The DNC's Ultimatum Game with Progressives

Economists and rationalists got something important dead wrong.

They sorted it out in an oft-repeated experiment called the Ultimatum Game.  It's an exceedingly simple game and experiment. People play in pairs. They are told they are to split some money -- say $10. One person is assigned the role of deciding how to split the loot. 50/50? 60/40? 90/10? All for me and none for you (the Trump move)?

The second decides if he or she will take the offer. If he accepts the offer, they split the money according to the rule proposed. If she declines the offer, neither get anything.

Economists argued for a long time that rational people take ALL OFFERS (other than 100/0). That is, if I offer to take $9 and leave you $1, then you are being offered a choice between $1 and nothing, and rationally choose the dollar. If I offer to take $9.99 and leave you one penny, you are being offered a penny -- or not -- and take the penny.

The problem with this sort of rational analysis is that it may be that rational people take the penny (or the dollar) but real-life people DO NOT. In thousands of runs of this experiment, real life people tend to reject offers in which they are treated very unfairly. In fact, the data from these thousands of experiments show that people tend to reject offers in which they are being offered less than 20% of the original prize. Make an offer of 75/25 and most of us take it begrudgingly, but offer 85/15 and most of us reject the 15, preferring nothing at all to allowing you to take 85.

Why is this relevant right now? Because the Democratic establishment is counting on Progressives to be rational, and take something over nothing. Take Hillary over Trump or Cruz, because 25 is better than 0. Some Progressives are of course irrational -- many or most people are irrational -- so they may reject the offer because they are too angry to think clearly or because they are confused. BUT THE DEMOCRATIC PARTY ESTABLISHMENT IS WRONG TO THINK ALL PROGRESSIVES ARE IRRATIONAL. Many are smart human beings who understand that they have to take 25 begrudgingly, but should reject 15 because the level of unfairness would not be tolerable and should not be incentivized. That is, many Progressives who are balking at a vote for HRC are not confused about Cruz or Trump being the 0 and Hillary being better, but they are thinking that Hillary is the 15 that should be rejected in order to discipline the DNC into behaving more fairly and not the 25 that should be taken begrudgingly.

The lesson is clear: the DNC *must" find a way to make Hillary the 25 (the choice that we take begrudgingly even if we feel we have been treated unfairly) and not allow her to be seen as the 15 (the choice that is so unfair we would rather take 0 and thus punish the DNC into changing in the future). This will include substantial offers to Sanders and Progressives to write parts of the party platform.

I do understand that Obama got away with offering Hillary too little in 2008 and yet won, anyway. But had the economic crisis not hit us in September of 2008 closely following McCain's admission that economics was not his strong suit, the outcome of that election may well have been different. Obama should have offered more to Clinton supporters to earn their votes (his sense of entitlement was not right IMO). In fact, because Clinton supporters in 2008 played the part of DNC loyalists and supported Obama then, many of them consider it very unfair that Sanders supporters are being such poor team players now (and some of them are lousy team players). So Obama's selfishness then is hurting us now, as well. It is surely better to earn votes through consultative programs and doing good for your constituencies than through demands for loyalty oaths and dues-paying. Progressives are not soldiers sworn to die for the flag. They are people in need who expect politicians to try to do their jobs and serve the people fairly. The DNC can say correctly that they are the lesser of two evils, but remember the 80/20 rule: if you are the 15 instead of the 0, people who care about fairness (and liberals care more about fairness than others) will reject you. It is human nature to do so.  If the DNC wants to win in November, it must be the 25.

The DNC's Ultimatum Game with Progressives

Economists and rationalists got something important dead wrong.

They sorted it out in an oft-repeated experiment called the Ultimatum Game.  It's an exceedingly simple game and experiment. People play in pairs. They are told they are to split some money -- say $10. One person is assigned the role of deciding how to split the loot. 50/50? 60/40? 90/10? All for me and none for you (the Trump move)?

The second decides if he or she will take the offer. If he accepts the offer, they split the money according to the rule proposed. If she declines the offer, neither get anything.

Economists argued for a long time that rational people take ALL OFFERS (other than 100/0). That is, if I offer to take $9 and leave you $1, then you are being offered a choice between $1 and nothing, and rationally choose the dollar. If I offer to take $9.99 and leave you one penny, you are being offered a penny -- or not -- and take the penny.

The problem with this sort of rational analysis is that it may be that rational people take the penny (or the dollar) but real-life people DO NOT. In thousands of runs of this experiment, real life people tend to reject offers in which they are treated very unfairly. In fact, the data from these thousands of experiments show that people tend to reject offers in which they are being offered less than 20% of the original prize. Make an offer of 75/25 and most of us take it begrudgingly, but offer 85/15 and most of us reject the 15, preferring nothing at all to allowing you to take 85.

Why is this relevant right now? Because the Democratic establishment is counting on Progressives to be rational, and take something over nothing. Take Hillary over Trump or Cruz, because 25 is better than 0. Some Progressives are of course irrational -- many or most people are irrational -- so they may reject the offer because they are too angry to think clearly or because they are confused. BUT THE DEMOCRATIC PARTY ESTABLISHMENT IS WRONG TO THINK ALL PROGRESSIVES ARE IRRATIONAL. Many are smart human beings who understand that they have to take 25 begrudgingly, but should reject 15 because the level of unfairness would not be tolerable and should not be incentivized. That is, many Progressives who are balking at a vote for HRC are not confused about Cruz or Trump being the 0 and Hillary being better, but they are thinking that Hillary is the 15 that should be rejected in order to discipline the DNC into behaving more fairly and not the 25 that should be taken begrudgingly.

