By Olivia Smith and Steven van de Put Third Year, Second Prize

Transcription

1 Are humans always the rational, self-interested agents that mainstream economics assumes them to be? Discuss, using ideas of reciprocity, altruism and fairness By Olivia Smith and Steven van de Put Third Year, Second Prize Introduction The Homo Oeconomicus assumption has become a cornerstone of mainstream economic theory. This notion, introduced by Mill, states that society is an aggregation of atomistic individuals; each individual is said to act so as to maximize his well-being, given the constraints he faces 1. Agents are deemed to be fully rational, and only interested in factors directly linked to their own, personal wellbeing. Mill s claim contradicts a statement previously made by Adam Smith, who claims that humans show an interest in others welfare and happiness, even if they get nothing from it but the pleasure of seeing it 2. This seems to create a paradox between the self-interested individual assumed by economic theorists and the real-life situation. This essay will attempt to make a contribution to this debate, relying on theoretical, economical and philosophical notions. The existence of social preferences related to reciprocity, altruism and fairness will be assessed in terms of experimental and neural economics, as well as philosophical theory and mainstream economic theory. After assessing the arguments for assumptions of rationality and self-interest, a conclusion will be made that while there is significant evidence of humans demonstrating other regarding social preferences, it is not necessarily applicable to all humans; nor do these assumptions necessarily need to be accurate for them to be of use to mainstream economic analysis. Reciprocity Kindness is the parent of kindness. A. Smith (1759; 1982, p. 225) Reciprocity is demonstrated when agents act according to the actions of others; individuals decide on the payoffs of reference agents by assessing their actions 3. A kind response will be met with a positive payoff, whereas an action that is perceived as hostile will result in a negative reaction. Social preferences like this can be seen to occur during economic experiments. The following experiments have some significant drawbacks. Firstly, it has been claimed that transparency (complete information) significantly increases trusting behaviour in one-shot interactions 4. In the laboratory setting there is complete and perfect information, whereas in a real world economic transaction transparency is unlikely. Real life situations tend to be accompanied by at least some degree of 1 Sickert, 2009, P 1 2 Smith 1759, P 1 3 Fehr et Fischbacher, P Kanagaretnam, 2010 P 1

2 information asymmetry, meaning that an experiment in which complete information is available could be deemed unrealistic. Secondly, it has been argued that the idea of reciprocity is based on the idea of repeated interactions. In our social networks, interactions are highly unlikely to be one-shot only, as people are likely to surround themselves with a steady social group. This obviously leads to a certain form of behaviour, and some economists argue that subjects who routinely interact in the repeated game of life import routines and habits that are appropriate for repeated interactions into the laboratory s one-shot situation 5. This can lead to agents acting irrationally as they are unfamiliar with the idea of a one-shot game. These criticisms are, however, disproven by the following studies. The trust game demonstrates participants' positive reciprocal tendencies. The game has two players. Both players are given $10, and Player 1 is told that he can give any amount of this money to Player 2. This amount will be tripled before it is given to Player 2, following which Player 2 has the chance to return any amount of their money to Player 1. In this game, the rational and self-interested response for player one is to keep all of the $10, and player two's rational strategy is to retain any money that is given to him. This means the Nash equilibrium would result in each player receiving $10. In order to achieve Pareto efficiency, however, player one would have to give all of his money in the first place, to reach a total payoff between the players of $40. Thus it can be seen that higher initial investments trigger higher repayments. Berg, Dickhaut and McCabe 6 undertook a study of this game, in which player ones gave an average of 5.16 to their investors, and only 1/16th of the games achieved the Nash equilibrium. One explanation for this response could be altruistic - that player ones were willing to donate money to the other player. What seems more likely, and what the study suggests is that the money was given with an expectation that they would receive a payoff for making this investment. 7 Both possible explanations for this response show that humans are not rational and self-interested, and the latter explanation shows evidence of positive reciprocity in the human decision making process. This seems to imply that there is at least a factor of positive reciprocity at work here, instead of the agents being purely rational and self-interested. Altruism How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortunes of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it. Smith, A. (1969) page 47 5 Fehr and Fischbacher, 2004, P Berg, J., et al., (1994), p Cartwright, E., (2011), p. 187

