Homo Sapiens evolved to be fair? Part 2

We know that people tend to reject deals which they see as grossly unfair. This is most apparent in the classic economic experiment of the ultimatum game.

In this game, two players are given a pot of money to share. One player is randomly chosen. She can propose any a split for herself and for the other player. The second player can then reject the deal outright, in which case both players get nothing, or can accept the deal, in which case both players get what the first player proposed. Critically, there is no second deal. There is no Shadow of the Future notion of reciprocity of retribution. This game has been played thousands of times, across cultures. The consistent finding is that deals where the second player gets less than 20% of the pot are consistently rejected...although the second player is worse off in rejecting the deal outright.

The common interpretation of this game is that this dents the neo-classical notion of homo economicus. This is just wrong. The Economist article makes this error, quite surprising because the Economist is usually sympathetic to neo-classical notions. Neo-classical utility maximization theory easily accommodates this behaviour. The theory is framed in terms of maximizing utility rather than income for a very good reason. All you need to believe is that utility is a function of relative income as well as absolute income. The second player in the ultimatum game is maximizing utility, not income. He is happier saying no to a deal which feels wrong.

Under this interpretation the great neo-classical results, like Ronald Coase's insight into free agents negotiating their way to a Pareto-optimal outcomes, are totally valid. The ultimatum game does not create a case for governmental/ authoritarian meddling in people lives or in the economy generally.

What the ultimatum game does offer a really useful insight into is not economics, but politics. Why does income distribution so dominate political discourse? Why is unequal income distribution even though of as "unfair"? It seems to be a pattern of thought that is hard-wired into us as a species.

This is not a normative point; more equal outcomes in a society is not better or worse in a moral sense. My own take is that equality is simply irrelevant from a moral or normative viewpoint. This is just a positivist point. Privilege is naturally resented in every social group: cricket team, company or nation state. More so if it is seen as unearned, inaccessible or both. Finding ways to address or harness that resentment in a creative way is a necessary part of any polity. This is a managerial task...not a moral task.

There are some interesting puzzles that this view might help answer.

For instance, why to the janitors employed by Goldman Sachs earn more than the janitors employed by the municipal government? Both sets of janitors are equally skilled and productive. This is a commonly observed phenomenon. Most companies that pay well do so across job families or skill levels. Are companies trying to address that political problem thrown into sharp relief by the ultimatum game? I can just hear the Goldman janitor cribbing to his mates at the pub "I work for Goldman. The guy with a funny nose also works for Goldman. Why does he make 100 times what I make? How is that fair?". The guy with the funny nose might have a Ph.D. or an ivy league degree...but that sense of grievance is going to be out there anyway.

This may be the reason outsourcing often reduces costs even when working within the same labour pool. Changing the badge on the janitor's uniform breaks that limbic sense of connection between the janitor and the Ph.D. guy with the funny nose. Breaking that limbic connection makes the inequality easier to swallow.

A much more speculative and flaky line of argument...but what the hell...I've been drinking some Chardonnay from Burgundy...

This view might also talk to why third world countries find it hard to trade with the first world. As an Indian, I find it weirdly easy to understand the emotional heft of this argument.

India has done spectacularly well since opening up to the world economy in 1991. Yet, despite this success, political commitment to trade or free-market principles is really thin. Why? Because an Indian negotiating with an American is still talking to someone about 25 times richer than him. He is likely to come away from that negotiation feeling screwed, regardless of the objective outcome of the negotiation. I grew up in Indira Gandhi's India when we were trying to promote South-South co-operation. Meaning...we liked dealing with other poor countries more than we liked dealing with rich countries. This is self-destructive. India still badly needs the income that trade brings and the gains from trade are greater between dissimilar countries or agents. But at some visceral level, this all makes sense.

The populists are winning

Got into a discussion on Greg Mankiw's blog. Mankiw's post was about how even Republicans are turning protectionist.

http://gregmankiw.blogspot.com/2007/10/populists-are-winning.html

Politicians understand that protectionism makes nations poorer. They also understand that lumping blame on foreigners is easy.

The real question that needs answering is: how do politicians make free trade a vote-winning position? Even when times are not all that good.
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An interesting response to my comment was: "the responsibility for educating the public lies with those companies and those workers who would be harmed by restrictions on trade."
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It's a good thought, and is a beginning. But it's not going to win the war for the good guys who want all of humanity to live better lives.

The first problem is rhetorical. Corporations claiming the free trade will be no more credible than snake-oil salesmen claiming to cure erectile dysfunction. The fact that, in this case, the corporations are telling the truth will not matter.

The second problem is that most corporations are not for free trade. They like nothing more politicians shielding them from the tough world of real competition. Read Raghuram Rajan's "Saving Capitalism From the Capitalists" for a nice riff on this topic. One of the Bush government's failings is that it does not distinguish capitalism from the capitalists. Sweetheart deals for buddies who own companies is corruption, not capitalism.

The third, and possibly the deepest reason why this does not work is that corporations generally will not have the resources to do this important work. Most companies fail. Or just about survive. And even the few wildly successful ones like Walmart or Microsoft will become vulnerable. Because of capitalism. Talk to people who worked at Microsoft when Netscape had an 80% share of the browser market to know what that felt like. General Motors bosses haven't been shy about lobbying Washington for tariffs or handouts.

When the going gets tough, corporations inevitably look to friends inside the Beltway to help them out. Companies are fair weather friends of capitalism. Can't be trusted.

So who will fight the good fight?

Universities. It is not a coincidence that we are talking on an economist's web site. Ambitious academics looking for political appointments can have surprisingly convenient views. But in general, academic's standards of intellectual honesty are higher than those of businesses.

And politicians. Al Gore has done his share of 360 degree pandering. But he did sell NAFTA with passion and conviction when it mattered. John McCain took on the might of Mississippi catfish farmers to fight for Vietnamese farmers who can supply the same catfish cheaper. Tony Blair (on the left) and Kenneth Clarke (on the right) have sold the case for the Polish plumbers who might breathe some life into Britain's building trades. Vaclav Havel in the old Czechoslovakia and Chandrababu Naidu in Andhra Pradesh, India, have tried to sell a case for trade to their people. Anders Borg, Sweden's 39 year old pony-tailed finance minister is selling his people radical market oriented messages like "make work pay", if welfare is too generous people have less reason to work.

It can be done. The case for trade has to be made in the public sphere. It has to be digested and accepted by the public for trade and its soul-mate, democracy, to co-exist. Unfortunately, this takes more political skill than pandering to xenophobia.

Can a pro-trade position fly?

Nice one pager on trade from Greg Mankiw's blog. Had gone to this link for solace after reading about Hillary Clinton's China bashing.

Greg Mankiw's Blog: Outsourcing Redux

Mankiw is stating the obvious, the part pretty much everybody agrees on.

The hard part is: how does one make free trade a vote winner? Or at least not a vote loser. Can't trade become an obscure technical issue that almost nobody cares about...like internet protocols or something? Did any politician ever make trade a vote winner? Vaclav Havel?