Trust and Markets Daniel Houser Professor of Economics

Trust and Markets Daniel Houser Professor of Economics Director, Interdisciplinary Center for Economics Science George Mason University, Fairfax, VA

I gratefully acknowledge that Joseph Henrich and Colin Camerer produced and made publicly available slides I use in the following presentation. Their related research has been published in several papers and book chapters (including Joseph Henrich, 2003, American Economic Review. ) A nice summary paper published by the research team is Henrich et al, 2005, Behavioral and Brain Sciences. This presentation is based on research related to that paper.

General Model of Decision Making Events Objectives Plans Choices Outcomes Value Beliefs Internal States Sensory Data Mc. Cabe, K. “Neuroeconomics”, Encyclopedia of Cognitive Science, 2003.

How can trust affect economic performance? (Knack and Keefer, 1997, Quarterly Jounral of Economics. ) • Activities that require trust can be conducted at lower cost in high trust environments: less need for contracts, less litigation, less monitoring, less resources devoted to enforcing the protection of property rights. • Virtually every commercial transaction has within itself an element of trust, certainly any transaction conducted over a period of time. It can be plausibly argued that much of the economic backwardness in the world can be explained by the lack of mutual confidence. ” (Arrow, 1972).

• Trust can facilitate investment through better performing informal credit markets. • Trusted government officials might be perceived as more credible when making policy statements. • Trust might facilitate the development of social norms that promote appropriate provision of public goods.

How to measure trust in a society? One approach is the World Value Survey, which contains data on thousands of respondents from 29 market economies: 21 in 1981 and 28 in 1990 -91 survey. Question of interest: Generally speaking, would you say that most people can be trusted, or that you can’t be too careful in dealing with people?

Why are there differences across regions (or people) in trust and trustworthiness? ?

homo-economicus: self regarding and exogenous preferences Political writers have established it as a maxim, that, in contriving any system of government …every man ought to be supposed to be a knave, and to have no other end, in all his actions, than his private interest David Hume, Essays, (1754/1898): 117 [Let us] consider men as if sprung out of the earth, and suddenly (like mushrooms) come to full maturity, without any kind of engagement with each other. Thomas Hobbes The Citizen (1651/1949): 100

The first principle of economics is that every agent is actuated only by self interest. F. Edgeworth, Mathematical Psychics, (1881): 104. Second thoughts? Hume: it is “strange that a maxim that is true in politics should be false in fact. ” Edgeworth: the principle is literally true only in “contract and war. ” Hobbes: the uncultivated mushroom metaphor was a hypothetical “as if. ”

culturally-evolved social behavior l l Evolution of societal complexity: how humans got from small-scale foragers to complex nation states is fundamentally about solving problems of coordination, cooperation and bargaining. If humans are heavily reliant on imitation and social learning, then cultural transmission will have solved these problems in different ways in different places-multiple stable equilibria. We should expect to observe differences in behaviors among social groups related to cooperation, fairness & punishment. How to measure? Economic Experiments.

background l l Recent experimental investigations of strategic behavior have found large and consistent deviations from the canonical self regarding model of human behavior; some subjects act like Homo economicus, most do not. Many subjects appear to care about fairness, and condition their behaviors on their understanding of the intentions of others, often acting in ways that reduce material payoffs to themselves; they are better described as Homo reciprocans or Homo equalis.

an example: the Ultimatum Game l l l Two subjects, anonymous, non-repeated play. The first player -- the “proposer” -- is allocated a amount of money (the “pie” known to both players) and instructed to offer a portion of this to a second person -- the “responder” … who then can accept or reject the offer. If the responder accepts, she receives the amount of the offer and the proposer receives the remainder. If the responder rejects both the responder and proposer receive zero. Q: how would Homo economicus play this game? Guth (1982)

in ultimatum games with student subjects (worldwide) l l l Results: l Modal offers are fifty percent of the pie: means around 40% l Offers less than 25 percent are commonly rejected Observed offers are consistent with self regarding preferences (they maximize expected payoff)… …but rejections are not. Do these results reflect small stakes or confused subjects? The results do not change l when the pie is very large (three months salary, e. g) l and when subjects have extensive experience with the game. But subjects’ behavior is sensitive to situational cues (“exchange game” trivia test to select proposer) Fehr and Gaechter (2000)

fundamental questions remain unanswered l l Are behaviors universal (perhaps expressing a panhuman genetically transmitted predisposition to cooperate)? Are behaviors shaped by social learning and cultural transmission in local social and economic conditions? Do individual attributes (age, sex, wealth, etc) explain behavior, or are group attributes (structure of social and economic interactions, market integration) more important? Do some groups approximate the behaviors of Homo economicus? And if so why?

cross-cultural behavioral experiments project l These questions cannot be answered with experiments using subject pools with relatively similar life experiences (almost entirely university students). l The cross cultural experimental games project: l Economic and cultural diversity: 3 hunter-gatherers, 6 horticulturalists, 4 nomadic herders, 4 small-scale, sedentary farmers l Games: Ultimatum (18), Public Goods (7), Dictator (2), and Trust (2) l Field research team: 11 anthropologists, 1 economist

Ultimatum offer experimental sites From Henrich et al, 2005, Behavioral and Brain Sciences

The Machiguenga independent families cash cropping slash & burn gathered foods fishing hunting From Henrich et al, 2005, Behavioral and Brain Sciences

African pastoralists (Orma in Kenya)

Whale Hunters of Lamalera, Indonesia High levels of cooperation among hunters of whales, sharks, dolphins and rays. Protein for carbs, trade with inlanders. Carefully regulated division of whale meat Researcher: Mike Alvard

Fair offers correlate with market integration (top), cooperativeness in everyday life (bottom)

Main findings • The canonical model of Homo economicus is not supported in any society studied: In all but one (Hadza) UG offers exceeded the expected income maximizing offer (eimo) in most cases by a significant amount; six of the groups rejected UG offers more frequently than student subjects in Pittsburgh. • There is considerably more behavioral variability across groups than found in previous studies; and the canonical model fails in novel ways (hyper fair offers, offers in excess if eimo, rejections of hyper fair offers) • Group level differences (market integration, cooperative production) explain much of the behavioral variation

Interpretation • Results do not falsify the rational actor model (consistent, consequentialist behavior); rather they contribute to the evidence suggesting a reconsideration of its usual behavioral interpretation (self-regarding, exogenous preferences. ). • Little evidence of panhuman behavioral responses. • Subjects appear to map the experiment onto common interactions in their societies, and to adopt behaviors appropriate for those situations. • Behaviors appear to be strongly influenced by group level processes, probably including conformism in cultural transmission.

Implications for social science and policy • Optimal design of constitutions and contracts. Was Hume right? Aristotle: “Lawgivers make the citizen good by inculcating habits in them. . It is in this that a good constitution differs from a bad one. ” • Conditions for collective action (rethinking the Olsen paradox). • Analysis of credit, labor and other markets with incomplete contracts (gift exchange). • Efficient allocation of property rights (e. g cooperative production, local environmental commons, community governance and “social capital”).