Economics

Does the Invisible Hand Need a Helping Hand?

A behavioral economist explores the interaction of moral sentiments and self-interest

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Remember how you reacted to your micromanaging boss in a past job? He was forever looking over your shoulder, constantly kibitzing and threatening you. In return, you worked as little as you could get away with. On the other hand, perhaps you've had bosses who inspired you—pulling all-nighters in order to finish up a project so that you wouldn't disappoint her. You kept the first job only because you couldn't get another and because you needed the money; you stayed with the second one even though you might have earned more somewhere else.

In the June 20 issue of Science, Samuel Bowles, director of the Behavioral Sciences Program at the Santa Fe Institute, looks at how market interactions can fail to optimize the rewards of participants—e.g., the micromanager who gets less than he wants from his employees. For Bowles, the key is that policies designed for self-interested citizens may undermine "the moral sentiments." His citation of the "moral sentiments" obviously references Adam Smith's The Theory of Moral Sentiments (1759), in which Smith argued that people have an innate moral sense. This natural feeling of conscience and sympathy enables human beings to live and work together in mutually beneficial ways.

To explore the interaction of moral sentiments and self-interest, Bowles begins with a case where six day care centers in Haifa, Israel imposed a fine on parents who picked their kids up late. The fine aimed to encourage parents to be more prompt. Instead, parents reacted to the fine by coming even later. Why? According to Bowles: "The fine seems to have undermined the parents' sense of ethical obligation to avoid inconveniencing the teachers and led them to think of lateness as just another commodity they could purchase."

Bowles argues that conventional economics assumes that "policies that appeal to economic self-interest do not affect the salience of ethical, altruistic, and other social preferences." Consequently, material interests and ethics generally pull in the same direction, reinforcing one another. If that is the case, then how can one explain the experience of the day care centers and the micromanager?

Bowles reviews 41 behavioral economics experiments to see when and how material and moral incentives diverge. For example, researchers set up an experiment involving rural Colombians who depend on commonly held forest resources. In the first experiment, the Colombians were asked to decide how much to anonymously withdraw from a beneficial common pool analogous to the forest. After eight rounds of play, the Colombians withdrew an amount that was halfway between individually self-interested and group-beneficial levels. Then experimenters allowed them to talk, thus boosting cooperation. Finally, the experimenters set up a condition analogous to "government regulation," one where players were fined for self-interestedly overexploiting the common resource. The result? The players looked at the fine as a cost and pursued their short-term interests at the expense of maximizing long-term gains. In this case, players apparently believed that they had satisfied their moral obligations by paying the fine.

While this experiment illuminates how bad institutional designs can yield bad social results, I am puzzled about why Bowles thinks this experiment is so telling. What would have happened if the Colombians in the experiment were allocated exclusive rights to a portion of the common pool resources—e.g., private property? Oddly, Bowles himself recognizes this solution when he discusses how the incentives of sharecropping produced suboptimal results. He recommends either giving the sharecropper ownership or setting a fixed rent.

In fact, Bowles recognizes that markets do not leave us selfish calculators. He cites the results of a 2002 study that looked at how members of 15 small-scale societies played various experimental economics games. In one game, a player split a day's pay with another player. If the second player didn't like the amount that the first player offered, he could reject it and both would get nothing.

The findings would warm the hearts of market proponents. As Bowles notes, "[I]ndividuals from the more market-oriented societies were also more fair-minded in that they made more generous offers to their experimental partners and more often chose to receive nothing rather than accept an unfair offer. A plausible explanation is that this kind of fair-mindedness is essential to the exchange process and that in market-oriented societies individuals engaging in mutually beneficial exchanges with strangers represent models of successful behavior who are then copied by others." In other words, as people gain more experience with markets, morals and material incentives pull together.

Interestingly, neuro-economics is also beginning to delve deeper into how we respond to various institutions. In one experiment done by Oregon University researchers, MRIs scanned the brains of students as they chose to give—or were required to give—some portion of $100 to a food bank. The first was a charitable act and the second analogous to a tax. In both cases, their reward centers "lit up," but much less so under the tax condition. As Oregon economist William Harbaugh told the New York Times, "We're showing that paying taxes does produce a neural reward. But we're showing that the neural reward is even higher when you have voluntary giving."

Bowles, with some evident regret, observes, "Before the advent of economics in the 18th century, it was more common to appeal to civic virtues." Bowles does recognize that such appeals "are hardly adequate to avoid market failures." How to resolve these market failures was the subject of Smith's second great book, The Wealth of Nations (1776), where he explained: "By pursuing his own interest (the individual) frequently promotes that of society more effectually than when he really intends to promote it."

Ronald Bailey is reason's science correspondent. His book Liberation Biology: The Scientific and Moral Case for the Biotech Revolution is now available from Prometheus Books.

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  1. Science Correspondent Ronald Bailey uses neuro-economics to see if the invisible hand of the market ever needs the helping hand of government.

    Of course it does, as Congressman Dingall (Political Party unknown) proved in the Energy and Commerce Committe and has been thouroughly debated in a Matt Welch thread below.

