by Jacob Oldaker
The theory of mechanism design is used to the influence the behavior to increase the social preferences of a population to pursue a solution that will increase the well-being for an entire group of people in comparison to maximizing one’s individual material payoff. Bowles, Samuel, and Sandra Polanía-Reyes. “Economic Incentives and Social Preferences: Substitutes or Complements?” Journal of Economic Literature 50.12 (2012): 368-425. Economist and policy-makers (principal) use the assumption that all individuals act in the best interest of oneself, making the design of this mechanism difficult in achieving the best scenario for the entire group (agent). Id. The way policy is introduced impacts how people interpret it determining whether the influence will have either a marginal or categorical effect on social preferences. Id. I will begin this article by explaining why the assumption in economics that people are rational actors is not always the best indicator to use when predicting the agent’s decisions. In coordination with these theories, I will use examples to show how these theories have helped mold the process that principals use to devise their influences which they use on their respected agents.
The theory of fairness presented in Ernest Fehr and Klaus Schmidt article, “A Theory of Fairness, Competition, and Cooperation,” suggests that in contrast with most economic models, the way an individual views the fairness of the outcome from their decision, has a larger affect on their decision then acting in their own material-self interest. Fehr, Ernst, and Klaus Schimdt. “A Theory of Fairness, Competition, and Cooperation.” The Quarterly Journal of Economics 114.3 (1999): 817-78. Web. 12 Dec. 2015. For example, an individual A, Adam, is working with individual B, Bob, on a live game show to accumulate an earnings of $20. Adam wins the contest and now has the choice to keep the $20 or split it equally with Bob. Under the assumption that individuals act in their own material interest, Adam will gain more utility by keeping the $20 for himself compared to the utility he would gain by choosing to split the $20 with Bob. Using the Fehr-Schmidt Utility Function, Adam will choose to split the $20 with Bob, but why? Id. Adam understands that he and Bob had cooperated with one another to achieve the pot of $20. In the presence of the live-audience, the guilt of associated with keeping the $20, outweighs the utility he receives from keeping the $20. In this example, Adam receives a higher utility by choosing to be “fair,” splitting the earnings equally with Bob.
Understanding that individuals will act in a way that they deem fair, not solely in their own-material interest, allows policy-makers to take the next step in developing their economic incentive that will influence a larger group of agents. Let’s assume there is a policy-maker that is worried about the depletion of fish among the state’s local fisheries. To prevent further depletion of the fishery, the policy maker may introduce a fine that is used to incentivize those using the fishery to abide by regulations that are put into place to help save the fishery. Rather than decreasing the rate of depletion, the fishery begins to deplete at a higher rate. Although the fine seems both rational and fair in the eyes of the rational actor model and Fehr-Schmidt utility function, what causes those individuals in the community to continue making the irrational decision of depleting their common resource pool? Id. The agents are concerned with more than the costs and benefits that are associated with the economic incentive. Id. There are three additional factors that influence the agent’s decisions that the rational actor model and Fehr-Schmidt utility function fail to include: moral disengagement, “bad news,” and control aversion. Bowles, Samuel, and Sandra Polanía-Reyes. 50.12 (2012): 368-425.
It is plausible that the agents who use the fisheries do not understand why the incentive by the policy-maker has been put in place. The agents may not understand the threat to their fisheries, so instead of taking the measures to prevent further depletion, they continue to over-fish. This is when the agents become morally disengaged; they feel that in the end, they are better off paying for the fine because by in one way or another they will pay for it anyway. Some individuals may feel that the incentive is “bad news,” in which the money the state receives from the fines does not help towards the prevention of depletion of their common resource pool, but is instead put towards the support of another issue that is on the policy-makers agenda. According to the theory of self-determination, some individuals will have acted on their own will to help prevent further depletion of the fishery before the introduction of the incentive. Id. In turn, the new regulations the agents must abide by make the individuals feel like they have to do something that they otherwise would have done anyway. Each of these three factors will negatively affect the agent’s social preferences by producing a categorical effect. Id. at 372. A categorical effect happens when the economic incentive introduced, crowds-out, or substitutes the agent’s social preferences for the economic incentive. There are ways however, to use economic incentives in order to gain a positive effect on the fishery problem.
