I suppose that the original intent of financial aid—most particularly scholarships—was to attract good scholars who would be likely to become famous and thus increase the prestige of the university. By offering intelligent, driven individuals an opportunity to be educated for reduced rates or for free, universities could be assured that they would attract some number of desirable students, and increase their prestige. Note that increasing prestige has a tendency to turn into a self-reinforcing feedback loop, which means that increasingly prestigious universities attract increasingly desirable students, thus making the university more prestigious. As such, universities engage in a sort of arms race to increase their prestige, and thus offer scholarships to scholastically-minded students.
However, the role of financial aid has morphed in recent years to serve as a marketing tool, and functions similarly to a price-sensitivity indicator.* By this I mean that financial aid is to colleges as coupons are to grocery stores. The comparison is not perfect, of course, but the general comparison is the same in that both financial aid and coupons both serve to differentiate the price-sensitive from the price-insensitive.
What’s interesting is that both the original function and the modern function of financial aid are both the same: marketing. The original form, though, is less direct and has a longer time horizon. The latter is more price-driven. This suggests that the product has changed in some way. Assuming that a postsecondary education is a way to signal employ-ability, it should make sense that colleges emphasize affordability in their advertising because the signaling benefit has declined due to the increase in noise.
When only a few people graduate from college, there is likely an appreciable difference in the graduates of different institutions, hence the need for prestige. However, if a lot of people graduate from college, it will likely be difficult to discern a difference in the graduates of different institutions. The lesson in all this is that colleges that emphasize prestige in their marketing are colleges that will offer a clear signal of prestige while colleges that emphasize affordability are all likely interchangeable in terms of signal utility. Therefore, if you aren’t going to a prestigious university, the best course of action is to acquire a college education as cheaply as possible. And if you can’t a get a cheap college education, you are probably better off skipping college.
* I recall when I was being recruited by various colleges that many would state what percentage of students received financial aid. There were a large number of colleges that claimed that over three-quarters of their students received some sort of scholarship money.
Maybe my discipline for reading has been waning in recent weeks, because this is the second consecutive book that I’ve been unable to read in its entirety before quitting. The problem with The Winner’s Curse is that it is a highly technical way of saying “duh.” By this I mean that Thaler addresses issues that are only problems for economists that apparently have no experience with actual human beings.
Economists have long assumed that humans are, fundamentally, rational creatures. Even von Mises assumed as such, although it should be noted that his usage of “rational” was tautological, and based solely on economic actor’s behavior (instead of, say, the economic actor’s stated goal) and bound by the limits of human knowledge. Basically, Mises argued that one’s “true” desires were shown by one’s behavior, and that all humans pursued the most efficient course of action to attain the desired ends.
However, mainstream economists generally tend to define “rationality” as one’s tendency to act in one’s best long-term interest. Whether this definition accounts for the constraints of humanity (i.e. imperfect knowledge, the constraint of time, etc.) varies by economist. At any rate, the assumption is that humans have a tendency and desire to act in their long-term best interest, and, furthermore, derive only (or mostly) direct utility from consumption.
These assumptions are wholly fallacious, and contradict observable reality, which creates quite a problem for economists who try to make detailed policy prescriptions, since doing so generally requires the ability to correctly predict micro-level behavior. Obviously, economists have largely been unable to do so, in part because they bought into the myth of the average person, and in part because the average person does not resemble an actual human as much as it resembles a watered-down version of what economists think an ideal human being would look like.
Thus, much of what has been written about theoretical human behavior from an economist’s standpoint has been largely irrelevant and useless to those who live in reality because economists desire a reality that does not exist. One example of this is what’s known as the Ultimatum Game. The game is played by taking two people, giving one of them a sum of money, and telling him to split it however he chooses with the other player. If the other player accepts, they split the money accordingly and go on their merry way. If, however, the other player declines the offer, neither player gets anything and they go on their unmerry way. Theory dictates that the most rational course of action is for Player A to offer Player B one penny and for Player B to accept, with the idea being that one penny is better than nothing.
But when put into practice, as Thaler details quite extensively in his book, the offer is rarely a penny. It is usually substantially more than that (close to 50% in many cases).
It turns out that humans are more complex than economists would lead you to believe. Many humans, it appears, have more than a direct pecuniary interest in monetary offers. This shouldn’t be surprising, since humans are social creatures with a rather common need to show off. Non-economists tend to recognize this, and therefore make a point of making an offer that is not perceived as insulting. If an offer were too low, the recipient would decline it because the recipient would perceive the value of the money to be lower than the value of the social communication that declining the offer would bring (i.e. the recipient would find it more useful to say he’s insulted than to accept the money). This is, without a doubt, an economic judgment. Yet it is one that economists seem incapable of accounting for because it makes no sense to them.
