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Reconstructing normative economics on a foundation of mutual advantage

Periodic Reporting for period 4 - NormativeEconomics (Reconstructing normative economics on a foundation of mutual advantage)

Reporting period: 2020-10-01 to 2021-06-30

Economics has traditionally assumed that individuals seek to satisfy coherent and asocial preferences, and has used the satisfaction of those preferences as a normative criterion for assessing policy proposals. This ‘neoclassical’ approach has supported a view of the market as an institution in which privately-motivated individual actions tend to produce socially beneficial consequences. These ideas have been called into question by developments in behavioural economics, which point to the cognitive limitations of economic agents, the instability of preferences, and the existence of pro-social motivations. A common inference is that traditional presumptions in favour of the market and against paternalism are invalidated. The objective of the project was to develop an approach to normative economics, and a corresponding understanding of the role of markets, which do not require neoclassical rationality assumptions but may still support those presumptions.
We have extended economic theory in two directions, linked by a common theme of mutual advantage, and, more fundamentally, by a philosophical conception of society as a cooperative venture.
First, we have developed a form of normative analysis which uses opportunity rather than preference satisfaction as its principal criterion. Even if individuals lack coherent preferences, opportunities for mutually beneficial transactions can be defined in a normatively significant way, and competitive markets can be shown to be effective in providing such opportunities. This approach offers a new understanding of the role of government in the economy. It does not support paternalistic policies aimed at counteracting psychologically-induced ‘bias’ in individuals’ decisions (a concept that we show to be problematic), but it identifies a role for market regulations to promote competition and fair trading practices, and for social insurance schemes designed to ensure that everyone can gain overall benefit from the opportunity-expanding properties of the market.
Second, we have identified and formalised a norm, the Principle of Mutual Benefit (PMB), that applies to a wide class of ‘voluntary interactions’ that includes market transactions and many forms of cooperation in civil life. The essential idea is that if such an interaction has a ‘practice’ – a commonly-known set of expectations about behaviour within it – then an individual who chooses to enter it ought to conform to that practice as long as other participants do the same. General adherence to this norm can induce non-self-interested cooperative behaviour in voluntary interactions without disabling market incentives. In a society that endorses the norm, market behaviour is motivated by intentions for mutual benefit, and so has moral content.

We have used a novel experimental design to test how far behaviour in voluntary interactions is explained by PMB, as compared with existing theories of ‘social preferences’ which do not distinguish between voluntary and non-voluntary interactions. In this design, participants have recurring opportunities to engage in market-like interactions in which possibilities for cheating (e.g. not paying for a delivered good) can occur. We find a distinctive combination of self-interest in decisions about entering these interactions and non-self-interested ‘honest trading’ within them, as implied by PMB.

PMB is related to the concept of ‘team reasoning’, first theorised by Sugden in 1993, but rests on fewer assumptions about individual rationality. Previous studies of experimental games have found that team reasoning can explain players’ ability to use shared but ‘irrelevant’ knowledge to solve coordination problems (e.g. choosing a meeting-place without communicating). However, such reasoning is less likely to be used in ‘Battle of the Sexes’ games in which the players receive unequal payoffs and have conflicting preferences between alternative ways of coordinating. If unavoidable inequality was a serious obstacle to mutually beneficial cooperation, that would count against the claim that markets promote mutual benefit. In a series of experiments, we have found that team reasoning is inhibited by conflicts of interest but not by inequality per se.

Behavioural economists often claim that, because of psychologically-induced errors, people make choices that do not reflect their ‘true’ preferences and that, recognising this tendency to error, people welcome paternalistic polices that counteract it. We have presented a critique of these claims, arguing that the concept of true preference is psychologically ungrounded. As an experimental test of the hypothesis that people want to constrain themselves, we reproduced the type of setting in which ‘paying not to go to the gym’ (pre-purchasing a ‘virtue good’ on a membership contract when actual consumption could have been bought more cheaply on a pay-as-you-go tariff) has been observed. We reproduced this phenomenon and found that it was better explained as mis-forecasting than as a commitment device chosen to counter a self-control problem. Using an online survey, we tested whether (as is often implicitly assumed in behavioural economics) people’s attitudes to self-control are stable. We found no evidence contradicting that assumption, but respondents reported positive attitudes to both self-control and spontaneity, i.e. willingness to deviate from resolutions.

Our work has led to publications in leading economics journal and presentations at major conferences. Further papers are under review and further presentations are planned. A monograph, The Community of Advantage: A Behavioural Economist’s Defence of the Market (published by Oxford University Press) synthesises the main themes of the project for a cross-disciplinary readership. This won the American Philosophical Association’s 2019 Joseph B. Gittler award ‘for an outstanding scholarly contribution in the field of the philosophy of one or more of the social sciences’. It was the invited subject of four academic conferences, of a special session at a fifth, and of two special issues of academic journals.

We have investigated the implications of the opportunity-based approach and the Principle of Mutual Benefit for market regulation. We have developed a concept of ‘transactional fairness’, distinct from standard economic concepts of efficiency and distributional fairness, that can guide the regulation of unfair pricing practices. This work has aroused a lot of interest among market and industry regulators, who are conscious of current public concern about unfair pricing practices. We have presented this work, by invitation, to the four main UK regulatory agencies and to the UK Government Department for Business, Energy and Industrial Strategy.
The project as a whole was intended to advance the field of normative behavioural economics beyond the current state of the art in two ways, related by the common idea of mutual benefit - developing a new theory of non-self-interested behaviour, and developing criteria for policy guidance that do not rely on psychologically unsupported assumptions about the existence of ‘true’ preferences. We believe that we achieved these advances and have put the mutual benefit approach firmly on the agendas of economics and philosophy.
Cover of 'The Community of Advantage: A Behavioural Economist's Defence of the Market'