Friday, January 25, 2008

Equality and Fairness

I ran across a very interesting question the other day.

If all goods and services remained the same price, which would you prefer?
A. To make $50,000/yr while everyone makes $25,000/yr
B. To make $100,000/yr while everyone makes $250,000/yr

I would daresay that the majority of respondents chose option A.

Let us modify the options--
If all goods and services remained the same price, which would you prefer?
A. To make $50,000/yr while everyone makes $25,000/yr
B. To make $100,000/yr while everyone makes $100,000/yr

And make yet another change to the question--
If all goods and services remained the same price, which would you prefer?
A. To make $50,000/yr while everyone makes $50,000/yr
B. To make $100,000/yr while everyone makes $150,000/yr

A slight majority of respondents chose option B in both scenarios. Most of the remainder chose option B then option A. Are these surprising results? Perhaps. The purpose of these questions was to find the boundary between the respondent's preconception of relative wealth and absolute wealth.

In the first scenario, why option A? It would seem that if everything costs the same in both scenarios, you would be able to have twice as much with option B. That's twice as many dinners out, twice as many Caribbean vacations, and twice as many savings. It can only mean that the amount everyone else earns makes a difference. Everyone else would be able to have two and a half times of everything more than you. That is what what option B so unpalatable to most people.

In the second scenario, why option B? Going by the same logic, it would make sense because you would double your potential. At the same time, everyone else is on the same ground, and most people will accept the equality. Between the first two scenarios, you can see why socialism works in certain civilizations.

In the third scenario, the respondents were more evenly split. With option A, everything is even, and you do not have the inequality in option B. With option B, you have more potential, but that potential is not so severely disproportionate to everyone else as to make it so unpalatable. You would suspect that by gradually reducing the difference in income in option B, that more and more people would chose option B over A. I would believe it, but have not done an informal survey to show it.

So there seems to be a difference with regards to self perception and equality. Everyone has an amount with which they would be happy. Whether it's $25,000, $50,000, $100,000, or whatever, there is an absolute number that people believe they deserve. This number is not necessarily what people want, but what they are willing to accept as a fair estimation of the worth of their work. This number is also affected by current market prices. Market prices correlate with the overall averages of the worth of goods and services. Unfortunately, we tend to believe that the average, or mean, worth of goods and services is the same as the median and mode (mean=mathematical average, median=middlemost number, mode=number most common). We want to believe that the average person really is average is all respects.

This is not the way the world works, though. Inequities are everywhere. The most obvious example is the disparity in income between men and women in the same profession. And that these inequities exist today tells us that there are people who are getting something for nothing. And people want the same options as everyone else. Everyone has the same opportunity to play the lottery and strike it rich. Everyone has the same opportunity to buy stocks and save for the future. But not everyone has the opportunity to be grossly overpaid for doing little to nothing. This is the problem for everyone who chooses option A in the first question. If there is to be inequality, they want to be on the greener grass. In fact, a large number of people would gladly sacrifice some of their benefits to ensure that others do not gain undeserved benefits.

A study performed by Gurerk, Irlenbusch, and Rockenbach (Science 2006) participants were given twenty tokens and then allowed to join one of two groups. In both groups the members would earn a profit based on the number of tokens in the pot at the end of a round. Each member could chose how many tokens to add to the pot. In the first group, a freeloader could still earn profit without contributing tokens, as long as one other member in the group contributed to the pot. In the second group, the option to penalize another member three tokens for the cost of one token was given to every member. As predicted, nearly all participants joined the second group after twenty rounds, and freeloaders in the second group earned less then other members. Also, members who opted not to punish ended up with slightly more tokens than members who opted to punish freeloaders. This suggests that some people are clearly willing to sacrifice self benefit if it means more equality, and that perhaps those who did not punish had either a higher threshold for inequality or anticipated others to punish the freeloaders.

This ingrained aversion to inequity is not unique to humans. Brosnan and de Waal (Nature 2003) conducted an experiment with female brown capuchin monkeys where the subjects exchanged tokens for cucumber. Then the monkeys witnessed partner monkeys either receiving a grape (a better treat than cucumber) for a token or for nothing at all. All the while the subjects continued to receive only cucumber for their token. Upon witnessing the partner exchanges with grapes, the subjects began not only to refuse to relinquish their tokens, but also refused to eat the cucumber. This even happened with subjects who had been bartering tokens for cucumbers for two years time and had accepted the value of the cucumber. The authors concluded that the monkeys responded not to the lack of positive reinforcement, since cucumbers were accepted for two years in bartering, but to the observed inequity to both reward value and reward for degree of effort.

