Repugnant Markets | Alvin Roth on Trading Kidneys

A repugnant transaction is an economic term that describes an exchange between people that is generally perceived as morally or ethically wrong. These transactions fall outside of regular market mechanisms, hence the term repugnant markets. The repugnant nature of these transactions, cause these markets to be structurally inefficient. 

Examples of Repugnant Markets

  • Organ transplants
  • Child surrogacy 
  • Prostitution 
  • Recreational drugs

Whether a market is considered socially repugnant in not a binary definition. At the same time, what people consider to be a repugnant transaction can change over time and across cultures. Some transactions that are considered repugnant, are also illegal. Some are not.

Matching Markets

When you think about markets, the first examples that come to mind will be something like stock exchanges, farmers markets or auctions. In all these examples, the transaction is impersonal. If you want to buy a stock on the New Youk Stock Exchange, you simply need to place an order through a stockbroker. In fact, anybody can place a bid. 

Many markets are, however, personal. These markets are called matching markets. In order for a transaction to take place, a buyer and a seller need to be matched. A good example of this is the labour market. If you are in the labour market, you can’t simply choose a job. You need to match with an employer who is looking for someone who matches your skillset. 

Repugnant Transactions

In a matching market, price is not the only mechanism. For a matching market to be repugnant, it means that other people feel that it should not be allowed to engage in the desired transaction. 

Alvin Ross, the economist who coined the phrase, formulated the concept of repugnant transactions when studying kidney transplants. It is against the law almost anywhere in the world, to buy and sell kidneys for transplantation. Yet there is a black market for kidneys, which means that there are instances where individuals are willing to transact in kidneys, while people, in general, feel that it is immoral to do so. 

Alvin Roth on Repugnant Markets and Forbidden Transactions

In the following lecture, Nobel laureate Alvin E. Roth will investigate the nature of and reasons for repugnance with its implications for the design of markets. Why is it forbidden to sell and buy organs? Why is the exchange of kidneys that leads to many successful transplants allowed in some countries such as the US, but not in others like Germany? Which markets or transactions we allow, affects the choices that people have?

Watch the lecture and learn more:

Also on How to Value Stuff

10 Ways to Profit by being Less Logical than Anybody Else

Here at How to Value Stuff, we are all great admirers of Rory Sutherland. Rory is the head Ogilvy Advertising – founded by David Ogilvy, another man we greatly admire. David wrote a legendary book on marketing and sales, called Ogilvy on Advertising – and one of the most influential advertising professionals in the world today.

Rory has a fascinating view of how we perceive the value of the products and services we enjoy. In 2019, Rory published a book called Alchemy: The Surprising Power of Ideas That Don’t Make Sense, which was a follow up on a book he published the year before, Alchemy: The Dark Art and Curious Science of Creating Magic in Brands, Business, and Life.

Here are 10 rules you can adopt which will help you profit by being less logical than everybody else:

1. The Opposite of a Good Idea can be another Good Idea

Nobody can blame you for getting at a single right answer regardless of the materials you used to get there. Conventional logic uses the idea of a single right answer. This is mostly needed where your job is in the line and you need to make everything right.

When it comes to driving at a single right answer, no subjectivity is involved in decision making and what you decide is what you deem right.

2. Don’t Design for Average

Solving a problem with an average person in mind is very difficult. Some models in conventional logic require you to solve a problem for people in aggregate. This can make problems very difficult to solve.

Do not limit yourself to the average person and focus on the fringes. That way, it is easy to find things that will be adopted by extreme consumers.  They can then be ploughed back in the mainstream.

3. It Doesn’t Pay to be Logical if Everybody Else is being Logical

Being logical in business will get you to the same place just like everybody else. In business strategy, it does not pay to be logical because being logical will get you to the same place where your competitors are going. In business, you need to be differentiating yourself away from your competitors.

Find out what your competitors are logically wrong about. If you find out what is wrong with their model, you are in a position to exploit it. Adopt contrarian thinking.

4. Our Attention affects Our Experience

The nature of our attention affects the nature of our experience. Quality is relative. The perception of quality is determined by the difference between expectations and experience. It is more difficult to change how a person experiences something than the expectation of that experience.

Rory gives an example of one of the best hotels he has stayed in. The hotel had previously been a prison or a police station. Everything from the bed and bathroom to the TV and wall hangings was very spartan nature.

