Endogenous Preferences

Today’s post is going to be related to my research for my Honours dissertation. I have decided to look into risk attitudes for my dissertation because this area has gained momentum recently with more and more studies confirming a positive link between the macroeconomic environment and individuals’ risk attitudes.

One of the topics in my literature review is preference stability and what standard economic theory has to say about this. The textbook story is that agents have ‘exogenous preferences’, meaning that their preferences are determined outside the economic system. In this case one can think of agents’ preferences as inherited traits. Everyone is endowed with a certain set of preferences but they are stable over time. Yet economic theory often goes beyond this preference stability, assuming that these sets of preferences are also similar among people. Stigler and Becker in their well-known paper De Gustibus Non Est Disputandum (1977) propose that economists should regard people’s tastes as stable over time and comparable to other people’s tastes. They provide the following analogy for the ‘economics view’ on preferences:

On this interpretation one does not argue over tastes for the same reason that one does not argue over the Rocky Mountains-both are there, will be there next year, too, and are the same to all men. […] On our preferred interpretation […] the economist continues to search for differences in prices or incomes to explain any differences or changes in behaviour. (p.76)

Stigler and Becker’s paper exemplifies that standard economic theory has traditionally eschewed differences in preferences between people and changes in preferences of an individual over time from economic analyses. In 1998, Samuel Bowles saw this dominance of preference similarity and stability in economics as an opportunity to propose an alternative theory of ‘endogenous preferences’ in which he defines preferences as “reasons for behavior, that is, attributes of individuals that (along with their beliefs and capacities) account for the actions they take in a given situation” (p.78).

In the first step, Bowles recognised that every society – whether capitalist or communist – has some ‘allocation rules’; that is, a set of rules for the production and distribution of its goods and services. In the second step, Bowles argued that these allocation rules lead to characteristic interaction patterns in society and that these allocation rules shape human development and influence individuals’ personality, habits, tastes and values.

His alternative approach allowed Bowles to identify five important ways how economic institutions may have a significant impact on agents’ preferences; these are:

  1. Framing and situation construal
  2. Intrinsic and extrinsic motivation
  3. Effects on the evolution of norms
  4. Task performance effects
  5. Effects on the process of cultural transmission

While the first four reasons establish a direct link between economic institutions and preferences, the fifth is of indirect nature. The first reason for a link between economic institutions and individuals’ preferences is that institutions ‘frame’ the choices available to individuals. In particular, a market environment will be a significantly different frame compared to a non-market environment. This leads to behaviour and attitudes depending on the context (i.e. the frame). The second reason recognises the influence of extrinsic market rewards on individuals’ preferences. Bowles argues that, for example, a change in reward structures in society can also alter individuals’ motivations and attitudes. The third reason highlights that economic institutions have a significant impact on the evolution of norms which subsequently shape individuals’ preferences. Task performance effects are also of importance because the tasks which the agents carry out depend on the economy’s overarching economic institutions and how they structure work. Lastly, economic institutions indirectly shape the cultural learning process itself.

It is due to this five reasons that Bowles sees preferences as ‘endogenous’ rather than ‘exogenous’. In his view preferences are both inherited and learned. While the inheritance argument is in line with the reasoning of standard economic theory, the argument that preferences are learned is based on a ‘social interaction approach’. Important evidence for his view comes from examples like the conformist transmission of preferences. What is more, Bowles points out that ‘endogenous preferences’ are not only more realistic but have also macroeconomic policy implications. For example, he argues that preference endogeneity implies a new type of market failure and that these behavioural foundations, i.e. endogenous preferences, must feature in governance and policy making.

I reviewed Bowles theory of ‘endogenous preferences’ today because it potentially allows for a link between the environment and individuals’ risk attitudes, hence explaining phenomena time varying risk attitudes or countercyclical risk aversion. I hope this will prove valuable for my ideas in the field. Also, if you are interested to hear more about the research by Samuel Bowles, there is a talk he gave at the World Bank in 2014 on Economic Incentives and Social Preferences on YouTube which also features his work on endogenous as well as state dependent preferences.

Many thanks for reading!

Jasse

 


References

Bowles, S. (1998). Endogenous Preferences: The Cultural Consequences of Markets and other Economic Institutions. Journal of Economic Literature XXXVI (March 1998), 75-111.

Stigler, G.J. and Becker, G.S. (1977). De Gustibus Non Est Disputandum. The American Economic Review 67(2), 76-90.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s