walrasian economics in retrospect - bowles & gintis

WALRASIAN ECONOMICS IN RETROSPECT

SAMUEL BOWLES AND HERBERT GINTIS

Two basic tenets of the Walrasian model behavior based on self-interestedexogenous preferences and complete and costless contracting have recently comeunder critical scrutiny First social norms and psychological dispositions extend-ing beyond the selsh motives of Homo economicus may have an important bearingon outcomes even in competitive markets Second market outcomes depend onstrategic interactions in which power in the political sense is exercised It followsthat economics must become more behavioral and more institutional We canreturn to these themes of the classical tradition now equipped with the morepowerful mathematical tools developed over the past century

I INTRODUCTION

What do we know that a century ago Alfred Marshall did notMarshallrsquos Principles rst published in 1890 became the

lsquolsquoSamuelsonrsquorsquo of an entire generation of English-speaking econo-mists and bristles with ideas anticipating late twentieth centuryeconomics Marshallrsquos text touches on increasing returns nowcentral to endogenous growth theory the importance of nonselshmotives and other preferences that are unknown to Homo economi-cus now staples of behavioral and experimental economics andthe relevance of the biological (rather than lsquolsquomechanicalrsquorsquo) analo-gies now key elements in the burgeoning eld of evolutionarygame theory

But Marshall failed to make much of these modern ideas andas the century progressed his insightful but frumpy Victorianeconomics was supplanted by a more elegant and thoroughlycontinental Walrasian model that dropped them altogether Twobasic tenets of this model behavior based on self-interestedexogenous preferences and complete and costless contractingunderpin the distinctive analytical results of what came to beknown as neoclassical economics They also inuenced the subjectmatter of lsquolsquopolitical economyrsquorsquo which soon was to drop the adjectiveand become lsquolsquothe relationship between given ends and scarcemeans rsquorsquo to use Lionel Robbins [1935] famous phrase

The reader who doubts the centrality of these tenets might

We would like to thank Kenneth Arrow Robert Barro Larry Blume ErnstFehr Nancy Folbre Karla Hoff Robert Solow Alessandro Vercelli ElisabethWood and the editors of this Journal for helpful comments and the MacArthurFoundation for nancial support Themes touched on here are developed at lengthin Gintis [2000] and Bowles [2001]

r 2000 by the President and Fellows of Harvard College and the Massachusetts Institute ofTechnologyThe Quarterly Journal of Economics November 2000

1411

consider for instance how different post-World War II textbookswould have looked if they had addressed as the standard caseindividuals with socially formed and not always selsh prefer-ences whose exchanges are governed by incomplete contractsrequiring strategic interaction in markets that need not clear incompetitive equilibrium

The Walrasian assumptions about preferences and contract-ing have recently come under scrutiny and now command lessassent than in the days when the Marshallian variant of neoclas-sical economics was rejected in favor of Walrasian wisdom Wehere explore recent contributions to economic theory that attemptto correct the weaknesses of Walrasian economics The lack ofrealism of the complete contracting assumption is hardly in doubtand we will do little more than mention the now familiarconsequences of the failure of this Walrasian assumption amongthem the fact that competitive equilibria may be Pareto-inefficient and include credit-constrained borrowers and unem-ployed (or misemployed) workers unable to make the transactionsthey desire at the going rates of interest and wages We will focusinstead on some unexpected implications of abandoning thefamiliar terrain of complete contracts

The rst implication (Section II) is that where some aspect ofan exchange is not subject to a costlessly enforceable contractsocial norms and psychological dispositions extending beyond theselsh motives of Homo economicus may have an importantbearing on outcomes even in competitive markets The secondimplication (Section III) is that market outcomes depend onstrategic interactions in which something akin to lsquolsquopowerrsquorsquo in thepolitical sense is exercised Where contracts are complete asOliver Hart remarked there is nothing for power to be about butwhere much remains to be determined after the handshake theinstitutional details of the exchange process determine the strate-gic opportunities and effectiveness of the parties concerned Theresult of these two consequences of incomplete contracts is thateconomic analysis must become more social and psychological inits treatment of the human actor more institutional in itsdescription of the exchange process yet no less analytical in itsmodel-building and no less dedicated to the construction ofgeneral equilibrium models In Section IV we discuss the problemof public policy and institutional design observing that we mustjudge policies and institutions not by how closely they approxi-mate the assumptions of the fundamental theorems of welfare

