Law and Morality in Economic Life

It is easier to destroy a society than it is to build it. And tipping points that cause people en mass to lose faith and confidence in institutions are more likely than we might assume. This was one of the themes from an outstanding lecture given at the Royal Institution yesterday by Sir Partha Dasgupta as this year’s Royal Economic Society annual public lecture. Drawing on a lifetime of experiences and research, Sir Partha enthralled his audience with a brilliantly structured talk on the growing importance of social norms in helping us to understand more clearly the gulf in economic wealth and life chances between different parts of the world.

Why some countries are rich and others remain poor is a question that has tested economists for well over two hundred years. Many growth theories have been developed and the emphasis has shifted from the importance of physical (fixed) capital to the importance of human capital (education, skills and health outcomes), and more recently to the economic and social returns from investment in the production of knowledge especially in science and technology.

But the most recent developments in growth theory have a different focus, namely the impact that social capital can have and in particular, the ways in which trust can be created among people and how best to generate confidence in institutions and rules. The banking crisis remains fresh in our memories and we remember too instances of social breakdown (for example the LA riots) which few people predicted.

Trust is a vital component in so many aspects of our daily lives - our willingness to trust each other and collaborate lies at the heart of a vast number of economic transactions from creating a new business, to offering insurance, entering into marriage or engaging in collaborative teaching. How best to sustain trust was a theme at the heart of Professor Dasgupta’s lecture. He identified five strategies:

1/ Mutual affection (the implicit understand that comes from loving relationships)
2/ Pro-social disposition (I might feel bad about letting someone else down, our incentives to be honest)
3/ Mutual reinforcement (e.g. punishments for broken promises, withholding future cooperation)
4/ Reputation (reputations can be built or undermined when transactions are repeated on many occasions, brand values)
5/ External enforcement (an impersonal approach to changing behaviour, verification, witness statements, the rule of law, legal institutions and enquiries)

Professor Dasgupta focused on mutual reinforcement and took his audience into the realms of game theory using the classic Prisoners’ Dilemma game as the basis for exploring the risks of defection in relationships becoming a social norm. He chose a behavioural strategy in the game known as GRIM - namely that players start by co-operating and continue to do so as long as no one has broken the co-operative trust established at the start. However, once one player has defected, under GRIM the other player chooses to defect forever with no forgiveness. Under this most punishing of strategies (a long way removed from tit for tat) he showed that if the prospect of meeting again and repeating game is pretty high (less than 50%) then GRIM can become a social norm (an equilibrium strategy) even though the mutual benefits of co-operation are strong in the classic PD game matrix.  Indeed he argued that social co-operation is not inevitable even if conditions are assumed to be favourable.

We find that trust can be reinforcing and have huge economic and social benefits - especially when trust extends far beyond the boundaries of localised economic relationships and transactions. From climate change negotiations through to trade discussions, and from the consequences of a breakdown of trust for the cost of our insurance premiums or the chance of a business start up getting a loan, trust is a component of social capital we are beginning to understand more. But economists have had little to say about this in the past, perhaps this is an age when economists can realise mutual gains from trade in ideas with psychologists and biologists in reforming policies and institutions to promote co-operation, trust and a stronger sense of mutuality in economic life?

Economics Explained, by Evan [12 Feb 2012]
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Unit 1 Micro: Winning the War on Deforestation [5 Feb 2012]
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Unit 2 Macro: Focus on China - Trade and Growth [27 Jan 2012]
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Unit 1 Micro: Can the UK Computer Games Industry Grow [24 Jan 2012]
Unit 4 Macro: Focus on India - Economic Growth [24 Jan 2012]
Unit 2 Macro: Exporting to the Booming Chinese Economy [23 Jan 2012]
Unit 4 Macro: Money, Debt and the New World Order [22 Jan 2012]
Unit 4 Macro: Russia Joins the WTO [22 Jan 2012]
Unit1 Micro: Processed Meat and Cancer Risk - Information Failure? [17 Jan 2012]
Unit 3 Micro: World’s Largest Solar Plant Opens [15 Jan 2012]
Unit 2 Macro: Frontier Markets - the New BRICS? [15 Jan 2012]
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Unit 4 Macro: Time to Re-Boot the British Economy [14 Jan 2012]
Unit 4 Macro: Economics of Fiscal Deficit Reduction [12 Jan 2012]
Unit 4 Macro: Competitive Advantage in Trade (Some Videos) [12 Jan 2012]
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Unit 4 Macro: UK Trade Patterns [11 Jan 2012]
Unit 2 Macro: Factors Driving Business Investment [10 Jan 2012]
Hopes and Fears 2012 [10 Jan 2012]
Economics at the Movies - Freakonomics [9 Jan 2012]
Unit 4 Macro: Natural Disasters and their Economic Impact [7 Jan 2012]
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Unit 1 Micro: Low Cost Airlines Beat the Recession [1 Jan 2012]
Unit 4 Macro: Exchange Rate Economics - Where next for the US Dollar? [31 Dec 2011]
Unit 1 Micro: Biomass Subsidies and Timber Prices [30 Dec 2011]
Unit 2 Macro: The UK Housing Market in 2011 [26 Dec 2011]
Unit 2 Macro: Brazil Overtakes UK in Economic Size [26 Dec 2011]
Unit 3 Micro: Sub Normal Profits - BP Leaves the Solar Industry [21 Dec 2011]
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Prezi on Information Failures [20 Dec 2011]
Economic Corruption - Global Rankings for 2011 [19 Dec 2011]
Unit 2 Macro: Long Term Unemployment - A Human Story [15 Dec 2011]
Unit 4 Macro: Does UK Manufacturing have a Future? [30 Nov 2011]
Unit 2 Macro: Will a Youth Jobs Subsidy Work? [30 Nov 2011]
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Beyond the Bike - The Value of Money [19 Nov 2011]
LSE Lecture: Daniel Kahneman - Thinking Fast and Slow [15 Nov 2011]
Unit 2 Macro: Should the EU introduce a Tobin Tax? [14 Nov 2011]
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AS Macro: The State of British Business [13 Nov 2011]
Unit 2 Macro: Video Clips on Unemployment [6 Nov 2011]
Unit 3 Micro: Impulses to Change Management Models [5 Nov 2011]
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Unit 1 Micro: Google Maps to Charge for Usage [31 Oct 2011]
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Unit 3 Micro: UK Executive Pay - All in it Together? [29 Oct 2011]
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Unit 2 Macro: Economic Importance of Investment [19 Oct 2011]
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Unit 1 Micro: Exercise on Market Supply [26 Sep 2011]
Unit 4 Macro: Greek Economy at Default’s Door [25 Sep 2011]
Unit 4 Macro: IMF Flags up Risks of Double Dip [20 Sep 2011]
Unit 4 Macro: Bangladesh and Comparative Advantage in Textiles [19 Sep 2011]
Unit 2 Macro: Economic Growth and Inequality [14 Sep 2011]
UK Macro: Risks of a Double Dip Recession [12 Sep 2011]
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Monetary Policy Roundtable [25 Jul 2011]
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Unit 4 Macro: Dangers of High Inflation [11 Jul 2011]
Unit 2 Macro: Reducing Unemployment after a Recession [11 Jul 2011]
Unit 3 Micro: Oligopsony - Dairy Losses Drive Farmers from the Fields [10 Jul 2011]
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