How culture and institutions shape risk and time preferences
12/19/2022
The Long-Lasting Effects of Communism
Johannes Schaewitz / Mei Wang / Marc Oliver Rieger - December 19, 2022
Our risk and time preferences are determining factors in many areas of life and have a crucial influence on our educational and occupational choices. From the extent to which we consume, save, invest, or accept the risk of a confrontation (e.g., to challenge someone’s opinion or even go to war) to how whole communities choose and/or design environmental or health policies, these preferences are a central component of the decision-making process—both on an individual and a societal level.
Risk and time preferences – the basis of many economic and political decisions
Risk and time preferences may not always be straightforward, and they may seemingly be inconsistent in real life and contradictory to some rationality principles in neo-classical economic science. This is a phenomenon dependent on many situational and psychological factors. Behavioral economists discovered that people’s risk preferences depend on how the potential outcomes are framed in terms of gains or losses. Typically, people opt for the safest bets when it comes to a potential gain (i.e., they are risk-averse) and prefer to take some risk when it comes to a potential loss (i.e., they are risk seeking), as described in what is known as “prospect theory.” As for time preference, people also tend to be less patient concerning the short-term but more patient regarding the distant future. For example, this insight had been used by Richard Thaler and his colleagues to design a “Save more tomorrow” (SMarT) pension scheme to improve under-saving problems, i.e., one where people commit to saving in advance, thereby increasing their pension slowly over time. The new survey we conducted for our study has brought to the forefront certain preferences born of such behavioral frameworks, i.e., risk attitudes in gains and losses and patience in short and long time horizons.
Influence of culture and institutionalized standards on preference
Scholars are debating to what extent preference is shaped by culture and institutionalized standards. Neo-classical economists may argue that preference should always follow the rationality principle, regardless of these two aforementioned principles. People’s preferences, however, can be shaped by their social norms and the experiences they may have had. For example, most citizens of a communist regime will never have made a financial investment due to the absence of free financial markets in such territories. Would the lack of such an experience have a long-lasting effect on people’s risk and time preferences, even after decades of transition? Would people in post-communist regimes be somehow more naïve and less “rational” in their financial decisions?
Differences between Western and post-communist Europe
We find evidence that even three decades after the end of communism in Eastern Europe, there are still observable differences in financial risk and time preferences when comparing both sides of Europe. Using data from two large-scale surveys—one for European countries (INTRA) and one for West and East Germany (SOEP) specifically—we show that the causes behind these differences are not the same: our results indicate that the experiences during the communist era and the more turbulent transition processes that followed after socialism might be related to stronger behavioral biases regarding financial risk preferences (e.g., stronger risk aversion in gain domains and more risk seeking in loss domains) as well as more impulsiveness (i.e., stronger present bias). Differences in loss aversion and level of patience, by comparison, are most likely caused by deeply rooted cultural differences that date back to times before the rise of communism. We found that individuals from post-czarist countries have a higher degree of loss aversion and show more impatience regarding intertemporal financial decisions than do people from other areas of the world.
Mutual understanding could lead to improved state-level political coordination
Today, the European Union comprises 16 Western European and 11 post-communist states (excluding East Germany), and discussions and negotiations about further EU memberships for post-communist states are ongoing. All members share essential institutions and must constantly compromise to uphold consistent European policy. That being said, former formal and informal institutions can have long-lasting effects on a person’s attitudes, beliefs, and preferences. Because all members must support policy-related decisions unanimously, such effects may hinder the realization of mutually beneficial solutions.
Additionally, the EU is forced to cooperate with post-communist countries, such as Russia. By being aware of different risk and time preferences, policymakers can better understand the legacies left behind by these former formal institutions and cultures, thereby enabling themselves to incorporate their insights into their political and economic decisions. In short, tensions may be reduced on a political level, and a mutual understanding for the other parties’ political agendas may become possible.
Key Findings
- Individuals from post-communist countries that went through a more erratic transition process show a higher tendency for behavioral biases regarding risk preferences (i.e., a higher degree of risk aversion in gains and a higher degree of risk-seeking in losses) than do individuals from post-communist countries that experienced a smoother transition process.
- Stronger risk aversion in gains and high risk-seeking in losses found in Eastern European countries may converge with Western Europe’s less risk-averse and risk-seeking preferences in a relatively short period, given stable political and economic institutions in the post-communist countries.
- Deeply rooted cultural differences may influence loss aversion and patience: More distinct impatience levels and a higher loss aversion seem firmly embedded within people from Eastern Europe, traits that will likely not be altered in the short-to-medium term by political and economic reforms.
Literature Reference
Schaewitz, J./Wang, M./Rieger, M. O. (2022): Culture and institutions: Long-lasting effects of communism on risk and time preferences of individuals in Europe, in: Journal of Economic Behavior & Organization, 202 (2022), pp. 785–829.
Co-Author of the study
Dr. Johannes Schaewitz
Dr. Johannes Schaewitz received his doctoral degree from WHU – Otto Beisheim School of Management, Chair of Behavioral Finance. He works as a portfolio manager in the wealth management department of a German private bank. His main research interests are behavioral finance, behavioral decision theories, the relationship between culture and institutions, and cross-cultural comparisons.
Co-author of the study
Professor Mei Wang
Professor Mei Wang is an expert on behavioral and cultural finance at WHU – Otto Beisheim School of Management. Her studies focus on the impacts of culture on individual preferences, decisions, and markets.
Co-Autor der Studie
Professor Marc Oliver Rieger
Professor Marc Oliver Rieger is an expert on banking and finance at the University of Trier. His main research fields cover decision theories, financial derivatives, behavioral and cultural finance.