QUARTERLY JOURNAL OF ECONOMICS1412

economics but rather according to their ability to functioneffectively in the second-best world of ineradicable state andmarket failures Section V suggests that Walrasian economics wasa detour avoiding the hard problems in economic theory andfailing to elucidate the central issues of policy and institutionaldesign We close with some thoughts on the challenge of acquiringand teaching the economistsrsquo craft

II INDIVIDUAL BEHAVIOR AND ITS EVOLUTION

In the opening pages of the Principles Marshall dismissedthe idea that economics should model the individual as a selshcalculating machine lsquolsquoAttempts have been madersquorsquo he wrote in thepreface of the rst edition lsquolsquoto construct an abstract science withregard to the actions of an lsquoeconomic manrsquo who is under no ethicalinuences and who pursues pecuniary gain warily and energeti-cally but mechanically and selshly But they have not beensuccessful rsquorsquo adding lsquolsquonor even thoroughly carried outrsquorsquomdashacknowledging that the economic man of neoclassical theoryalthough calculating and selsh was also a perfect gentleman forwhom a handshake was a handshake and who thus would notconsider behaving opportunistically by shirking on the job default-ing on a loan or otherwise taking advantage of contractualincompleteness simply because it suited him to do so

Instead of the abstract lsquolsquoeconomic manrsquorsquo of Walrasian theoryMarshall advocated empirically based assumptions concerningthe heterogeneous but lsquolsquoregularrsquorsquo behaviors and cognitive orienta-tions of members of distinct social groups (among which werewomen about whom Marshallrsquos views were anything but mod-ern) He also stressed that these behavioral regularities areshaped by the economic circumstances under which they live andwork The third sentence of the Principles states that lsquolsquo manrsquoscharacter has been moulded by his everyday work and thematerial resources which he thereby procures more than by anyother inuence unless it be that of religion rsquorsquo and later on thesame page he adds an idea taken from Smith that lsquolsquohis characteris formed by the way he uses his faculties in his work by thethoughts and feelings which it suggests and by his relations to hisassociates in work his employers or his employeesrsquorsquo Subsequentgenerations however were ushered past these guideposts andoffered an analytically more tractable but empirically ungroundedconception of human behavior The economic man known to

WALRASIAN ECONOMICS IN RETROSPECT 1413

students of Walrasian economics acts on the basis of preferencesthat are self-regardingmdashexcluding such intrinsic values as altru-ism fairness and vengeancemdashand are dened over a restrictedrange of outcomesmdashexcluding honesty as well as concerns aboutthe process rather than simply the outcome of exchange per se

This view has always had its critics of course from thesociological insights of Thorstein Veblen concerning conspicuousconsumption through the attempts of James Duesenberry toexplain consumptionsavings patterns in terms of lsquolsquokeeping upwith the Jonesesrsquorsquo to John Kenneth Galbraithrsquos notion thatconsumer tastes are created by advertising Doubtless the mostrecognized of such critics is Herbert Simon whose concept oflsquolsquobounded rationalityrsquorsquo has motivated considerable research ininstitutional economics most notably in the work of OliverWilliamson In addition Armen Alchian [1950] and Gary Becker[1962] wrote pioneering papers on how what would now be calledadaptive agentsmdashnamely rms and consumers with limited cogni-tive capacitiesmdashmight give rise to competitive market outcomessimilar to those of fully informed utility-maximizing agents

Yet until recently these critics induced few economists to gobeyond the conventional notion of preferences in the Walrasianmodel Human capital theory in the 1950s and 1960s and theeconomics of education in the ensuing years might have been theoccasion for a sustained investigation of how social institutionsshape preferences and human character But the pioneers of thiseld preferred to leave the ancient de gustibus non est disputan-dum canon undisturbed Our dissenting view presented in Gintis[1972] and Bowles and Gintis [1975 1976] had little impactwithin economics