Under most circumstances, you normally would have experienced this as a lack of quality. But the hotel was in East Berlin and the experience came across as authentic East Berlin. It fit the circumstances. It met what you would have expected from an authentic East Berlin hotel.

5. If there were a Logical Answer We would have found it Already

If a problem becomes persistent even after discussing it with every person who can relate to it, it means you are giving it a logical explanation. There is a solution somewhere to be found through conventional linear rationality approach.

Exposing everything to logic and the problem persists, it indicates that logic is not the answer to that problem. Gather some courage and test less rational solutions. Context is a marketing superweapon.

6. The problem with Logic is it Kills off Magic

Logic and magic cannot coexist. There is no magic where logic is involved. The rules of logic demand that there can be no magic.

Logic requires that you change your product instead of improving the perception of the product in order to enhance the customer experience. This confines you into doing exclusively objective things because you think that people perceive the world objectively.

7. A Good Guess which stands up to Empirical Observation is still Science

You should not let methodological purity restrict your capability of coming up with multiple solutions. It is good to allow solutions that come in randomly rather than being restricted to explainable solutions. The latter will hold you captive and will monopolize your progress.

8. Test Counterintuitive Things because Nobody Else will

Since you do not want to put your source of livelihood on the line, create a space in your business where you can test things that do not make sense. This will be an advantage to win over your competitor because your experiment will land you in a lucrative business idea that will make you outdo your competitors.

9. Don’t Solve Problems using only Rationality

Solving problems using only rationality is like playing golf using only one club. Using rationality as the only way of solving a problem will get your solution based on a very narrow path.

Solving problems by using only rationality will generate solutions that restrict themselves to a very narrow definition of human motivation and how they think, act and decide.

10. Dare to be Trivial

Sometimes big problems do not require huge intervention. On the contrary, a small thing can have an enormous effect. You do not have to do things in the correct order simply because it is the way they should be done. Small changes, such as alternating the order of options or changing relative scales, can yield an order of magnitude in results.

 

 

How do Banks Make Money?

You might think that the role of commercial banks is to accept deposits from the public and channel them into projects, where the bank can lend the money out at higher rates of return. You would be wrong.

When you hear the world deposit, you might think that the bank is storing the money for you, therefore acting as a custodian. It isn’t. When you deposit your money in the bank, in a legal sense, you are lending your money to the bank.

Money Creation

Banks, currently, are the effective creators of the money supply. They produce money. They do this by selling promissory notes, such as mortgages, car loans or business loans. Deposits are more like a by-product of the money creation process.

This is brilliantly explained by Professor Richard Werner (who happens to also be the guy who came up with the terms Quantitative Easing), in the following video:

Richard Werner: Essentially, if we want to produce something we need funding. So there is a role for banking in almost everything that happening in the economy. But what exactly is that role? Banks are being thought of as intermediaries. This is not really what is happening. They are creators of the money supply. 

Interviewer: So, you are firmly of the view that banks create money out of thin air?

Richard Werner: I produced the first empirical study to prove that, in the 5,000-year history of banking. Banks are thought of as deposit-taking institutions that lend money. The legal reality is that banks don’t take deposits and banks do not lend money. So, what is a deposit? A deposit is not actually a deposit. It’s not a bailment. It’s not held in custody. 

At law, the word deposit is meaningless. The law courts in various judgements have made it very clear. If you give your money to the bank, even if it is called a deposit, this money is simply a loan to the bank. So, there is no such thing as a deposit. 

Banks borrow from the public. That much we have established. What about lending? Are they lending money? No, they don’t. Banks don’t lend money. At law, it’s very clear. They are in the business of purchasing securities. That’s it. 

So you say: “Ok. don’t confuse me with all that legalese. I want a loan.” Fine, here is the loan contract. Here is the offer letter. And you sign. At law, it’s very clear. You have issued a security, namely a promissory note. And the bank is going to purchase that. That is what is happening. 

Interviewer: Put it in laymen terms.   

Richard Werner: It means that what the bank is doing is very different from what it presents to the public that it is doing. How does this fit together? You say “fine, the bank purchases my promissory note. But how do I get my money?” 

The bank will say, “you will find it in your account with us.” That will be technically correct. If they say, “we will transfer it to your account,” that’s wrong. Because no money is transferred at all. From anywhere inside the bank or outside of it. Why? Because what we call a deposit is simply the bank’s record of its debt to the public. Now, it also owes you money and its record of the money it owes you is what you think you are getting as money. And that is all it is. 