The lesson is clear: the DNC "must" find a way to make Hillary the 25 (the choice that we take begrudgingly even if we feel we have been treated unfairly) and not allow her to be seen as the 15 (the choice that is so unfair we would rather take 0 and thus punish the DNC into changing in the future). This will include substantial offers to Sanders and Progressives to write parts of the party platform.

I do understand that Obama got away with offering Hillary too little in 2008 and yet won, anyway. But had the economic crisis not hit us in September of 2008 closely following McCain's admission that economics was not his strong suit, the outcome of that election may well have been different. Obama should have offered more to Clinton supporters to earn their votes (his sense of entitlement was not right IMO). In fact, because Clinton supporters in 2008 played the part of DNC loyalists and supported Obama then, many of them consider it very unfair that Sanders supporters are being such poor team players now (and some of them are lousy team players). So Obama's selfishness then is hurting us now, as well. It is surely better to earn votes through consultative programs and doing good for your constituencies than through demands for loyalty oaths and dues-paying. Progressives are not soldiers sworn to die for the flag. They are people in need who expect politicians to try to do their jobs and serve the people fairly. The DNC can say correctly that they are the lesser of two evils, but remember the 80/20 rule: if you are the 15 instead of the 0, people who care about fairness (and liberals care more about fairness than others) will reject you. It is human nature to do so.  If the DNC wants to win in November, it must be the 25.

The Too Big to Fail Meme Explained

The Too Big to Fail (TBTF) meme is, if understood, a shorthand for something more than the size of the Wall Street investment banks.

TBTF is of course the idea that because banks are interconnected in our financial system, the failure of a large bank has repercussions on the rest of us. Hence, we are obliged to rescue them when they are on the brink of failing.

The three key questions that arise are: (1) what’s wrong with having to rescue a failing bank, (2) can it be avoided and (3) are there other issues here not being discussed directly?

(1) What’s wrong with having to rescue a failing bank? Those who wish to let failing banks fail without our help are in a few camps. One camp says that they don’t deserve to be rescued for poor performance and misconduct of their own doing, especially when others, more innocent and more vulnerable, e.g., homeowners, were not rescued. It smacks for good reason of favored person status among the plutocrats. (Recent revelations of the SEC turning a blind eye even on actual convictions of hedge fund investors reinforces this view as does the extraordinary lack of criminal charges in the case of the financial crisis.) Another camp – most mainstream economists are in this group – care very little about what is fair and more about efficiency and the role of incentives. These folks worry about so-called ‘moral hazard’ which is the idea that if a firm knows in advance that you will rescue it if the risks it takes on blow up in a downside scenario, that firm will take on too much risk and impose too much risk on the rest of us. (In its financial decision making, they are now discounting the downside of highly volatile investments, thus raising the ranking of those that impose the greatest risks on the enterprise and on the rest of us.) In other words, we not only rescue banks for failing normally, but we distort their incentives so they are more likely to fail. Still another camp is comprised of “free-market” ideologues (the subset who are not charlatans merely promoting the power and profit of business, but the group who actually believe in markets) who do not want the government bailing out anyone; they want firms to be unfettered to both succeed and fail. The bailouts make them unhappy for obvious reasons.

(2) Can it be avoided? The simpler TBTF critics want us to believe that by making banks smaller, they will be small enough to fail. This may not be right for a few reasons. (1) Small banks are still interconnected, so small bank failures will still lead to small charges to the rest of us – the problem that they are not being forced to fully subsume their own costs and mistakes goes on; (2) Break large banks into many small banks and if they fail the sum of those small charges may still add up to a lot of problems for the rest of us, demanding a rescue of some sort, anyway; (3) the chaotic/ catastrophic aspect of financial systems means that a butterfly flapping his wings can cause a tsunami – so even small bank failures that are still connected can cause outsized harm. (If you unplug a supercomputer you have tampered with a tiny part of it but you have caused a major problem.) So interconnectedness counts as well as size and it may be too complex for us to forecast and manage.

(3) The other issues not being discussed were highlighted in The Big Short where we learn that the investment banks are problematic for reasons apart from their size and interconnectedness. We see firsthand that the big investment banks (especially Goldman Sachs) have displaced the market altogether – fixing prices when it would cost them profit until they can manipulate buyers into taking on toxic assets and only then moving prices in line with market pressures. THIS MARKET DISPLACEMENT is (1) illegal, loosely, but should be punishable by extreme measures; (2) a product of power and opacity more than size; (3) a product of incompetent regulation, although it may not even be possible to regulate this sort of behavior. THIS FEATURE IS ARGUABLY MORE IMPORTANT THAN SIZE. All arguments in favor of markets, all arguments in favor of finance capitalism, all arguments that say that we have to take the bad (gross inequality) to get the good (supposed efficiencies) go out the window if THERE IS NO MARKET, but instead there is a profit-seeking vulture at the heart of the system fixing prices for their own profit.

So this problem cuts at the heart of finance capitalism. If you solve it, the system we have may be justified (with other fixes). If you don't solve it, all the formal arguments for finance capitalism go out the window and you may as well try socialism or something else.

In this last, both political extremes, socialists and social democrats at one end, and Tea Partiers on the other, can agree. Mainstream and radical economists can agree. We need a financial system in which banks are not so interconnected that their mistakes make us sick – but that is hard to fix. We need a financial system in which banks are not so big that their failure will cause crises – but making them small is not a complete solution. And, arguably most important, we need a financial system in which markets function honestly and players are never so powerful, opaque, or “made” (like a mobster) that they can manipulate prices of billions of dollars without vigilant regulation and extreme prosecution.