At an accelerating pace over the closing fteen years of thiscentury however an empirically grounded view of economicbehaviormdashone increasingly subject to analytical modelingmdashhasarisen to challenge the Homo economicus of the Walrasian modelamending and augmenting the conventional view as it happensalong the lines suggested by Marshall The approach draws oninsights and empirical results from biology psychology sociologyand experimental economics We refer to the approach as lsquolsquobehav-ioralrsquorsquo for lack of a better term The primary contribution of thebehavioral approach to economics is to understanding the diver-sity and context-dependent nature of human preferences howelements of this repertoire of preferences become salient inparticular strategic interactions how they have evolved over the


long run and how individuals form the beliefs that along withtheir preferences explain what people do The behavioral ap-proach is not a critique of optimizing subject to constraints Ittakes for granted that people are purposeful and have reasons forwhat they domdashalthough it recognizes that individuals may haveinternal conicts and time-inconsistent preferences Rather itchallenges conventional accounts of the content and origins ofpreferences Important early contributions here include Akerlof[1984] Tversky and Kahneman [1974] and Kahneman Knetchand Thaler [1986]

Everyday observation as well as introspection suggests thatother-regarding and process-regarding preferences may be impor-tant in explaining behavior Experimental evidence conrmsthese impressions The commonly observed rejection of substan-tial positive offers in ultimatum games is an example Theultimatum game pairs subjects (usually anonymously) one beingrandomly designated the lsquolsquoresponderrsquorsquo the other the lsquolsquoproposerrsquorsquoThe proposer is provisionally awarded a sum of money withinstructions to divide it between proposer and responder If theresponder accepts the offer the responder gets the proposedportion and the proposer keeps the rest If the responder rejectsthe offer both get nothing The prediction based on conventionalpreferences is of course that the proposer knowing that theresponder will accept any positive offer as preferable to nothingwill offer the smallest possible positive amount which will beaccepted

But in experiments conducted in the United States JapanIsrael Europe Russia China and Indonesia the vast majority ofproposers offer between 40 and 50 percent of the pie and offerslower than 30 percent of the pie are often rejected [Camerer andThaler 1995 Guth and Tietz 1990 Roth Prasnikar Okuno-Fujiwara and Zamir 1991] These results have occurred inexperiments with stakes as high as three monthsrsquo earnings andthey are unlikely to reect subjectsrsquo misunderstanding of thegame as they have been replicated for repeated one-shot play Wehave recently replicated these experimental results in a numberof hunter-gatherer pastoral and other simple societies [BoydHenrich Bowles Fehr and Gintis forthcoming Henrich 2000]

The substantial offers made by proposers need not imply anethic of fair division They could be due to the prudence ofself-interested proposers anticipating rejection of low offers Butself-regarding motives can hardly explain the respondentsrsquo com-


mon rejection of substantial offers We are persuaded by theinterpretation of these results as reecting strong reciprocitynamely a propensity to reward those who have behaved coopera-tively and correspondingly to punish those who have violatednorms of acceptable behavior even when reward and punishmentcannot be justied in terms of self-regarding outcome-orientedpreferences

Strong reciprocity is unlike the self-serving kindness ofreciprocal altruism studied by biologists [Trivers 1971] popular-ized by the success of tit-for-tat in Axelrodrsquos [1984] simulationtournaments and embodied in cooperation-inducing lsquolsquotrigger strat-egiesrsquorsquo in the theory of repeated games The key difference is thatstrong reciprocity is not rewarded by higher payoffs in subsequentplay and hence is not readily explained by outcome-orientedbehavior By contrast reciprocal altruism tit-for-tat and coopera-tion in repeated games are fully consistent with conventionalself-regarding preferences Strong reciprocity also differs from thesimple altruism studied by Becker [1981] Barro [1974] Hamilton[1975] and others as it is conditional on the norm-observingbehaviors of others While unconditional altruism describes someobserved behaviors among family members and intimates (al-though rarely of the complete form assumed by Barro and Becker)and it is sometimes extended to strangers we nd little evidenceexperimental or other of its generality as a robust and widespreadmotive among nonkin especially by comparison with strongreciprocity

Additional experimental evidence for the importance of strongreciprocity comes from public goods games in which subjectsengage in costly punishment of noncontributors even on the nalround of the game where the possibly self-interested objective ofimproving the behavior of the slackers cannot be germane [Os-trom Walker and Gardner 1992 Fehr and Gachter 2000]Corroborating evidence is to be found in sources ranging fromdescriptive accounts of collective action and vendettas to anthropo-logical studies of norm enforcement in social groups lackingstates such as foraging bands [Boehm 1993]

