There’s an old saying in the financial markets: “If you don’t have a position, then you don’t have an opinion.” It is a blunt aphorism that speaks to the macho culture of market traders, but it also reflects the role financial markets play in our economy – they enable us to allocate capital for profit.
So if you think the market is going up, then you go out and you get yourself a piece of the action. The markets don’t have time for cheap talk or Monday morning quarterbacking. If you want to be taken seriously, you need to put your skin in the game.
If you’re not willing to do that, then you need to be honest with yourself: do you really believe what you’re saying? Because if you’re not willing to back yourself, why should anyone else?
Humans naturally give more attention to a decision when they have something riding on the outcome. Whether it’s a threat to be avoided or a prize to be won, the inherent risk of the situation triggers an automatic, evolutionary response that focuses our mental faculties on the task at hand. This is good for both the individual and the collective, as the marginal gain from each improved decision multiplies through the system, to everyone’s benefit.
Skin in the game makes the world a better place by incentivising people to make better decisions, but it also has a deeper, more profound influence on outcomes in society.
Returning to the markets, if you put your money where your mouth is and the market subsequently tanks, you will lose some of your capital. That’s the market’s way of letting you know that you made a mistake. You should take heed because the market will keep doing that, either until you learn to correct the mistake or until you run out of capital, at which point you and your bad decisions will be out of the game.
The hidden value of skin in the game – and the key insight here – is that the market is all the better for your absence. The system becomes stronger by incentivising everyone to do better and by removing those who don’t. The filtering process is less visible, but no less important. You might survive a few mistakes in the short run, but if you don’t learn your lesson, you will eventually face the chop whether you are a novice in the markets or the slowest animal in the herd.
Skin in the game lends itself to biological analogy as it mirrors the process of natural selection. Every organism wants to survive and to reproduce, but not all will be successful. The weaker organisms will eventually be removed from the population, while the stronger ones will pass on their superior traits to their offspring, enabling the species to evolve and become more resilient over time.
This process works as well for a virus as it does for any other organism. The longer a virus exists in a population, the more opportunity it has to replicate. It could become more airborne, more contagious or more resistant to vaccines, and all of these outcomes are good for its survival – if not for its hosts.
In contrast, the virus would never evolve in a way that would risk its survival at the level of the species as the weaker mutations would be naturally de-selected before they could become characteristic of the population. It is a ruthless process, but Mother Nature knows a thing or two about survival and she demands your skin in the game.
To fully appreciate the necessity of skin in the game, consider what happens when it goes missing.
If insurers offered 100 per cent coverage on auto insurance, there would be more write-offs and fewer insurers – both of which represent bad outcomes for society (really). The insurers discourage this reckless behaviour by adding minimums and deductibles to their policies. In doing so, they align the policy-holder’s interests with those of the insurer, and this makes insurance a viable option for everyone.
Economists call reckless behaviour “moral hazard” – the risks people take when they are separated from the consequences of their actions – and it is ever-present in society.
A child growing up in a wealthy household may never learn good financial habits. Indeed, if mum and dad are always there to provide a safety net, junior may never learn to take responsibility for any of his decisions.
Government bailouts have a similar effect on the corporate sector, while a lack of investigative journalists could create the conditions which make those bailouts more likely. If students weren’t graded, would they ever study? And where would that leave our legal, engineering and accountancy professions?
Whether it is a species, a financial market or an entire society, skin in the game at the level of the individual is a prerequisite for the health and stability of the collective. It is an incentive structure that promotes fairness and equity in all social dealings because, above all, it guarantees accountability. If your mistakes or misconduct continue to put others at risk, you will eventually be removed from the system and someone else will take your place.
When I see that Ireland now has the longest lockdown in the world, and that it has been maintained by an unchanging group of policymakers who are largely unaffected by its constraints, I have to wonder: is Ireland suffering from a contagious outbreak or a chronic lack of skin in the game?
Dermot Dorgan is an investment risk manager and a member of the Irish Covid Action Network/ican2021.ie