Priceless: The Myth of Fair Value (and How to Take Advantage of It) (16 page)

“We had a very good time making up those questions,” Kahneman said. “In fact they’re pretty funny.” The group also found that the survey answers became reasonably predictable. “You ask a few of these questions, and you get a sense.”

The public was realistic enough to appreciate that prices sometimes
have
to go up. It was okay for stores to pass on their own increased costs. It was okay for a company that’s losing money to cut wages. But it
wasn’t
okay to take advantage of market forces (say, to raise prices on existing stock during a shortage). The cardinal rule of fairness appeared to be
Don’t increase your profit at my expense
.

This reflects the thesis that losses hurt more than gains feel good—and perhaps a melancholy picture of the world in which everyone’s out to squeeze a few extra dollars out of everyone else. Yet the framing of “gains” and “losses” was easily manipulated by words in the working vocabulary of any real estate agent or con artist. One survey question began:

A company is making a small profit. It is located in a community experiencing a recession with substantial unemployment but no inflation. There are many workers anxious to work at the company. The company decides to decrease wages and salaries 7% this year.

Sixty-two percent judged the wage cut unfair.

In an another version of the question, the community was said to have “substantial unemployment and inflation of 12% . . . The company decided to increase salaries only 5% this year.” Now 78 percent said this was acceptable. But of course the workers’ lot is almost identical in both versions. Getting a 5 percent “raise” when prices rise 12 percent translates into nearly a 7 percent cut in buying power.

One conclusion is that inflation is the Scroogish employer’s best friend. A similar principle applies to bonuses. It was judged okay for a troubled company to skip an annual 10 percent bonus it had been in the habit of paying, but
not
to cut wages 10 percent for a year. (Wall Street employers, at the mercy of a volatile market, have long made use of this.)

Kahneman, Knetsch, and Thaler wrote,

Conventional economic analyses assume as a matter of course that excess demand for a good creates an opportunity for suppliers to raise prices, and that such increases will indeed occur. The profit-seeking adjustments that clear the market are in this view as natural as water seeking its level—and as ethically neutral. The lay public does not share this indifference . . . The gap between the behavior that people consider fair and the behavior that they expect in the marketplace tends to be rather small.

The shock was in how self-serving the folk rules of fairness are. Philosophers of left and right have always felt the need to be logically
consistent. The public had no such inhibition. Overwhelming majorities rejected the laissez-faire capitalist view of property and free enterprise, and equally rejected any consistent notion of workers’ rights and the common good. The public displayed Ayn Rand selfishness to such a degree that it judged free markets unfair—for free markets are as likely to work against one’s selfish interests as for them.

Imagine a postapocalyptic future in which nothing survives of American culture except some Farrelly brothers movies. That is virtually what happened with the earliest Roman literature: all is lost, save for the appealingly lowbrow farces of Plautus (c. 254–184 bc). Thanks to this accident of survival, one of the West’s earliest descriptions of bargaining is a comical one. It occurs in the pivotal scene of Plautus’s play
The Rope
. A slave named Gripus dreams of buying his freedom with a trunk of gold he found in the sea. Gripus crosses paths with the conniving Trachalio, who recognizes the gold as the property of a notorious pimp and senses a blackmail opportunity.

T
RACHALIO
: Right, then; listen. I saw a robber robbing—I knew the man he robbed from—I went up to the robber—I offered him a bargain—“I know the man you robbed from,” I said—“you give me 50-50—I’ll say no more about it.” He wouldn’t listen to me. Well, I ask you, wasn’t half a fair share?

G
RIPUS
: You should have asked more than half. If he won’t give it you, I’d say you ought to tell the owner.

T
RACHALIO
: Thanks, I will. Now see here: this is where you come in.

G
RIPUS
: What do you mean?

T
RACHALIO
: You’ve got a trunk there. I know who it belongs to. I’ve known him a long time.

In modern terms, this is an “ultimatum game.” One person (Gripus) has some loot, and another (Trachalio) has the power to make the loot
disappear. Does that entitle the latter to a share? It assuredly does in Plautus’s tale. Unless he gets half the gold, Trachalio threatens, he will tell the rightful owner. Then neither slave will get anything. Gripus snaps, “The only share you’re going to get is a share of trouble, I can promise you that.” He vows he would sooner get nothing than give anything to Trachalio.

As a metaphor for the absurdity of the human condition, Plautus found all he needed in two actors and a series of ridiculous ultimatums. Gripus’s trunk is said to be snared in the fishing net in which he caught it, attached to a rope (hence the play’s title). The play’s viewers must have witnessed the slaves’ comic war of words devolve into a literal tug-of-war. The message is timeless: “bargaining” is a polite word for extortion, and logic has little to do with the outcome.

Kahneman, Knetsch, and Thaler presented their fairness research at a University of Chicago conference. Their talk was published (in a 1986 issue of the
Journal of Business
), and that article included the diabolical little experiment now known as the
ultimatum game
.

You are given $10 to split with a stranger, and you get to propose how the money is divided—for example, “$6 for me and $4 for the other guy.” The twist is that the other person gets to decide whether to accept your split or reject it. Provided he accepts, the money is split exactly as you specified. Should he reject the split, neither of you gets a penny. As the game’s name indicates, this is a take-it-or-leave-it deal with no counter-offers.

You are under no obligation to be “fair.” You can demand as much of the $10 as you think you can get away with. Naturally, you want to stop short of the point where your partner will be so upset with his “unfair” allotment as to veto the deal.

You might want to decide how you would play the game before you read further. First, pretend you’re the person splitting the money (the “proposer” or “allocator”). How much of the $10 prize would you offer to a complete stranger? (You will never learn this person’s identity, nor will s/he learn yours.) Write down the figure.