And that is how the banks create the money supply. The money supply consists of 97% of bank deposits. And these are created out of nothing by banks when they lend. Because they invent fictitious customer deposits. Why? They simply restate, slightly incorrectly in accounting terms, what is an account payable liability arising from the loan contract, having purchased your promissory note, as a customer deposit. 

But nobody has deposited any money.

 

The Peltzman Effect & Risk Compensation

Peltzman effect is a theory which states that people tend to increasingly engage in risky behaviours once a security measure has been mandated. This effect is named after Sam Peltzman, an economist who postulated the theory with the use of seatbelts in automobiles.

The original context of the theory was the regulation of risk as the government tries to make things safer by issuing new regulations. Peltzman used auto safety as a case study, where the government made people wear seatbelts and also regulated various other features in the manufacturing of automobiles, such as pop-out windshields and other protective devices which are meant to make us safer.

The Economics of Risk

According to economic theory, when you make things cheaper then you will get more of them.  This is what led to Peltzman postulating that when you make a car safer in this way, drives will adjust their behaviour in response to the perceived level of risk.

In other words, if driving becomes safer, the drivers will become riskier when driving. Hence, the increase in safety measures will be compensated by riskier behaviour. This is what economists call Risk Compensation. In the case of auto safety, Peltzman predicted that the increase in risk behaviour would lead to more accidents, that would partly or completely offset the safety benefits of the regulation.

Later, Peltzman performed a study to see what the effects of the first generation of automobile safety regulations were auto-related accidents. The study did not focus on the first order effect (driver safety) but on the global effect (did more people survive on the road or did the automobile death rate goes down).

Risk Homeostasis

The conclusion of the study was that there was no effect on the death rate but there was a reduction in the probability that you would die in an accident which is the main purpose of the device. However, this benefit was completely offset by more accidents and many accidents involve people who weren’t in cars that are protected.

The Peltzman effect shows that people tend to drive recklessly and with less attention since they felt safer in the car which leads to more accidents than when these safety devices came out. The ratio of fatalities in accident went down but there was an increase in the accident which offset the decreased fatality rate.

He then concluded that if government regulates risk or anything, there is going to be an incentive created for behaviours that offset some part of what the government is trying to regulate and it could be a complete, partial, or more than complete offset. And the main thing that this regulation does is that it makes the consequences of an accident less severe.

Examples of Risk Compensation

Although the Peltzman study used the auto safety regulations as an example of risk compensation, this phenomenon has been observed in a range of activities. A few examples would be:

  • The use of helmets in skiing, snowboarding and rollerblades has been observed to increase risky behaviour.
  • A popular aphorism amongst skydivers, named Booth’s rule nr. 2 states that the safer skydiving gear becomes, the more chances skydivers will take constant

The Water and Diamond Paradox

How can we know the true value of a thing? This has been a philosophical question that dates back to the times of Aristoteles. Philosopher throughout the ages have asked themselves why water which is vital for all life is cheap while diamonds are expensive even though we can easily do without them?

Diminishing Marginal Utility

The solution to the Water-Diamond Paradox is the economic law of diminishing utility. This can be defined as the economic law which states that when there is an input in the production of a community while the other factors are fixed, it is going to get to a point whereby any addition of the good to the consumer of the good is going to lead to low satisfaction with the diminishing increases in the output.

Supply and Demand

A case study is that assuming you are hungry and you find one apple then it is going to precious to you and you are going to eat it to satisfy your hunger and to stay alive. Then if you go for a walk and you see two more apples then you can eat one just for the fun of it and keep the second one till when you are hungry.

If you then happen to see an orchard with lots of apple fruit and you decide to stay close to the orchard, it will come to a time when you will grow tired of eating an apple as it will be nauseating to you. You can then trade some apple for some other commodities that other people will find it to be valuable to them while it is invaluable to you.

This case study shows that each additional value of a given good satisfies a less important need. You can see this as the first apple that you take is mainly for the appraisal of your hunger so as to survive while the second apple fills you up and the third apple was kept for later so as not to be hungry in the future.

This also implies that the first apple that you saw was priceless as you need it to avoid starvation while the second one was just a pleasurable snack while the value of other apples that you find keeps decreasing.