While I asked quite a number of people these questions, I did get a tremendous number of comments about how the questions are flawed because the scenario in unreal, could never exist in real life, does not account for how hard you work, blah, blah, blah. This, of course, shows how closely our happiness is tied to equality, our comparison to other people. People would consider working three days a week better than five, and if they made less than the Joneses but worked less, they might consider it fair. Or if they got to use the company car or had better insurance it would make up for less pay. It is this dislike of not having other compensation to make up for a relative disparity in pay that demonstrates our need for comparison. But you cannot phrase a hypothetical question designed to elicit people's need to compare themselves to others with five hundred stipulations of nonmonetary compensation.

Monday, January 14, 2008

Relative Vs. Absolute: Part I

There are different ways of measuring quality or liability, and for the most part you see two methods--relative and absolute. The relative method is based on percentages. A Hollywood agent typically collects 10% of an actor's earnings. The absolute method is based on hard numbers. A contractor charges six thousand dollars to build a new deck or an attorney charges three hundred dollars an hour. Current methods work well in most instances, but there are several situations where it would make more sense to use the other method--percentages for absolute and vice versa.

Look at realtors. Realtors typically get 3% of the sale cost of the home. Some get four or more percent. During the housing boom, when houses were overpriced, realtors made a killing in the market. And all you needed was a realtor license. It was easy, simple, and quick. If you were a fast talker you could close on a house very quickly, get paid, and move on to the next sale. There is a very interesting chapter in the book Freakonomics about how realtors as a whole are not working for the sellers and buyers as they are for themselves and their profit margin. Realtors will spend more money to advertise and leave their own houses on the market longer to get a better price than a house they did not own. They do not negotiate the price for you, but benefit if you do. So when the housing bubble was growing, realtors were making out like bandits. Now let's take it one step farther. If you sell your house in middle class Podunk, USA for $400,000, your realtor makes 3%, or $12,000. During the housing bubble that house might have sold in less than ten days. So an average realtor could easily sell ten houses a year and generate $120,000 in income. Not bad for just needing a realtor license. And certainly aggravating to the rest of the world who work hard to earn their money. Now look at houses in affluent communities. Say Orange County, California, where the show The Real Desperate Housewives of Orange County in taped. Houses there sell for $3 million and up. that would mean the realtor would make at least $90,000 on that sale. I would bet that is a sore point even among realtors.

Perhaps a better way to determine realtor profit is to place a cap on the fee, such as $40,000 or 3%, whichever is lower. I just find it hard to believe that a realtor selling a $3 million dollar house is doing eight times the work or requires that much more capital to sell the house than the realtor selling a $400,000 house. I hesitate to say eight times the expenses because I seriously doubt that it requires that much more money to advertise to a wealthier buyer class.

You could also make the argument that a realtor selling $3 million dollar homes does not sell as many homes in a year as a realtor selling $400,000 or even $800,000 homes, simply because there are not enough "estate" communities. But that is untrue. Even with the housing market downturn, the estate communities are still growing because the wealthy homebuyer has no problem getting a loan and is far far less likely to need a subprime loan. Just as commercial real estate is weathering the subprime fiasco, so is the estate community.

There are similar inequities in other professions. A very common problem is that of lawyers. A large driving force behind medical malpractice cases is that in those cases, the lawyer charges a percentage of the settlement or award won by the client. It is not that people have become more disgusted with medical errors over the years, but that malpractice lawyers, seeking a higher payout, have inundated the public with advertisements promising huge financial compensations for wrongs they may have perceived or for treatments that failed to work. Though one could argue that an ignorant patient would not sue his physician if he was not aware of any wrongdoing, malpractice advertising presupposes that the prevalence of wrongdoing is unrealistically high. In many cases, the amount of damages requested or even awarded is arbitrary. And who can really show that with the growing knowledge that the lawyer will get upwards of 10% or more of the damages, judges and juries are not subconsciously inflating the damages they award? It is a very poor system that is feeding upon itself, creating a slowly growing bubble.

Beyond malpractice, there are the class action lawyers. If you have ever seen a class action lawsuit solicitation, it typically has a clause dictating the terms of lawyers' fees--a percentage up to a certain amount, or else a minimum on how much each client will receive in damages. Depending on the costs spent soliciting cases and due diligence to ensure true clients, each class action lawsuit can net hundreds of thousands to millions of dollars. Which also means that the defendants are almost always cash rich large corporations. Granted, if there was a dollar cap on lawyers' fees for malpractice or class action lawsuits, the majority of these cases would never see a sheet of paper with a law office letterhead. This could mean that the few true wrongdoing cases would otherwise never be settled. So as with employee drug testing, you test all the employees rather than wait for someone to overdose on the job. But the current practice of malpractice and class action suits is more akin to putting everyone on a methadone wean and then searching their belongings for drug paraphernalia.
It's much to costly on the system and public and reaps little rewards for anyone. Perhaps a percentage of the award up to a dollar cap may work as well for these suits. It might help staunch the oozing of greed into case solicitations and shift more money to the winning parties, especially if they deserve it.

There are so many other examples of inequity between relative and absolute systems around us, but that is for another day.