3 Pure altruism is shown through acts that benefit others, but from which the actor himself receives no benefit. This can include behaviour ranging from tipping waiters and waitresses to donating to charity. We can establish that there is at least some form of altruism in human beings, as there are many charities collecting money for causes that do not directly affect us or our loved ones, but such an explanation is a gross simplification. Experiments conducted in the field of economics seem, generally, to support the notion that there is some form of altruism in each human being. This can be seen for example in the dictator game, a simple game in which there are two players. The proposer is given a sum of money and is asked how much he would like to give to the other player. If the proposer was completely self-interested and rational, he would retain the complete payment, and the receiver would never obtain any money. This is, however, not the case, and the games often average more than zero 8, providing an argument against the traditional image of the self-interested individual. Although this argument might appear convincing at first, there is a strong argument against the blind acceptance of the dictator game as a purely altruistic act. Firstly, we must take into account Neuro-economics of the situation. There is evidence that the brain s reward centre the mesolimbic pathway - is active when a person donates to charity. This part of the brain is responsible for doling out the dopaminemediated euphoria associated with sex, money, food and drugs 9. This provides evidence that acts of altruism can be a source of great enjoyment, illustrating that there might be a selfish motivation behind acts that seem like altruism, as there is a focus on achieving a state of bliss. It might also be the case that altruism is linked to Bordieu s social capital. This social capital consists of two parts: first, the social relationship itself that allows individuals to claim access to resources possessed by their associates and second, the amount and quality of those resources 10. Altruism might be a way to increase this social capital, and thus altruistic acts might be impure, serving the agent s goals over any other cause. This can be seen, for example, when politicians participate in charity events; their interest is often firstly on the public image it generates, and the actual act of charity is only of secondary concern. Whereas it is unrealistic to assume that this is the case for everyone, it might still be the case that people participating in altruistic acts do so to further their reputation, and further their social capital by gaining or improving their relationship with associates or peers. Fairness In 2007, List undertook a study which demonstrates agents sense of fairness, refuting economic assumptions of self-interest and rationality. 11 The experiment is a form of the dictator game, in varied formats. In the first two variations, the players are able to give up to $1 and take up to $5 respectively from the receiver, and in the 8 Fehr and Fischbacher, 2004, p The economist, Portes P 4 11 List, J. A., (2007), p.187

4 other variation as well as being able to take up to $5 from the receiver, players are made to earn their fee by completing simple tasks for a charitable cause. Here, the Nash equilibrium is for the proposer to take the maximum amount of money. There is no repetition of this game, and so nothing to gain by not keeping the full amount. In the standard dictator game, results are very similar to other experiments of this nature, with proposers giving a mean of 20% of their $5 leading to the equalising of the payoff for the two players. In the games in which the proposer is able to take money from the receiver, much less money is given. List s experiment suggests that having the option to take money from other players is seen as an excuse to give nothing to them. The results of the game in which proposers earn their fee are indicative of the mentality that people believe they deserve the money that they worked for, as very few of the proposers in this game gave or took any money at all. This model teaches us that social norms and institutions can influence people s perceptions of fairness the slightly differing circumstances of each of these games show very different results. In a more broad sense, this kind of model is more indicative of the changing nature of social preferences with the manipulation of situation than it is proof that people have a sense of fairness in real world circumstances. This notion of social preferences being affected by social constructs is also clearly illustrated in a study by Henrich et al., which involves the same ultimatum experiment played by participants in 15 different small-scale societies. 12 There are significant differences in the behaviour of both players in the ultimatum game across societies. These two examples thus demonstrate substantial evidence of the impact that cultural forces exert over human altruism and social preferences. Further evidence against the aforementioned criticisms is provided by the ultimatum game. In this game there are two players, between which a sum of money is divided. Player 1 proposes an offer of any amount of the money to give to Player 2. Player 2 then has two options; either he accepts the offer, and they both receive the agreed amount, or he rejects the offer, meaning that neither player receives any monetary payoff. Here the dominant strategy for Player 2 is to accept any positive offer. Player 1 s dominant strategy therefore is to offer the smallest possible positive offer. In this situation, however, it was the case that while Player 1s tended to act largely in accordance with money-maximising principles, Player 2 was not acting in accordance with rationality Player 2s were commonly rejecting offers under half, or the point of equal payoff. Bearden instead concludes that Player 2 is driven by a sense of fairness and a desire to be treated fairly by the other player 13. This study gives evidence that there is a high degree of reciprocity at work here. Conclusions 12 Henrich, J., et al. (2004), 13 Bearden, 2001, P 1

