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Highlights

First, the policies that follow from this paradigm sometimes make the assumption of universal amoral selfishness more nearly true than it might otherwise be: people sometimes act in more self-interested ways in the presence of incentives than in their absence. Second, fines, rewards, and other material inducements often do not work very well. No matter how cleverly designed to harness the avarice of knaves (as Hume put it), incentives cannot alone provide the foundations of good governance.

I am right, then an erosion of the ethical and other social motivations essential to good government could be an unintended cultural consequence of policies that economists have favored, including more extensive and better-defined private property rights, enhanced market competition, and the greater use of monetary incentives to guide individual behavior.

while some economists imagined that in a distant past Homo economicus invented markets, it could have been the other way around: the proliferation of amoral self-interest might be one of the consequences of living in the kind of society that economists idealized.

Haifa,

Even the sight of money and the discussion of coins (rather than nonmonetary objects), in a recent experiment, induced children to later behave in less prosocial ways and to be less helpful toward others in their ordinary interactions.

Confucius had provided advice about how this might be done, and about the pitfalls to be avoided: “Guide them with government orders, regulate them with penalties, and the people will seek to evade the law and be without shame. Guide them with virtue, regulate them with ritual, and they will have a sense of shame and become upright.”5

“Economism is Machiavellianism come of age.”

good laws and good customs are complements rather than substitutes.

“No men are … less fit to govern … than theorists or philosophers … [who] sing the praises of a human nature nowhere to be found, [who] … rail at the sort which actually exist [and] conceive of men not as they are but as they would like them to be.”32

What the classical economists (and most economists since) missed is the possibility that moral and other prosocial behavior would be affected—perhaps adversely—by incentive-based policies designed to harness self-interest.

implicit assumption of separability has led economists to ignore two important possibilities: first, the use of incentives to harness self-interest to the public good might attenuate civic virtue or its motivational salience, and second, there might be conditions under which ethical and other-regarding concerns can jointly flourish and synergistically promote societal outcomes.

Good institutions displaced good citizens as the sine qua non of good government. In the economy, prices would do the work of morals.

For every good to have the right price, all economic interactions must be governed by what economists call complete contracts. This means that every aspect of an exchange—anything valued by either the exchanging parties or anyone else—has a price that is included in a contract governing the exchange.

the problem of incomplete contracts is not some curiosum on the periphery of the economy. We will see that it is a ubiquitous characteristic of markets for labor, credit, information, and the other central arenas of the capitalist economy.

The fact that incomplete contracts are the rule and not the exception sets in train a series of implications for the use and limits of incentives,

writers of introductory economics textbooks struggle to find empirical examples of even a single market that approximates the model on which the theorem is based.

because contracts are incomplete, morals must sometimes do the work of prices, rather than the other way around.

“no social system can work … in which everyone is … guided by nothing except his own … utilitarian ends.”48

inserting explicit provisions covering breach of contract increases the likelihood of breach.8

avoiding being a chump appears to be the motive here, not the prospect of a higher payoff.

design incentives and other policies in the presence of crowding out?

Because of the effect of incentives on experienced values, the total—direct and indirect—effect of an incentive may fall short of what we would expect if we looked only at its effects on the costs and benefits of the targeted activity.

may suspect that a person who is happy to give to a charity may be less inclined to contribute when a donation reduces her tax bill.

incentives worked, yet there was collateral cultural damage: the bonus appears to have obliterated pre-existing social preferences.

optimal incentives depend on the nature of the citizens’ preferences that result from this process (of imposing fines or providing subsidies), for these will determine the effects of the incentives.

a shrimper might resist the temptation to defect if he were both public spirited toward the other fishers and sufficiently patient to value the future opportunities that they all would lose were he to use traps with smaller

Motives such as reciprocity, generosity, and trust are common, and these preferences may be crowded out by the use of explicit incentives.

constitution for knaves may produce knaves, and may cause the good to act as if they were “wicked.”

altruistic preferences and their influence on social behavior can be studied by using the same analytical tools that have been developed for the study of, say, the shopping habits of an individual and her taste for ice cream.

The experiments show that policies premised on the belief that citizens or employees are entirely self-interested often induce people to act exactly that way. The challenge is to understand why.

The genius of the market as a system of organizing an economy, Hayek pointed out, is that the message comes with its own motivation to pay attention; eating potatoes rather than bread will save money.

