Fairness, norms, and reciprocity Standard economic models ("
neoclassical economics") assume that people pursue only their self-interest and do not care about "social" goals ("
homo economicus"). Neoclassical economics is divided into three theories, namely methodological individualism, methodological instrumentalist, and methodological equilibration. Some attention has been paid to the idea that people may be
altruistic, but it is only with the addition of
reciprocity and norms of
fairness that the model becomes accurate. Thus of crucial importance is the idea of exchange: a person who is altruistic towards another expects the other to fulfil some fairness norm, be it reciprocating in kind, in some different but – according to some shared standard – equivalent way, or simply by being grateful. If the expected reciprocation is not forthcoming, the altruism will unlikely be repeated or continued. In addition, similar norms of fairness will typically lead people into negative forms of reciprocity, too – in retaliation for acts perceived as vindictive. This can bind actors into vicious loops where vindictive acts are met with further vindictive acts. In practice, despite the neat logic of standard neoclassical models, these sociological models do impinge upon many economic relations, though in different ways and to different degrees. For example, suppose an employee has been exceptionally loyal. In that case, a manager may feel some obligation to treat that employee well, even when it is not in his (narrowly defined, economic) self-interest. It would appear that although broader, longer-term economic benefits may result (e.g. through reputation, or perhaps through simplified decision-making according to fairness norms), a significant factor must be that there are noneconomic benefits the manager receives, such as not having a guilty conscience (loss of self-esteem). For real-world, socialised, normal human beings (as opposed to abstracted factors of production), this is likely to be the case quite often. As a quantitative estimate of the importance of this, the total value of voluntary labor in the US – $74 billion annually – will suffice. Examples of the negative aspect of fairness include consumers "boycotting" firms they disapprove of by not buying products they otherwise would (and therefore settling for second-best); and employees sabotaging firms they feel hard done by. Rabin (1993) offers three stylised facts as a starting point on how norms affect behaviour: (a) people are prepared to sacrifice their material well-being to help those who are being kind; (b) they are also prepared to do this to punish those being unkind; (c) both (a) and (b) have a greater effect on behaviour as the material cost of sacrificing (in relative rather than absolute terms) becomes smaller. Rabin supports his Fact A by Dawes and Thaler's (1988) survey of the experimental literature, which concludes that for most one-shot
public good decisions in which the individually optimal contribution is close to 0%, the contribution rate ranges from 40 to 60% of the socially optimal level. Fact B is demonstrated by the "ultimatum game" (e.g. Thaler 1988), where an amount of money is split between two people, one proposing a division, the other accepting or rejecting (where rejection means both get nothing). Rationally, the proposer should offer no more than a penny, and the decider accept any offer of at least a penny. Still, in practice, even in one-shot settings, proposers make fair proposals, and deciders are prepared to punish unfair offers by rejecting them. Fact C is tested and partially confirmed by Gerald Leventhal and David Anderson (1970), but is also reasonably intuitive. In the ultimatum game, a 90% split (regarded as unfair) is (intuitively) far more likely to be punished if the amount to be split is $1 than $1 million. A crucial point (as noted in Akerlof 1982) is that notions of fairness depend on the status quo and other reference points. Experiments (Fehr and Schmidt 2000) and surveys (Kahneman, Knetsch, and Thaler 1986) indicate that people have clear notions of fairness based on particular reference points (disagreements can arise in the choice of reference point). Thus, for example, firms who raise prices or lower wages to take advantage of increased demand or increased labour supply are frequently perceived as acting unfairly, where the same changes are deemed acceptable when the firm makes them due to increased costs (Kahneman et al.). In other words, in people's intuitive "naïve accounting" (Rabin 1993), a key role is played by the idea of entitlements embodied in reference points (although as Dufwenberg and Kirchsteiger 2000 point out, there may be informational problems, e.g. for workers in determining what the firm's profit is, given tax avoidance and stock-price considerations). In particular, it is perceived as unfair for actors to increase their share at the expense of others. However, over time such a change may become entrenched and form a new reference point which (typically) is no longer in itself deemed unfair.
Sociological efficiency wage models Solow (1981) argued that wage rigidity may be partly due to social conventions and principles of appropriate behaviour, which are not entirely individualistic. Akerlof (1982) provided the first explicitly sociological model leading to the efficiency wage hypothesis. Using a variety of evidence from sociological studies, Akerlof argues that worker effort depends on the work norms of the relevant reference group. In Akerlof's partial
gift exchange model, the firm can raise group work norms and average effort by paying workers a gift of wages over the minimum required in return for effort above the minimum required. The sociological model can explain phenomena inexplicable on neoclassical terms, such as why firms do not fire workers who turn out to be less productive, why piece rates are so little used even where quite feasible; and why firms set work standards exceeded by most workers. A possible criticism is that workers do not necessarily view high wages as gifts, but as merely fair (particularly since typically 80% or more of workers consider themselves in the top quarter of productivity), in which case they will not reciprocate with high effort. Akerlof and
Yellen (1990), responding to these criticisms and building on work from psychology, sociology, and personnel management, introduce "the fair wage-effort hypothesis", which states that workers form a notion of the
fair wage, and if the actual wage is lower, withdraw effort in proportion, so that, depending on the wage-effort
elasticity and the costs to the firm of shirking, the fair wage may form a key part of the wage bargain. This explains persistent evidence of consistent wage differentials across industries (e.g. Slichter 1950; Dickens and Katz 1986; Krueger and Summers 1988): if firms must pay high wages to some groups of workers – perhaps because they are in short supply or for other efficiency-wage reasons such as shirking – then demands for fairness will lead to a compression of the pay scale, and wages for different groups within the firm will be higher than in other industries or firms. The union threat model is one of several explanations for industry wage differentials. This
Keynesian economics model looks at the role of unions in wage determination. The degree in which union wages exceed non-union member wages is known as
union wage premium. Some firms seek to prevent unionization in the first instances. Varying costs of union avoidance across sectors will lead some firms to offer
supracompetitive wages as pay premiums to workers in exchange for their avoiding
unionization. Under the union threat model (Dickens 1986), the ease with which industry can defeat a union drive has a negative relationship with its wage differential. In other words,
inter-industry wage variability should be low where the threat of unionization is low. ==Empirical literature==