today, the tax break for employer-paid benefits is estimated at over $600 billion, making it the largest tax break in the tax code, the nation’s second largest entitlement after Medicare, and the primary wage suppression driver.”

 

During World War II, wages to employees were frozen to prevent rapid inflation in the United States during the war. To attract and retain qualified employees, businesses turned to employer-paid benefits, and congress created a law which would allow those benefits to be tax-deductible for employers. This was a way to effectively give employees a bonus without paying them more, keeping inflation down, but still giving them something that economically and socially benefited them. Today of course, you are taxed on anything of value you receive from your employer as if it was straight cash, so your healthcare benefit basically still counts as wages, but that tax break for the employers is still in place for the health benefits they provide.

 

This is where we are hiding the cost of healthcare in America when it comes to private insurance. Most Americans receive healthcare through their employer, and the US government loses out on $600 billion in taxes to allow employers to offer health insurance. So the plan you are on that you might lose if you are fired, the plan you have this year that might not be offered again next year if the insurer changes, the plan that still has a $1,500 deductible and $4,000 out of pocket annual max, costs you and U.S. tax payers $600 billion per year.

 

Because this is a hidden cost, it is not something we discuss very often. We are afraid of the cost of a nationwide healthcare system, but we don’t discuss how much money is not being collected in taxes and being sheltered by a tax break that maintains a system that very few people are actually happy about. We face high costs ourselves, even if we are covered by a plan that fits within this $600 billion tax break system, and the system has warped the way that care is payed for and provided to the point where we don’t even know what knobs and levers to try to pull to get the who thing to be more transparent, provide real value, and to be less costly. We need to be honest about the ways that our current system is hiding the cost of healthcare in America, or we will never be able to make real changes to improve the system.
Jobs and Addiction

More Than The Chemical: Jobs and Addiction

A simple view of addiction is that people become hooked on a powerful chemical and their entire life becomes focused on nothing but the drug. The chemical sinks into the brain of the addicted person, and their desire for the neurological high from the chemical drives them beyond everything else. If only we could stop the person from ever being exposed to the chemical, even once, we would prevent them from ever developing their drug addiction and chemical dependence.

 

This view, however, is incomplete. A lot of what I try to do with this blog is show that the world is more complex than we often realize. It is easy to sit at home, listen to a news story on TV, and call everyone an idiot while offering an obvious solution from the couch. In reality however, our first impressions of the world and its problems are woefully inadequate, and drug addiction is a good example.

 

I recognize that chemical hooks, neurotransmitters, and brain chemistry are major parts of addiction, whether to a chemical substance, to a behavior like gambling, or other forms of addiction, but research that Dave Chase’s book The Opioid Crisis Wake-Up Call presents is a good indication that there is more going on than just a drive to fill the brain with a chemical. Chase writes, “For every one percent rise in unemployment, there’s a four percent rise in addiction and a seven percent increase in emergency department visits.

 

Our economy, it appears, is deeply connected with addiction. It is not hard to think of a causal model between economic performance and addiction. Having a meaningful job gives people a chance to feel valued, gives people a chance to contribute to society, and gives people an increase in their social status (in political science we might think of Social Construction Theory: working people are Advantaged or at least Dependents whereas the unemployed are simply Deviants).

 

When people lose their job, they feel a loss of social status, they may feel helpless if they cannot find another job of equal status, and they lose their feeling of importance. They become more vulnerable, and it appears are more likely to turn to substances to blunt the pain they feel, either physically, mentally, or emotionally. This sets people up for addiction.

 

In this model, addiction is not just a moral failure. It is a failure at more levels than just the individual and their ability to work and resist chemicals. Our society has isolated people and made it hard to maintain strong family connections. When jobs disappear and people don’t have close people and community connections and organizations to turn to for meaning, purpose, and participation, they will struggle, and in their empty void potentially turn to drug use. Economic data makes this clear, and the solution is not just to provide someone with a bleak call-center job, but to really develop community connections, meaningful work, and opportunities to improve social status while deepening relationships and opportunities to contribute to society. Drug use is not a simple issue, it is tied to larger economic and social forces, and we have to recognize that reality to solve our nation’s problems.
Disruptive Innovation

The Basics of Disruptive Innovation

In his book Deep Work Cal Newport shares a story about Clay Christensen, the Harvard Business School professor who coined the term disruptive innovation. Its an idea I like quite a bit, especially since it is a big concept in healthcare right now, and I focused quite a bit on health policy and dabbled slightly in healthcare economics during my graduate studies.

