Optimal Parochialism: The Dynamics of Trust and Exclusion in Networks

Networks such as ethnic credit associations, close-knit residential neighborhoods, 'old boy' networks, and ethnically linked businesses play an important role in economic life but have been little studied by economists. These networks are often supported by cultural distinctions between insiders and outsiders and engage in exclusionary practices which we call parochialism. We provide an economic analysis of parochial networks in which the losses incurred by not trading with outsiders are offset by an enhanced ability to enforce informal contracts by fostering trust among insiders. We first model one-shot social interactions among self-regarding agents, demonstrating that trust (i.e., cooperating without using information about one's trading partner) is a best response in a mixed-strategy Nash equilibrium if the quality of information about one's partner is sufficiently high. We show that since larger networks have lower quality information about specific individuals and greater trading opportunities, there may be an optimal (payoff-maximizing) network size. We then model the growth and decline of networks, as well as their equilibrium size and number. We show that in the absence of parochialism, networks may not exist, and the appropriate level of parochialism may implement an optimal network size. Finally, we explore the welfare implications and reasons for the evolutionary success of exclusion on parochial and other grounds.

Walrasian Economics in Retrospect

Two basic tenets of theWalrasian model, behavior based on self-interested exogenous preferences and complete and costless contracting have recently come under critical scrutiny. First, social norms and psychological dispositions extending beyond the selfish motives of Homo economicus may have an important bearing on outcomes, even in competitive markets. Second, market outcomes depend on strategic interactions in which power in the political sense is exercised. It follows that economics must become more behavioral and more institutional. We can return to these themes of the classical tradition, now equipped with more the powerful mathematical tools developed over the past century.

Power

We consider the exercise of power in competitive markets for goods, labour and credit. We offer a definition of power and show that if contracts are incomplete it may be exercised either in Pareto-improving ways or to the disadvantage of those without power. Contrasting conceptions of power including bargaining power, market power, and consumer sovereignty are considered. Because the exercise of power may alter prices and other aspects of exchanges, abstracting from power may miss essential aspects of an economy. The political aspect of private exchanges challenges conventional ideas about the appropriate roles of market and political competition in ensuring the efficiency and accountability of economic decisions

Risk Aversion, Insurance, and the Efficiency-Equality Tradeoff

Under conditions of informational asymmetry, redistributing the property rights may improve work incentives but lead to an inefficient choice of entrepreneurial risk. We present a model in which reassignment of property rights does not affect factor prices and we show that there exist egalitarian asset redistributions that enhance allocative efficiency. The scope for such redistributions can be broadened by offering fair insurance protecting the independent entrepreneur against risk unassociated with the production process and against production uncertainties that are unrelated to the quality of their individual decisions. The market will generally supply insurance of this type suboptimally.

The Evolution of Strong Reciprocity

A number of outstanding puzzles in economics may be resolved by recognizing that where members of a group benefit from mutual adherence to a social norm, agents may obey the norm and punish its violators, even when this behavior cannot be motivated by self-regarding, outcome-oriented preferences. This behavior, which we call strong reciprocity, is a form of altruism in that it benefits others at the expense of the individual exhibiting it. While economists have doubted the evolutionary viability of altruistic preferences, we show that strong reciprocity can invade a population of non-reciprocators and can be sustained in a stable population equilibrium. Under assumptions that may reflect the relevant historical conditions, the model describes the genetic evolution of strong reciprocity as a component in the repertoire of human preferences.

Mutual Monitoring in Teams: Theory and Experimental Evidence on the Importance of Reciprocity

Monitoring by peers is often an effective means of attenuating incentive problems. Most explanations of the efficacy of mutual monitoring rely either on small group size or on a version of the Folk theorem with repeated interactions which requires reasonably accurate public information concerning the behavior of each player. We provide a model of team production in which the effectiveness of mutual monitoring depends not on these factors, but rather on strong reciprocity: the willingness of some team members to engage in the costly punishment of shirkers. This alternative does not require small group size or public signals. An experimental public goods game provides evidence for the behavioral relevance of strong reciprocity in teams.

Unequal Chances: Family Background and Economic Success

Is the United States "the land of equal opportunity" or is the playing field tilted in favor of those whose parents are wealthy, well educated, and white? If family background is important in getting ahead, why? And if the processes that transmit economic status from parent to child are unfair, could public policy address the problem? Unequal Chances provides new answers to these questions by leading economists, sociologists, biologists, behavioral geneticists, and philosophers. New estimates show that intergenerational inequality in the United States is far greater than was previously thought. Moreover, while the inheritance of wealth and the better schooling typically enjoyed by the children of the well-to-do contribute to this process, these two standard explanations fail to explain the extent of intergenerational status transmission. The genetic inheritance of IQ is even less important. Instead, parent-offspring similarities in personality and behavior may play an important role. Race contributes to the process, and the intergenerational mobility patterns of African Americans and European Americans differ substantially. Following the editors' introduction are chapters by Greg Duncan, Ariel Kalil, Susan E. Mayer, Robin Tepper, and Monique R. Payne; Bhashkar Mazumder; David J. Harding, Christopher Jencks, Leonard M. Lopoo, and Susan E. Mayer; Anders Björklund, Markus Jäntti, and Gary Solon; Tom Hertz; John C. Loehlin; Melissa Osborne Groves; Marcus W. Feldman, Shuzhuo Li, Nan Li, Shripad Tuljapurkar, and Xiaoyi Jin; and Adam Swift.family background, economic success, education, status, public policy, inequality, genetic inheritance, intergenerational mobility