The Economics of Vice and Virtue

The Rational Bully

You are big, tough, and, like most people, fond of having your own way. You make it clear to all and sundry that you don’t like people disrespecting you and will respond by beating them up. You gradually expand your definition of “disrespecting” to include flirting with any woman you are interested in or failing to show proper respect for your opinions. Actually beating people up can be risky but most of the time you don’t have to, because other people take care not to offend you. A psychologist might describe it as an aggressive personality. To an economist it is a commitment strategy — one that usually works.

One problem is that you may not be the only one following it. One day you walk into your favorite sports bar, sit down next to a stranger, and start telling him how much better your team is than any of the others. He has the audacity to disagree. Half an hour and six beers later one of you is lying dead on the floor, the other standing over him with a broken beer bottle in his hand and a dazed expression on his face. Is this rational behavior?

To an economist or an evolutionary biologist, the logic of the situation is simple. If nobody else adopts an aggressive personality, the strategy pays; other people do what you want in order to avoid offending you and you never have to make good on your threats. Since it is a profitable strategy, more and more people adopt it. The more people adopt it, the higher the risk of running into someone who will call you on your commitment  —  because he too is committed to a strategy of beating up people who fail to adequately defer to him. In equilibrium, there will be just enough bullies so that the gain from encounters with wimps who back down just balances the loss from encountering another bully who doesn’t.

Evolutionary biologists call their version the hawk/dove game. Hawks and doves in their model are two variants of the same bird, differing only in how they behave; when two birds go after the same bit of food, doves back down and hawks don’t. In equilibrium, produced this time by Darwinian evolution, there are just enough hawks so that the gain to a hawk from hawk/dove encounters balances, on average, the loss from hawk/hawk encounters.

I first encountered the barroom brawl story in a presentation at UCLA many years ago. The presenter’s conclusion was that you could not deter such a crime by punishment since the behavior was irrational; the killer regretted what he had done as soon as he did it. I at one side of the room and Earl Thompson at the other promptly objected that the behavior was indeed rational seen as the working out of a commitment strategy, a doomsday machine going off.

One implication is that it is also deterrable. The more severe the punishment is for killing someone under those circumstances, the higher the cost of a hawk/hawk interaction. The higher the cost of a hawk/hawk interaction, the fewer the equilibrium number of hawks.

The Economics of Virtue

There are people, probably many people, who will not steal even if they are certain nobody is watching. Why?

My preferred answer starts with the observation that many, although not all, human interactions are voluntary. In deciding whether to hire someone, one relevant consideration is whether he is someone who will steal if not watched. The benefit to the employee of being willing to steal is the amount stolen net of the effort of stealing it and concealing the theft. The cost to the employer is the amount stolen plus the cost of keeping an eye on the employee in order to hold down that amount. It follows that the cost to the employer is normally greater than the benefit to the employee. It further follows that, if employers could tell which employees were honest and which were not, if the worker’s utility function, his preferences with regard to his own behavior, were written on his forehead, the wage premium for honesty would be greater than the fringe benefit of dishonesty, making honesty in the narrow self-interest of the worker.

Our utility functions are written on our foreheads, with a somewhat blurry crayon. Each of us produces, in voice tones, facial expressions, body movements, a stream of information about what is going on inside his head. In order to send a false signal, to persuade people that your preferences are sharply different than they actually are, you have to simultaneously think as the person you actually are in order to decide what to do, for instance when it is safe to steal, and as the person you are pretending to be in order to project the signals that you would be projecting if you were that person.

If you require a computer to do twice as many calculations it slows down. So do we; most of us are not very good liars. It follows that it is easier, for most of us much easier, to signal honesty if we are honest than if we are not. It is in my selfish interest to be thought to be honest; the easiest way of achieving that result is to be honest.

Suppose, however, that everyone was honest. It would then not pay employers to make any effort to distinguish those who were from those who only pretended to be, making it possible for a moderately competent liar to collect both the wage premium for honesty and the fringe benefits from dishonesty. The mechanism of equilibrium here is different from the hawk/dove game but the logic is the same: The more dishonest people there are the more attention other people pay to whether you are dishonest, hence the lower the payoff to dishonesty. In equilibrium, the number of dishonest people pretending honesty is just large enough to make it in other people’s interest to pay just enough attention to keep it down to that number. The best con men take advantage of their talents. For most of the rest of us, honesty pays.

This assumes the existence of some mechanism by which the number of honest people responds to the payoff to honesty. That might happen through individuals training themselves into good habits, through parents bringing up their children to be honest, even through biological evolution if honesty is, to some degree, a heritable trait that pays off in reproductive success.

The genetic explanation also suggests why people show their thoughts and feelings on their faces. No doubt the genes could design a human with no facial expressions at all but who would do business with him? Who would marry him? Just as honesty is valuable in our associates, so is being known to be a bad liar.

To simplify my explanation I have put it in terms of one relationship and one virtue but the application is much broader. It is better to be married to a spouse who does not cheat on you than to one who does, to work for an employer who does not cheat you, to patronize an honest seller, to rent to an honest tenant or from an honest landlord. If you are known to be honest you can even get people to give you valuable information for free — because they know that you will reciprocate by doing something for them in exchange.¹

What the argument implies is that, to the extent that you are engaged in voluntary  interactions with people who correctly perceive what you will or will not do, it is in your self-interest to be committed to act in ways that maximize the summed benefit to the group of people with whom you are interacting. The value to the other people of dealing with someone so committed, which should show up in the terms they are willing to offer you, is greater than the cost to you.

Virtue pays.

The Punchline

Consider two societies. In one, most associations are voluntary; we choose our jobs, our employees, our spouses. In the other most associations are chosen for us. The former might be a modern free market society, the latter a centrally planned socialist society where workers are allocated to jobs² or a traditional society where most people are born into a particular role with very limited alternatives.

In the market society, since most people who associate with me do so only if they think they benefit by the association, there are costs to being dishonest and benefits to being honest. If you are a worker in a centrally planned society, on the other hand, your job is determined and your salary set by someone far away who does not know you and will not have to associate with you. It follows that the dishonest employee will have the same opportunities as the honest one — and the additional opportunity to steal things when nobody is looking.

A similar argument applies to vices. One disadvantage to being a bully is that people choose not to associate with you. If, when you apply for a job, you inform the employer that if he does not treat you as you think you should be treated you will beat him up, you are unlikely to be hired. It follows that the payoff to being a bully will be much lower in a society where most relations are voluntary than in one where most are not.

The implication of this argument is that a market society will have nicer people than either a traditional or a centrally planned society. Virtues will have a higher payoff so more people will be honest. Vices will have a lower payoff so fewer will be bullies.

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A commenter writes:

If market societies have nicer people, they will also have more people whose personal experiences imply collective economies can work, and the inverse for command economies... I guess this could be known as, "the grass is always greener on the other side of the iron curtain."

1. A point discussed in two past posts, one on gift exchange, one on a rationalist saint.

2. My parents, visiting the Soviet Union, asked a young man what he planned to do. “I don’t know,” he replied, “they haven’t decided yet.”