If Only the Ayatollah Learned Fairness in Kindergarten

Watching the Iranian election, Karsh reminded me about a study I had read about in Wisdom of the Crowds that emphasized the importance of the perception of fairness in human society.

The study went something like this: you and I would sit across from each other, and the researcher would give me $10. I could then divide up the $10 between you and me however I wanted. I could take all $10 for myself and give you $0 in fact. The catch, though, was that if you rejected the amount I gave you, we both got nothing. Most people split the $10 down the middle, $5:$5, or slightly skewed to the person making the offer, $6:$4.

Now let's go back to the two of us sitting across from each other. I get the $10, and I decide to give you $1, and I take $9. What would you do? Do you accept? If you accept, it would make rational economic sense, since you would have one more dollar than if you reject (remember, we both get $0 if you reject).

What the researchers found was that in most cases, people would reject an offer of $3 or less. People cared more about fairness in the interaction than they did about the economically rational move.

The author of Wisdom of the Crowds, James Suroweicki, goes on to explain that they did studies on income disparities between the rich and poor in various industrialized countries, and the United States came out with one of the higher disparities. Poor Americans, though, were among the most satisfied with the income distribution. Why? Suroweicki points to the perception of the American Dream. The poor Americans believed that with hard work and dedication they could be rich too - it was a system that was perceived to be fair (though that's easily disputed).

The perception of fairness is just so powerful. One of the most remarkable moments in American history was the first change in power between political parties. Historically, despots would be overthrown and political factions would war with one another instead of giving away power. In the United States, not a single ounce of blood was shed or riots started over the change in power. It was peaceful; the election of leadership was a system that enough people bought into and believed was fair.

The protests in Iran did not start because Iranians hate Ahmadinejad (though many of the protestors do) - they started because Iranians didn't believe the elections were run fairly. They bought into a system of government where their votes would be counted, and they perceived that the Ayatollah changed the rules. The protests are now about more than just the fairness of the election system, and discontent has certainly been brewing in Iran for a while, but the fairness of the election is what set this whole thing off.

I find it fascinating to look for the perception of fairness and the systems that people buy into to create that perception. The systems are everywhere - from lottery drawings to admissions processes - and don't underestimate the stir people can create if a system isn't fair. Sometimes it can overthrow governments.

Why Is Health Care Spend Worse Than iPod Spend?

What makes health care spending particularly "bad?" I mean, we're trying to limit our health care spend as a country, but why would health care spend be any less of a productive use of money than say buying an iPod?

Harvard economist Greg Mankiw today juxtaposed a statement by Barack Obama forewarning that health care costs could rise to 30% within 30 years with a study that showed that optimal health care spending was over 30% of a peron's income:

Economists Robert Hall and Chad Jones, writing in the QJE a couple years ago:

Over the past half century, Americans spent a rising share of total economic resources on health and enjoyed substantially longer lives as a result. Debate on health policy often focuses on limiting the growth of health spending. We investigate an issue central to this debate: Is the growth of health spending a rational response to changing economic conditions—notably the growth of income per person? We develop a model based on standard economic assumptions and argue that this is indeed the case. Standard preferences—of the kind used widely in economics to study consumption, asset pricing, and labor supply—imply that health spending is a superior good with an income elasticity well above one... In projections based on the quantitative analysis of our model, the optimal health share of spending seems likely to exceed 30 percent by the middle of the century.

Amazing what economic models can show you. What makes health care spend a "bad" cost to me though is that it's too often an unmanageable financial burden, namely for:

1. Government. The major driver of our budget deficit is an exponential rise in health care spend. The government will go bankrupt unless it lowers costs and/or cut back coverage.
2. Individuals. According to the Center of Economic Advisers, about 17% of individual bankruptcies result from catastrophic health care expenses. The "rational consumer" who "smooths consumption" doesn't plan for those outlier events of severe injuries and illness. Extending life may be worth the financial burden, but it too often bankrupts a person.

The Center of Economic Advisers report other positive externalities from health care reform, such as higher GDP , lower unemployment, and more discretionary spending for families.

Health care spend, in itself, is not inherently "good" or "bad." I think the key is to find a way to make health care costs manageable for both government and individuals.

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• Obama Pushes Theme That Health Reform Is Good Economics (blogs.wsj.com)

The $2M School Teacher

Venture capitalist Bill Gurley posted about a Korean company called Megastudy that provides online courses for students. The company sells each lesson for somewhere between $20-$120, and it shares a quarter of its revenue with its teachers. The business has reached a billion dollars and it has paid a teacher as much as $2M in a year.

Think about that for a minute: a school teacher that makes $2M.

Before the internet, the economics of a teacher were constrained to the size of their classroom. If I teach 25 kids in a class for a year, it limits the amount of money I can make. People bemoaned the millions that football players made in comparison, but each football player entertained millions of people through television, where teachers could only reach 25 at a time.

The internet has a remarkable ability to lift prior scale restraints. One teacher can now reach millions of students through the internet, and they can start making a football player's salary.

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• Tech Company Helps South Korean Students Ace Entrance Tests (nytimes.com)
• A Really Interesting Online Education Company in Korea: Megastudy (abovethecrowd.com)