Alan Page Fiske provides a taxonomy of four psychological models corresponding to distinct kinds of social relationships: authoritarian, communal, egalitarian, and market, each with culturally prescribed patterns of appropriate behavior.

What they found was astounding: to get 72 percent of the subjects in the individual treatment to let their mice die, the subjects would have to have been offered 47.50 euros. Recall that in the market treatment, compensation of only 10 euros was sufficient for this number to let their mice go. This almost fivefold difference between the market and individual treatments in the experiment may be considered a measure of the moral disengagement created by the market setting.

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Notice that it was not the incentives per se that reduced the price at which the market-treatment students would let the mice die. There were monetary incentives in both the individual and the market settings. What differed was that the subjects in the market setting could disengage morally.

Hoffman and her coauthors found that proposers’ offers and responders’ rejections of low offers were both diminished by simply relabeling the game the “Exchange” game and relabeling proposers and responders “sellers” and “buyers.” The renaming did not in any way alter the incentives at work in the game. Instead, it affected the subjects’ sense of appropriate behavior independently of the incentives.

close supervision or arbitrary deadlines for completion of an otherwise enjoyable activity has almost the same negative effect as financial or other rewards.

there is some evidence that incentives and social rewards activate different regions of the brain.

consequentialist reasoning is often (but not always) less prosocial than deontological judgment.

The three reasons why incentives may crowd out social preferences—bad news, moral disengagement, and control aversion

The second is that the corrosive effect of markets and incentives on social preferences indeed exists, but in many societies has been offset by other social processes allowing for the survival, and even flourishing, of a robust civic culture.

Karl Marx’s broadside condemnation of capitalist culture: “Finally there came a time when everything that men had considered as inalienable became an object of exchange, of traffic and could be alienated. This is the time when the very things which till then had been communicated, but never exchanged, given but never sold, acquired but never bought: virtue, love, conviction, knowledge, conscience—when everything passed into commerce. It is the time of general corruption, of universal venality.”

a standard deviation difference in our measure of market exposure was associated with about half a standard deviation increase in the mean Ultimatum game offer.

majority determination of the punishment system made the punishment of shirkers not just an incentive but also a signal of group norms.

In liberal societies, by contrast, the tasks of moral instruction and maintenance of order are routinely entrusted to individuals who are unrelated and, at least initially, unknown to those whom they teach, police, or judge. In an inversion of the moral code of lineage-segmented societies, the legitimacy of these teachers, police, and court officers is based on their anonymity and lack of relationship to those they interact with.

liberal political, judicial, and other nonmarket institutions as the key to liberal civic culture. This differs from the usual explanation of the civic culture of liberal societies, namely, the doux commerce hypothesis, which credits the exchange process itself.

When people seldom deal with one another, we find that they are somewhat disposed to cheat, because they can gain more by a smart trick than they can lose by the injury which it does their character.”

markets with a restricted number of people, in which exchanges take place repeatedly over a long period, might promote honest dealing.

The result is a cultural environment favorable to the evolution of universal norms, which apply to strangers as well as to the clan.

The rule of law and other aspects of the liberal state make the consequences of mistakenly trusting a defector much less dire. As a result, the rule of law lowers the bar for how much you would have to know about your partner before trusting him. Thus, the rule of law could promote the spread of trusting expectations and hence of trusting behavior in a population.

The assurance that defectors would be punished by a third party reduced a subject’s fear that a defector would gain at her expense.

norms appears to have been at work during the expansion of the eleventh-century Mediterranean trading system, in which familial, communal, and other parochial systems of so-called collectivist contract enforcement were eclipsed by more universalistic, state-based, individualist systems.

The spread of markets often contributed to the emergence of national states bound by the rule of law, and if my argument is correct, this dynamic favored the evolution of generalized trust.

Constitution for Knaves Crowds Out Civic Virtue.”

three conditions efficiency, voluntary participation, and preference neutrality.

Mechanism design, it appeared, had failed in its quest for mechanisms to address market failures that would have Pareto-efficient outcomes while respecting preference neutrality and voluntary participation.

the three conditions of liberal constitutional design and public policy—neutrality with respect to preferences, voluntary participation, and Pareto efficiency—are not generally compatible.

The literature on mechanism design reads like one piece of bad news after another. The negative results were important contributions, and as they accumulated, some in the field beat a strategic retreat, weakening the standard of efficiency in order to resolve the trilemma by the stroke of a pen.

