Here is the second installment of my series on game theory explanations for the difficulties facing international development work. I will be comparing Aid NGOs to the Tragedy of the Lemons while also introducing the concept of decision trees.
Two quick words of caution to the reader: First, this is dry-reading in comparison to the rest of the blog, so if you want fun please scroll down. Second, at no point should you mistake economics for a science. Science is a permanent search for temporary truth built on a rigorous process of empirical data collection and consensus by peer review. Economics uses sciences like math to further its cause, but economics remains to this day philosophy.
To begin, ‘The Tragedy of the Lemons’ is a well-known economics lesson about the importance of measuring the quality of goods. The first important thing to know about the Tragedy of the Lemons is that ‘lemon’ is slang for a used car in poor condition.
Okay. Imagine you want to buy a used car. You go to a used car dealer. You are presented with two used cars for sale but you cannot measure the value of either. These two cars look exactly the same. You also know that 1 of the 2 cars is a ‘lemon’ and the other is a quality ‘pre-owned’. You know that the ‘lemon’ is worth 500 dollars (an arbitrary number) and that the quality ‘pre-owned’ car is worth 5,000 dollars.
The essential choice in this situation is how much would you be willing to pay for an item that could be worth 500 dollars or 5,000 dollars. You have no way of knowing which car is which. Also, the seller is a decision maker. They choose which car to sell you given the offer you make, or if to sell to you at all.
If you offer the dealer $500 the only car they would sell you would be the lemon, because no seller will intentionally operate at a loss (in the realm of economics) and would not sell you a $5,000 car for only $500. They would lose $4,500.
Or, to put it into a decision matrix:
The Seller will do better by selling you a lemon in either situation, ($4,500 dollar loss versus fair deal, $4,500 gain versus fair deal). The rational choice is for the Seller to choose Lemon. The buyer will understand this and make their choice between the remaining two options ($4,500 loss versus fair deal). The rational choice is for the Buyer to offer $500.
Or, to put it into a decision tree:
First the Buyer decides between their two choices, then the Seller decides between their two choices. The outcome is the same as the decision matrix, but decision trees can be helpful as a visual alternative or when dealing with multiple decisions in a sequence. The important thing to learn about game theory here is that the order in which moves are made influences outcomes. The Seller having the final move gives the Seller an advantage.
Also keep in mind that the car seller is not a villain. They will sell you a $500 car for $5,000 out of pure economic interest, the same way that you would happily purchase a $5,000 car for only $500.
What is tragic about this situation is that when the only rational choice for both players is to buy and sell ‘lemons’ then the market for the superior good disappears. Yes, better cars exist, but who will buy them and who will sell them?
The nature of the game is tragic; it leads to a world of ‘lemons’.
In contrast to the lemon world is one where we have a mechanic who can tell the difference between lemons and pre-owneds (for a fee) and suddenly the economy all starts working again. Shirtsleeves are rolled up, roses blossom and all the world’s children prosper.
Or, to put it into a decision tree:
Basically, you must be able measure something that is valuable in order to promote its value. Otherwise you destroy the market for valuable goods and all of society suffers for the loss. Also, this measuring system can be its own business.
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It is here that I make the argument that the Tragedy of the Lemons concept can be applied to Aid NGOs. Aid based Non-Governmental Organizations. Aid NGOs fit the Tragedy of the Lemons concept well because we all know what an Aid NGO looks like from the outside, yet there are little to no truly useful ways to measure the quality of an NGO (see what’s under the hood). They all attempt to do good things, but how can we know who is successful and who is a ‘lemon NGO’?
By comparison, for-profit business is easy to measure. Did you make money? Yes. How much money? This much. It’s right here on our audited statement. Did you help people? Yes, by providing goods and services people wanted. In the business world the non-performers are weeded out. On occasion the importance placed on profits over ethics will lead to bad business practices, but poor performance is never tolerated in business (in theory).
In contrast, we cannot measure the value of Aid NGOs against each other. This causes two very difficult problems for the international development community and developing countries. First, you can’t get rid of the ‘lemon NGOs’ without losing the valuable ones. Second, you can’t target more money to the better NGOs because you don’t know which are which.
Moreover, Aid NGO work that is poorly managed is worse than no aid at all because aid money can lead to inflation, market distortion, and lost opportunities to have spent the money on something more useful. Worse still, the loss of trust among the local community for unmet promises from the ‘lemon NGOs’ will make it more difficult for well-managed Aid NGOs to operate.
We have no way of knowing which NGOs are succeeding at their missions and which are simply causing inflation with their high salaries paid in foreign monies. Well-managed NGOs bring human development (safe water, access to food, human rights, etc.). Poorly managed NGOs create market bubbles in the countries that can least afford them. But, to backtrack from hyperbole, it’s not a bipolar system of good and bad. There is a spectrum that ranges from the truly wonderful to the truly incompetent, and not all NGOs are well paid.
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The Tragedy of the Lemons is solved by a wonderful mechanic who simply knows what cars are worth. The mechanic tells you the value of a car, for a price. The mechanic runs a private business built to support the existence of another business. I propose that The Tragedy of the Lemons meets Aid NGOs can be fixed in the much the same manner.
If we can prioritize funds to better performing NGOs, if we can remove the ‘lemons’ from the system, then we may be able to preserve the most important aspect of development work, the local communities’ trust. To do this we need a series of measurements supported by a network of smaller private groups, much like a credit bureau supports banks. Private enterprise created to measure the effectiveness of Aid NGOs.
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