Economic Fun and Games

Flags of the Nordic countries - from left: Fin...

It's prim up North

 I used the Prisoner’s dilemma in my last post to illustrate how game theory can be used to understand the effects of inequality, but numerous other economic games or thought experiments are relevant too. Many of them conform to the same general type, where there is the chance to act in purely self-interested terms, but cross-cultural findings show that people almost never act like this. This is problematic for neoclassical economic theory, which presumes that maximising returns is the only concern (greed is good).

Behavioural economics on the other hand has started to incorporate these findings, recognising the influence of reputation and future interactions on decisions. In other words, if you show yourself to be selfish today, other people will be less willing to help you tomorrow. This is still compatible with individuals maximising their personal gains, but it takes into account the long term, rather than short-term profiteering.

In light of this, some differences between liberal market economies and social market economies are unsurprising. According to Jonas Pontusson’s classification, LMEs like UK and US subscribe more to neoclassical economics, or the ‘Washington consensus’, than SMEs, like the Nordic countries. In LMEs, industrial and employment contracts are shorter, and there is less employee training. The shorter you know someone for, the less important reputation is in the long term, and the less important cooperation becomes if you will be working for another company next year. It is difficult to determine the direction of causality, and unrealistic too, as there will be mutual reinforcement between the different traits. Suffice to say that bad things tend to go together – inequality, lack of trust, lack of importance of reputation, shorter contracts.

There are numerous other traits that seem worse in LMEs, which I hope you won’t be surprised to learn, occupy the bottom places of the rich countries in terms of income inequality. The move from personal business relationships to faceless financial transactions contributed to the global recession, as Will Hutton has pointed out. It is hardly surprising from a psychological perspective that bankers made more reckless decisions when their actions were separated from the human consequences.

Economics is starting to acknowledge the effects human psychology has on economic decisions, and the effect of economics on human psychology is all too clear at the moment.

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