5 It is important to note that in each of the experiments undertaken there is a great variance of social preference between agents, and there are always a percentage of players who do act according to the rational and self-interested principles. It seems that it could be the case that some humans are always the rational, self-interested agents that mainstream economics assumes them to be however this essay is geared towards answering the question of whether the average person is always rational and self-interested. A further problem is the nature of the experiments. The dictator game places participants in an unfamiliar environment with an inbuilt obvious cognitive demand to give some money and to follow whatever other cue can be read by the decision environment. 14 This unnatural situation might lead to an equally unnatural outcome, and it can thus be seen that the altruism displayed in this experiment might not reflect real life situations; participants feel unnecessarily pressured into giving money away which they normally would not do. These criticisms are meant to highlight that although behaviour might seem altruistic at the base, it can still be in line with the rational model. Actions may not be completely self-interested, due to the realization that there is a reliance on other agents in these situations. This is maybe best highlighted by the quote given by Becker, who said that I decide whether to turn out my reading lamp in bed by comparing the utility of my pleasure in reading with the amount of utility I receive from my wife's being able to sleep. 15 The rationality of altruism gets further highlighted by Simon, as he advocates that self-interest actually disadvantages the individual: altruists will be fitter than selfish persons, and will gradually dominate the population. 16 While this essay has argued that humans do demonstrate characteristics of other regarding preferences, a significant question to be asked is whether this has much broader significance for economics. It is true that the assumptions that economic models are based on are often grossly inaccurate, but this is not to say that because of this the predictions of the models themselves are inaccurate. It is hard to deny that in the past few decades, model building in economics has yielded many powerful, clear results with rigorous demonstrations. 17 And, as earlier highlighted, a focus on anything but rationality might lead to unworkable models due to the degree of variation needed in the economic models. By creating rationality as a starting point, we can, however, create a situation in which the conclusions of an applied model are approximately true, and that that is because its assumptions are sufficiently close to the truth. 18 This shows that even though humans might not always be perfect examples of rationality and self-interest, these assumptions have proven themselves to be very useful tools in mainstream economic analysis and modelling. 14 Zizzo, 2011, P 4 15 Simon, 1982, P Simon, 1982, P Gibbard et Varian, P Gibbard et Varian, P 676

6 In conclusion, this essay has argued that, generally speaking there is at least some degree of rationality in economic agents behaviour. This rationality can however take unexpected form, as highlighted by the notions of social capital and impure altruism; in some cases it might actually be more rational to not be completely selfinterested and be more involved with others. It is not necessarily the case that any act of altruism should be seen as irrational by definition, for example. While the essay has demonstrated the existence of other regarding preferences, illustrating evidence of the existence of reciprocity, altruism and fairness in human social decision making, drawbacks of this evidence have also been highlighted.

7 References Bearden, J., 2001, ultimatum bargaining experiments: the state of the art, available at: f (accessed ) Berg, J., et al., (1994), Trust, Reciprocity and Social History, Games and Economic Behaviour, 10: Cartwright, E., (2011), Behavioral Economics, New York, Routledge Fehr, E. and Fischbacher, U., (2008), Testing theories of fairness Intentions matter, Games and Economic Behavior, 62: Gibbard, A., and Varian, R., 1978, Economic Models, In: the journal of philosophy, available at: (accessed ) Henrich, J., et al. (2004), Foundations of Human Sociality, Oxford, Oxford University Press Kanagaretman, K., 2010, Trust and Reciprocity with Transparency and Repeated Interactions, available at: (accessed ) List, J. A., (2007), Journal of Political Economy, Vol. 115, No. 3 (June), pp , Chicago, The University of Chicago Press. Stable URL: (accessed 30/03/14) Sickert, C., 2009, Homo Economicus, available at: Handbook-E.Elgar_.pdf (accessed ) Simon, H. A., 1982, Models of Bounded Rationality: Empirically grounded economic reason, Massachusetts, MIT Press The Economist, 2006, The Joy of Giving, available at: (accessed ) Zizzo, D., 2011, Do Dictator Games Measure Altruism? Available at: (accessed )

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