Wednesday, January 2, 2008

Road Rage I: Aggressive Driving

While driving to the shopping center the other day, I got stuck behind a beige Subaru. It was three in the afternoon and I was on a single lane road. The speed limit was forty-five miles per hour and this beige Subaru Outback was going a little over thirty-five. My first reaction, of course, was to mutter expletives and to tell the driver to “pick up the pace, jerk!”, but alas, the other driver could not hear me. So I stewed for the next mile as I drove behind this beige Subaru, trying not to tailgate. When the road finally split off a left turn lane and the beige Subaru pulled into the left lane at the light, I pulled up and glanced over at the driver.

It was a middle-aged man on his cell phone.

Now I’ll be the first to admit I expected a seventy-six year old woman with glasses behind the wheel of that beige Subaru. But I wasn’t shocked to see a middle-aged man driving like my grandmother, and that surprised me. Since when did anyone drive ten miles under the speed limit that was not lost or had a history of cataract surgery? When had the stereotypes been broken?

Befuddled but ecstatic to be free of this road sloth, I motored on pass the light. Unfortunately, not half a mile from the traffic light, I would look into the rearview mirror to see a black Acura MDX practically driving into my trunk. First the tortoise and now the hare! So I look at my speedometer—fifty miles per hour. The speed limit is still forty-five on this road. I briefly contemplated changing lanes to the right, but before I could signal, the black Acura sped around my passenger side and rocketed away. I did get a good look at the driver, of course.

It was a middle-aged woman.

She was not on the phone, though. As I shook my head in disgust I pondered why this woman was in such a hurry. My first guess was that she was just a jerk. Sure, she could have been late for a meeting, late to her child’s soccer game, rushing to get home and meet the cable guy, or really have to go to the bathroom badly. Common sense and experience told me that it was more likely that she was an aggressive driver than subject to some outstanding circumstance.

I've been on the other side of the fence before, where I thought I was the best driver on the road. Everyone else was an idiot. But I've also had my share of moving violations and traffic tickets, and I'd like the think that I have changed my driving habits. Ultimately, with or without the citations, I don’t think my aggressive driving really accomplished my main purpose—to reduce to time I had to spend in the car.

Over the years it seems that people have only become more aggressive drivers. I think there is a good reason that explains this phenomenon. It is that we care far less about petty crimes and social misconduct. It is reasonable to channel your resources towards fighting the more violent crimes and offenses. The problem with that approach is that if you are unable to control and taper the number of offenses within a short period of time, the number of offenses begins to grow, eventually outstripping your resources. The broken windows theory and the turnstile theory argue that resources are better used to fight smaller crimes. The broken windows theory argues that people see broken windows, they assume, perhaps not consciously, that no one cares or no one is policing the petty criminal. This makes people more likely to commit a petty crime they otherwise would have refrained from committing. The turnstile theory argues that people who see turnstile hoppers get away without paying train fares are more likely to also hop turnstiles. This is turn creates more petty criminals who may then escalate to more violent crimes over time. So by policing turnstiles and punishing hoppers quickly, violent crimes of the future could be prevented.

Looking at traffic violations, the enforcement of traffic violations has always remained very poor. We all know someone who has a horde of tickets packed into the glove compartment of his or her car. We all have been in the car with someone whom we thought was an aggressive driver, or been the person our passengers thought was the aggressive driver. We have all also honked our horns at some jerk we thought was driving like an idiot. More and more people take liberties while driving every day, and with good reason. How many times has that car going ninety-five miles an hour while weaving in and out of lanes on the highway really gotten caught and pulled over? Practically never. Are there really any consequences seen by the drivers who take up two parking spots because they don't care or know how to pull into a spot? Who actually gets pulled over for tailgating? Aggressive driving has permeated so far into the daily life that controlling it is more difficult than ever. If all traffic violations were actually enforced, there would be such an enormous volume of tickets equaling millions of dollars each week that no one would bother paying the ticket. Who will then enforce the remission of the fines? If this continues, driving skills will deteriorate to the point where accidents are so commonplace that nice cars disappear from the blacktop.

This should not imply that the police do a poor job with traffic violations. For some cities there aren't enough policemen to watch the roads. I suspect that for most cities it is impractical to police the traffic. Unfortunately, this only reinforces an individual based system of driving, which is based on people's aversion to being in their care any longer than needed. And every aggressive drive believes that driving faster gets you where you are going faster, even if it is not on a long stretch of highway. I do not have a good solution to this problem. We could be more stringent in driving tests for new drivers. We could crack down on speeders and tailgaters. We could ticket all parking violations. We could garnish wages to limit the number of unpaid tickets. In the end, the revenue from traffic violations may easily pay for the increased staff and man hours needed to enforce good driving behavior. There may even be surplus revenue to funnel into schools and health care. And of course, the roads might even be safer.