 

Newport describes the basics of disruption like this, “entrenched companies are often unexpectedly dethroned by start-ups that begin with cheap offerings at the low end of the market, but then, over time, improve their cheap products just enough to begin to steal high-end market share.”

 

In this model, Uber wouldn’t be a disruptive innovation. Uber didn’t do anything to dramatically change the world of taxis. They sidestepped a lot of entrenched thinking and decided that laws and regulations didn’t apply to them while introducing badly needed technology to the world of taxis, but they didn’t offer a new cheap version of the service to gradually build upon and improve.

 

An example of disruptive innovations that I like, that I learned about in a healthcare economics class, is Bose headphones. Bose is producing headphones that have impressive noise cancelling, noise isolating, and noise amplifying technologies. They are certainly not cheap consumer products, but compared to highly technical, very expensive, and highly individualized hearing aids, they are. They don’t do everything that a hearing aid does now, and they don’t provide quite as good of a hearing experience for someone who relies on hearing aids, but they do seem to be able to compete at the lower end of the market. For people who are currently priced out of hearing aids and people who don’t have complete hearing loss but maybe should start considering hearing aids, Bose headphones seem like they can help. They can cancel competing sounds and provide just enough amplification and isolation to improve some people’s hearing…even if hearing aids would be a better long term solution.

 

The concept is important for several reasons. If you are a business executive, you need to know what is happening in your market space, and you need to know when someone is coming along to provide a cheaper service that might one day compete with you directly, or steal your market share. Also, from a regulatory standpoint, understanding disruptive innovations and where they may be occurring is important. If people are ditching their pricey hearing aids for less effective Bose headphones, are they putting themselves at risk while driving or navigating busy environments? What happens if a disruptive innovation guts an industry, and leaves people with disabilities who relied on the high priced product’s level of support and customization without a suitable product or service?

 

We should keep disruptive innovations in mind because they can unlock new potentials (we do a lot with our phones in ways that are quicker but not always as user friendly as old standard alternatives) but can also be dangerous for individuals and markets (should we really allow anyone to use a phone to scan their eyes to get a new glasses prescription?). Thinking about disruptive innovations helps us think about current social and economic trends, and it also forces us to be more considerate of others. We have to balance and weigh the interests of business, the interests of new consumers, and the interests of vulnerable populations when we think about where a disruptive innovation could push a market.

City Growth – The Sports Play

I’m a fan of the research and work that comes out of the Brookings Institute, a generally center-left think-tank in Washington DC that I believe does a good job at looking at politics and policy holistically, and is able to get beyond the partisan rhetoric that dominates most of our political landscape. An area of interest for many of the writers and policy experts at Brookings is the area of economic development in metropolitan areas, particularly as related to sports and business retention. Two Brookings experts, Bruce Katz and Jeremy Nowak look at how Indianapolis used sports to help jump-start the city’s economy, but present the information in a way that shows that reliance on sports alone is not sufficient to develop a thriving middle class and robust regional economy.

 

“A sports-based development strategy,” they write, “can take a city only so far. Sports attract tourism and visitors. Game time enhances demand for lodging and restaurants. Name teams may have an intangible effect on the attraction and retention of innovative firms and talented workers. But in the end, the sports industry thrives on low-wage jobs and does not represent a model of economic growth for a city or metropolis. Beer and hot dogs are not the stuff of a sustainable middle class.”

 

In their book The New Localism, the authors talk about the efforts that Indianapolis took to attract and retain an NFL football franchise and also to attract the NCAA headquarters. They go on to further explain how Indianapolis was not content to simply rest on being a sports headquarters and reinvested the energy and revenue from sports to drive and build new sectors. Sports teams can help be a support for a local economy, but they will never be a major driver, and on their own don’t appear to be worth the enormous tax breaks and stadium construction assistance that many cities and states seem eager to provide.