A remarkable regularity in these experimental results is thesubstantial effect on subjectsrsquo behaviors induced by ostensiblyirrelevant differences in experimental protocols Hoffman and hercollaborators varied two aspects of the experimental environmentof the ultimatum game proposers either won their position bydoing well on a trivia quiz or were randomly assigned and their


relationship to their game partner was either described as anlsquolsquoexchangersquorsquo (with prices elicited by the experimenter) or simply aslsquolsquodivide $10rsquorsquo [Hoffman McCabe Shachat and Smith 1994] De-spite the fact that the experimental situation was otherwiseidentical the lsquolsquoearned statusrsquorsquo plus lsquolsquoexchangersquorsquo combined experimen-tal condition protocol yielded signicantly smaller offers Blount[1995] found that respondent rejection rates fall dramaticallywhen they are told that the offers are generated by a computerrather than a person suggesting that the desire to punish anorm-violator not simply rejecting a bad deal is at work Theimportance of context in cueing behaviors is further suggested bythe fact that defection rates in the prisonerrsquos dilemma game aresubstantially higher if the game is explained to subjects as thelsquolsquoWall Street Gamersquorsquo rather than the lsquolsquoCommunity Gamersquorsquo [Ross andWard 1996]

Economic behaviors are apparently strongly affected by whatHomo economicus would consider irrelevant details In someexperiments anonymity generates behaviors differing from thoseinduced by more personal settings even when the subjects arevery unlikely ever to meet again Communication a reduction insocial distance among experimental subjects or other conditionscontributing to group identity increases contributions in publicgoods games [Sally 1995 Ledyard 1995 Dawes Van de Kragt andOrbell 1988] and induces cooperative play in prisonerrsquos dilemmainteractions [Kollock 1997] Gachter and Fehr [2000] nd that in apublic goods interaction even brief experimentally induced famil-iarity among subjects enhances the impact of social approvalincentives Combining familiarity and the public revelation ofonersquos contributions leads to a signicant increase in prosocialbehavior

Extending the behavioral foundations of economic theorycannot be done on the basis of experiments alone of course We donot know whether experimental results are robust indicators ofbehavioral traits in real world situations [Loewenstein 1999] Dothose who reject low offers in ultimatum games also vote forprograms that would more equally distribute income Are defec-tors in the prisonerrsquos dilemma experiments less cooperative in thecommunity or workplace There is some evidence that experimen-tal subjects who display trust in the laboratory also are morewilling to engage in trusting behaviors in their daily lives[Glaeser Laibson Scheinkman and Soutter 2000] The experimen-tal results are suggestive however in that they often document


behaviors that if common in real life would resolve widelyrecognized anomalies within the conventional preference para-digm Included are such basic behaviors as voting self-destructiverevenge and the vagaries of support and opposition among thewell-off for income transfers to the poor [Fong 2000 Bowles andGintis 2000]

It appears then that concerns about others and about theprocesses generating economic resultsmdashsometimes codied asethical normsmdashare important sources of behavior and thatbehavior is often context-specic It follows that because economicinstitutions shape the structure of social interactions they alsodiffer in the types of situation-specic behaviors that they maymotivate Moreover anthropological and social psychological evi-dence some of it summarized in Bowles [1998] suggests thatbehavioral orientations are learned under the inuence of eco-nomic institutions are generalized to other noneconomic areas ofsocial life and persist from generation to generation

Economic institutions shape preferences by inuencing whointeracts with whom who performs which tasks and with whichbehaviorally conditioned payoffs As Gintis [1972] and Becker[1996] have stressed individuals often deliberately alter theirpreferences adopting the traits of their happier and more success-ful neighbors for example But in addition to such consciousprocesses preference change often works sub rosa through psycho-logical mechanisms of dissonance reduction or conformism Ex-amples include studies from both simple and advanced societieson the effects of the ways that adults make their living onchild-rearing practices and values and on general psychologicalmakeup [Barry III Child and Bacon 1959 Kohn 1969 Edgerton1971 Kohn et al 1990] The importance of the nonintentionalaspect of cultural updating differentiates our approach fromBeckerrsquos [1996] valuable contribution on the deliberate alterationof onersquos preferences

