This weekend I sat in the garden a lot, reading Sam Bowles’ excellent new book [amazon_link id=”0300163800″ target=”_blank” ]The Moral Economy: Why Good Incentives Are No Substitute for Good Citizens[/amazon_link]. The book explores the incorrect standard (although shifting, I think) assumption in economics that incentives and morals do not affect each other – or in jargon, that they are additively separable. It describes research involving many, many experiments looking at how people behave in different contexts, cultures and communities in response to incentive changes.

The book begins with an explanation of the first theorem of welfare economics and underlines its power as a demonstration of the fact that in life, contracts are almost always incomplete, asymmetric information pervasive – and ever more so in modern economies – and externalities rife. Given the reality, Bowles writes: “Morals must sometimes do the work of prices, rather than the other way round.” His key argument is familiar in the post-public choice literature discussion targets and incentives in the public sector: that treating people as knaves (in Hume’s well-known formulation) makes them more likely to act knavishly. Introducing incentives – like the standard Pigouvian taxes or subsidies to correct externalities – can crowd-out intrinsic motivation, sometimes to the extent that the policy intervention backfires altogether.

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Later chapters go on to consider the information conveyed by the standard incentives tool kit – the social information contained in a fine, for instance – and the importance of the social context in which policies are being implemented. For the experimental results show that behaviour in something like the Ultimatum game differs greatly between cultures. Paradoxically, there is far more pro-social or altruistic behaviour in advanced market economies than in those where the role of the market is limited. Bowles suggests it is because these long-standing capitalist societies have a liberal social order, meaning tolerance, respect for individual rights, relatively few barriers to social mobility. He quotes [amazon_link id=”2012183840″ target=”_blank” ]Voltaire[/amazon_link]’s astonishment on visiting the London Stock Exchange:

“The Jew, the Mohameddan, the Christian deal with one another as if they were of the same religion, and give the name infidel only to those who go bankrupt. … upon leaving this peaceful and free assembly some withdraw to the synagogue, others retire to their churches, some to have a drink … and everyone is happy.”

An apt quotation the week after the Mayoral election in London. The book suggests that there is a virtuous circle whereby “in more market-oriented societies … people learn from their market experiences that fair dealing with strangers is often profitable.” Equally, there can be a vicious circle of distrust outside the family or clan. The point is that preferences are endogenous, not fixed. But, “Where market failures arise because contracts are incomplete, socially valuable norms like trust and reciprocity may be important in attenuating these market failures.”

Finally, the book touches on mechanism design, and why it is not a solution for the policymaker who wants to stick with incentive-based responses to market failures, explaining the impossibility result in this literature: that if there is private information, no voluntary mechanism produces a Pareto efficient outcome. It would also be interesting to think about the role of Al Roth-style market design in using the informational power of markets to devise better policies even where the involvement of money would be ‘repugnant’.

The book does end with some rather general suggestions for ‘Aristotelian’ policymakers who understand the important role of virtue in underpinning efficient as well as fair outcomes. I concluded that in fact there is still a lot of work to be done to understand how incentives and intrinsic values interact. Early in the book, Sam talks about the well-known experiment in a nursery introducing fines for parents who were late to collect their children; the fines made parents feel they were paying for being late, so lateness rose rather than declining. But other examples go the other way: [amazon_link id=”0718193660″ target=”_blank” ]Duflo and Banerjee[/amazon_link] report on the use of mosquito nets rising when a small charge was introduced, rather than giving the nets away for free.

We don’t understand well enough when markets and price incentives are effective and when counter-productive, or the balance between the anonimity of market transactions, the role of reputation and trust in repeated transactions, and the power-laden character of both market and non-market transactions. There is a reason people flock away from their villages for the monetary relations of the big city. In an interesting section the book discusses the importance of identity for understanding these distinctions: people mind being manipulated through incentives by their boss – ‘he doesn’t trust me’ – but they don’t seem to mind the application of monetary incentives like fines so much when the authority is the collective decision of their peers.

It would be good to get to first base with policy makers, and have them appreciate the fact that policies change behaviour at all – there are still so many examples of the assumption that the economist or rule maker is ‘outside’ the economy. For this reason I find the fashion in policy circle for ‘nudging’ alarming as it is being done so much in the spirit of Madison Avenue. Having said this, the insights of [amazon_link id=”0300163800″ target=”_blank” ]The Moral Economy[/amazon_link] point to a potentially far more fruitful approach to policy than either of the current modes of the policy world, where it is either all about incentives or all about nudges. Fundamentally, designers of policies need to recognise that the people to whom they will apply have moral agency. So I applaud this book. And as it is non-technical and a terrific summary of the research on the relevant kinds of experiment concerning collective choice, I’ll be adding it as ‘further reading’ to my public policy course syllabus next semester.