Once the cradle of European civilization, Greece is now at the epicenter of Europe’s economic crisis. The now-fading consensus in the market and among opinion-makers was that Greece is likely to fail, taking the euro zone with it. The country’s sovereign debt, which a few months ago was priced only a few basis points above Germany’s, has been trading higher than Pakistan’s in the credit default swap market.
Mimicry plays an important role, and market participants often tend to “follow the herd,” but does this sufficiently explain the negative consensus on Greece? Indeed, there are lessons to be learned from neuroscience on what distorts our cognitive abilities that are highly relevant to understanding the Greek crisis.
For a start, “judgment extremism” pays dividends. The neural system used when anticipating rewards is active long before the one in charge of evaluating risks and losses. Most academics and opinion-makers know that the rate of return on postulating extreme outcomes is far greater than that of simply establishing facts: A columnist is much better off predicting a dire outcome than being caught up with the facts that lead to a complex and uncertain one.
Therefore, an outlandish prediction (albeit, perhaps, inadequately grounded) of a euro zone implosion is likely to be rewarded by editorial success and intellectual kudos; and by the time it may be proven wrong, it might well go unnoticed.
A narrow framing of choices is another problem. Increasing specialization in expertise affects investors to a disproportionate degree because of a tendency to think about their own discipline in isolation from the rest. This leads to thinking in “silos” — and often to a failure to connect the dots.
As a case in point, before May 2, when the Greek authorities finally signed an agreement with the European Union and the International Monetary Fund, the markets became convinced that a Greek default was both imminent and inevitable by refusing to consider that the political imperative would trump the economic reality. Put simply, they did not connect the dots between politics and economics.
Although our brains do not function biologically in a dichotomous fashion, binary thinking is the brain’s favored method, as it is easier to categorize events in terms of success/failure, cooperation/competition, rational/irrational, etc.
This is why, regardless of the context, a careful “it depends” explanation will never be as convincing as a clear-cut opinion. Accordingly, we tend not to paint a nuanced picture of a complex reality, but to stick to the version constituting extreme outcomes. This leaves very little room for analyzing the nuts and bolts of the reform process, with its inevitable successes and failures.
Then there is another bias: We tend to form opinions by falling back on intuitions or hunches and then look for confirmatory evidence to reinforce these. When someone confirms our views, they are reinforced in our brain’s reward system. Hence, we seek further evidence to validate those views, shutting off contradictory information.
In the case of Greece, this has been particularly evident with respect to the public demonstrations that are often portrayed as a watershed event about to precipitate the nation’s collapse. But the opposite is true: In relative terms, demonstrations have so far been poorly attended — at most 50,000 from a population of 11 million. This may change, of course, but so far Eurosceptics have been only too happy to disregard evidence that would contradict their view.
It would seem therefore that how we distil information prior to making a financial decision has exacerbated negative market sentiments. As returns in the financial markets are often generated by investing against the prevailing consensus — betting on the neglected and the improbable — let us suggest a contrarian idea.
Recent events in the credit markets have at last focused the minds of European policymakers. Policies of fiscal austerity will no longer be postponed and painful structural reforms will be implemented. The required adjustment will be prolonged and messy; and debt restructuring may occur. Although there are many unknowns, nothing as yet indicates that Europe’s collapse is inevitable or that Southern Europe is “unreformable.” It could well be that Europe emerges from the Greek maelstrom and its aftermath much stronger.
Thierry Malleret, head of research and networks at IJ Partners, an investment company based in Geneva and Olivier Oullier, a professor of neuroscience at the University of Provence and a scientific adviser at the Center for Strategic Analysis of the Prime Minister of France.