I offer $_____ out of $10

Next, you’re the other person, the “responder.” Since you’re playing alone here, it is necessary to decide how you would respond to every possible offer you might receive. These offers could range from nothing at all to the full $10. For simplicity, proposers are often restricted to whole dollar amounts. Circle your minimum acceptable offer (indicating you would accept the circled offer, and any offer bigger than that, but no smaller offer).

I will accept
$0  $1  $2  $3  $4  $5  $6  $7  $8  $9  $10

To a rational maximizer, the ultimatum game should be a no-brainer. The responder should never turn down “free money.” He should accept a pittance rather than veto. In turn, a reasonable proposer should anticipate that and offer a token amount, in blissful confidence of its being accepted.

That didn’t happen. When Richard Thaler tried this game on students at Cornell, he found that a “fair” fifty-fifty split was by far the most common proposer offer. He also found that responders were willing to reject stingy offers. The average responder would accept $3 but reject $2.

It’s not hard to understand what was going on. The proposers had enough social intelligence to know they had to give the responders enough to keep them satisfied. One thought that must have occurred to all is that a fifty-fifty split is “fair.” That makes a case for offering an even split, as a plurality of Cornell students did.

The thing is, neither life nor the ultimatum game is necessarily fair. The two participants have different choices and different powers. Unless the responder is
so
upset that he is willing to cut his own throat, the proposer has power and incentive to shave a little off the even split. Why not offer $4, or $3 . . ., uh, or even $1?

You can see where this is going. For any responder, there’s a point where he gets so angry that he vetoes. A greedy-though-prudent proposer would want to approach that point as closely as possible without exceeding it. Where is that point, exactly? That is one question that the ultimatum game asks.

It’s easy to recognize echoes of the ultimatum game in your own life. Every day people use pushiness, entitlement, and chutzpah to get their
way in the world. Those making unreasonable demands succeed because everyone else sighs and puts up with them—
up to a point
. The ultimatum game explores the not unreasonable anxiety that fair dealing will get us only so far in the world. To do that, it creates an ambiguous ethical space. The proposer did not do anything to deserve the $10. The responder did not do anything entitling him or her to a share. By stripping away all the customary social, legal, financial, and ethical entitlements, the game lays bare the issue of inequality, something that all societies struggle with.

In a way, the ultimatum game is the monetary version of S. S. Stevens’s classroom demonstration that black is white. The value of money depends on context and contrast. How would you feel about getting $100 for doing nothing? You’d feel pretty good. How would you feel if that $100 was your share of a $1,000 windfall—and your “partner” had unilaterally decided to keep $900 for himself? That
wouldn’t
feel so good. The $100 is insultingly small next to the $900, even though it would be a nice piece of change in another context. The contrast creates emotions, and emotions influence actions. There are those who seize advantages because they think they can get away with it, and others who find their only bargaining chip to be a self-destructive veto. In a real sense, we
all
play the ultimatum game.

“We were very pleased with the ultimatum game,” Kahneman said. “We thought it was a very good idea—we didn’t realize how good it was. Then, just as the piece was written, Dick Thaler was doing a routine research of the literature just before publishing, and he says, ‘Sorry, guys . . . we’ve been scooped.’ ”

The same game had already been published in 1982 by a German game theorist, Werner Güth, and two colleagues. Güth, then at the University of Cologne, well understood that game theory is no predictor of human behavior. As a child he had been taught game theory’s method of sharing a treat: “divide and choose.” One child cuts the cake into two slices, and the other gets first pick. “My brother and I always relied on divide and choose to limit the amount of fighting,” Güth told me. “However, we weren’t too successful.”

Starting in the mid-1970s, Güth became interested in ultimatum bargaining—the
kind in which one party makes an offer, take it or leave it. Güth returned from a 1977 academic conference with 1,000 deutsche marks in his bag, a grant for running economic experiments. He and colleagues Rolf Schmittberger and Bernd Schwarze did the first ultimatum game experiments during the 1977–78 academic year.

Güth said it was never his intention to demonstrate that humans don’t behave as economists assumed. “That would have been overkilling an already dead man.” He was interested in devising “the easiest nontrivial ultimatum bargaining games with only two players” and seeing how real people would play them.

He came up with two games, calling one the “complicated game” and the other the “easy game.” In the former, a player had to split some black and white chips into two piles, then the other player got to pick one pile for himself. The complication was that all the chips were worth 2 marks each to the first player, but the white chips had only half this value for the other. University of Cologne students were not especially good at finding the optimal split.

So Güth tried the “easy game,” now known as the ultimatum game. In the first experiment, forty-two graduate economics students were paired off. One person in each pair split a variable cash prize that ranged from 4 to 10 marks. The offer was conveyed to the partner, who was limited to a simple
ja
or
nein
. The most common offer, made by seven of the twenty-one proposers, was a fifty-fifty split. According to Güth, one of the more common reactions to this research among economists was a simple question: “Are those students in Cologne stupid?”

Kahneman remembered “being quite crestfallen” when he learned of the Güth paper. “I would have been even more depressed if I had known how important the ultimatum game would eventually become.” He, Knetsch, and Thaler didn’t revise their paper, aside from mentioning Güth and adding him to the references. Fortunately, they had taken a different approach from the German group and had new things to offer.

Güth did not ask his responders to state a minimum acceptable amount. Because most proposer offers were close-to-even splits, the German group did not get many chances to observe how responders reacted to grossly unfair allocations. Kahneman, Knetsch, and Thaler were more
interested in the responder. “All our questions on fairness had to do with, ‘Do you think the behavior of that guy, the powerful guy, is fair?’ ” Kahneman explained. “As a psychologist, I like the idea of people wanting to be fair. But Dick was enough of an economist to take the responder as the key.”