Two Words That Could Shape the Politics of the Trade War: Loss Aversion

https://www.nytimes.com/2018/07/13/upshot/trade-war-loss-aversion.html

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To understand the political risks for the Trump administration in starting a trade war, not to mention in undermining Obamacare or celebrating its tax overhaul, it helps to know one powerful human tendency: loss aversion.

That’s when people feel the pain of losing something more intensely than they do the pleasure of an equivalent gain. Losing $20 feels more awful than winning $20 feels great.

Originally described in 1979 in what would become a seminal paper in the field of behavioral economics, loss aversion is a persistent psychological response that researchers have found to affect actions as varied as professional golfers’ putts and taxi drivers’ work patterns.

There’s strong reason to think it applies in the realm of trade politics.

As trade agreements have been adopted over the last three decades, industries that have lost ground have tended to fight harder for protectionist actions than industries with potential gains from trade have fought to reduce them.

Loss aversion can explain the gap, according to papers published in 2004 and 2009. You can also find this attitude among individual voters affected by trade, and in the underlying message of President Trump’s 2016 campaign, with its emphasis on lost jobs in industries like steel making. By contrast, he had little to say about the benefits many industries — like aerospace, agriculture and advanced industrial equipment — have received from trade agreements and exports.

Even some workers directly helped by globalization have focused on loss. Consider, for example, a worker in a B.M.W. factory in South Carolina who told The Wall Street Journal in 2016 that she was skeptical of international trade because her uncles had lost their jobs at a cotton mill 30 years earlier.

Now, with his willingness to upend trade relationships that have been decades in the making, Mr. Trump faces the risk that he has spun things around. Suddenly, loss aversion may work in a pro-trade direction.

In a trade war, it is the companies, and workers, that benefit the most from globalization that find their incomes at risk. As China, Canada and the European Union retaliate against American tariffs, the winners from trade are the ones at risk of becoming the losers.

If loss aversion holds, the winners of a trade war — domestic producers of steel and aluminum, for example — could turn out to be as complacent about those gains as globalization’s winners have been for decades.

“The evidence says that a loss hurts about twice as much as a gain of the same size, so there is a large asymmetry,” said Patricia Tovar Rodriguez, author of the 2009 paper on loss aversion and trade and now a professor at Pontifical Catholic University of Peru. “Losers may therefore have a much larger incentive to lobby, and to lobby harder, for the removal of those trade barriers.”

Caroline Freund, an author of the 2004 paper and now director of macroeconomics, trade and investment at the World Bank, agreed that the old pattern could reverse. There’s another wrinkle, she notes: In the past, the dynamic was that smaller, declining industries became forceful opponents of trade. Now, the sectors that stand to lose, like the auto industry, are considerably bigger than the ones likely to experience direct gains, like the aluminum and steel industries.

“Lobbying against a policy that hurts a relatively bigger group should be even stronger, especially when the gains are fairly isolated,” she said.

You can expand the idea of loss aversion far beyond the realm of international trade.

President Obama’s health care law experienced miserable polling numbers in the initial years after its 2010 passage, with more people disapproving of the Affordable Care Act than approving of it, according to the Kaiser Health Tracking Poll. But those lines crossed in late 2016 as Republicans gained more power to repeal the law, and now the A.C.A. is favored by a six-percentage-point margin.

There are many ways to interpret that, but one of them is through the prism of loss avoidance. Perhaps in the rollout of Obamacare, the people who had something to lose — either through higher taxes or the risk of losing a health plan they were happy with — were most engaged.

Then, once the law was fully enacted and there was a president seeking to undermine it, the politics of loss aversion shifted, with people who had gained insurance more likely to be energized. That certainly lines up with the ferocity of the protests against legislative efforts to repeal the A.C.A. in early 2017 — and with the comparison to the energy of anti-Obamacare forces in earlier years.

Then there’s tax policy. The tax overhaul passed at the end of 2017 cuts taxes for most American households. But loss aversion might help explain why its polling numbers are not what you might expect for legislation that leaves more money in most people’s pockets.

The Tax Policy Center found that 80.4 percent of households received a tax cut under the legislation, compared with 4.8 percent who saw a substantial tax increase, with the rest seeing no big change.

The logic of loss aversion would imply that those who are paying more in tax — largely people in high-tax jurisdictions losing out on some deductions they previously enjoyed — might have stronger (negative) opinions about the legislation than the many who benefit.

The intersection of human psychology, economics and politics is a complicated place. There’s no certainty that people are forming their opinions on political questions like trade, health care or taxes based on the same logic that steers purely economic choices.

At the same time, loss aversion is real and it’s powerful. In time, we may see the winners from globalization fight ferociously to avoid becoming the losers in a trade war.