Those who doubt the importance of strong reciprocity some-times claim that nonselsh human motivations could not haveevolved under the inuence of Darwinian natural selection andhence are likely to be of limited importance But while theevolution of a genetically transmitted altruism (the most studiedcase) is indeed unlikely the skepticrsquos claim is uncompelling Firstpreferences are the result of cultural as well as genetic inheri-tance and one can demonstrate that prosocial traits (ie traitsthat are nonselsh and promote the well-being of others) could


have evolved under the joint inuence of cultural and genetictransmission [Boyd and Richerson 1985 Sober and Wilson 1998Bowles 2000] And second highly developed human capacities forinsider-outsider distinctions and cultural uniformity within com-munities greatly increase the likely importance of group selectionof genetically transmitted traits and hence the evolutionaryviability of group-benecial traits Indeed for reasons presentedin Bowles and Gintis [1998] it is plausible that strong reciprocityand the other behavioral orientations we have described couldhave evolved by this route

This evolutionary approach to preferences sees human behav-ior as the result of individualsrsquo adherence to behavioral rules thathave proved successful by comparison with other behavioral rulesand that as a result replicated and hence diffused throughoutpopulations [Cavalli-Sforza and Feldman 1981 Boyd and Richer-son 1985 Durham 1991] The context-specic and diverse humanbehaviors we seek to understand are the result of the repertoiresof these behavioral rules that have proved evolutionarily robust(which is not to say lsquolsquosocially optimalrsquorsquo) This approach displacesattention from cognitive and affective dispositions of individualsto the behavioral rules themselves and how they both replicateover time and combine in complicated ways to explain how peoplebehave in particular situations

III CONTRACTS AND SOCIAL STRUCTURE

While Marshallrsquos neglected endorsement of an empiricallybased approach to economic behavior now commands consider-able assent little in his writings or for that matter in the writingsof the founders of the Walrasian model anticipates the moderntheory of contracts It is true of course that Marshall knew that awage increase might increase worker effortmdashhe used the termlsquolsquoefficiency wagesrsquorsquomdashbut as with so many of his modern insights hedid not develop the theoretical ramications of this fact Walrasshowed even less interest in the strategic aspects of exchangewriting [Walras 1954 [1874]] lsquolsquo the pure theory of economics resembles the physico-mathematical sciences in every respect Assuming equilibrium we may even go so far as to abstract fromentrepreneurs and simply consider the productive services asbeing in a certain sense exchanged directly for one another rsquorsquo[pp 71 225] Marshall and his contemporaries adopted theclassical theory of contracts according to which every aspect of


concern to one or more parties to an exchange is subject to acontract that is enforceable by a third party (the courts) at zerocost to the exchanging parties The early neoclassical economistsand especially Marshall did not ignore cases where markets wereincomplete as for example with environmental and trainingexternalities But they regarded as exceptional the fact thatliabilities from environmental spillover for example are notgenerally subject to contractual compensation

Ronald Coase [1937] by contrast made incomplete contractscentral to economics noting that economic transactions take placewithin the rm when they can be effected at lower cost throughhierarchical command in which the employee carries out theemployerrsquos directives rather than through a market exchangeKarl Marx had presented an analogous view of the capitalist rma century before distinguishing between what is contracted for(the wage) and the service delivered (the activity of work itself)which is not subject to contract but rather as Marx put it islsquolsquoextractedrsquorsquo by the employerrsquos exercise of authority The verbalarguments of Marx and Coase were cast in analytical form byHerbert Simon [1951] thereby highlighting two serious lacunaein Coasersquos analysis what determines who is the employer andwhy should the employee obey the employer

ArmenAlchian and Harold Demsetz [1972] answered the rstquestion by claiming that only the owner of the rmrsquos assets asresidual claimant on the rmrsquos income has an incentive tomonitor employee behavior and hence must be the hierarchicalsuperior Stephen Marglin [1974] offered a famous alternativeanswer in which the owner of capital assets must also control theproduction process in order to generate a ow of prots HerbertGintis [1976] Carl Shapiro and Joseph Stiglitz [1984] andSamuel Bowles [1985] answered the second by showing that iflabor markets failed to clear the employer could induce workerperformance with the threat of dismissal and conversely whenlabor contracts take the form of long-term contingent renewalcontracts equilibrium unemployment can result even with com-petitive markets Finally Oliver Williamson [1984] expandedCoasersquos framework to handle a wide variety of contractual andinstitutional relations including partnerships and nonprot firmsvertical and horizontal integration and a theory indicating whichagents will ll the role of residual claimants in the rm

