Riddle me this, Mr. Economist:
Two strangers are selected to participate in an experiment. They are given a combined sum of $10. This sum is to be split between the two of them. One person will be the splitter, and the other the receiver. The splitter makes the choice of how the $10 would be split. The receiver would then have the choice - he could accept the split, in which case both participants would get the amounts chosen by the splitter; or he could decline the split, in which case both parties walk away with nothing.
Question - How should the splitter break up the $10?
Here is how the game theory calculations based on traditional economic arguments would go - If I am the receiver, it really doesn't matter what the offer is, I should accept anything. After all, getting anything is better than the alternative - getting nothing at all. Now, if I am the splitter, I know that is what a rational receiver is thinking. So I would go as extreme as I could go. I would keep $9 for myself for instance, and offer a $9-$1 split. And the receiver, true to form, would accept.
Life, mercifully, is way more interesting than that. The description of how interesting, is one of the highlights of brothers Ori and Rom Brafman's superficial but entertaining book Sway - The Irresistible Pull of Irrational Behavior.
The '$10 splitting' experiment was first performed in Berlin, with the two strangers in each pair sitting in physical separated rooms, so they can't even see each other. Here is the fascinating thing: Far from offering a $9-$1 split, the most common split offered was $5-$5. And every receiver offered this split accepted. In the minority of cases that the splitter assumed 'rational behavior' and offered a less than 50% share, the receivers flatly refused the offer and preferred to walk away with nothing. Classical economic theory is founded on the premise of rationality of economic actors. The behavior of the receivers in this case, not to put too fine a point on it, isn't exactly rational.
It gets more interesting. The experiment was repeated in the US, Japan, Indonesia and Israel. Everywhere, the same 'irrational' behavior. Receivers wouldn't take an 'unfair' split. Then, the researchers took the research deep into the Peruvian Amazon, to the Machiguenga tribe. The same structure of the game, though this time, the $10 has been converted into a local currency of equivalent value to the tribesmen. Here is what happens - the splitters routinely offer 85/15 splits in their own favor - and the receivers almost always accept the unfair split!
What is going on here? Why are tribesmen in Peru acting more in accordance with principles of rational economic behavior than college educated Westerners? The answer lies in the principles of fairness. No book on classical economic theory likely ever talks about 'fairness' as an economic principle. But in the real world, it is difficult to ignore it. The Western participants in the $10 experiment have deep rooted belief in the principle of 'procedural justice'. The process of sharing should be, in their view, fair. If it is perceived to be unfair, they will ignore their own economic self-interest to thwart it. The tribesmen in Peru on the other hand, have a different sense of fairness. This is a more fatalistic group. The fairness principle they have in their mind is "I had equal chance to be chosen as the splitter. It is just my luck that I ended up being the receiver. If I had been the splitter, I would have kept the most amount of money to myself too." Fairness, it appears, is in the eyes of the beholder too.
This, in summary, is why I am so excited about Behavioral Economics. Readers of Brick and Rope might remember my enthusiasm for Predictably Irrational - the Dan Ariely book that was on my list of Best Reads from 2009. I have maintained for a little while that Behavioral Economics is going to fundamentally change businesses like Banking over the next few decades. I am not much of a seer, but if I were in that business, this is the prediction I would make - The business that figures out how to tame the behavioral element in economic decision making of individuals, stands to make a lot of money.
Daniel Kahneman, one of the patron saints of Behavioral Economists, seems to have similar ideas. I saw a group of corporate suits with snazzy presentations walking banking hallways with Behavioral Economic jargon. Turned out they represented a firm that had Kahneman as a star employee. They even had (surprise!) a Behavioral Economics product to sell. From the look of their well cut suits, someone out there is buying.
Back to Sway for a minute though. The book grabbed my eye only because it is another popular book on this subject that is one of my favorite areas of recent advancement. The anecdotes in the book are exactly the kind that would make you shake your head in amazement and say "I wonder which Neanderthal ever came up with the 'rational agent' idea?"
This isn't exactly breakthrough stuff. Sway is a breezy enough read that you wouldn't have sunk countless hours into the book. But don't go looking for great insight. Much of the book is just as clunky as its subtitle. I mean, "The Irresistible Pull of Irrational Behavior"? Really? Where did they find the focus group that liked this title? In the Peruvian Amazon?