By using the framing mechanism, the policy-maker can rearrange the proposed economic incentive to receive a marginal effect the agents that use the fishery. Id. at 374. When using the framing mechanism, the policy-maker can design the incentive to guide individuals to act with more appropriate behavior. In the last example, I said the policy maker would fine anyone who does not abide by the regulations when using the fishery. Instead the incentive can be framed as follow: By increasing taxes on fishing license, boat permits, and safety checks for those that use the fishery, we can better ensure that individuals in our community are abiding to the new regulations put in place to stop the depletion of the fishery; we can work together to better save our natural resources, ensure consistent economic usage of our fishery, and guarantee safer recreational use of the fishery for our younger generation. In doing so, we can expect more cooperation by the agents with the new fishery regulations because the correct information was provided to help the agents understand the mission of the incentive that provides benefits both socially and economically to the agents that use the fishery. The individuals are likely to change their social preferences in support of the saving of the fisheries because they are now morally engaged. The consequences of not following the incentive to the agent’s family and friends not being able to receive continued usage of the fishery for both economic and recreational benefits are now prevalent. The positive impact on the social preferences results in a marginal effect, where the incentive and social preferences of the agents work together as compliments to increase the protection their common pool resource. Id. at 373.
In addition to the framing mechanism, when using the fishery example, the policy maker can induce another marginal effect through the conformist mechanism. The conformist mechanism focuses on upgrading the preferences of the agents in the long run. Id. If the incentive that used when using the framing mechanism were to stay in place, the younger generation (generation X) will have greater social preferences than the previous generation (generation Y). Id. Generation X will successfully be able to observe the positive impact that incentive has had from a young age into adulthood. Id. Cooperation from generation Y and the increased benefits gained through cooperation will allow generation X to notice a crowding out effect in which their social preferences increase in coordination with the economic incentive. Id. at 374.
An alternate solution to public policy issues like the fishery example is offered through the work by authors Thomas Dietz, Elinor Ostrom, and Paul Stan in their article, “The Struggle to Govern Commons.” The author’s proposed the idea of self-governance, in which the agents in the community actively participate and become engaged in the policy that will be introduced to the community. Fehr, Ernst, and Klaus Schimdt. “A Theory of Fairness, Competition, and Cooperation.” The Quarterly Journal of Economics 114.3 (1999): 817-78. Web. 12 Dec. 2015. Since the community members collectively agree on the policy, the social-costs associated with breaking the policy outweigh are greater than any cost associated through a purely economic incentive.
In order to instill the cost of social pressures cognitively into the agents of the community, the agents need to first be presented with information that they can relate to. A national statistic that states the depletion of fisheries has eliminated 1% of fish species along with 2.5% jobs nationwide will barely affect the way people in the community look at the issue. Id. If the policy-maker were to use a statistic in the agent’s community that stated 34% of fish species in our species have become extinct, as a result 25% of individuals who were employed in the maritime industry have lost their job, that policy-maker would see a much larger increase in participation to help save the fishery. Id. After providing the agents with hometown examples of how their affecting their community, the agents need to meet to work out a set of rules they agree they can all abide by. Id. There will always be a one individual who will disagree with another individual when trying to negotiate the policy. To ensure compliance, it would beneficial to make an incremental system of warnings and fines for those who break the policy. A first time offender will receive a warning while a second time offender will receive a small fine. The fine will then increase after the second offense. Id. at 615.
To achieve a complete adaptive governance, the agents in the community may suggest that policy makers use money from those who broke the policy anyway or some other form of funding to create technologies that ensure the safety of the common pool resource. Returning to the issue of the fisheries, the policy maker make choose to invest in more cost guards that will ensure all boats meet regulation, all fisherman use proper tackle and are registered to fish the fishery. Id. at 614-6201.
After all rules, compliance measures, and sufficient technologies are in place, an agent in the community that decides to breaks the new policy will socially become an outlier. These individuals will be looked down upon because everyone in the community is now aware of the threats to their common pool of resources without proper cooperation of policy. The social pressure associated with the need to follow the policy, becomes much greater than the cost associate with trying to further take advantage of the common pool resource. Id. at 611-618.
In conclusion, the use of pure-economic incentives suggested by neoclassical economists is not the most viable option when deciding public policy. The complexity of the representative agent goes far beyond the rational actor model in which economists assume that all individuals act in their own interest. This idea is can be a great base for a starting point, but this idea alone will not achieve cooperation. Combining the theory behind the rational actor model with theories in the social sciences will allows us to develop models to create public policy that increase the benefits to a broader group of individuals.