The time has come, the Legislator muses, to take a second look at liberal neutrality.

policies that would more effectively harness self-interest to public ends may compromise the ethical and other-regarding preferences on which the success of the Legislator’s constitution must also depend. And as we will see, the reverse is also true: policies that support the proliferation and expression of ethical and other-regarding motivations will sometimes reduce the effectiveness of explicit incentives in implementing efficient outcomes.

by allowing the sale of one’s share, privatization also makes it easier to leave. This undermines the conditions that sustained cooperation. It reduces the expected duration of interactions, so the value of avoiding retaliation is reduced, possibly by enough to make overexploitation the more rewarding strategy.

The Legislator’s visits to economics faculties have left him with five uncomfortable facts about incentives: incentives are essential to a well-governed society; incentives cannot singlehandedly implement a fully efficient use of economic resources if people are entirely self-interested and amoral; ethical and other social preferences are therefore essential; unless designed to at least “do no harm,” incentives may stand in the way of “creating better people”; and as a result, public policy must be concerned about the nature of individual preferences and the possibility that incentives may affect them adversely.

the kinds of policies advocated by economists to make markets work more efficiently in an economy of knaves—roughly, by putting a price on everything—may compromise exactly those ethical and other-regarding motives that are essential to a well-governed society.

Those who felt unjustly burdened could appeal their assignment (called a liturgy). They would do this by challenging some other (also presumably wealthy) individual to either take on their liturgy, or else to exchange with the challenger all their real and personal property holdings. If the target of the challenge refused to do either, then a popular jury would determine which man’s estate was the larger and should therefore bear the costs of the liturgy. By allowing citizens to use private information about their own and their neighbors’ wealth to mitigate injustices in the assignment of the liturgy, this ingenious provision limited opposition to the provisioning of the mission.

Had the Athenians been consulted, they certainly would have not approved. Instead, their sign would have announced: “The Council of Parents wishes to thank you for arriving on time to pick up your children, since this reduces the anxiety that the children sometimes feel and allows our staff to leave in a timely manner to be with their own families. We will recognize all parents who have a perfect record unblemished by lateness for the next three months with an award of NIS 500, to be given at our annual parents and staff holiday party, with an option to contribute your award to the school’s Teacher of the Year celebration.” But that would not have been all: “Those who arrive more than ten minutes late, however, will pay a fine of NIS 1,000, with the payment of the fine publicly transmitted also at the holiday party. In the unlikely event that the occasion for such a fine arises, the payment will also support the Teacher of the Year celebration.” And the message would have ended with: “Of course, sometimes it is impossible, for reasons beyond your control, to arrive on time; and should this occur, you may explain the circumstances before a committee of parents and staff, and if the lateness was unavoidable or if the fine would cause extreme hardship, the lateness will be publicly reported but no fine will be imposed.”

The problem of crowding out may arise when the information that an incentive conveys is off-putting about the person imposing the incentive, or when it frames the problem as one in which self-interested motives are acceptable or even called for, or when the incentive compromises the autonomy of its target. The problem, we will see, may be the information, not the incentive itself, and there may be ways that the information conveyed by the incentive could be more positive.

the presence of an incentive, generous actions such as helping others may be misunderstood as self-interested, even when they are not, and that this may result in people adopting self-interested preferences to a greater extent than they would in the absence of the incentive. But like the adverse information sometimes conveyed by incentives, this problem might be attenuated by providing ample opportunity for the display of civic-minded motives, as the Athenian assembly did. The Legislator is beginning to wonder

When people engage in trade, produce goods and services, save and invest, vote and advocate policies, they are attempting not only to get things, but also to be someone, both in their own eyes and in the eyes of others.2 Our motives in other words are constitutive as well as acquisitive.

Distinguishing between acquisitive and constitutive motives and determining which is at work in cases like this can have important implications for the advocacy and design of public policy.

In Haifa, the announcement of the fine included no justification for the punishment. There was no “moral lesson.”

We found that while the altruists contributed generously to the public good, they were less likely to inflict peer punishment on free riders. Instead, when it came to sustaining the social norm of contributing, it was the altruists who free rode on other group members’ willingness to sacrifice their own payoffs in order to pay to punish low contributors.19

as those with reciprocal preferences become more altruistic, their willingness to punish free riders diminishes, and this indirect effect of their greater altruism can offset the direct effect of altruism in increasing contributions.

Most people have an “internal” incentive, in the form of conscience, to take modest care to avoid harming others. Corporations may lack this incentive. .

An important part of this process (as we saw in chapter II) was the realization that saints are not the only alternative to knaves.