Thursday, October 7, 2010

Do We Really Prefer Winner-Take-All Races?

In a recent post, Ezra Klein talks about the founding of Facebook and makes some important, relatively rarely considered, economics points. The following is a long drop quote, but please read it; the points are  important, and the ones I will make after depend on it:
At the same time, of course, Friendster, MySpace, Orkut, and a variety of other social networking platforms were swirling about. After all, technological advances had made these things simple enough that even college students could pull them together in a few weeks. If it hadn't been Zuckerberg, it would've been someone else. Maybe Goldberg.

This is a rather common phenomenon: It's called "simultaneous invention," and it happens all the time: Technology advances to the point that the next step is obvious to multiple people, and so they all take the next step at approximately the same time. In the end, one of them gets the patent, or the market share, and so squeezes the other out and becomes synonymous with the invention. That's what happened with Alexander Graham Bell, who in all likelihood invented the telephone after Elisha Gray -- and both of them came after Antonio Meucci. Amusingly, the discovery of "simultaneous invention" was another case of simultaneous invention, with multiple thinkers and researchers publishing on the phenomenon all at once. "Unjust Deserts," by Gar Alperovitz and Lew Daly, has a good discussion of this.

What does this have to do with the movie? Not that much. Insofar as the film implies that only Zuckerberg could've invented Facebook, that's wrong. But since the movie is mainly a character study of Zuckerberg, it's a bit churlish to criticize it for focusing on his characteristics so intently. Alperovitz and Daly, however, would argue that it has a lot to do with how we should think about inequality. "Differences between individuals are almost negligible compared to the influence of the resources, infrastructure, and most important of all, the knowledge an individual has at his disposal," they write.

In other words, the difference between Mark Zuckerberg and Adam Goldberg was very small, while the difference between Mark Zuckerberg and the smartest college kid in 1999 was huge. It was the advancing storehouse of human knowledge, not the advancing capabilities of particular humans, that made up the difference. But humans tend to think about things in terms of other humans, and so we overestimate the impact of personalities (autistic genius) and underestimate the importance of technology (all sorts of people could suddenly build social networking platforms in under three months). That also makes it easier for us to believe people deserve* enormous, inconceivable monetary rewards for their inventions, as we tend to attribute the entire value of the product to them, as opposed to attributing the incremental difference between that product and whatever was right behind that product to them.

"There's a different argument that assuring people astronomical profits for creating useful things makes them more likely to create useful things. That argument makes more sense."
Ezra finishes up with this:
Note the word "deserve." There's a different argument that assuring people astronomical profits for creating useful things makes them more likely to create useful things. That argument makes more sense.
It does to some extent, but you can be way past the optimal point on that.

Consider this situation, which is analogous to the entrepreneurial, innovational example Ezra discusses:

You're in a race with 100 other people (or considering entering one). To have any chance of winning, you have to train for a year full time, so you can't work and make any other income besides what you may win in the race. Everyone has very close to the same odds of winning, about 1%. Even if you're most likely to win, your odds are still only 3% of winning and 97% of losing.

There are three ways the race's prizes can be structured that all cost the same to the races sponsors; let's call those sponsors society:

A) The Winner-Take-All Way – the winner of the race, first place, gets $100 million; everyone else gets zero.

B) The Very-Low-Taxation Way – the winner of the race gets $99.55 million. Second place gets $100,000. Third place gets $70,000, and the other 97 competitors get $20,000 – and this is for a year's work.

C) The Strongly-Progressive-Taxation Way – The winner of the race gets $30 million, and the other competitors divide up the other $70 million in a not extremely uneven way: Second place gets $2 million, third place $1 million, fourth place $700,000, and so on, so that even the 100th place competitor still gets $40,000, so he can at least afford to keep his family's health insurance and not lose their house.

Now really think about this:

1) Suppose you were able to enter this race, and chose either A, B, or C. Which would you prefer – even if you knew you were the most likely to win, even if you knew you had the 3% chance?

2) Do you really think you'd have that much less incentive to train hard for the race if the highest potential winnings were only $30 million, like in C, as opposed to $100 million, like in A (and keep in mind that in C you still have a strong incentive to train hard even if you think you have no chance of getting first, just because 90th pays a lot more than 100th)?

3) If the race were set up like A, would you even risk spending a year to train to enter? Would you even risk trying? And would you be (far) more likely to enter the race, to risk trying, if instead the race were structured like C?

So, the moral of the story is the vast majority of us are far better off, both ex-ante and ex-post, with highly progressive taxation in "winner-take-all" type situations, and such situations are common in the ultra high economies of scale, ideas/information based, modern high tech world. In addition, rather than decreasing the incentives to make an effort, take risks, and innovate, progressive taxation (if not taken to a ridiculous extreme; no one in power in the Democratic Party wants communism) increases incentives to make an effort, take risks, and innovate. And it funds the widespread education, public resources, and seed funding that makes widespread effort and high utilization of human productive potential possible.

As the world becomes more and more "winner-take-all" with ever greater increases in economies of scale, technology, and importance of zero marginal cost ideas/information, greater progressivity of taxation will become more and more important to maximizing growth and total societal utility.

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