Category: Entrepreneurship

You can trace nearly all of the problems in the world back to one cause: lack of skin in the game. From the financial crisis, to our broken government, to most wars, corruption, pollution and famine, you’ll find a lack of skin in the game as the foundational cause of nearly every one.

What is skin in the game? According to Nassim Nicholas Taleb, “skin in the game is about being harmed by an error if it harms others.” In finance, it means having personal monetary risk associate with any deal you make. A simple example: If I create an investment fund and invest my own capital so that I own 10% of the fund, I have skin in the game. If the fund loses money, I lose money. My decisions not only affect my investors, they affect me. If I don’t invest any of my own money, but make high fees just for managing the fund, whether it goes up or down, I don’t have skin in the game. Taleb believes that skin in the game is “the most important marker of credibility.” Without it, he continues, people are “frauds.”

When people share in the costs and benefits of their decisions that affect others, they are more likely to make good decisions than if they just impose their decisions on others. Taleb believes skin in the game is “a moral imperative” that should serve as the base of a functioning society. I agree wholeheartedly.

The financial crisis was caused by bankers who made incredible amounts of money whether their investments made money or not. The Iraq war happened because the people authorizing the war didn’t have to fight. Neither did the vast majority of their children. The war was fought by a small sliver of the US: our volunteer army. If George Bush or his supporters would have had to send their sons and daughters to war, I bet we wouldn’t invaded Iraq.

Our government doesn’t work because bureaucrats who make laws aren’t affected by them. Lawmakers don’t have skin in the game because massive gerrymandering has rendered their seats safe, unless they’re caught, as the saying goes, “with a dead girl or a live boy.” Global warming is an incredibly hard problem to solve because we don’t have actionable skin in the game. The consequences will happen far off in the future, likely to our grandchildren.

Lack of skin in the game causes the rich to not participate in their own communities because they believe their outcomes are no longer connected to their local communities. A massive student loan bubble because universities don’t have skin in the game to actually help students to get a job after they graduate. Journalists and bloggers to pontificate endlessly without any consequences for being wrong. Large companies and the top 1% to go to extreme lengths to avoid paying taxes because they feel decoupled from their communities: they can operate from anywhere, recruit employees worldwide and be citizens of the world.

More controversially, Jaron Lanier argues that many internet companies that are worshiped as paragons of having skin in the game in fact don’t. He contends that they’re wrecking our economy and that internet companies, via siren servers, are killing, not creating jobs and pushing too much economic activity off the books. They use the world’s most powerful servers to create defacto monopolies that earn money via arbitrage, solely because they have access to the most powerful computer, not because they are taking risks and creating value. (Read my previous posts for background.)

Taleb and Lanier are two of the most important thinkers of our time. It’s interesting that they both find a lack of skin in the game as the core cause of the world’s problems even though they write about completely different subjects.

So how can we start to fix our broken institutions? Simple. Add more skin in the game. Some examples from Taleb: In Roman times, bridge builders, or members of their family, had to sleep underneath newly built bridges for a time. If it collapsed, the builder lost too. He continues:

I feel much safer on a plane because the pilot, and not a drone, is at the controls. Similarly, cooks should taste their own cooking; engineers should stand under the bridges they have designed when the bridges are tested; the captain should be the last to leave the ship. The Romans even figured out how to deter cowardice that causes the death of others with the technique called decimation: If a legion lost a battle and there was suspicion of cowardice, 10 percent of the soldiers and commanders — usually chosen at random — were put to death.

Now I wouldn’t advocate for the Roman Legion’s solution, but what if we started to design public policy, laws and societal norms that required some amount of skin in the game as a moral imperative, along the lines of “thou shall not steal?” What if we said that it’s immoral to force decisions on others when you don’t have skin in the game?

What if we required bankers to personally invest in any deal they proposed to their own investors? Or their bonuses were tied to long term performances? Or if we devolved more power to local institutions instead of concentrating power at the federal level? What if we forced siren servers to have skin in the game and not make money solely on arbitrage? Or pushed the 1% to once again have skin in the game in their local communities? What if we had a partial military draft? Or some sort of selective service? Or forced banks to keep at least 50% of any loan they originated?

I don’t have many specific proposals yet, but all we need to do is use skin in the game as our guiding heuristic. We should be extremely skeptical of anyone who doesn’t have real skin in the game. The likelihood that they are a fraud is exponentially higher.

What do you think? Is skin in the game as important as I believe it is? Do you have any proposals to push for more skin in the game? What do you think we can do to help push for more skin in the game?