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3 October 2017

Which came first, fairness or the market?

by Tim Worstall

Originally published by CapX.

In his column this week, Matt Ridley talks about the ultimatum game, and how the results of the test – how selfish people are and how that is punished – change over societies. Indeed they do. But we should take this insight one step further.

The ultimatum game is quite simple: one guinea pig – the proposer – is given some money. A split of the cash must be offered to the second participant, the responder. If that share is accepted, then both subjects get to keep the cash. If the offer is rejected, then they both lose.

The standard economic approach would be to offer $1 of the $100 to the second, which would maximise the gains for the proposer, and the responder would accept, on the grounds that anything is better than nothing. But this isn’t what happens. In fact, splits of less than 70/30 routinely get rejected. Or at least they do among American undergraduates where the effect was first observed.

Much has been made of this: that humans have some inherent desire for fairness and are willing to punish the unfair at cost to themselves. But this is not actually true for, as Ridley points out, different societal set ups produce very different responses.

Among people living in determinedly non-market societies, a 99/1 split is often accepted. In which case, we cannot have an inherent predisposition for fairness – or, at least, the different results of the experiment across different populations show that it’s not a natural human response.

It is, rather, a learned trait. Whether it’s the one that allows market societies to operate, or the one which market societies inculcate is the standard chicken and egg problem. But it’s evidently true that it’s a feature differing between market and non-market societies.

This is because market societies are a series of repeated interactions with strangers. Within an entirely nuclear, familial perhaps, society fairness can be enforced by a clip on the ear for not sharing with your brother. When we’re repeatedly dealing with strangers, this societal response develops.

Interestingly, the result for policy is similar to that of the Prisoners’ Dilemma. If the two accused both keep shtum, they get a short sentence, if both rat, they each get a longer one and if one rats and the other doesn’t, then ratter gets off and rattee serves the longest sentence.

The optimal strategy has been much discussed over the years, and the only clear answer is that it changes when it’s a game of repeated iterations. A one off game, well, people still argue. But over many iterations, the optimal strategy is tit for tat. If you ratted last time, I’ll rat this; if you kept silent then I will.

A market society is indeed a series of repeated interactions. Multiple dealings with other people and products. Except not quite. What we actually have is a spectrum.

Buying bread is, for example, a fairly common activity. Anyone trying to cheat us will quickly find their market disappearing. We might tell on them. We might just reject their offering. But bad bread does quickly disappear.

Buying pensions on the other hand is different – we only really do it once in a lifetime. And it takes perhaps 50 years to find out we made the wrong decision. We can rely a great deal less upon that trained-to-operate-in-markets set of reflexes that multiple iterations allow.

Which is rather a long-winded way of explaining what must be regulated and why. Bread can be left to markets and human interactions in them. We can see this historically. It is entirely true that the newly industrialising Britain of the 1840s had the most horrible food adulteration problems. They were largely solved by the rise of brands in the 1850s and 60s – the brand was the thing of value protected. The first serious legislation came in the 1870s when the problem was largely already solved.

Pensions, however, can’t be left to the market, so we should indeed have pensions regulators. This isn’t to say that the current regs are right or correct, rather to say that the very idea of regulation is just fine, justified even.

All of which is the great lesson of this behavioural economics – even if it’s not the one that people are picking up on just as yet. Where economic activity is made up of repeat interactions, we can leave human nature to do the regulating. Where it isn’t we might have to strive a little more.

How excellent, that’s some 90 per cent of the rule book that can be burnt then, isn’t it?

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