A Union Ultimatum

Pundit Surfing

Last week (2011-03-25) I was channel flipping at the Houston Airport Marriott, preparing for my flight home to Ottawa the next morning. I stopped on a pointless pundit discussion involving Peter Schiff (CEO of Euro Pacific Capital), a brightly dressed Curtis Sliwa (founder of the Guardian Angels), Kim Guilfoyle (host of “Hitting the Headlines”) and Fox News’ token liberal strawman effigy punching bag, Alan Colmes. It turns out it was Fox Business’ Follow the Money with Eric Bolling. You can see the discussion on Schiff’s page.

They were talking about unions and union-busting and Colmes and Schiff got into a heated discussion about the value of workers versus entrepreneurs, obviously with Colmes defending workers and unions, and Schiff claiming that the real value and real risks are taken on by the entrepreneurs who create jobs. (It starts about 8:24 in the video.)

This discussion seemed to me to the be epitome of the left vs right ideological arguments as far as unions: the left claiming that workers deserve “their fair share” and the right claiming the business leaders create the value and the workers should take what they’re offered or lose their jobs. I was a little disappointed in Peter Schiff though. He seems to be smart enough and should have some decent background in economics. Perhaps he just never learned anything about economic game theory, particularly the Ultimatum Game.

The Two-Player Single Game

You may have heard of the Ultimatum Game before. Two players have an opportunity to earn a combined $100. Player 1 decides what portion of it to offer to Player 2, and Player 2 decides to either accept the split or reject it, in which case neither player gets any money. In that context, I’ll call Player 1 the Bidder and Player 2 the Decider.

If you are a Decider and playing a single game, the only rational answer is to accept whatever the Bidder offers to you, even if it is only $1. Your choice is between you getting $1 and nothing How much the Bidder gets is irrelevant to your direct interests. The interesting thing is that in formal testing, most people reject low offers, typically below 20%. I’ll talk about that in in a later post (and link it here). It’s not really relevant at this point.

The Two-Player Repeated Game

The optimal Decider strategy changes if you play the same Bidder many times. If you reject low offers, you will earn them back quickly. Reject a $1 offer you will be out $1 but next game the Bidder will offer more from the lesson. Bidders should increase their offer substantially after each “lesson” because they are losing a lot more each time. (Technically, they aren’t losing it, they are missing out on the opportunity to gain it.) Obviously they won’t offer more than 50% because then the tables turn and you are losing a lot by rejecting, which you won’t make back. (Somewhere between $20-$50 is a typical acceptance range for human players.)

The Multi-Player Repeated Game

If the repeated game is played by many different Bidders and Deciders, the most rational strategy for Deciders changes again. You, as the Decider, cannot expect your current Bidder to learn a lesson from you for next time because there may not be a next time. You’ll be playing a different Bidder. The most rational strategy is, once again, to accept any offer. It’s even worse if Bidders get to decide which Deciders they play against. Competition between the Deciders will push them to accept and maintain the lowest possible offer. If they reject and try to force an increase, the Bidder will switch who he plays against.

The key thing to note here is that the Bidder has done nothing to deserve any of the money more than the Decider. The money doesn’t exist until the Decider says it does. It is a symbiotic relationship where each player needs one another to gain from the opportunity. Yet the construction of the circumstances allow Bidders to exploit Deciders. As a result, Bidders become hyper-rich and Deciders stay poor and must scrounge for whatever they are offered. I will point out again, this divide isn’t by merit, but by construction of the circumstance.

The Deciders’ Solution

There is a better solution for the Deciders. If all of them could agree to always reject low offers, then the different Bidders could learn a lesson across players and start offering more. This agreement would have to be enforceable to be useful. It would be in your best interest if everybody else lived up to the agreement, but you could cheat and accept the low offers in addition to benefiting from the pressure to give higher bids. That’s true of everyone, so it’d fall apart fast if not enforced. To be enforceable, the transactions would have to be visible to the other Deciders and they’d have to be able to inflict some penalty. In other words, they would have to form a union.

Now, with a Deciders union, the Bidders would have their low offers rejected and learn to share the opportunity more fairly. I say fairly because, as I pointed out earlier, the Bidders do not inherently deserve a larger cut and certainly not 99% of the opportunity. Furthermore, now the Bidders have to compete to play the Deciders. If the Deciders decide a certain Bidder offers too low, that Bidder never plays and gains nothing.

Mistaken Like a Fox

So this is where Schiff is simply flat our wrong. Indeed, entrepreneurs and business leaders are a wonderful and important part of the economy. Without them, there’d be fewer opportunities. But they aren’t saints who generously create jobs for people. They are looking for a buck and symbioticly need workers to take advantage of the opportunity. And without unions, they can exploit the workers to take a portion much larger than they deserve. Entrepreneurs are not the generators of wealth or jobs. They are the generators of opportunities. The workers actually generate the value, wealth, and subsequent jobs that come from the opportunity. Both are needed and neither is fundamentally more important than the other.

This is why a union structure is a necessity in a meritocracy.

I’m shocked to hear myself say that. I used to hate unions, especially when I was part of one. I used to think I’m fine with negotiating my own conditions, and I was angry at the union executive for entertaining the whiniest, most unreasonable, and most irrational complaints in their demands. To me, unions were not a means towards empowering workers. Rather, it was taking power over my situation from the business management and giving it to the union management, with whom I rarely agreed on demand positions. I still think that is true, and unions need to keep reality and rationality in check. But, I now understand their economic and strategic value. 

What Schiff et al properly pointed out was that GM’s union asking too much would take the work elsewhere where work was cheaper. That is true, to some degree, but only so much as there was skilled labour available, and only because those Deciders had not formed a union. That is a structural issue. It does not mean that GM is deserving of more share than the workers. Wherever GM moved, a union might be the best solution for the workers, which gets rid of that structural problem. But that’s not what Schiff and the pundit team suggested. They were clearly anti-union anywhere, as Colmes tried to suggest.

Further, Bolling got it completely wrong at the beginning (08:24) when he suggests the inmates are running the asylum. As the Ultimatum Game shows us, it is neither the Deciders nor the Bidders that run it; it is a collaboration. Guilfoyle is even worse at economics, saying these demands are “crushing the city and the local economy”. If the money is going to GM, it doesn’t help the local economy. If it goes to the workers, they spend it locally and help the local economy. Additional profit at GM doesn’t go towards groceries, housing, or consumer products in the area.

In the end, I’m just saddened that this group of highly trained, expert economists get the economics so wrong. (OK, perhaps none of them are, which is likely the problem.) OK, so I’m not exactly one either. (How about intermediately trained and experienced then.) But Schiff has a degree in finance and accounting, and works in the field of financial economics. He should know better. That’s the most disappointing part. Then again, he proclaims to follow the Austrian school of economics, a set of outdated, non-scientific, non-mathematical principles normally associated nowadays with libertarians, and they clearly do not understand game theory, a topic for a later post.

Incidentally, the exaggeration of entrepreneurial value relative to that of workers is also a byproduct of the erroneously oversimplified Objectivist application of rational self-interest in Ayn Rand’s works such as Atlas Shrugged and The Fountainhead. The error results in concluding that laissez faire capitalism is the best economic system. The problem is that this doesn’t address the common economic paradox of the Prisoner’s Dilemma, of which the Ultimatum Game is one form. It has the paradoxical solution that your best interests actually lie in giving up the right to pursue your own best interest in favour of accepting the collective best interest. This is also a topic for another post.