  2. Guy, I tried this once before, you obviously missed it.
    Dingell is a pro-defense, pro-labor democrat representing Dearborn, Michigan, His seat extremely secure. The Detroit VA hospital is named after him.

    He’s been in congress ~forever.

  3. JsD,

    Who am I supposed to believe? You or the esteemed editor of a major Cosmotarian magazine?

  4. Guy, I tried this once before, you obviously missed it.

    Guess you missed my reply to your comment on the other thread. Still time to bet as it has not been noted in the post.

  5. The players looked at the fine as a cost and pursued their short-term interests at the expense of maximizing long-term gains. In this case, players apparently believed that they had satisfied their moral obligations by paying the fine.

    I believe this has been found in other cases as well. I seem to remember an (informal?) study of day care outfits, where arriving late to pick up your child was considered a social fauxpas. To try to reduce the number of people who stubbornly picked up children late, the daycare instituted fines for late pickup. To their surprise, the number of late pickups increased. They found that when the fine was introduced, people saw late pickup as a service that carried a simple financial cost. Ie, the fine took the morality out of it, and turned the whole concept into a fee-for-service model.

  6. I believe this has been found in other cases as well. I seem to remember an (informal?) study of day care outfits, where arriving late to pick up your child was considered a social fauxpas.

    Isn’t that in Ron’s article?
    See six day care centers in Haifa, Israel, paragraph 6.

  7. Paul,

    Wow, thats just like the day-care study mentioned in the article. That same article you pulled the quote from even.

  8. If a fine is less than you stand to gain, then it is just a cost of doing business. They really just drive up prices for the consumer.

    I think Paul might need a good boob slapping. (Just kidding, Paul. I think your boobs are fine.)

  9. I can give another example – deposits on kegs. The deposit on a keg isnt remotely near the cost of a keg to a brewery. However, people think it they dont take it back and get their deposit back, the keg is theirs to keep. I would have agreed, back before I found out the cost differential – who would have thought they actually wouldnt charge enough on a deposit to encourage people to return it?

  10. Allow me to register my great skepticism about controlled experiments regarding human decision-making as predictors of real-world behavior. Regardless of what their results’ suggest.

  11. robc,

    It’s especially odd when you notice that the deposit on a keg tap is almost exactly what they cost to replace. It is maybe a third party payer problem, where a non-returned keg is the brewery’s problem as opposed to the liquor store’s?

  12. Beer kegs make great gas tanks for hotrods.

    I wonder if the higher deposits discouraged too many people from renting because of higher upfront cost? Just wondering, I have never rented or owned a keg.

  13. SugarFree,

    I think that is exactly the problem. I know in some states (not sure about ours), the deposit is set by law. Really. With the 3 tier system, Im not sure where the problem lies. The brewery gets a deposit from the wholesaler, the wholesaler gets it from the retailer, the retailer gets it from the consumer. If it never comes back, the wholesaler and retailer still dont lose. Somehow, either thru law or pressure, all the risk is on the brewery. Im guessing wholesalers/retailers argued that it kills their cash flow. Or maybe the bars. Even at a higher amount, they always break even, but for every keg sitting in a warehouse/store/bar they have money basically sitting in escrow at the brewery. Once they sell it, they have pushed the escrow another layer down the chain.

  14. Guy,

    I think that is part of the problem too. Frat boys buying the $70 keg for the party dont want to drop $270 down. But, they will put $100 down.

  15. They make a great pot for mash as well.

    I also thought that the deposit was not just for the keg materially, but the cost of replacing the keg, e.g. would take into account the cost of the bother or overhead of replacing it and include the wholesale or retail price of the keg. Don’t know about depreciation cost though.

  16. From some googling:

    “You can get usually $25 to $35 on a keg that is turned in for scrap metal,” said a Beer Institute spokesman. “When the deposit’s only $5 to $10, you can see how people stand to make a profit.”

    As a result of unreturned kegs, brewers have increased keg deposits. Unreturned kegs now have a replacement cost of more than $130, the Beer Institute spokesman said. The beer industry loses $50 million annually for about 250,000 unreturned kegs, many of which are being sold to scrap metal companies.

  17. Matthew,

    A friend offered me one as a gift for my brew kettle. After I explained the whole “its theft” thing to him (what with him being a lawyer and all) he took it back to get his deposit back. He thought, like I did originally, that a deposit would more than cover replacement cost.

  18. Huh, never knew that about beer kegs.

  19. It is no way a condemnation of the free market that people don’t always act in their own best self interest. Part of the idea, the “knowledge problem”, is that no one else can realistically say they know what’s best outside of individual scenarios.

  20. Bowles tends to do nice work.

    I can’t tell from Ron’s write up whether he has in this case. Ron’s piece seems even more like fluff than usual.

    As for neuroeconomics…that is a field that needs a few more years under its belt before it will have a coherent theory that will produce reasonable hypotheses to test. Right now they are in the “playing with brain images” phase of research. Not that there is anything wrong with that.