Assuming that the reader is familiar with principal-agentand transactions costs models [Williamson 1985 Stiglitz 1987]


we will explore some broad implications of contractual incomplete-ness

To x ideas consider a case where a principal P benets froman action a which is costly for an agent A to perform and aboutwhich information is either costly for P to acquire or cannot beused by P to enforce a contract P often addresses the problem byoffering A a payment in excess of Arsquos reservation price promisingto renew the transaction in subsequent periods unless Arsquos perfor-mance is found to be inadequate If this should occur thetransaction will be terminated and A will receive a reservationasset z less valuable than v the present value of the expectedutility of having the transaction The quantity v 2 z may betermed an enforcement rent as it is a payment above Arsquos next bestalternative and along with the threat of termination it is used byP to enforce claims against A when these are not third-partyenforceable

These so-called contingent renewal models of principal-agentrelationships generate competitive equilibria consistent with aneconomywide zero prot condition in which principals offer posi-tive enforcement rents and agents perform a level of the actiongreater than they would choose in the absence of the threatModels of this type have been applied to labor markets creditmarkets contracts for residential and agricultural tenancy andthe exchange of variable quality goods among others [Gintis1976 Calvo 1979 Stiglitz and Weiss 1981 Shapiro and Stiglitz1984 Bowles 1985 Banerjee and Ghatak 1996] In these casesmarkets do not generally clear in equilibrium and one side of themarket is quantity constrainedmdashsome agents are unable tosecure the level of transactions they would prefer under the goingterms The quantity constrained may be either suppliers (work-ers for example in the case of the labor market) or demanders(borrowers in the case of the credit market)

While modeling strategies differ a large class of similarapproaches supports two conclusions First those on the shortside of the marketmdashemployers and lenders in these exampleswho are not quantity constrainedmdashadvance their interests byusing the credible threat of a sanction to alter the behavior of thequantity-constrained agents on the long side of the market Shortsiders can in this sense be said to exercise short-side power overthe long siders with whom they interact

Second the exercise of short-side power is generally Pareto-improving since both parties are better off than in a situation in


which principals are constrained to offer agents contracts equal totheir next best alternative But the resulting equilibrium isPareto dominated by an outcome in which the agent providesmore of the noncontractible service to the principal and theprincipal provides a higher payment Of course this Paretosuperior outcome is not feasible unless the information andincentive structure of the problem can be altered as it may forexample by collective bargaining cooperative workplace prac-tices (the handshake) or redistribution of property rights apossibility to which we will return in the next section

This approach casts new light on the relationship betweenwealth and power and allows a more satisfactory understandingof why the wealthy not only have ample budget sets (purchasingpower) but frequently direct the actions of others through com-mands We are not here concerned with the political inuence ofthe wealthy or the fact that owners of rms in highly concentratedindustries may alter prices to their advantage (market power)Rather our point is that the wealthy have power (in the sensedened above) because they tend to be located on the short side ofnonclearing markets as lenders in credit markets and as employ-ers in labor marketsmdashemployers are more likely to be wealthybecause lack of wealth generally precludes access to funds onterms consistent with survival in business

The fact that power may be exercised in competitive equilib-rium provides a valuable link between the process of exchangeand the exercise of authority In the quite different markets versushierarchies approach pioneered by Williamson the exercise ofauthority is a nonmarket phenomenonmdashattributable to the struc-ture of organizations But the contingent renewal model shows itto be a consequence of the ways the organizations and marketsinteract If markets cleared and hence enforcement rents werezero then barring specialized ad hoc assumptions individualswould be unconcerned about the prospect of termination sosanctioning would be impossible no matter how lsquolsquohierarchicalrsquorsquo theorganization The phenomenon of short-side power by contrastexplains why those in authority in rms may reasonably expect tobe obeyed namely because they are in a position to deprive theemployee of a substantial enforcement rent even where notransaction-specic assets are involved It thereby resolves whatwe call the puzzle of obedience thrown up by the Coasian theory ofthe rm

Suitably elaborated models of this type provide a compelling


account of many aspects of modern economies going some way tomake sense of empirical regularities that are anomalous or areresolvable only at the cost of ad hoc reasoning in the Walrasianmodel The empirically observed inability of the unemployed tounderbid the employed and to drive wages to market-clearinglevels the covariance of real wages with the level of employmentthe high-employment prot squeeze and the end-of-expansionproductivity slowdown are standard predictions of the incompletecontracting models while less readily explained within a completecontracting framework [Bowles Gordon and Weisskopf 1983Bowles Gordon and Weisskopf 1989 Blanchower and Oswald1994]

