The trouble with confidence
Society rewards overconfidence. We want our leaders to be overconfident. If they told us the truth about the uncertainty, we would discard them in favour of others who give the impression that they know what they’re doing. We want, support and sustain overconfidence in society, and there is an awful lot of it; it’s most of what we read in the paper, to the extent that it can be catastrophic. Just about every war has optimistic leaders and generals on both sides, which is also true for litigation. So, a lot of conflict is actually fed by overconfidence.
There is an interesting story here, of two biases that work in opposite directions. One familiar bias is what we call “loss aversion”. People put a lot more weight on negative events than on positive ones; on losses than on gains. If people gamble money on the toss of a coin, and stand to lose $100, they will demand more than $200 to accept the gamble, which is, in some ways, ridiculously risk averse. This tells us that people are loss averse. On the other hand, they’re optimistic.
Many of the decisions that people make, especially in starting new businesses, people think and believe that they will succeed. They open a restaurant because they think they will succeed. When in fact, less than a third of small businesses will survive more than 5 years. Here it’s clear that overconfidence and loss aversion are acting in opposite directions. You have to distinguish the perspective of the individual from the perspective of society.
For society, it is very good that we have a lot of optimistic entrepreneurs who think they will succeed. Most of them really don’t know the odds, yet they take the risks willingly. From the point of view of the individuals it’s not always good to be optimistic; for example, we have no interest whatsoever in whether or not our financial advisor is an optimist. For an entrepreneur, it’s a good thing to be an optimist because it will make him or her persevere more. We know that being an optimist is useful under some conditions, but it is not always useful in making decisions.
Listen to psychologist Daniel Kahneman talk about optimism and overconfidence in his short talk on Big Think below: