The ultimatum game, a key experiment showing intrinsic fairness and altruism among strangers

Knowledge will come only if economics can be reoriented to the study of man as he is and the economic system as it actually exists.
Ronald Coase

There is a line of economic research on altruism that get only little attention in the media, which is why I want to report on it here. There is by now solid evidence that humans can behave altruistically towards strangers. This is surprising because a naive version of evolutionary theory would expect that altruism is only possible among kin. It also goes against the basic assumptions of economics, game theory and public choice theory, which all assume that humans only have an eye for their self-interest. These assumptions are often defended referring to evolution by stating that you need to be an unapologetic egoist for optimal reproduction. I mention this, because non-academics may think it is natural to assume humans can be altruistic and wonder why one would research something that trivial.

It is not controversial science. There are hundreds of scientists working on it. Almost every month Nature or Science publishes an article on altruism. And at the University of Bonn, where I work, Reinhard Selten is emeritus professor and got his Nobel price for experimental research on the ultimatum game. That is also how I heard about it, our University Magazine had an article on Selten and this beautiful experiments.

In a social setting, where there is an opportunity to build up a reputation, altruism can be explained. In this case, altruism may lead to future benefits and one may even argue that it is thus not real altruism. However, this type of altruism is expected to break down when a group is under pressure and may soon dissolve, but humans also collaborate under such difficult circumstances. Furthermore, reputation-building naturally does not work under conditions of anonymity, while experiments show that humans also collaborate with strangers they will never see again. Our ability to collaborate with non-kin is an important innovation that contributes much to our success as dominant animals.

Ultimatum game

A very simple and pure economic game, which thus shows the problem very clearly, is the ultimatum game (Güth et al., 1982). In the ultimatum game, two players must divide a sum of money. The first player has to propose a certain division. The second player (responder) can accept this division or reject it; in the latter case both players do not receive any money. In its purest form, the experiment is played only once and anonymously with players that do not know each other.

When the article described the experiment, I wondered what was interesting about that. Naturally people offer 50% and the responder accepts this. Not? That only showed my lack of economic training.

Darwinian or Smithian competition

Econtalk recently held an interview with Robert Frank, author of the book "The Darwin Economy".
The most interesting part starts with the statement:

"I start with a prediction that I won't live to see whether it comes true or not: I predict that if we were to poll professional economists a century from now about who is the intellectual founder of the discipline, I say we'd get a majority responding by naming Charles Darwin, not Adam Smith. Smith, of course, would be the name out of 99% of economists if you asked the same question today. My claim behind that prediction is that in time, not next year, we'll recognize that Darwin's vision of the competitive process was just a lot more accurate and descriptive than Smith's was."

I think he is right, but am hopeful we do not have to wait an entire century.

The competition of Adam Smith is the competition between lion and gazelle. It makes both fast and strong. You could say, it also makes the group better of, on evolutionary time scales. Charles Darwin was aware that this is not always the case, competition between males can lead to aggressive and too strong males, competition between trees for the sun makes them tall (inefficient) and fragile (storm damage). In these cases collaboration between members of a species would make everyone better of.

The irony for economics, the study of how humans allocate their resources, is that humans are one of the most cooperative species on earth (we are strong reciprocators). You can see this everywhere, if you have an eye for it. You can see it in its most distilled form in economic games performed in laboratories, such as the ultimatum game and the common goods game.

Productivity and context

Just listened to Econtalk with Bob Lucas, Nobel Laureate and professor of economics at the University of Chicago, on economic growth. Naturally they also touched on productivity. It was almost funny how they avoided one conclusion. It was on the tip of my tongue as the ending of many sentences.

They talked about a person raising chickens in Indonesia, producing about 50 eggs per chicken per year and having to pick them himself. They asked themselves the question why he did not use modern technology to produce 300 eggs a year. Lucas answer was the lower cost of labor in Indonesia and he stated that this cost is determined by people working in factories in the cities. Lucas: "Economic growth is always associated by a move out of agriculture and into the city environment."

Then the host Russ Roberts asked Bod Lucas why an unskilled immigrant makes so much more money as soon as he (illegally) crosses the US border. Or in other words why he suddenly becomes more productive, while his human capital did not change. Lucas said that it is about cooperation with other people, how productive you are, e.g. as a busboy, depends on the quality of the waiters and of the cooks. Furthermore, the richer people in America are willing to pay more for a dinner.

Roberts then notes that it is a beautiful and interesting problem, that he is probably not more intelligent than his dad, but his standard of living is much higher. Lucas avoids answering, but states: "The other thing is: How many people are competing with you at your level?" "Don't drop out of high school!"

The answers hint at the following: Context is very important in determining productivity and wages. In the two examples, the farmer and the immigrant, context determines their wage, not their skill, not their education, not their human capital. For the farmer it is important that other people get better wages in the city, for the immigrant is is important where he works.

Productivity thus cannot be determined by looking at a person, it is not defined at the level of a person. Scientifically put: it is a nonlinear computation, not a linear one. In the latter case you could isolate one element, one person. Strictly speaking productivity is only defined at the global level. It is still reasonably well defined for nations and probably for large companies. (Even the productivity of companies is determined strongly by their network of partners and institutional factors.) Thus it is also not possible to compute how much a worker should earn. It is up for negotiation. And you certainly cannot claim that someone deserves to earn a certain amount.

Of course, the employee does need to work and often needs skills. Lets not start a nature-versus-nurture-type debate. Productivity is determined (almost) 100% by context and 100% effort. Just as an organism is determined 100% by nature (genes) and 100% by nurture (environment; context) and you can only split these two factors for a given variability in the environment.

It is thus very well possible that top managers get better salaries because they have a better bargaining position, not because they are more productive as it often stated in the media. Doubling the salary of all workers would be a problem to a company. However, a company does not go bankrupt because their CEO gets a double salary; there is only one CEO and there are basically no market forces to reduce it until it becomes extremely excessive. That may be an important reason for the differences in salaries, rather than skills.

Further reading

More posts on economics.

Good ideas, motivation and economics

Steven Johnson recently wrote the book Where Good Ideas Come From: The Natural History Of Innovation. In this book he argues that good ideas mostly do not come as a sudden spark out of the blue, an epiphany, but rather grow slowly over time by combining ideas. His recommendation for finding good ideas is to create a diverse network with people with very different interests to increase the chance of seeing a new combination. The latter is similar to recommendations from creativity books to read broadly. Also personally, I like to read about a broad range of topics; reading just meteorology papers, it is highly unlikely that I will get an idea a colleague did not yet have. On the other hand, you do need to know your field to know what contribution is needed. Johnson also advices to write up your ideas and ideas of others and to discus them freely. Another advice from Johnson to organizations is to give employees the freedom to explore wild ideas in part of their time.

In the last chapter of the book and in an article for the New York Times, he answers the question why most good ideas come from amateurs and academics rather than solo entrepreneurs or private corporations. His answer is that the commercial guys are handicapped by keeping their ideas secret.

That may be part of the answer. Another is likely that people are not that much motivated by money when it comes to such complex cognitive tasks. As Daniel Pink explains in a talk at TED and in a beautifully made animation, offering people more money will increase their productivity for simple manual tasks. However, for tasks needing only a little cognitive skill people actually often perform worse if they are given a large monetary reward. Daniel Pinks equation: Motivation = autonomy + mastery + purpose.

Another indication that people are not solely motived by money, but also by concepts such as fairness comes from academic economics, from experimental micro-economics. The deviation from mainsteam economics (the neoclassical synthesis), with its concept of a homo economicus, who only cares about monetary gain, is beautifully distilled in a classic simple economic game, the ultimatum game.

In the ultimatum game, person A get to divide a sum of money. Person B has to agree with this division. If B doesn't, no one gets any money. When I first read about this game, I was wondering why it was interesting; people would simply split 50/50, wouldn't they. However, then it was explained that if B would be a good homo economicus, he would accept any offer, because it is better to receive something as getting nothing. Person A knows this and will only offer the smallest possible amount. As expected, reality looks very different. If Person A does not offer at least 30 to 40 percent, it is quite likely that B rejects the offer. Typically A offers 50 percent. This also happens if A and B do not know each other, if the game is only played once, and the results is similar in any culture or group. This game and many similar ones have led to the conclusion that humans have a innate sense of fairness.

This is a combination of three ideas. It is not yet sufficient to derive a new economic theory, but it might be a start. Do you have any ideas that together may make this network of ideas more fruitful?

Further reading

More posts on economics.

More posts on creativity.