It has been objected however that if enforcement rents weresubstantial principals could prot by charging an up-front fee forthe right to transact with them (eg Carmichael [1985]) Employ-ers for example would charge prospective employees a feesufficient to make them indifferent to taking the job but notindifferent to losing it once the fee had been paid (the ex ante rentis thus zero appropriated by the employer but the ex post rentremains and the threat of its removal continues to motivate theemployee) The fact that such fees or their surrogates such assteep tenure-earnings proles are not widespread is taken tomean that models of the contingent renewal type are awed

While it is possible to model contingent renewal and bondingassuming agents have self-regarding preferences over outcomes[Dickens Katz Lang and Summers 1989 MacLeod and Malcom-son 1993] we think that the behavioral approach provides a morecompelling explanation Jobs are not sold because doing so wouldviolate the norms of reciprocity and incur retaliation on the part ofworkers in the form of reduced effort or care In experimentallabor markets lsquolsquormsrsquorsquo offer wages well above the supply price oflsquolsquoworkersrsquorsquo and the latter then choose to incur a cost of effort wellabove the minimum even in one-shot interactions In theseexperiments the few lsquolsquormsrsquorsquo embracing the simplistic view ofHomo economicus assume that lsquolsquoworkersrsquorsquo will perform the mini-mal effort in any case and hence offer them the minimal wage[Fehr and Falk 1999 Gachter 1998] These lsquolsquormsrsquorsquo do poorlycompared with those relying on strong reciprocity Moreover evenwhen a labor market is operative in such laboratory experimentsreciprocity and gift exchange produce an equilibrium that is farfrom market clearing [Fehr Gachter Kirchler and Weichbold1998b Fehr Kirchsteiger and Riedl 1998] Wage setting therefore


appears to reect the importance of reciprocity norms oncesummarized in the phrase lsquolsquoa fair dayrsquos work for a fair dayrsquos payrsquorsquo

We mention the job fees objection not only because it isimportant but because it indicates a complementarity betweenthe agent-based economistsrsquo reconsideration of preferences andmodern contract theory The symbiosis is not accidental Thetheory of incomplete contracts suggests that spot markets amonganonymous actors will fail to solve incentive problems wherelonger term interactions may succeed But the durable face-to-face interactions that result from long-term contracting areprecisely the kinds of social situations shown to evoke thebehavioral motives that the Homo economicus ction assumesaway Siamwallarsquos [1978] study of the rice and raw rubbermarkets in Thailand for example found long-term trust-basedexchanges where quality variations make contracts incomplete(in rubber) but anonymous relations where quality is easilydetermined and complete contracts were therefore possible (inrice) Similarly Kollock [1994] found that trust and commitmentevolve in experimental exchanges with unobservable and noncon-tractible quality differences in the goods but not when quality isgiven

The incomplete contracting framework thus provides a set-ting in which issues not only of efficiency but also of fairnesstrust and reciprocity (long stressed by sociologyrsquos theory of socialexchange) arise and where the beliefs and preferences of employ-eesmdashtheir views on fairness the extent of their identication withthe organization or their degree of solidarity with other employ-eesmdashmay like employeesrsquo skills inuence the wage-setting pro-cess [Blau 1964 Solow 1990 Bewley 1995] The complementaritybetween the theory of incomplete contracts and behavioral ap-proaches to preferences is demonstrated clearly by the fact thatexperimental markets with complete contracts quickly convergeto the equilibria predicted by the conventional theory [Smith1982] while experimental markets with incomplete contracts(such as those described above) generally exhibit behaviors thatare anomalous in the conventional paradigm Indeed it is pre-cisely the social preferences revealed in these experiments thatsometimes allow individuals to surmount the obstacles of contrac-tual incompleteness to exploit mutually benecial gains fromtrade Arrow long ago stressed this connection lsquolsquoIn the absence oftrust opportunities for mutually benecial cooperation wouldhave to be foregone norms of social behavior including ethical


and moral codes (may be) reactions of society to compensatefor market failuresrsquorsquo [Arrow 1971 p 22]

