Framing at work, to our detriment

For the most part, the field of economics assumes rational behavior — i.e., the idea that economic decisions conform to common sense. In reality, however, many examples can be found where that notion is violated, where people can and do behave in a way that reveals some kind of logical inconsistency. Behavioral economics came into being as an offshoot of the more traditional economics focusing on these kinds of contradictions, where people make what seem to be irrational decisions.

Perhaps the most influential economists in this area were Daniel Kahneman and Amos Tversky. Both were acclaimed academics who collaborated widely. Their work inspired a book by Michael Lewis, The Undoing Project: A Friendship That Changed Our Mind. Kahneman also independently wrote, Thinking Fast and Thinking Slow, which may be the most impactful book about behavioral economics, for economists and non-economists alike.

One of the key concepts in behavioral economics is that of framing, which posits that the way information is presented can influence the way decisions are made or how attitudes are formed. Put another way, context matters.

A classic proposition in the behavioral economics literature is that people respond differently to equivalent economic situations depending on how those situations are presented. For example, a vendor might set the price for a product at $100, offering a $10 discount if purchased before some date. Alternatively, the price could be quoted at $90 with a $10 penalty if purchased after that specified date. It should be clear that regardless of which pricing description is given, the same pricing outcome arises – a price of $90 if purchased early; $100 if purchased late.

It turns out that people react differently to these different alternatives. Studies have shown that people are generally more predisposed to avoiding the penalty than they are to seeking bonuses. Thus, the presentation of the penalty generally motivates the earlier payment more effectively.

The concept of framing is also relevant in our assessments of value. Consider the process of buying and selling homes. Such sales typically start with the seller posting an asking price. Then, under typical market practices, prospective buyers would be expected to make a counteroffer, and both buyers and sellers would hope to meet somewhere in the middle. The prospective buyer, however, operates under the presumption that the larger the difference between the original asking price and the counteroffer, the lower the probability that the process will end in a sale. Thus, the original asking price strongly influences the sense of value that both parties will mutually determine.

Turning to the political, we see this framing idea at work today in connection with Trump’s tariffs. At this point, the world seems to have breathed a sigh of relief at the tariff on Chinese imports being reduced to 30 percent and ten percent tariffs applying nearly universally to goods from other US trading partners. Behavioral economists will explain the apparent acceptance of these outcomes because Trump had previously prepared the world for substantially higher tariff rates, even as high as 145 percent for Chinese imports.

The latest tariff expectations are tolerable only because they are so much lower than what many (most?) people had thought could be coming. The world’s reaction to the currently expected tariff levels would have been far different today, however, had the higher tariff possibilities never been expressed. The benign reaction by the world at large to where we stand now follows from framing. What would have been unthinkable in a pre-Trump era now seems to be something that many are grateful for. It's only 30 percent on Chinese goods and 10 percent for the rest of the world!

Let there be no mistake. Irrespective of the world’s reaction, tariffs at these levels aren’t a good thing. They’re bad. Somehow, Trump has managed to bamboozle many into thinking that some ultimate Shangri la will evolve from imposing these tariff hikes, but no good will come of them. These new tariffs will result in higher prices and slower growth – globally. Nothing good about that. Additionally, Trump has managed to obscure the fact that we, the importers, pay the tariffs on the goods we import; and we shouldn’t ignore the fact that those tariffs are regressive taxes that extract a larger share of income from those lower on the economic ladder.

I don’t know which is worse, though, the tariffs themselves, or the obsequious way our trading partners have responded to Trump’s destructive dictates, publicly humiliating themselves by making fawning laudatory comments about Trump’s wonderful leadership all the while he’s destroying economies around the world. Unfortunately, it seems that the concept of framing made this fiasco possible. Understanding how the current tariff policy has come into being, however, doesn’t make the policy right.