Individual rationality is a central concern of economics. This is because of the influential view, associated with Adam Smith, that, even if all individuals are selfishly rational, the ‘invisible hand’ of the market will guide society to achieve efficiency. Smith’s work in the late eighteenth century had a huge impact because it seemed to controvert Thomas Hobbes’ thesis that human beings, left to themselves without the controlling hand of the government, would end up in anarchy and chaos.
Over time, neo-conservative writers contorted Smith’s thesis to assert that, as long as the government does not interfere with the individuals’ pursuit of self-interest, an economy will prosper. All the government has to do is not be there. But this thesis is flawed.
First of all, modern game theory illustrates that rationality itself is a contentious idea. In ‘strategic’ situations, where several ‘rational’ agents confront one another, the meaning of rationality may be innately contested. Last year I published a paper in Scientific American, called ‘The Traveler’s Dilemma’, to demonstrate this. I had also hoped that it would rid some of our public intellectuals of their neo-conservative predilections. But, while I got a lot of response from around the world, the article went virtually unread in India. However, my paper now shows up on a travel and tourism website next to the announcement: “Fight Traveler’s Diarrhea, developed by a gastroenterologist.” Given the Indian obsession with gastric health, my hope is that people will find this website and then mistakenly read my paper.
Second, new research in economics shows that while the individual urge to maximise income and accumulate are stimulants to growth, a society also needs altruism, integrity and trust. These are the flora and fauna which enable industrialised economies to flourish, and their absence can doom an economy to stagnation. In some of the poorest parts of India, there is no trace of government. By the conservative argument these should be the most prosperous regions. One reason they are not is because they lack the enabling social norms and customs. If a group of people is known to be trustworthy, they will find jobs more easily (since they will not have to be monitored closely), others will be willing to sign business contracts with them (since they will be less likely to renege), and, over time, this society will become more advanced. There is evidence that some groups are believed to be more trustworthy than others. Some recent laboratory experiments in Israel show that Ashkenazi Jews are more trustworthy than Eastern Jews. In Delhi, South Indians were believed to be more trustworthy as used-car sellers. I remember in the early eighties numerous car advertisements in newspapers claiming: “car owned by South Indian”. (When I went to see some of these cars, on more than one occasion I was met by a large North Indian, who assured me that the South Indian owner was having a bath.)
The reason why individual rationality is not sufficient to generate trust is the ‘free-rider problem’ — If your community is known to be trustworthy and you are not, you will do even better. Others will trust you and you will benefit by betraying the trust. Hence, trustworthiness and pro-social behavior survive only when these are social norms, and people adhere to them instinctively, without thinking of self-interest.
Inculcating the norms of honesty and pro-social behavior is important not only as an end in itself but because it is good for development. A part of the trust problem can however be solved, without overcoming the free-rider hurdle, if people become far-sighted. Being more trustworthy means being willing to take some immediate losses in order to build up a good reputation and do better in the future. I believe this is happening in India. It is difficult to provide hard data for this, but there is one piece of indirect evidence. India’s savings rate has risen sharply in recent years. But saving is the desire to sacrifice current consumption for future gain. This suggests that Indians are beginning to taker a longer run view of their own welfare. This in turn is making them more trustworthy. And from the point of view of development, this is reason for hope.
Kaushik Basu is Professor of Economics and Director, Center for Analytic Economics, Cornell University