(featured image: Arek Socha via pixabay)
Economics is part and parcel of most human interaction, but does that mean we understand it?
My very first post hereabouts carried the somewhat bold title, “We are all economists”. Even if we know nothing about economics, we do face competing calls on our scarce resources (money, time, or attention, for example) that cannot all be fulfilled at the same time, and we need to make trade-offs in order to resolve this. Two core aspects of economics happen to be the allocation of scarce resources and trade-offs, so the claim that early post makes is not without merit.
We have been paying attention to how we allocate scarce resources since long before, in 1776, Adam Smith marked the start of modern economics. Being able to utilize scarce resources efficiently is advantageous. When our ancestors Ug and Ag figured out which foodstuffs kept longer and which went off rapidly, and consumed them accordingly, they wasted less food, and needed to spend less time hunting and gathering than their ignorant neighbours Og and Eg, who often first ate the stuff that would have kept longer. Whether Ug and Ag’s offspring inherited this valuable ability, we do not know. But while Og and Eg were busy getting more food, Ug and Ag would have had a more enjoyable time (perhaps engaging in activities that might produce offspring).
Society’s killer app
That is, however, not the whole story. There is another economic phenomenon: the win-win transaction. While we encounter scarce resources and trade-offs even when there is nobody else involved, transactions take place between people. Some transactions have a winner and a loser: what one party gains, is the other’s loss. Stealing – not uncommon among animals and humans alike – is a prime example of such a zero-sum transaction.
But it is win-win transactions that are the killer app of complex human societies: voluntary exchanges in which both participants bring something to the party, and leave with more than they came with. Magic!
Imagine Ug, Ag, Og and Eg’s descendants, at the time when farming was gaining currency. One couple might have been especially good at hunting and gathering, while another was skilful at cultivating grain and baking bread, and making cheese from their sheep’s milk. Occasionally the farmers may have fancied boar and berries instead of bread and cheese (or vice versa) – but the farmers were lousy at hunting and gathering, and the hunter-gatherers hadn’t a clue about growing wheat and herding sheep. What if instead they swapped some of their production, thus getting something they valued, but could not produce cost-effectively themselves? Hey presto, a win-win!
Unwittingly, they had discovered the economic surplus: the value that a transaction itself creates. The farmers value some boar and berries as a change more than the cheese and bread they already have, and for the hunter-gatherers, it is the other way round. Through the exchange, both end up better off. For thousands of years, this has been the way in which communities organized themselves efficiently, and indeed the engine of economic growth and welfare, at both a local and at a global scale.
Fast forward to today, and we observe something strange. People often engage in zero-sum thinking, assuming that if one party benefits from a transaction, the other party must necessarily be losing out. We see politicians considering international trade as something in which it is better to be an exporter than an importer, and campaigning for protectionist measures, like putting tariffs on imported goods, if not for outright trade wars now and then. We see it also on a smaller scale. Consumers perceive manufacturers end up the winners by taking their money without considering the value they get (think of the debate around the profits pharma companies make from their COVID-19 vaccines). Even when we frequent a local shop, the intuition of the zero-sum transaction is hard to suppress: every pound, euro or dollar we hand over to the shopkeeper is one they get, and we lose.
This denial of voluntary exchanges as win-win transactions is detrimental in at least two ways. It can depress the number of transactions and hence economic activity, thus leaving people worse off than they would otherwise be. And if a transaction takes place, it will leave the party entertaining the misperception that they are the loser unnecessarily miserable.
The strange case of win-win denial
A team of psychologists, led by Samuel Johnson at Warwick University, investigated this remarkable case of win-win denial, in search for explanations. They identified four possible mechanisms that might contribute to it. First, they considered evolutionary mismatch. Our distant ancestors engaged in bartering. Both parties were clear what they gave and what they got, and both were clear that they valued more what they got than what they gave. These direct exchanges did not involve money, though, and so one possibility is that the mental mechanisms they evolved are not adapted for transactions using abstract currencies and market prices.
Next was a hypothesis related to mercantilist theories. The economic policy of mercantilism seeks to maximize exports (which bring in money) and minimize imports (which cost money), in the belief that wealth equates to money. From this perspective, a transaction in which money changes hands would lead to a loss for the buyer and to a gain for the seller.
The third possibility is based on the theory of mind, which refers to our ability to consider someone else’s viewpoint. This is critical in the concept of a win-win transaction: our ancestors could only barter cheese and bread for boar and berries provided they preferred what they didn’t have, and provided both parties could understand that this was true for the others too. If we are unable to appreciate this difference in preference, then only one party can win.
Finally, the authors propose that people may fail to see the win-win nature of a transaction because they ask the wrong question (they call it heuristic substitution). Instead of considering whether or not a buyer ended up better off after a voluntary exchange, people consider whether the buyer got the best possible deal, or whether the seller overcharged them.
The researchers conducted four studies, in which participants were presented with a set of transactions – purchases of goods (e.g., a shirt) and services (e.g., a haircut), and barter (e.g., a McDonalds burger for a Burger King one) – and then had to evaluate whether both parties were better off, worse off, or the same, compared to before the transaction. One variant compared a conventional money frame (“the shirt costs $30”) with a time frame (“Sally worked for 1.5 hours to pay for the shirt; she earns $20 per hour”); another compared transactions where no reason was given with one in which the buyer was said to “want” the good or the service. A final variant varied the price of the goods or services between 50% and 150% of the nominal value in the earlier studies.
Not quite economists after all
The results were unequivocal. The researchers found strong evidence for win-win denial: across all studies the buyers were seen as benefiting less than the sellers, consistent with the idea that whoever gets the money is the winner. Welfare is seen as determined by monetary wealth, rather than useful goods and services – naïve mercantilism. This was further supported by the study where the transactions were presented with a time frame, as this decreased the denial effect.
Explicitly stating a preference for the purchase (even as trivial as “Mary wanted the chocolate bar”) also decreased win-win denial. This supports the theory of mind hypothesis: unless prompted, people tend to neglect others may have different preferences to their own. The studies provide little or no support for the other two hypotheses – the study varying the price showed that this had little effect, for example – leaving these two as the main reasons behind win-win denial.
It is hard to maintain that denying that transactions can leave both parties better off is rational, or even that it simply reflects a preference for monetary wealth. This would be inconsistent with the vast number of actual transactions that take place, which cannot possibly all be detrimental to welfare. But while this research pinpoints the causes of win-win denial, it leaves us with a huge conundrum: if people believe that purchases are zero-sum transactions (where we, as purchasers, are the loser!), how come the economy doesn’t grind to a halt? We can speculate, but there is no conclusive evidence that solves the puzzle.
Perhaps we can conclude, to borrow an old Northern English saying: there’s nowt so queer as folk –people can behave very oddly sometimes. And I will certainly have to revise my earlier claim that we are all economists.