• Max Stearns

Robert F. Smith at Morehouse College: Gifting and Neoclassical and Behavioral Economics

Updated: Dec 23, 2019

Morehouse College, a men’s Historically Black College, or HBC, in Atlanta, Georgia, held a remarkable graduation ceremony. Robert F. Smith, the commencement speaker and honorary doctorate recipient, announced that he was wiping out the entire 2019 graduating class student debt. The gift’s estimated value is $40 million. Smith, formerly a chemical engineer, went on, as an investment banker, to become founder, chairman, and CEO of Vista Equity Partners. By some estimates, he is the 163rd wealthiest person in the United States and the wealthiest African-American.

Describing this singular philanthropic moment as generous is an understatement, and nothing that follows should cast Mr. Smith, or his decision to be so generous, in a negative light. The reactions to his gift do, however, raise fascinating questions implicating a fault line separating neoclassical and behavioral economics.

In standard neoclassical analysis, the most basic test of efficiency is the Pareto criterion. The Italian economist, Vilfredo Pareto, defined as efficient any reallocation of resources from the status quo that makes at least one party better off without making the anyone else worse off. By contrast, Kaldor-Hicks efficiency, widely used in assessing public policy, defines as efficient any reallocation of resources in which the winners gain more than the losers lose, even though the losers are not actually compensated. (If the losers were compensated, these efficiency criteria would merge.)

Public policy makers rely on Kaldor-Hicks because the stricter Pareto criterion risks inviting strategic opportunities for persons who are not necessarily, or actually, disadvantaged by a proposed policy to strategically claim that they are, and to thereby insist upon a side payment absent which they would threaten to prevent implementation. Economists refer to such behavior as pursuing appropriable quasi rents. That fancy term simply means seeking an opportunistic gain, typically part of an expected return properly belonging to another person.

A famous study involves two separately caged capuchin monkeys. The primatologist gives the monkeys an elemental task followed by a reward. Each receives a slice of cucumber for pulling a lever. The monkeys catch on quickly. That is, until the researcher mixes things up a bit. In the second phase, he continues to reward one monkey with cucumber slices, but rewards the other with grapes, following each pull. Immediately it becomes apparent that grapes are far more highly valued than cucumber slices in the capuchin world. The monkey who continues receiving cucumber slices becomes so enraged that it refuses the cucumber slices, throwing the bits back and hitting the cage. Although that monkey's compensation hadn’t changed, it nevertheless perceives an egregious injustice.

Shortly after the Morehouse graduation, news reports emerged that some graduates and parents had expressed concern about Robert Smith’s remarkable gift. Although many students borrowed significant sums, some parents, often at considerable financial sacrifice, or by taking their own loans, managed to let their children graduate college debt free. Of course, there is tremendous variation among family financial circumstances. Small sacrifices or better planning is unlikely to help low income families avoid having their children take on debt, and conversely, very well to do families can pay their child’s way through without feeling much pain. Those perceiving an injustice likely fall in between, such that with careful planning and meaningful sacrifice, including taking their own loans, it was possible either to pay entirely for the undergraduate program, or at least to do so without the child incurring student loans. Apparently, some parents expressed concern that the Smith gift might have overlooked their personal sacrifices. And no doubt there are also other potential meritorious recipients beyond the children of such parents, including, for example, students in prior or subsequent Morehouse graduating classes, or gifted and financially needy African-American students attending altogether different schools.

A simple Paretian economist might respond that however one defines the denominator of potential gift recipients, Mr. Smith has made no one worse off by selecting a subset for his tremendous gift. So viewed, Mr. Smith’s gift improved social welfare for the recipients, but without harming anyone, thus satisfying even strict Pareto efficiency. And yet, some parents were left feeling worse off, perhaps following years or decades of careful planning and sacrifice, or taking their own loans, all to ensure sure that their children begin adulthood with the very financial head-start that others, due to family financial circumstance or perhaps lesser planning, will suddenly receive nonetheless by virtue of this tremendous gift.

