Why Knowing Behavioural Economics is Important: On COVID-19, Biases, and Decisions

Coronavirus has caused an upheaval, creating unstable and unprecedented decision-making conditions around the world. As the disease continues to spread, so does the necessity of taking appropriate and timely actions. Yet, retrospectively, we see that the most sensitive decisions were made under the influence of behavioral biases, which, alas, contributed to the disease becoming a pandemic. In this week’s blog, we analyze specific behavioral biases in the context of the COVID-19 outbreak and demonstrate the negative impacts that stemmed from the inconsideration of these biases. In particular, we address the following questions: Why do governments and people behave as they do? What were their mistakes, which behavioral biases were fomenting those mistakes, and what are the consequences?

The Ostrich Effect

‘Ostrich Alliance’ is the nickname given to the world leaders who, despite the presence of evidence suggesting otherwise, deny the coronavirus threat and bury their heads in the sand. We can view this behavior through the lens of normalcy bias – the observed tendency of people to believe that things will function the way they normally have and thus significantly underestimate threat warnings. To put it into a relatable context, in a series of investigations, Ripley (2008) identified the underlying response mechanism of people to natural disasters, and revealed that the first response is denial of the problem, followed by deliberation, and decision. This emphasizes that in response to disastrous events, our ability to react fast and implement forward-looking policies are rather limited, since at first, we tend to deny the occurrence of the event. It is no coincidence that after the spread of the first cases in Europe, the international flights continued, since governments were under the influence of the normalcy bias, and therefore denied even the possibility that the virus can become a worldwide phenomenon. What is more interesting, however, is that the governments did not take strict measures until the evidence suggesting the virus as a threat became highly formidable, implying the difficulty in transition from denial stage to deliberation. Unfortunately, the difficulty in transition further manifested itself in the latency in the responses to the coronavirus outbreak and, therefore, indirectly contributed to the spread of the virus.

Overconfidence

Overconfidence is a bias that seems to come back over and over; however, it is especially important in the context of coronavirus – as there’s a lack of information on the effects, and the transition-mechanism of the virus and a lot of other factors are unknown. There are working theories, but there are a lot of contradictions. There still is, for example, debate on whether we should wear masks in public or not.

One of the consequences of overconfidence is the optimism-bias, and we’re sure that you already experienced it before. In short, optimism-bias is when you tend to say: “Sure, this is a really bad thing, but it won’t happen to me!”. It demonstrates that people tend to think that dangerous or harmful events at work are less likely to occur to themselves compared to others doing the same exact job. Note that it does not have the prerequisite of underestimating the danger – one can acknowledge it, but for their own safety, they could still disregard it as a potential threat.

The unique thing with pandemics such as this is that if people disregard these threats, it could be potentially harmful to those who they come in touch with – or externalities, as it is being referred to as in economics. For non-econ majors: externalities are effects which are being inflicted upon others, which decision-makers do not include in their cost-benefit analysis. Obviously, in this case, we are talking about negative externalities (although there exist positive ones as well). Bethune and Korinek (2020) measured the magnitude of these externalities. They developed an epidemiological model, where economic agents had to choose their social and economic activities, while also considering a statistical mortality risk value of $50,000. Individual agents weigh the private gains from still engaging in social and economic actions with the growing cost of being infected. In their result, they showed that people severely underestimate their individual risks compared to social risks.

The Shifting of Social Norms, or: How I Learned to Stop Worrying and Love the Virus

Within the realm of social sciences, what never ceases to amaze us is how dynamic everything is. Something that was thought to be correct by everyone in one day is criticized by everyone in another day. The case with coronavirus is not exempt to this observation.

If you think about it, if you have seen someone with a mask and a glove in the beginning of the year, you would have treated them with much caution and, perhaps, antipathy. Nowadays, you would treat them in such a way if they were not wearing masks and gloves. This is a prime example of how norms, how institutions, change in a society.

The economic definition of institutions according to North (1990) is “humanly devised constraints that structure political, economic and social interactions”, or to put it simply: the rules of the game. While they are a set of rules (often formalized by legislation) which restrict how we can conduct transactions, they also make life easier – by reducing uncertainty, transaction-costs, and the cost of cooperation. In a lot of cases, social distancing and mask-wearing started as an informal institution, and was later formalized by governmental actions. While it is an inconvenience for sure, these arrangements help to make our interactions safer (at least perceive them as safer, thus tending to our gross uncertainty). While there is a debate whether it is useful or not, it is in line with the human tendency to follow each other and herd, thereby giving people some sort of rule-book that they can apply, inducing mental comfort.

This phenomenon underscores an insight that we are all aware of, but often forget the implications of: People, by definition, are social constructs, in the sense that our decisions are governed not only by our own ideas, but also the ideas of others. It is of seminal importance to remember that whenever there is a decision to be made with high consequences, independent thinking should be facilitated, since waiting for the mass to realize the importance of the problem might cause significant delays in addressing the issue at hand, which, in the case of coronavirus is exactly what happened.