New Evidence Of The Impact Of Emotions On Economic Decisions

Emotions such as anger and guilt can have a powerful impact on the decisions we make about whether to benefit ourselves at the expense of our clients, our colleagues or the government. That is the central finding of research by Astrid Hopfensitz and Ernesto Reuben, published in the October 2009 issue of the Economic Journal.

Their study, which uses an experimental two-player game, finds that participants are likely to retaliate if they feel they have been treated unfairly, even if retaliation is costly. But even more striking is the fact that if the ''punished'' participant feels angry but not guilty, they too will retaliate. This can lead to an escalation that is bad for everyone.

The researchers conclude that moral feelings are an important ingredient of ''social control'' and need to be considered by economists and politicians. Understanding the role of emotions can help to design policies that induce ''socially desirable'' behaviours in markets and societies.

Why should I report all my income to the tax authority – even though the chances of being caught are very small? Why should I be honest to my clients – even though they might have no way of verifying what I did?

For long, economists have been occupied studying how we act in social dilemmas such as these. Understanding them is important for policies ranging from environmental regulations to figuring out what went wrong with ''immoral'' investors. Social dilemmas are situations where everyone is better off if everyone cooperates, but at
the same time, each person has no (obvious) individual motivation to do so. Laws and regulations are one way to enforce certain behaviours. But things get tricky for situations where neither state nor police can observe everybody and enforce the rules.

One alternative is decentralised social enforcement. But under which conditions does such enforcement work? Situations might escalate because the implied parties feel unjustly punished by their peers. Do moral emotions, such as guilt, inhibit escalation and make social control truly effective?

These are the questions approached in this study. It features an economic experiment in which two players faced a social dilemma. Both players receive points that represent real money. One player is asked to move first and can decide whether to ''trust'' the second player by transferring some of his points. If he does, these points gained in value and the second player gets comparatively richer.

Now it is up to the second player to decide what should happen with this gain in wealth. He can act fairly and split the gains equally, be selfish and keep everything for himself or take a middle way by returning the investment but keeping a larger portion.

After this interaction, players can ''penalise'' the other if they feel they have been treated unjustly. But this is costly: players have to give up one point to be able to reduce the other's earnings by four points. When a player decides to penalise his partner both therefore lose real money. In addition after being penalised the punished party can retaliate and so on until one of the two stops.

The results show that social control ''works'' and prompts around 60% of second players to return high amounts in the first place. But it is especially interesting to look at those who return less than the ''fair'' amount. Most of these players receive punishment from their partners.

The question is how do they react to it. The study finds that 40% of participants that get punished decide to spend some of their money to retaliate. This is striking since these players had initially breached a social norm and had higher earnings than their partner. Instead of stopping the game by renouncing punishment, they decide to lose some of their earnings and risk angering their partner even more. Indeed, in 55% of the cases they get punished again. This leads in most cases to the complete destruction of both players'' resources. Escalation is thus highly inefficient.

The experiment shows that the experience of moral emotions reduces escalation. Of those players that feel angry after being punished, 100% retaliate if they do not experience guilt. None of those experiencing guilt decide to succumb to their anger. 

''The Importance of Emotions for the Effectiveness of Social Punishment'' by Astrid Hopfensitz and Ernesto Reuben is published in the October 2009 issue of the Economic Journal.