  21. Many of these unintended effects of incentives occur because people act not only to acquire economic goods and services but also to constitute themselves as dignified, autonomous, and moral individuals. Good organizational and institutional design can channel the material interests for the achievement of social goals while also enhancing the contribution of the moral sentiments to the same ends.

    Seems to apply a pragmatic test to policy design…therefore I like it. Evidence-based policy won’t be crafted according to an underlying philosophy, but designed to achieve a goal. If it is well designed the goal will be achieved. If not, the policy should be adjusted/corrected. Bowles seems to be pointing out a potential pitfall for policy makers.

  22. NM,

    Bowles seems to be pointing out a potential pitfall for policy makers.

    By now you would think they would realize that the law of unintended consequences is a rider on every bill.

    So I doubt they will listen to Bowles.

  23. Wow, sorry guys, I scanned the beginning of the article, got interrupted by work, then went down to the discuss online.

    I think Ron must have be re-referencing an older article that I read some time ago (yes, probably in Reason) and Ron must have used that info.

    So actually, it’s Ron’s fault for plagiarizing himself… or something.

    I’ll get out of it somehow.

  24. While I don’t necessarily disagree with Bowles conclusion I think the increase in lateness has mostly to do with the price of the fine; they set it too low. Had they increased the fine, the lateness commodity would have been less in demand. At some point the parents and teachers would have arrived at a price model that would have served the interests of both. My 2 cents.

  25. Doug,

    That was my first thought too. A la Coase, raise the price of noncompliance until the revenue actually balances the cost. They may in fact find that everyone is happier with a later pickup time when properly compensated.

    Also, setting an accurately high price should work even better than trusting moral suasion. After all, even thoughtless ingrates might be prompted to think, “Wow. They are really serious. My lateness must cost them quite a lot.”

  26. a Beer Institute spokesman

    To Lobbyists! The cause of… and solution to… all life’s problems.

  27. to see if the invisible hand of the market ever needs the helping hand of government.

    The thing is, the helping hand of government is also a burden.

  28. Seriously, the government’s helping hand tends to be nothing more than a middle finger in almost every case.

  29. How can you view Adam Smith’s writings as good, considering he was a loyal subject of notorious tyrant King George III?

  30. Grab the children and run for cover, “the helping hand of government” is approaching!

    As a Libertarian, I understand government has it’s VERY limited role in which it is a “help” and improves life, as opposed to complete anarchy, but I still can’t help but to laugh and cringe at the same time when I read that phrase.

    I prefer to call it “the magically growing hand that keeps on taking.” If you have a problem with that, talk to the hand.

  31. It’s punishment that doesn’t work (see our prison system). If the day care centers paid a small reward for on time pick up more people would come on time to pick up their reward. It worked for my husband’s law firm. When fines didn’t help getting lawyers to turn in their timesheets on time, a $100 reward created enthusiastic compliance. We can be Pavlovian dogs sometimes.

  32. If “fines” for late pick-ups at the day care center cause people to think of lateness as a service that they can pay for … then why not just do that? The day care center could figure what it actually costs to provide the extra hour or so of care, tack on a nice bit of profit, and bill accordingly.

    Rather than framing it as a “fine” and a “punishment” — by what authority may a service provider punish its customers? — it seems that framing it as a fee for additional service and budgeting accordingly would be a much more rational action in the market.

    The “irrational behavior” is not on the part of the parents. They reasonably conclude that while previously being late was something the day-care center did not plan for, that has changed: they clearly *are* planning for it; the existence of the “fine” proves that. The truly irrational behavior is on the part of the day-care center, that apparently would prefer to punish its enthusiastic customers who simply want (and are willing to pay for) more of its services.

    If a customer wants to buy more of your service, at a price that you have set for it — but you would rather be nasty to them and call that price a “fine” instead of just part of the bill — who is being irrational?

  33. A good reason to leave picking up children as a moral issue and not an economic customer-provider issue is to discourage parents from leaving children with “third parties” instead of taking care of them. It’s not simply about covering costs. What’s valuable about the article is showing that economic rationality and morality intersect, and it is there where the trade-offs will be made, to our credit or discredit.

    What some people forget is that the border area between normative and calcuated decision-making can shift over time based on decisions made in the past.

    BTW: If the parent is simply the customer of daycare, and the provider the entrepreneur, what is the child?

    ABTW: A wide selection of solutions exist between “the helping hand of government” and the laissez faire attitude (I can’t call it a policy because then it wouldn’t be laissez faire anymore). I would suggest keeping eyes square on the middle ground because both of the above are cop-outs. Yawn! The government will take care of it. Yawn! The market will take care of it.

  34. All of these seem like cases where private companies or institutions noticed a policy didn’t work right, find the underlying reason, and (in most cases) changed the policy because it was in their own best interests to do so. No need to involve the government. Plus, when a government policy doesn’t turn out as expected, the immediate assumption is usually that it hasn’t been funded enough, so I’m against the “helping hand” idea, except in cases involving negative externalities (such as pollution) that cause provable harm.

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