When teaching the Pareto criterion, I encourage my students to consider two ways of improving social welfare—production and exchange. Two parties, A and B, can barter or transact, reallocating resources from whichever party values those resources less to the other who values them more. When I buy a cappuccino for $4, I value it more than the cafe, and the cafe values the $4 more than the coffee. Social welfare is improved, and the cafe and I have shared in the resulting gains. When I make the cappucino, which I prefer, I combine inputs in a manner that improves their value to me, and thus also my social welfare, once more without harming others.

Is the Morehouse gift more like my cappuccino or the capuchin monkeys?

The Paretian liberal might criticize the Morehouse parents for implicitly seeking something to which they were never entitled. If we ignore the parents’ feelings, Pareto is restored. The gift recipients are better off, and no one is worse off. Yet dispensing with feelings of regret, or a sense of somehow being overlooked and to that extent being treated unfairly, accomplishes this by definitional fiat.

The Morehouse parents aren’t unique. Consider the times that you’ve witnessed a family member, friend, or colleague upset, not for having been denied an expected raise or promotion, but rather because someone else at work received an unexpected perk, say a bonus, a newly created position, or an academic chair. Rarely are such persons consoled when told how well they are doing, in comparison, say, with their parents or grandparents, or others who are or were far more seriously disadvantaged now or in the past. Like the monkeys, people naturally gravitate toward immediate benchmarks—why is the person in the next office, or the monkey in the next cage, getting so much for more for the same effort? If manna from heaven falls only on one side of the street, are those on the other side wrong to feel aggrieved? Although Mr. Smith is a mere mortal, make no mistake: his commencement speech announced onto which side of the street his manna would fall.

Just as I don’t want to criticize Mr. Smith, a remarkably generous man, I also want to be fair to the parents feeling a sense of regret. My wife and I are profoundly fortunate in sending our children to college debt free. I like to imagine that were I at my child’s graduation when such an incredible gift was announced, I would share in the joy of both the benefactor and the recipients. After all, when I graduated college in 1983, and law school in 1987, had I been listening to the same speech, I would have been a thankful recipient myself. And while my wife and I have since paid off our loans, today we are anything but resentful to have had the wonderful good fortune of moving to the other side of the street. Even so, people are not wrong to feel as they do.

Opportunities for appropriable quasi rents typically coincide with a divergence between what people know about and plan for and what they confront fortuitously after the fact (in economics-speak, between ex ante and ex post). I commend Mr. Smith’s astounding generosity, and yet, there are sound reasons why scholarship programs tend to be carefully crafted and announced well in advance, with specified criteria generally associated with financial need, merit, or some combination, plus whatever additional factors, demographic or otherwise, inspire the benefactor. If the terms had been announced in advance, and if the most worthy recipients were selected based on whatever criteria Mr. Smith worked out with Morehouse College officials, I imagine that few if any students or parents would perceived unfair treatment. (Mr. Smith is also created a separate $1.5 million Morehouse scholarship program.) Neoclassical and behavioral economists, along with moral philosophers, can certainly debate whether such claims to unfairness are themselves unfair, but the capuchin monkeys make one thing plain: there is something visceral going on here. Resolving the Pareto criterion by ignoring how people feel might save the neoclassical model, but does little to avoid future perceived unfairness. It is possible that if just some of the manna fell on the other side of the street, Vilfredo Pareto could truly rest in peace.

I do not anticipate ever being so fortunate as Mr. Smith in having the ability to make such a generous gift. He will have changed many lives. I sincerely hope the students who benefited find opportunities to pay his generosity forward. If so, maybe those who perceive having been treated less fairly today will feel differently about Mr. Smith’s gift in the future.

A final (day late) Memorial Day comment:

Yesterday was Memorial Day. I don’t know Mr. Smith, but my own experience with generous souls is that they appreciate all the more when others also are generous. I suspect he would agree that those who contributed to our great nation with their lives gave the greatest gift of all.

I hope you enjoyed the long weekend. Those who sacrificed would have wanted that. We honor them by leading productive and happy lives. And we also honor them when we recognize the profound sacrifices they made in allowing us do so.

I welcome your comments.

#neoclassicaleconomics #behavioraleconomics

© 2020 by Maxwell Stearns  Proudly created with Wix.com

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