By Gitika Arora
We make countless decisions every day. We weigh the costs against the benefits, the losses against the gains. However, whenever there is uncertainty, risk is inherent, making it an integral part of life. Be it an individual sailing a ship across the Atlantic or an individual ordering a fleet of missiles to be launched. It’s just that the stakes are pretty high in the latter (figuratively and literally!). So how exactly can we explain the risk-taking behaviour in Foreign Policy around the Globe? Enter prospect theory, developed by Daniel Kahneman and Amos Tversky, who suggest that individuals do not evaluate gains and losses in an objective manner but rather in relation to a reference point. They exhibit a tendency to be risk-averse when facing potential gains (preferring certainty) and risk-seeking when facing potential losses (preferring uncertainty). This implies that people are more willing to take risks to avoid losses than to achieve gains. This is also based on the fact that we are “loss aversive” – we would rather avoid losses than similar gains because of the stronger emotional effect of loss. Let’s apply the theory to the field of International Relations.
Why is there no NATO in Asia?
Building a multilateral alliance is more risky than building a bilateral alliance, ceteris paribus, because a country has more responsibilities as well as more dangers. Therefore the United States is more likely to pursue a multilateral alliance only when it faces “losses” or “fear”. The growing dominance of Moscow and communism in Europe framed the U.S. in a domain of losses, and this explains the success of NATO in Europe. On the contrary, U.S. policymakers did not face similar levels of threats or “losses” in Asia. Therefore, the United States refused to build multilateral alliances with Taiwan, the Philippines, and South Korea. Although the outbreak of the Korean War subsequently framed the U.S. in a domain of losses, Great Britain, however, did not share U.S. concerns over the communist threats and the U.S. multilateralism-based “Pacific Pact” plan failed. Therefore “Herding Effect” did not pan out unlike during the Invasion of Afghanistan and The Iraq Wars where the presence of many parties involved led to increased risk-taking and overall failed outcomes. Instead, the United States established several bilateral alliances in Asia which were less risky and offered perceived gains.
The logo of North Atlantic Treaty Organisation (NATO)
The development of Nuclear Bombs in Pakistan could also be explained through the prospect theory. The development of a Bomb is a risky business with little gain, ceteris paribus therefore most countries choose not to, especially if they are newly independent underdeveloped countries. However, as soon as India developed its nuclear bomb, Pakistan was suddenly faced with potential losses which led to a hurried scramble to develop a Nuclear Bomb not for its gains but to simply offset the losses. Here India’s development of the nuclear bomb is the reference point over which Pakistan gauged its relative losses and gains as opposed to the real gains and losses in conformity with the global situation.
Prospect Theory challenges normative models of choice like that of expected utility models which were based on the idea of “homoeconomicus” by introducing cognitive biases and heuristics in the study of decision-making. This theory formed the foundations of Behavioral Economics and won a Nobel Prize for Kahneman in 2002.
“Gains and losses are short-term. They’re immediate, emotional reactions. This makes an enormous difference to the quality of decisions.” – Daniel Kahneman
References
The Decision Lab. “Prospect Theory – The Decision Lab,” n.d. https://thedecisionlab.com/reference-guide/economics/prospect-theory.
Kahneman, Daniel, and Amos Tversky. “Prospect Theory: An Analysis of Decision under Risk.” Econometrica 47, no. 2 (March 1, 1979): 263. https://doi.org/10.2307/1914185.
McDermott, Rose. Risk-Taking in International Politics, 1998. https://doi.org/10.3998/mpub.15779.
He, Kai, and Hao Feng. Prospect Theory and Foreign Policy Analysis in the Asia Pacific, 2013. https://doi.org/10.4324/9780203077368.
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