Economics is sometimes called the ''dismal science'' because economists routinely make worst-case assumptions about people''s motives. Certainly, most economic analysis is based on the self-interest hypothesis, which assumes that all people are exclusively motivated by their material self-interest. But in recent years, experimental economists have gathered strong evidence systematically refuting the self-interest hypothesis. The evidence suggests that many people are also motivated by social preferences – the interests of others – and that concerns for fairness and reciprocity cannot be ignored in economic interactions.
Writing in the latest issue of the Economic Journal, Professor Ernst Fehr shows that fundamental economic questions cannot be properly understood if social preferences are neglected. He provides evidence for the following claims:
· Competition: it is not possible to understand the nature and impact of competition when neglecting social preferences. Depending on the specific context, the selfinterest hypothesis leads economists both to underestimate and overestimate the impact of competition on wages and prices. Even in competitive markets, wages and prices are also affected by concerns for fairness and reciprocity.
· Cooperation: it is not possible to understand the nature and determinants of cooperation and collective action when neglecting social preferences. The selfinterest hypothesis greatly underestimates the possibilities of cooperation and collective action because it neglects the retributive forces unleashed by concerns for fairness and reciprocity. This hampers the proper management of cooperation in firms, organisations and society as a whole.
· Incentives: it is not possible to understand the nature and impact of material incentives when neglecting social preferences. Concerns for fairness and reciprocity themselves constitute powerful material incentives in situations where the selfinterest hypothesis predicts the absence of any incentives. But material incentives may also be rendered ineffective if they are not compatible with fairness. Thus, understanding the interaction between fairness concerns and material incentives is crucial for the design of proper incentive mechanisms.
''Why Social Preferences Matter: The Impact of Non-selfish Motives on Competition, Cooperation and Incentives'' by Ernst Fehr is published in the March 2002 issue of the Economic Journal. Fehr is Director of the Institute for Empirical Research in Economics at the University of Zürich.