 

As Katz and Nowak stated, sports can have intangible benefits for communities like city pride and can serve as a hub for local events. But cities need to provide other attractions and benefits for their citizens. The people need additional higher paying jobs than can be found in a stadium and need real innovation to keep pace in our globalized world. If cities and states over-invest on the sports side, they may miss out on developing and investing in the factors that can make cities dynamic and competitive in the long run. Ultimately, sports teams can be a good attraction and can serve as a spark for energy and investment in making a city a good place to live and do business.

Collaborative Governance

In The New Localism, Bruce Katz and Jeremy Nowak discuss the elements needed for cities to continue to grow as economic engines of modern economies. The United States currently has a handful of dynamic cities across the country which are powering the national economy. San Francisco (really the Bay Area as a whole and Silicon Valley) is powered by tech companies, Houston is powered by oil giants, Boston is driving medical and biotech engineering, and New York City continues to be a powerful financial hub. While each of these metro regions is a model for the resto the country, they must adapt to globalized economies moving forward and must find ways to embrace new innovations to keep diversify and strengthen their own economies.

 

Katz and Nowak write, “the critical element is collaborate governance across networks of public, private, civic, and university institutions and leadership. No one sector can alone power a city and metropolis forward in today’s complex and competitive economy.” A single sector is not enough to reliably and consistently sustain an entire city or region. New innovations in diverse fields that share common foundations is required for economic well-being today. In order for cities to diversify and develop new industries in new sectors, a confluence of public institutions, private businesses, involved philanthropies, and cutting edge research universities is key.

 

The public sector has to be able to adapt and adjust laws, rules, regulations, and oversight in a world where every competitive advantage matters. Government must continue to protect the public interest and safety, but needs to allow for the organization of structures that can make real decisions timely. Private sector leaders also need to be involved and commit to place-making, developing the cities where they are located and bringing something beyond “jobs” to a region. Civic organizations and groups can fill the gaps between these actors and help provide funding and leadership initiatives to related to place-making and oversight.

 

None of these efforts will succeed if an intelligent and motivated workforce is not available to connect with the agencies and organizations involved. Research universities play a role in new economies by connecting students with relevant research and helping to get innovation out of the lab and into the private sector. Connecting students with real companies that are taking real steps to make their communities better will build the energy and excitement necessary for an educated and motivated workforce to make economic growth, innovation, and development possible. Some of this I recognize is “pie in the sky” thinking, but it is necessary for future growth. Pushing companies to become Public Benefits Corporations and rewarding more civic minded and responsible organizations is a small and necessary step to move in the direction I described, otherwise, there is nothing to convince companies to make greater investments in place-making rather than just finding a nice place to move to.

When Disciplines Collide

One of the case studies presented by Bruce Katz and Jeremy Nowak in their book The New Localism is Pittsburgh, PA, which has merged academic research institutions with business industry and supportive public policy. Pittsburgh has two major research universities within a block of each other, The University of Pittsburgh and Carnegie Mellon University. Experiences from Carnegie Mellon in the past are fueling the city’s reinvention and powering new industry as research is getting out of the institutions and into new businesses to drive the economic engine of the city.

 

What Pittsburgh does so well, explained by Katz and Nowak, is merge diverse industries and fields to create new innovation. They write, “A convergence economy emerged: a fusion of academia and industry with electrical and mechanical engineering, computer science, and multiple other fields. When disciplines collide, magic happens.” The idea of a convergence economy is crucial to New Localism. Academic institutions have been learning valuable lessons by creating more crossover between their divisions and fields. Bringing together academics who would otherwise rarely communicate is driving fields that previously had stagnated. With two leading institutions in the city, Pittsburgh has taken this lesson out of the academic fields into private industry.

 

Academics on their own don’t have a lot of great business sense or experience, but do have a good sense of where innovation is heading and what might be possible with new technology. Combining their expertise and knowledge with people who understand business and have connections with funding agencies can help lead to scale and commercialization of innovations. This cannot happen without something that creates a convergence between disparate entities.

 

Hospitals today are creating incubator labs to help get new medical advances out of the research lab and into industry. Universities are beginning to merge with private industry to find ways to get innovation out of the academic hallways and journal articles into factories and business. Governments are helping back quasi-governmental networks to share the risk of new innovation and find new ways to fund local developments in technological innovation. Pittsburgh is leading in this field, and cities across the United States are following by finding new ways to engage their academic institutions and industries.