But, without becoming too dryly analytical, humans are not hardwired to think solely in terms of direct utility. Products can serve multiple functions; some direct, some indirect. Polo shirts, for example, have a direct function of keeping one’s upper body shielded from the elements. But certain polo shirts, such as those made by, say, Ralph Lauren, have an indirect function as a status symbol. And there are people in this world, apparently, who find the added, indirect value to be worth the cost. Economists have failed to account for this sort of thinking, and have thus neglected to consider the full range of value that decisions can provide, which is why there is such a divergence between reality and theory when it comes to things like Ultimatum Game.
The rest of the book, or at least the parts I read, seemed to bear this sort of thing out as well. Why is there such a difference between reality and theory in economics? The answer is, for the most part, quite simple: Economic theory doesn’t actually account for the behavior of real people.
Thaler, in making this decidedly simple point, feels compelled to dress it up in fancy mathematics. There is, of course, nothing inherently wrong with doing this, but it does make for a very dry read. Also, it seems to be a very complicated way of stating the obvious.
However, this degree of precision and insight makes the Winner’s Curse a necessary read for any aspiring economist. Economics, as a method of study, is not particularly useful if one neither knows nor corrects for the fundamental mistaken assumptions upon which the intellectual edifice is built. Economics does have plenty to offer, as a method of analysis, but it is only useful if its axioms are realistic. The Winner’s Curse, then, is useful because it questions the basics of theory. Not only that, it provides the answers as well.
One of the fundamental concepts in economics is utility, which, in the cant of the profession, means whatever works for you. Utility is a need, a preference, a source of satisfaction; if it improves your physical, spiritual or emotional well-being, then it’s said to give you utility.
Many people assume that utility is associated with money or wealth. While that can be true, the term covers much more ground than that and, in fact, can be expansive.
Utility: The Measure of One’s Satisfaction
In the excellent primer Naked Economics: Undressing the Dismal Science, author Charles Wheelan presents the example of a can of tuna. For some people, utility is contained within the inexpensive generic brand found on the bottom shelf. For others, it’s worth the additional cost to purchase the name brand that advertises itself as “dolphin and turtle friendly.” For hungry people in disadvantaged regions of the world, it’s whatever brand they can get.
This example points out one of the underlying principals of utility: it’s different for everyone and can change over the span of a lifetime, usually in conjunction with one’s political views. What comprises a person’s utility varies according to income and educational levels. However, we all want as much of it as we can get, and economic theory is based on the fact that people do what maximizes their utility in the same way that companies maximize their profitability.
And therein lies the problem.
Utility without Happiness
Maximizing utility isn’t necessarily the same as finding happiness or contentment. To again borrow from Wheelan, immunizations give us utility because they prevent us from dying of a preventable disease; however, few people actually enjoy being stuck with a hypodermic needle.
Other notable examples of utility trumping happiness include waiting at traffic lights, paying taxes and staying in a high-paying job that you detest. Some of these examples are part of the sacrifices we all make toward the greater good; however, some of the choices we make, or feel we are forced to make for financial reasons, give us utility but not happiness.
It is true that the citizens of rich nations tend to self-report themselves as happier than those of poor nations. However, studies performed within both categories show that, as long as per capita income in a nation is sufficient to provide for the basic necessities of life (currently around US$15,000), the level of happiness claimed isn’t directly correlated with the level of wealth owned, meaning that money really doesn’t buy happiness, at least not according to these researchers. When the number of lottery tickets sold diminishes, we’ll know people believe them.
The Study of Happiness
Enter the new field of happiness economics, a fascinating but uneasy blend of economics and psychology, which seeks to measure not merely a nation’s gross domestic product but also the level of emotional well-being among its citizens.
Measurements for these criteria include the Satisfaction with Life Index, which comes right out and asks people how happy they are. There is obviously an issue here with subjectivity, but when measured internationally and plotted on a map, as shown in the image at the beginning of this article, the results tend to support the concept of money buying, if not outright happiness, then at least the basics required to survive so that a person can pursue it. On the illustration, green equals most happy, then blue, purple, orange and finally red equals least happy, while grey means the data weren’t available.
Other indices used by happiness economists lean less on subjective self-reporting and more on somewhat harder data. These include:
- Happy Life Years, which blends self-reported happiness with life expectancy;
- the Happy Planet Index, which branches out from human happiness to also include a nation’s ecological impact; and
- Gross national happiness, an index proposed by the King of Bhutan in 1972 which seems to depend less on any strict definitions of anything and more on his own personal preferences.
The true problem with the concept of happiness economics is that happiness is not only difficult to define, it’s also difficult to compare across cultures. The wild joy the Western world believes to be the ultimate in happiness has little appeal for more spiritual nations, where the goal is a Buddhistic calm.
The danger here lies in the political ends to which a happiness index can be turned. Bhutan remains dependent upon subsistence farming with 32% of its population living in abject poverty. But it’s the happiest nation in Asia.