There is no such Thing as Fixed Value

The example above shows that no good has a fixed value. A good will always be considered valuable when people value them. For example, imagine that your parents would buy a sculpture which they really love. Later, once they once they are passed on, you inherit the sculpture. However, you have never liked the sculpture and you feel like it is taking up space.

You mean to throw it away but you’re reluctant to do so because of the sentimental value your parents attached to the sculpture. When discussing your predicament at a party, you discover to your amazement that there is an art collector in town that has been looking for this exact sculpture for years. Suddenly your perceived value of the sculpture has gone up and you are not willing to part with it unless the art collector submits a reasonable bid for the artwork.

In the context of the Water-Diamond Paradox:

  • During a drought, people would value water more than rare diamonds as they need it to survive.
  • As soon as there is enough water, they will tend to value diamonds more as they have the essential needs to satisfy their hunger and thirst then people try to satisfy their sophisticated needs.
  • This theory applies to all the needs in human lives.

How do Bankruptcies Work?

Did you know that bankruptcy affects a great number of people? One in ten persons is likely to file bankruptcy. In 2017 alone, 767,721 people have filed for bankruptcy in the United States.

Going through a bankruptcy is a painful and the process itself can be quite frustrating and stressful. In this article, we will try to address some of the main concerns you might have regarding bankruptcy and how they work.

Photo by Melinda Gimpel

Types of Insolvency

First things first: A bankruptcy is a procedure that aims at giving financial relief to a person who has reached a state of insolvency. This basically means that the person has reached a point where he or she is unable to pay back the debt that he or she owes. There are two types of insolvencies: cash-flow insolvency and balance sheet insolvency.

  • A cash flow insolvency means that a person is not able to meet debt repayments.
  • A balance sheet insolvency means that the debtor does not have assets to cover his liabilities.

Nonetheless, bankruptcy and insolvency or not synonyms. Bankruptcy is a legal status of a person. Not all insolvent persons are bankrupt. For a person to be bankrupt, a bankruptcy has to be filed with courts.

Declaring Bankruptcy

While a person can declare bankruptcy, often the bankruptcy process is initiated by a creditor. A bankruptcy process will differ between countries and states, but in general, the process is as follows:

  1. A petition is filed and approved within the judicial system.
  2. A trustee (most often a lawyer) is assigned to the estate and control over all assets moved under his control.
  3. The bankruptcy is announced in a public venue and creditors are asked to file claims on the estate.
  4. The trustee is tasked with monetizing the estate and distributing the proceeds to the claimants based on the seniority of their claims.
  5. Once claims have been settled and the estate has been wound down, the debtor is discharged. The timing of the discharge after the wind-down of the estate can differ greatly between countries.

Bankruptcy in the United States

In the United States, there are two main options to choose from when it comes to personal bankruptcy, namely Chapter 7 straight bankruptcy and Chapter 13 repayment plan case.

Chapter 7

The first option – namely chapter 7 – it enables you to have all your outstanding debt discharged, granted that some liquid assets have been utilized in order to repay part of the debt. The only situation in which you can file for this type of bankruptcy is if you can demonstrate that your current income is lower than the average income for a family in your home state.

Chapter 13

In case you don’t qualify for this, then you will have to choose chapter 13. This plan entails paying a specific portion of your debt in a payment plan of three to five years. As a rule of thumb, these payments are made to the courts.

In the position of a business, then you might file Chapter 1 bankruptcy. Through this option, you have the opportunity of restructuring and reorganizing through a court-appointed trustee. More specifically, you will have to follow a given plan to cope with your creditors.

Note that bankruptcy will remain on your file for five years – at the very least. Therefore, make sure you think this through before resorting to it.

Benefits of Going Bankrupt

The positive thing about bankruptcy is that it usually translates into a discharge. This will prevent your creditors from collecting on debts. Nonetheless, note that there are still some exceptions to the rule and some of these are alimony and child support obligations, recent tax liabilities, and so on and so forth.

Another potentially positive aspect associated with bankruptcy is, of course, the automatic stay. This represents a preliminary court decree that prevents creditors from actively trying to collect debts from you during the actual bankruptcy timeframe. This means you will not be contacted via mail or phone in this respect. Essentially, the automatic stay applies until the bankruptcy court decides to issue a discharge.

The Bottom Line

Bankruptcy is usually the last resort of a person in financial difficulties. There are many nuances when it comes to filing for bankruptcy and options to choose from. Therefore, getting legal and accounting counsel is paramount for anybody considering his or her options.

