Biased Beliefs and Reciprocal Behavior in Social Dilemmas Von der Fakultät für Wirtschaftswissenschaften der Rheinisch-Westfälischen Technischen Hochschule Aachen zur Erlangung des akademischen Grades eines Doktors der Wirtschafts- und Sozialwissenschaften genehmigte Dissertation vorgelegt von Dipl.-Ing. Anselm Hüwe Berichter: Univ.-Prof. Dr. rer. pol. Wolfgang Breuer Univ.-Prof. Dr. rer. pol. Christine Harbring Tag der mündlichen Prüfung: 21.04.2015 Diese Dissertation ist auf den Internetseiten der Hochschulbibliothek online verfügbar. Table of Contents 1 Introduction ............................................................................................................................. 1 2 Economic Experiments ........................................................................................................... 3 3 Game Theory and (Common) Belief in Rationality ................................................................ 8 3.1 Boundedly Rational Behavior ........................................................................................ 11 3.2 Biased Beliefs ................................................................................................................. 14 4 Social Preferences ................................................................................................................. 15 4.1 When Social Preferences Should Be Assumed, and When Not ..................................... 16 4.2 Evolutionary Analysis .................................................................................................... 18 4.3 Reciprocity ...................................................................................................................... 22 5 Remarks on the experiments ................................................................................................. 24 5.1 Reciprocity in the Public Goods Game .......................................................................... 25 5.2 Reciprocity in the Trust Game ........................................................................................ 26 5.3 Reciprocity in the Ultimatum Game ............................................................................... 28 5.4 An Integrated View of All Three Experiments .............................................................. 29 References ................................................................................................................................ 36 Explaining Individual Contributions in Public Goods Games Using (only) Reciprocity and Overoptimism ........................................................................................................................... 41 Trust, Reciprocity, and Betrayal Aversion: Theoretical and Experimental Insights ............. 100 Using the Carrot and the Stick? Theoretical and Experimental Insights Into Positive vs. Negative Reciprocity .............................................................................................................. 161 1 Introduction We cannot understand the […] economy without having a theory of how humans make decisions. Herbert Gintis (2009), p. 2. Adam Smith, who is usually considered to be the founding father of microeconomics, is most frequently cited for his image of the “invisible hand“, which expresses that everybody should intend only his own gain: By doing so, an “invisible hand” lets people simultaneously promote the public interest (Smith, 1937 [1776]). According to this concept, the existence of social dilemmas, where a conflict between self-interest and public interest exists, is denied. This “selfishness axiom” (Henrich et al., 2004) has for a long time prevailed in economic research. Typically, the selfishness axiom was (or still is) combined with the assumption of rational behavior, leading to a simple and often useful theory of human behavior (known as the homo economicus model, the neoclassical model, or the standard model). However, representations of social dilemmas, such as the public goods game (PGG), prove that selfishness is not always in the public interest. The selfishness axiom predicts that people cannot solve such social dilemmas. In contrast, experimental research in the last decades has proven that people often act in the public interest even when it causes harm to themselves. This finding, which – according to his less frequently cited book “Theory of Moral Sentiments” – even Adam Smith was aware of, has brought the understanding of social preferences for economic interactions back into the spotlight. In addition, experimental research has discovered various deviations from the rationality assumption, which is an essential part of the homo economicus model. While giving up this assumption makes models more complicated, upholding it hampers attempts to gain important new insights. For example, an important finding of this dissertation is that social preferences and seemingly irrational biases in human thinking interact with each other. Therefore, they must 1 be considered in an integrated way. More generally, the goal of this dissertation is to contribute to a better understanding of human decision making in social dilemmas. To achieve this objective, we reject both the selfishness axiom and the rationality axiom. Instead, we modify the reciprocity model of Dufwenberg and Kirchsteiger (2004) (henceforth DK), and extend it by introducing biased and therefore irrational beliefs. We extract these two essential aspects of human decision making by using experimental methods: Indeed, people have reciprocal preferences, and they believe in more reciprocal behavior of others than is actually the case. We will call such people “reciprocal believers” in the following, and our results show that this belief bias only makes sense in combination with reciprocal preferences. Briefly, our findings can be summarized as follows. People 1. cooperate because they (to some degree: wrongly) believe that others cooperate as well, 2. trust because they (to some degree: wrongly) believe that others are trustworthy, and the fear of being betrayed does not diminish trusting behavior, 3. behave in a fair way because they (to some degree: wrongly) believe that they will be punished if they do not. Furthermore, fair – meaning equal – payoffs are achieved because people want to be kind to others. Reciprocating kind behavior in one situation does not necessarily mean that unkind behavior in another situation will be reciprocated as well. The incorporation of these results into thinking about human decision making leads to a different way of designing corporations, institutions, and markets. Is it possible to auction goods anonymously and with little legal control via the internet? How much supervision is necessary to make people pay their taxes or for their bus tickets? Behavioral economists will come to very different conclusions compared to neoclassical economists: Reciprocal believers are much more successful in solving social dilemmas than homines economici, which is good news. 2 However, accepting that people are reciprocal believers is, at the same time, bad news because it implies that our economy is much more vulnerable than it would be if unbiased and selfish subjects were making economic transactions: Correct beliefs and selfishness are precisely defined. In contrast, biases are prone to framing. Akerlof and Shiller (2010) argue that people think with the help of “stories” (such as “house prices always rise”), and such stories can be significantly biased. Perceptions are influenceable or even manipulable positively as well as negatively (see Posten et al., 2014, to name only one example). With respect to social preferences, evolutionary analyses find oscillating or chaotic phases of cooperation and defection in social dilemmas (see Section 4.2). Thinking of people as reciprocal believers explains why economic developments can make sudden disruptions unjustified by “hard facts”. Three of the five irrational “animal spirits” which drive human behavior according to Akerlof and Shiller (2010) (trust, fairness, biased beliefs) are addressed in this dissertation (we do not address corruption and money illusion), and their link between economic decision making of humans and macroeconomic phenomena, such as financial crises, illustrates how important it is to understand human decision making in social dilemmas much better than has been the case up to now. 2 Economic Experiments Economists (unfortunately)… cannot perform the controlled experiments of chemists or biologists because they cannot easily control other important factors. Like astronomers or meteorologists, they generally must be content largely to observe. Paul A. Samuelson and William D. Nordhaus, Principles of Economics 12th ed. McGraw-Hill, New York 1985, p. 8 Experimental economics is an ‘exciting new development’. Paul A. Samuelson and William D. Nordhaus, Principles of Economics 14th ed. McGraw-Hill, New York 1992, p. 5 3 Science can be theoretical, observational, or experimental. In economics, research has for a long time not been experimental, and it was believed that it is not possible to conduct economic experiments. While other (natural) sciences began to conduct experiments much earlier (starting with physics in the time of Galileo, followed by chemistry, biology, and no more than about one hundred years ago, psychology, compare Friedman and Sunder, 1994), the first economic experiments were not made until the second half of the last century. Since the mid-1980s, the number of experimental papers