The giddy tournaments of capitalism
- Govt revokes passports of Nirav Modi and Mehul Choksi
- Warren Buffett warns investors that safe-looking bonds can be risky
- Rotomac fraud: Lucknow court hands over custody of Vikram, Rahul Kothari to CBI
- PM Modi launches Tamil Nadu government’s Amma scooter scheme
- India, China agree on bilateral engagement calendar
In spring, the fancies of the young and innocent turn lightly to love. Meanwhile, the rest of us must be content with the vagaries of the Uttar Pradesh election, which certainly cannot be accused of exhibiting the peace of the graveyard.
In terms of real-world applications, the analysis of auctions ranks as one of the most notable successes of game theory. But in the context of elections, even more far-reaching are its explorations of phenomena which, in general parlance, may not be referred to as auctions at all. These are “all-pay auctions”, in which there is only one winner, but all bidders pay the entire value of their bids. An electoral contest in which two or more candidates pour effort, resources, and, not to forget, a fair amount of liquor into the electorate, is one example of an all-pay auction.
What is the game theoretic prediction about the individual and aggregate resources expended in an all-pay auction? Since the efforts of a player will come to naught unless she wins, there is a strong incentive to “bid” aggressively. On the other hand, if everyone bids aggressively, competition will be fierce, and it might make sense to stay out of the contest altogether. But not bidding cannot be an equilibrium strategy either, because if everyone except one player chooses not to bid, then this player could walk away with the prize for next to nothing. Therefore, the optimal approach is to randomize the bid, choosing every possible level of bidding, including the zero bid, with some positive probability.
If bidders behave in the manner predicted by theory, then we would observe that, on average, the total effort and cost undertaken by all the bidders combined would be commensurate with the value of the prize on offer. However, evidence from experimental game theory research shows a regular pattern of overbidding in all-pay auctions resulting in an over-allocation of social resources. The 2016 US presidential election saw a total spending of close to $3 billion. In the Uttar Pradesh election as well, political parties, seemingly oblivious of the decree of demonetisation, are engaged in a bonanza of spending. The explanations for this phenomenon include the non-monetary satisfaction derived from winning, aversion to inequality, even spitefulness! This is in contrast to the observed behaviour in “rank order tournaments”, in which there are a large number of winners with graded ranks, and aggregate bidding is in alignment with the total kitty on offer.
While the all-pay auction theory predicts a pattern of over-expenditure, we must probe deeper to understand the stratospheric increase in the money spent in elections over the years. In the context of the US economy, we need to examine the workings of all-pay auctions in the sphere of technology businesses and the financial services industry.
Netscape founder and venture capitalist Marc Andreessen, known for his forthright prognostications, said: “Success in software is winner take all. Second prize is a set of steak knives, and third prize is you’re fired.” He also proclaimed, “Software is eating up the world”, when alluding to the increasing ability of software to occupy a central position in industries as disparate as healthcare and automobiles.
So competition in a large number of markets is beginning to resemble an all-pay auction. In such markets, not only is there an over-allocation of society’s resources to such industries but also a steep income gradient between those at the very top and those just below them. In 2014, the top 0.1% Americans took over 15 times the average income of the rest of the top 1% and over 184 times the income of the bottom 90%. A society which needs a balance of philosophers, poets and engineers gets instead a profusion of data geeks, reflecting issues of resource allocation.
One of the results from experimental evidence is that participants expend more resources in all-pay auctions when bidding with other people’s money. Whose money are venture capitalists and technology entrepreneurs playing with? If they are made to bear the brunt of their losses as much as they enjoy the benefits of their success, then it is their money, no questions asked. But if the losses of financial backers are protected by too-big-to-fail logic and profits are not taxed, then it means that the financial services and technology industries are playing with society’s resources.
The privileged position of those at the top is protected by links between these industries and government. Thus, the sharp increase in the share of gross domestic product going to industries like financial services and technology explains the rapid growth in the level of electoral financing in the US from the levels seen when market competition resembled rank-order tournaments rather than all-pay auctions.
In India, the money flows to political parties are mainly a result of rents earned by private enterprise in natural resource based industries, rents that are secured by government machinery and that, to a large extent, are not taxed. These rents have increased sharply since the liberalization of the Indian economy.
So one must acknowledge that many social ills, including development conflicts in India and the election of a rabble-rouser like Donald Trump in the US, are related to the cosy handshake between technology, finance and the government, mediated by the mechanism of the all-pay auction. While the masses are kept opiated by the giddy tournaments of capitalism, a few make off with the spoils. Petty considerations, perhaps, for the immaculate crystal-ball visions of the likes of Andreessen!
Rohit Prasad is a professor at MDI, Gurgaon and author of Startup Sutra. Game Sutra is a fortnightly column based on game theory.