Shortly after retirement, I was looking for interesting things to do. One idea was to pit economic theory against human nature in an experimental setting. For starters, I could take some college kids and pay them a nominal amount to participate in some games which would simulate real world situations. This would allow me to see if the assumption of strict rationality applied to various types of economic descisions. Fortunately, some of my basic questions have been answered because others have taken up the task. It is called experimental economics.
Game theory and classical economics are based on assumptions of rationality and self interest on the part of each participant. Theoreticians in physics, for example, are typically of a different breed than those physicists that perform experiments. This separation represents the contrast between abstract logic and empirical evidence gathering. A similar situation now exists in economics where, until recently, the field was dominated by the theoretists. A couple years ago an article appeared in Scientific American which reviewed some of the newly emerging experimental work.
THE ULTIMATUM GAME
Many years ago, Werner Guth of Humbolt University in Berlin devised an experiment called the Ultimatum Game. It was designed to test the assumptions that are the basis of most economic theory. In one version of the Ultimatum Game, two participants are selected and informed of the rules of the game as follows:
* A coin is flipped to select one of the two players to be the proposer. The other player is designated as the responder.
* The proposer is given $100 which is to be shared between the two players.
* A single offer is made by the proposer to the responder as to how the split should be made.
* The responder must give a simple "yes" or "no" answer to the proposal.
* If the responder says "yes" the transaction takes place and the game ends.
* If the responder says "no", the game is over and neither player receives any money.
Both game and economic theory would lead the proposer to believe that he could propose almost any amount and have it accepted. In reality, the proposer must make a reasonable offer or the responder will reject it and no money will be payed. On the other hand, if the responder is entirely logical, he should accept any amount he is offered. Anything is better than nothing and no lessons will be learned for the future becaure there will be no repetition of the game.
Suprisingly, two thirds of actual proposed offers were between $40 and $50. Only 4% of the offers were less than $20. Of those responders who were offered less than $20, over half rejected the offer. Similar results were found when this experiment was conducted in many other countries throughout the world. The results were also found to be largely independent of the amount of money involved. Some exceptions were noted in small undeveloped societies. Some of these societies favored transactions below the previous 45% average while others favored transactions above this amount.
It appears that the responder isn't necessarily making his short term self interest the only priority. Something within him wants to reject offers that are taking advantage of his position. The proposer, on the other hand, realizes he cannot be greedy without a costly retaliation by the responder.
THE PUBLIC GOODS GAME
This experimental game is designed to explore how people respond when contributing to a common pool of resources which benefit everyone. It is based on the following set of rules:
* Each of four players is given $20.
* The players are asked to contribute some portion of their money to a common pool. Each individual may contribute any amount he/she chooses.
* This common pool will be matched by external funds and the resulting money is then divided equally among all the players.
* The players are thoroughly briefed with respect to how other player's contributions might affect their own return.
If you do a detailed analysis of the above game, you find that the gain for an individual is mostly dependent on the contributions of others. Logically, from an individual/selfish viewpoint, each player would be better off not contributing at all and accept the gains from the common pool.
The implementation of this game revealed that, in the beginning, most players were willing to contribute a significant portion of their money to the common pool. When the game was recycled several times using the same players, however, the individual amounts invested began to decline to the point where no one contributed to the pool. An unexpected response was noted when these same players were each placed into a situation with all new players. In this case, they all began as before by contributing significant amounts to the common pool. As before the contributions declined with time.
An additional rule was then added to the game:
* At then end of any round, a player may choose to fine another player for failing to contribute to the pool. The player being fined will be charged $1 while the person requesting the fine will be charged $.30. The resulting collected money will be removed from the game.
Using the same players, repeated cycles with the "fining" rule produced a significant increase in the amount of money contributed to the pool by each player. Again, short term self interest was tempered by the rules of the game. Players tended to impose fines on others who were delinquent in the contributions to the common pool - in spite of the fact that they too incurred a cost for requesting the fine.
Human experience over the centuries and millenia has introduced into our psyche the necessity for balancing self interest and cooperation. Either of these two principles, when used alone, can produce less than optimium survival conditions for a society. Fairness might be a way to describe the optimum balance between these two extremes. Of course each of us will have a different opinion as where this optimum balance lies.
In the Ultimatum Game, each participant was potentially willing to give up some personal gain to satisfy his definition of fairness. Furthermore, the proposer's definition of fairness had to be tempered by what he thought the responder's definition might be.
The Public Goods Game showed how pure self interest was detrimental to the group as a whole. The overall accumulation of goods was only maximized after the imposition of fines. By default, the gains of each individual were increased by universal investment.
If we wish to apply the lessons learned from these experiments to our society, we must closely examine the rules for each game. The fairness concept is supported in the Ultimatum Game by the fact that a coin was flipped to determine which player was the proposer. Under this scenario, there is no reason that the proposer should be "entitled" to the lion's share of the money based on the fiip of a coin. Both players realize this and adjust their responses accordingly. To further support this point, these games were repeated with other players but the proposer was selected by achieving the best score on a short quiz prior to the game. The subsequent games show a distinct shift upward in the amount of money the proposer was permitted to keep without disagreement.
What lessons are to be learned from the Public Goods Game? First, we might conclude that, in a free market, self interest eventually becomes the norm after the players experience the results of pooled resources. This is especially true where, as the game rules stated, each person could contribute different amounts to the pool but equal amounts were to be redistributed to all the players. Doen't this sound like welfare? Universal participation was only achieved by the imposition of fines.
True, the whole group was better off with universal cooperation because the common pool investment had a 2:1 rate of return. If we apply this to our society, forced taxation would be advantageous for all if the government produced a sufficient return on our investment. In the real world of government, as time goes on, the rate of return to the taxpayer declines and eventually become negative. If we dismiss socialism, we find that in a private enterprise scenario investors get a return based on the amount of their contribution (or shares) and not just because they are standing around the feeding trough. This is the type of fairness exhibited in the Ultimatum Game when a "quiz" was introduced.
In spite of the caveats associated with the above experimental games, there appears to be a human tendency to balance self interest with cooperation. Individual preferences may lie more to one end of this spectrum than another but it must be recognized that neither complete anarchy nor total common ownership and sharing of resources are compatable with a productive society. Economists, with the help of experimentation, are beginning to explore this delicate balance.
"More than any other time in history, mankind faces a crossroads. One path leads to despair and utter hopelessness. The other, to total extinction. Let us pray we have the wisdom to choose correctly"
- Woody Allen