Toughen up

1. Milton Friedman’s comment, “Capitalism is a profit and loss system. Profit encourages risk-taking. Loss encourages prudence.”

2. Nassim Taleb, author of the Black Swan and Fooled by Randomness, released the prologue of his new book on Anti-Fragility online. In it, he expounds on Friedman’s point:

Which brings us to the largest fragilizer of society, and greatest generator of crises, absence of “skin in the game.” Some become antifragile at expense to others by getting the upside (or gains) from volatility, variations and disorder and exposing others to the downside risks of losses or harm from them.

In the housing crisis, losses were spread to other parties — investors in mortgages and ultimately to taxpayers — while the upside was retained by the bankers. This caused the bankers to exercise less prudence. How many lottery tickets would you buy if someone else was paying? Likely many more than you would buy on your own.

Then Taleb makes an even more important point:

And such antifragility-at-the-cost-of-fragility-of-others is hidden — given the blindness to antifragility by the Soviet-Harvard intellectual circles, this asymmetry is rarely identified and never taught.

Very few people see this. They even blame the problems on capitalism, never realizing that  spreading losses across taxpayers is not capitalism.

3. A blog post from the Wall Street Journal: Half of U.S. Lives in Household Getting [Federal Government] Benefits.  And, we’re not talking about benefits like driving on Federally-funded roads or sending a child to a public school that receives some Federal funds. No. We’re talking about getting a direct benefit from the government.

I’m guessing that Friedman and Taleb would suggest that this doesn’t end well.

Friedman might say that we are removing losses and therefore, removing prudence. Taleb might say that we are letting people gamble without having “skin in the game”.

Ultimately, this leads to folks taking risks they wouldn’t take if they had to pay the loss. This is dangerous itself. But, it also leads to something else that is even more dangerous. The loss of resilience, hardiness, grit and adaptability.

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7 thoughts on “Toughen up

  1. While I agree with the general point about the need to have “skin in the game,” I don’t see how my receiving Medicare benefits causes me to take bigger risks with my health. The negative effects of neglecting my health are large enough to qualify me as having skin in the game regardless of who’s paying for my healthcare. I doubt that many people decide to continue smoking because they know Medicare will pay for lung cancer surgery.

    • Hi Mark – Thanks for the comment. I agree that maintaining my own health seems like enough skin in the game. But, I’m open to the possibility that I might be fooling myself with that argument, as I saw how much of my own behavior changed when I moved from traditional health insurance to a HSA/high-deductible insurance combo. Incentives do matter.

      Here’s an example I gave in this post (https://ourdinnertable.wordpress.com/2012/01/13/another-example-where-government-begets-more-government/).

      “Let’s say you have borderline high cholesterol that could be addressed by diet and exercise or taking a cholesterol lowering medication that has a real cost of $150 per month, of which you pay $10 and insurance or government pays $140.

      If you paid the full cost for that medicine, you may be more inclined to modify your diet and exercise habits. But, for $10 a month, you feel it’s worth it to make no behavior modification.”

      I know people in this situation. Look around, you might too.

      • You make a good point. I guess we’d really need an empirical study to decide the issue definitively.

        • Thanks Mark. I’m not convinced empirical studies can decide issues definitively. We’ll always need some interpretation. For me, the evidence is draped around the waistlines of many Americans. While I do believe many factors contribute to this, I think government and third-party medical payments in general have contributed.

          Similarly, I don’t think people completely ignore saving for retirement because of the presence of Social Security, but they lazier and less prudent about it. The damage is caused on the margin, not in the absolutes.

  2. Mark and Seth – when we talk about people taking more risk when they have “no skin in the game”, we must be careful to define what the risk is and what the game is. Let’s carefully state the premise: People will engage in more risky behaviors if they don’t bear the negative consequences of those risky behaviors.

    In term’s of one’s own health, risky behaviors might include such things as smoking, neglecting your yearly physical exam, etc. The negative consequence (in terms of one’s health) – otherwise known as the cost or the skin in the game – is sickness. If Seth, and not I, bears the consequence of me smoking or skipping my physical exam, I have less incentive to avoid those risky behaviors. Since it is unrealistic that Seth (rather than me) would be more likely to get sick from my risky behaviors – in other words, because I do have skin in THIS game – from the standpoint of MY HEALTH, I have an incentive to avoid THESE PARTICULAR RISKY BEHAVIORS.

    Now, when it comes to Mark receiving his Medicare benefits, i.e. when Mark’s financial cost of getting sick is less than if had to pay with his own money, it can certainly be argued that he has less incentive to stay well. However, we must remember that wealth is not merely the dollars that we have in our bank account, but rather our entire state of well being. As such, Mark measures the cost of sickness not only in terms of how much he will pay in dollars, but how much he will pay in terms of his overall well-being. Mark essentially makes the point that these non-financial concerns outweigh the financial costs.

    But let’s consider the fact that roughly 25-35% of all Medicare dollars are spent on the 5% of Medicare patients who die in a particular year. If I told you that you have a terminal illness (and we all do) and that with and without treatment your life expectancy is 6 or 3 months respectively, but that treatment will cost $1,000,000.00, which option would you select? Better stated, which option do you think most people will select if the money is coming out of their (and their heirs) pocket versus someone else’s pocket?

    When the direct loss is removed, people will be less prudent and less concerned because most people do not either recognize or believe that by electing to have “the government” pay these huge sums (that they would be reluctant to personally pay), they are impoverishing their children and grandchildren and some (because they don’t have skin in the game) will not care because they see that it will be others that bear the consequences of their costly behavior, i.e. the behavior of seeking out care that they would not have demanded if they were paying the bill.

    PS – Seth, your point on American’s over-reliance on Social Security and the resultant lack of prudence concerning personal savings is well made. The government security blanket has fooled people into believing that there are no or few adverse consequences in failing to put something away for a rainy day. As such, rather than save, they spend it all now.

    • Nice post, Mike. Thanks. Not having to save for a raining day almost seems to be treated like an entitlement anymore.

  3. Pingback: No skin in the game | Our Dinner Table

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