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Strong reciprocators

March 25, 2009

Back in the saddle again – up good and early this morning and finished Loneliness.  I’ll have a full review up tomorrow.  It’s a pretty good book, especially as it isn’t padded out the way so many high concept nonfiction books are these days – books that are essentially long magazine articles (usually because they started as one) reset in large, well-spaced type with lots of repetition and digression.  There was one part I thought was interesting but off-topic, so I’ll condense it here rather than putting it in the review.  I think it’s a interesting take on our current financial collapse (edited/paraphrased with ellipses/brackets omitted for readability):

Researchers conducted an experiment that separated 84 participants into two different investment clubs.  The experiment consisted of thirty repetitions of a three stage process: a “choose your institution” phase, a “make a contribution” phase, and a “sanctioning” phase.  Each participant in the experiment started out with twenty “units” of money.  After choosing which institution to trust, players chose what to contribute to the collective fund, from nothing to all twenty units.  Whatever a participant chose not to include went into her own private account.  Whatever went into the collective pot would increase in value, and would be divided equally at the end of play, regardless of the level of individual contributions.  At the end of the contribution phase of each round, all the players were told how much everyone else had contributed, and kept informed of everyone else’s earnings to date.

In phase three, with the introduction of sanctions, the two institutions diverged dramatically.  In Institution A, there were no sanctions.  In Institution B, each player had the option of penalizing free riders and rewarding the generous.  Each player could assign a penalty token of three units to non-contributors, at a cost to themselves of one money unit, and reward generous contributors with a reward token of one unit at a cost to themselves of one unit. 

At the beginning, only a third chose the sanctioning institution.  However, by the tenth round almost 90% had gone over to that institution.  Moreover, the folks in B were cooperating fully.  By the thirtieth round, contributions to A had dwindled to zero.  The reason for the surge in B:  an institution in which generous contributions to the commonwealth are the norm – a norm reinforced by sanctions – delivered the highest returns to its members.

Free riders in A earned the highest payoff in the first round, but after that their profit declined sharply, eventually leading to a total collapse of their laissez-faire arrangement.  After the fifth round, high contributors to the sanctioning institution were earning more, which had a snowball effect on membership and earnings, as more people saw the benefit and wanted to join. 

But much of the credit for the high earnings belongs to the “strong reciprocators” who punished others for riding free, even at a cost to themselves.  In the first rounds there was no obvious financial benefit to slapping other participants with fines, but after several iterations, enforcement of standards led to a continuing increase in efficiency, with more and more people becoming high contributors, so much so that the need for negative sanctions faded away.

Essentially we’ve seen Wall Street and the financial markets become “Institution A,” wherein the reward was based on taking as much as possible out of the system in bonuses not tied to performance, commissions on repackaging and reselling debt, collecting premiums on “reinsuring” securities for which you didn’t have the capital to pay off the claims, etc.  But once everyone sees how the institution’s rules are skewed to benefit the free riders, they take their money out.  What we need now is to remake the financial system to be more like “Institution B,” where extracting value without adding value is punished.  Finance will never be an altruistic system, nor does the experiment suggest it should be – but to function successfully, it does need to be an honest, cooperative system.

Also in the news:  Hey everybody, the new Computational Linguistics is here!  I’ll be tackling some of that in the coming week as well.

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