Wednesday, September 7, 2016

Why Luck Plays a Big Role in Making You Rich

Robert Frank was playing tennis one cold Saturday morning in Ithaca, N.Y., when his heart stopped. Sudden cardiac arrest—a short-circuit in the heart’s electrical signaling—kills 98 percent of its victims and leaves most of the rest permanently impaired.

Yet two weeks later, Frank was back on the tennis court.

How did this happen? There was a car accident a few hundred yards away from where Frank collapsed. Two ambulances responded but the injuries were minor and only one was needed. The other ambulance, usually stationed five miles away, reached Frank in minutes.

“I’m alive today because of pure dumb luck,” says Frank, a 71-year-old economics professor at Cornell University. Or you can call it a miracle. Either way, Frank can’t take credit for surviving that day. From coincidence or the divine, he got help. Nine years later, he is still grappling with the concept of luck. And, applied to his field of economics, it’s led him into some dangerous territory: wealth.

Talk about luck and money in the same sentence, he says, and prepare to deal with “unbridled anger.” U.S. Democratic Senator Elizabeth Warren of Massachusetts and President Barack Obama were pilloried for suggesting rich Americans should be grateful for what Obama called “this unbelievable American system that we have that allowed you to thrive.” Even referring to the wealthy as “the luckiest among us”—as I did a few months ago—can spark some unhinged reactions.

“There are people who just don’t want to hear about the possibility that they didn’t do it all themselves,” Frank says.

Mild-mannered and self-effacing, he isn’t about to tell the rich “you didn’t build that,” as Obama did (and likely regretted). Frank’s new book, Success and Luck: Good Fortune and the Myth of Meritocracy, is a study in diplomacy. Combining memoir with academic research, it’s an earnest argument that all of us—even the rich—would be better off recognizing how luck can lead to success. (...)

Winner-take-all markets

For more than 20 years, Frank has been studying the rise of winner-take-all markets—fields of fierce economic competition in which only a few top performers take home the bulk of the rewards. More and more of the economy is starting to look like sports or music, Frank says, where millions of people compete and the winners are paid thousands of times more than the runners-up.

Another example he gives is the humble neighborhood accountant. In the 20th century, the typical accountant was competing against nearby rivals. If you worked hard, there was a good chance of winning over the most lucrative clients in town. Today, neighborhood accountants face much more competition: Sophisticated global accounting firms can swoop in and sign up their biggest clients. Tax preparation, an accountant’s bread and butter, has been mostly swallowed up by two large players—H&R Block for storefront preparation and TurboTax online.

“Technology has enabled people who are best at what they do to extend their reach geographically,” Frank says. TurboTax was initially just one of a number of tax software programs on the market. But, as happened with search engines and social media sites, it was able to win over customers early, and its competitive advantage snowballed. TurboTax now dominates online tax preparation—thousands of local accountants replaced by one company.

In these winner-take-all markets, luck can play a huge role. A simulation conducted by Frank shows how: Imagine a tournament in which every contestant is randomly assigned a score representing their skill. In this simple scenario, the most skilled person wins. The more competitors there are, the higher the score the winner will likely have.

Now introduce chance by randomly assigning each participant a “luck” score. That score, however, can play only a tiny role in the ultimate outcome, just 2 percent compared with 98 percent allotted to skill. This minor role for chance is enough to tilt the contest away from the top-skilled people. In a simulation with 1,000 participants, the person with the top skill score prevailed only 22 percent of the time. The more competition there is, the hardest it is for skill alone to win out. With 100,000 participants, the most skilled person wins just 6 percent of the time.

Frank writes:
Winning a competition with a large number of contestants requires that almost everything go right. And that, in turn, means that even when luck counts for only a trivial part of overall performance, there’s rarely a winner who wasn’t also very lucky.
Winner-take-all markets can end up creating vast wealth differences between the lucky and unlucky. One person—smart, persistent, but unlucky—struggles, while an equally (or even slightly less) talented and hard-working person gets a lucky break that can reap millions, or billions, of dollars.

by Ben Steverman, Bloomberg |  Read more:
Image: William Andrew/Getty Images