Unfairness in Life: Skin in the Game

In the normal, fair and well-functioning parts of our society, costs are borne by the people who benefit. In unusual, unfair and badly-functioning parts of our society, benefits accrue to select system-abusers, while the costs are borne by others.

When you invest money in a business, you ordinarily have a stake in the outcome – you benefit if it profits, and you suffer if it loses. Your shares give you skin in the game. When you invest time and resources in improving your physical fitness, you benefit from the physical impact while suffering the cost of effort. When you eat the extra piece of cake, you gain the pleasure of the cake at the expense of the future health impacts. In managing your personal health, you very obviously have skin in the game.

Those examples above are pretty simple, fair, and relatively well-functioning in our day-to-day lives. There are, however, a bunch of unfair and badly-functioning situations in our society where people do not have skin in the game. This creates unfairness in life, and often incentivises bad outcomes.

These situations of unfairness are often caused by one person enjoying the benefit, while someone else bears the cost. Here are some simple examples:

-Polluting businesses which dispose of toxic chemicals into a river. The business benefits from cheap disposal of chemicals, but the cost is borne by people downstream who can no longer benefit from the river because it is filled with toxic chemicals.

-The banking crisis of the mid-2000’s. For years, high-flying bankers took bonuses based on profits, while the underlying risk was subsequently funded by taxpayers in huge bank bailouts. This was caused by the banker remuneration not properly reflecting the risk they created.

Closer to home in the Isle of Man, matching costs and benefits lead to improved incentives for decision-makers. While, of course, there were some underlying mechanical differences between the Promenade and Tesco car park, there’s one key cost/benefit difference which encourages Tesco to minimise business disruption, but doesn’t impose the same requirement on the Isle of Man Government.

When Tesco needed to resurface its car park, it ensured that the work was done quickly and efficiently to minimise the harm to its business. As a corporation, Tesco bore both the cost (a temporarily closed car park) and the benefit (a subsequently improved car park) and was able to properly offset the two issues. By contrast, the Government Minister responsible for leading the redevelopment of Douglas Promenade suffers none of the cost: it’s not his business that is harmed by slow work and huge disruptions. It’s not his life’s work of building a business which is on the line when delays happen.

I don’t think it is any coincidence that Tesco’s car park was resurfaced quickly with minimum business disruption, while Douglas Promenade is facing delays at great cost to local businesses and workers.

So, what’s the lesson from this? To try to ensure that the cost of risks are properly borne and linked to the benefits of any endeavour. It means linking incentives properly to good measures of accountability. It means properly rewarding good performance and properly punishing bad performance in different areas of our society.

Of course, many of the ideas above are not new, and I certainly did not invent the concept of “Skin in the Game”. Much of my inspiration for this blog post and my broader thinking on this issue came from the author Nicholas Nassim Taleb, who has written an outstanding series of books on this issue. They’re well-worth reading, and I have found them to be deeply inspiring – and has improved my skepticism of frauds and bullshit artists who do not have “Skin in the Game”.

One thought on “Unfairness in Life: Skin in the Game

  1. This isn’t about skin in the game so much, well part of the article isn’t (it is disjointed article). You are talking about externalities for large parts, in particular negative externalities. Another example is taxation of ‘sins’, as in fuel, tobacco, alcohol et cetera. In these example, like your pollution one, you use regulation or taxation to charge for these externalities. You are asking how to internalise costs of delays et cetera on a government scheme.

    Tesco would have done the car park as they would have done some form of NPV analysis and understood a better car park would link to more customers and therefore more profit, they wouldn’t have done it otherwise. It is just an investment decision that every business makes. There isn’t really an externality quite like a public road. They probably paid a steep price to get the work don’t quickly, governments tend to focus on cost reduction (albeit they have done it poorly in this case).

    Governments tend to have a different incentive structure. Hence why they provide public goods, such as street lighting, roads et cetera. They also focus on things like cost over speed, as they want to minimise actual cost to taxpayers usually. So what incentive structure would enable them to provide the service better? Usually it would be elections, as you tend to get kicked out if you do a poor job and you could probably include reputation in that. Otherwise it is quite difficult to really punish politicians, they are not experts after all and in the Isle of Man case the word ‘layman’ could be used broadly.

    Like

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.