Submitted by Nicholas Colas of DataTrek
Today we have a behavioral finance tale called “The Ultimatum Game”. It is the most replicated study in the field, and shows quite conclusively that humans are hardwired to value fairness over money. An uncomfortable thought for those conditioned to quantitative disciplines like finance, but “fairness” is a powerful lever nonetheless. Strong enough, for example, for a sound economic deal like Amazon’s NYC expansion to fail.
By the numbers, New York City’s residents should have welcomed Amazon’s Queens expansion plans with unqualified approval. In return for just less than $3 billion in government incentives, Gotham would have seen:
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+25,000 new jobs, many of them high-paying tech positions. Remember that NYC has an income tax 2.9% to 3.9%, so that alone would have added roughly $88 million/year to the city’s coffers. Perpetuity value: $1.8 billion at a 5% discount rate, over half the incentives paid to bring the company to New York.
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A building boom in the Long Island City neighborhood, with commensurate increases in property tax revenues for both commercial and residential properties. And, unusually for NY, not growth driven by Wall Street or high rises for billionaires.
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Spill over effects as other businesses chose to expand in the area serving the new Amazon campus.
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Plus the halo effect of showing New York City is “open for business” despite its well known affinity for regulation and deserved reputation for being an expensive place to live.
So what went wrong? If we were writing a Saturday Night Live skit, we’d be tempted to make Amazon the young ingénue who arrives at the Port Authority bus station only to discover that New York is a harsh place. That local officials had little say and no veto power over the Amazon/NYC deal made them very grouchy indeed. Our sweet heroine, disillusioned by her first few days in the big city, packs her bags and heads home to Seattle.
The real story, however, ties that contentious $3 billion investment package (naysayers’ chief objection) with other current headlines about taxing wealthier Americans, increasing regulations on stock buybacks, and other intersections of economics and social priorities. Essentially, these are all debates about “the numbers” versus “fairness”. Capital markets professionals tend to weight the first factor more heavily, considering the latter to be (at best) harder to quantify and (at worst) at odds with classical economic analysis.
You can probably see where this is going: we need a sharper knife than old-school economics to cut the Gordian Knot and unravel the factors at play. We’ll start by describing a simple experiment that happens to be the most replicated study in all of behavioral economics:
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Two strangers enter a room and a researcher has them flip a coin.
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The winner of the coin toss gets some money – call it $100.
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The winner is then told that they must propose a split of that $100 with the loser of the coin toss. If the loser accepts the split, then both parties can keep their respective piles. If the loser rejects the proposal, then no one gets any money.
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There is only one round; the winner has to make an offer sufficiently enticing that the loser will accept. And neither party expects to ever see the other again.
Classical economics says the “right” proposal is $1; that’s more than the loser had when they entered the room so they should happily take it and not worry that the winner is taking $99 home. If the winner of the coin toss is seeking to maximize their own utility, a $1 offer is also the right answer.
The actual clearing price for a successful offer, described in countless peer-reviewed publications related to this game, is far higher and usually in the $30-$40 range. Enough so that the loser feels it is “fair”. They know they lost the coin toss, so they will accept less than $50. But $1 doesn’t work for them. Nor does $10, for that matter.
The lesson here is that human nature is hardwired to go against its own economic interests in the name of punishing what it perceives as greed or unfairness. And it’s not just humans that work this way; researchers have replicated a version of this study in primates, and the results are similar. Monkeys throw an absolute fit if they see another monkey getting better treats for the same task.
The name of this experiment is the “Ultimatum Game”, and it is ultimately a cautionary tale about the direction of several market narratives at the moment. “Fairness” spans topics as broad as:
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How users interface with the technologies they use every day. Is it fair that social media companies collect so much personal data and/or use it in ways that are not entirely transparent? And if the user is the one creating their data exhaust, is it fair they don’t own it?
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What is a “fair” individual income tax rate? How do we separate wealth from income? And how do we consider that a winner-take-most tech boom creates large but concentrated pockets of wealth?
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If less than half of Americans own stocks in any form, what is a “fair” way to apportion corporate cash flows across society? Corporate taxes only address what part goes to government, not whether it is reinvested, paid to workers, or used for buybacks and dividends.
On the whole, we find this an uncomfortable but ultimately important topic. Uncomfortable, because it is nonlinear and emotional rather than quantifiable and based on robust economic modeling. Important, because it is clearly at play in so many social/political/economic discussions just now. “Fairness” is an underappreciated fulcrum; attach a large enough lever and you can move the world.
via ZeroHedge News http://bit.ly/2Ed6V4e Tyler Durden