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Prospect theory: will the Greeks keep a hold of Nurse?

Will 2015 be the year in which fantasy economics in Europe is finally put to the test? Somewhat to the surprise of many commentators, in December the Greek political class failed to elect a new president even after three attempts. Parliament has now been dissolved and an election will take place on 25 January. The left-wing Syriza party currently leads in the polls.

In Scotland, the nationalists have rebounded following their heavy defeat in the referendum and seem poised to annihilate Labour in the May 2015 General Election. Paradoxically, this could very well ease their path into a Labour-SNP coalition and accelerate effective independence in Scotland.

Syriza’s leader, Alexis Tsipras, invites the Greeks to believe that most of their debts can be written off, austerity policies abandoned, and the country can still keep the Euro as its currency. Both Alex Salmond and the new SNP leader, Nicola Sturgeon, keep straight faces when they tell the Scots they can be independent, rich, stay in the EU, have high public spending and their banks supported by the Bank of England.

The clear warning provided by Russia, moving into deep recession after the collapse of the oil price, does not seem to have given the SNP pause for thought at all. Indeed, Mr Putin and Ms Sturgeon apparently share the gift of clairvoyance. They both assure us that the fall in the oil price is merely a temporary dip and it will soon return to a level above $100 a barrel.

Tempting though it is to wish Syriza and the SNP in power to test their theories, this does not seem the most likely outcome. The Greek leftists currently lead the conservatives by only 3 per cent in the polls, and there is all to play for in the British general election.

But there is much more to it than this. The financial crisis has simply not brought fantasy parties into power. Despite the banker bashing rhetoric and the cries from academic economists to abandon austerity, the electorates still seem, stubbornly, to prefer middle of the road governments. In the Netherlands in 2012, for example, the Socialists at one point led in the polls during their election campaign, but were defeated. In Scotland itself, the Yes campaign lost decisively. France is a possible exception, but Hollande is now exceptionally unpopular.

Prospect theory, developed by Nobel Laureate Daniel Kahneman and Amos Tversky, helps understand why this has been the case. This theory in behavioural economics describes how people choose between alternatives that involve risk. Hilaire Belloc anticipated it a century ago in his poem ‘Jim’, a boy who ran away from his nurse and was eaten by a lion: “Always keep a hold of Nurse, for fear of finding something worse”. A key element in prospect theory is precisely that losses hurt more than gains feel good. Maybe Syriza is right and the Greeks can have it all. But if it goes wrong, the consequences could be very unpleasant indeed.

Paul Ormerod

As published in City AM on 7th January 2015

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