Should I Invest in Gold?

All investments have to be made by taking into account the objectives of the portfolio, the allocation of assets, and the need for the new investment into the overall investment strategy. Hence, before investing in gold it is best to carry out a basic review of the portfolio goals and then make a choice.

The start of 2016 featured dull economic growth and feeble energy prices which caused the share market to open at its worst. This resulted in an increased demand for gold and its price soared. However, as the year progressed, the share market outperformed gold and by the year ending it was 3 percentage points above the yellow metal.

You may go through the below-listed pros and cons of gold before investing in it.

Advantages of investing in Gold

  • It is a great hedge against inflation and currency: Gold and other precious metals are a good source of hedging any risks such as a possible decline in the US Dollar or other major currencies. Price of gold tends to rise with the weakening of a currency. It is argued that high inflation is marked by increased prices of gold, which safeguard purchasing power. However, there are many who debate this argument. Additional information about the relationship between inflation and gold prices is provided below in the article.
  • Portfolio diversification: One of the major aspects of a good portfolio is diversification wherein there is no correlation between different classes of assets in the investments. This means that the different asset classes fluctuate in their own unique way thereby offering some protection during times of volatility. Over the past 5 years, the price of gold has differed from the different share indices and the movement of each is independent of one another. Thus, gold and other precious metals are a great way to diversify the portfolio.
  • Hedge against economic collapse: Gold and other precious metals can be a great source of barter when the world economy is in turmoil. Over the course of history, it has been observed that people purchase gold as a hedge against uncertain times. When the world appears to be in a state of disarray, investors like to buy and own gold. For example, in 2008, during one of the worst global financial crises in recent times, there was an appreciation of gold by 5 per cent while stocks tanked by nearly 40 per cent. Gold gained over 7 points against stocks in 2011 when it seemed that the United States may default and the credit rating of the country dropped.

Disadvantages of investing in Gold

  • The returns in the long-term are low: As compared to shares, the returns offered by gold have historically been low. It thus makes a bad investment selection for the long term.
  • No revenue in form of dividends: Investment in gold does not offer interest, dividends, or any other type of income. Hence, one of the most renowned investors in the world, Warren Buffet, is against investment in gold or other precious metals. Currently, the interest rate is low, and hence in such a scenario lack of income will play a smaller role as the opportunity cost with regards to investment in gold will be lower.
  • The worth of gold is determined by what a buyer is willing to pay for it: Gold does not have an intrinsic value. Thus, it’s worth can drop if people decrease their investments in gold. Also, it would not be of great value in a barter market as people may consider something like toilet paper or other true consumables to be worth more than gold which does not really take care of any human needs on its own.

The relationship between gold and inflation

It is said that gold does not offer any yield. The definition, however, states that increased interest rates will offer some yield to gold investors. On the other hand, if the FED detects inflation and increases the interest rates, then people will sell gold and purchase Treasury notes for better returns. This will cause the price of gold to drop.

President Trump has stated that he will begin a public works program amount to $1 trillion. Such fiscal stimulus may cause the inflation to rise sharply and making the FED increase the interest rates. This may eventually result in a drop in gold prices.

The above example has to be read in context with what happens in reality and not in theory. It is important to note that the FED does not increase interest rates haphazardly. It wants the inflation to be under control, but its main aim is to keep negative real rates wherein inflation is higher as compared to nominal rates. Raising the interest rate will not offer any positive effect unless there is a faster rise in inflation. This is the scenario where its job of wealth preservation is done by gold.

In the late 1970s, the United States was on the brink of hyperinflation, the gold price was about $130, and Treasury notes dived under 7 per cent. By 1980, gold reached its peak price of over $800, while the ten-year Treasury returns were over 10 per cent. To avoid a worldwide run on the dollar, the FED chief took anti-inflation steps in October 1979. The price of gold kept rising till it reached its peak, but the stranglehold kept on by the FED eventually yielded results and gold prices started to dive.

The current Fed chief, Janet Yellen, may not strangle inflation as in the above example. In the late 70s, the FED had hiked up the interest rates above the inflation rate. However, in 2018, the FED is most likely to increase interest rates but keep it under the rate of inflation.

Different financial issues across the world like persistent unemployment, the European debt crisis, and a hangover of the housing crisis, etc., have created an environment that is fraught with a probable collapse of the global economy. Hence, hedging in gold will offer stability and protect your ability to continue trading for varied goods and services.