IV ECONOMIC POLICY AND INSTITUTIONS

Contrary to the claims of many of its critics Walrasianeconomics never had a policy agenda From Walras to the presentthe policy positions of its leading exponents ranged from acondence in the ability of government to implement a socialoptimum without markets by a state functionary acting as theWalrasian lsquolsquoauctioneerrsquorsquo on the one hand to an equally unboundedfaith in the ability of markets to achieve a social optimum withoutstate intervention on the other While policy debates still occasion-ally turns on this dichotomy there have been important advancesin the study of economic institutions and policy since Marshalland Pigou inaugurated welfare economics in the 1930s

First market failures and state failures are now analyzed ina common framework rather than from competing viewpoints dueto development in information economics and especially themodeling of relations between principals and agents Moreoverpublic choice theory has given us a unied approach covering theactions of government officials and market actors alike As aresult the state is no longer the exogenous instrument wiselyimplementing some concept of social well-being and attention hasshifted from picking the right policy to setting up the right rules sothat the imperfect interplay of incentives of all the relevant actorswill support socially desirable if not optimal outcomes

This common framework as well as a century of historicallearning from the Great Depression and the fall of Communismhas dashed utopian assumptions Many are now convinced thatJohn Stuart Millrsquos injunction that we must devise rules such thatthe lsquolsquoduties and the interestsrsquorsquo of government officials wouldcoincide should be shelved in the museum of utopian designsalong with the assumptions of the Fundamental Theorem ofWelfare Economics Most modern economists see both marketfailures and state failures as common rather than exceptionalFurther market failures are no longer considered curiosa havingto do with bees and lighthouses but occur in the major markets ofa modern economy namely credit markets and labor marketsThus markets and states are now seen not as competing but ascomplementary institutions in the quest to lsquolsquoget the rules rightrsquorsquoand many formulations see a broader range of institutions of


economic governance as essential in this task including small-scale communitiesmdashneighborhoods nongovernmental associa-tions and the likemdashas well as families [Hayami 1989 Ostrom1990 Aoki 1995 Taylor 1996]

Second policies and institutions are no longer evaluated asthough preferences are exogenous David Hume [1754 (1898) p117] thought that lsquolsquoin contriving any system of government every man ought to be supposed to be a knave and to have no otherend in all of his actions than his private interestrsquorsquo Generations ofeconomists believed that the right institutionsmdashnotably well-dened property rights and competitive marketsmdashcould meetHumersquos challenge But economists are now turning their attentionto the ways in which institutions and policies can not only harnessself-interested motives but also evoke other-regarding motivesand inuence individual preferences in socially desirable ways

Discussions of policy measures addressed to crime the envi-ronment schooling discrimination and welfare reform now com-monly treat preferences as endogenous as do studies of the impactof markets and other modern institutions on indigenous cultures[Becker 1996 Kahan 1997 Bowles and Gintis 2000] Attempts toenhance what is widely (and vaguely) termed social capital reectthis new way of thinking The theory of implementationmdashwhichconventionally has sought policies to implement socially desirableoutcomes as Nash equilibria where agentrsquos preferences are givenmdashmust now consider the effects of the policies on the preferenceswith an equilibrium now requiring stationarity of preferences aswell as individual actions

Third the economistrsquos canonical desire to separate the issuesof distribution from those of efficient allocationmdashdating back toMillmdashnow seems quixotic The separation is formalized in theFundamental Theoremrsquos affirmation that (under suitable assump-tions) any Pareto-optimal distributional outcome can be achievedthrough an appropriate choice of initial endowments followed byWalrasian exchange But recent research in credit and labormarkets as well as other principal-agent relationships identiesviolations of the Fundamental Theoremrsquos complete contractingassumptions indicating that wealth endowments may have sub-stantial effects on allocative efficiency [Loury 1981 Stiglitz 1994Aghion and Bolton 1997 Laffont and Matoussi 1995 Benabou1996 Banerjee and Ghatak 1996 Hoff and Lyon 1995] The reasonis that the incentives sanctions and other contractual provisionsthat may be deployed in any particular exchange depend on the


wealth level of the parties to the exchange and an agentrsquos lack ofwealthmdashby a sharecropping farmer a wage employee or aresidential tenant for examplemdashmay preclude the use of efficientcontracts [Bardhan Bowles and Gintis 2000]

These cases are policy relevant where it is possible to deviseredistributive strategies that are implementable in the abovesense and improve the contractual environment by makingagents residual claimants on the consequences of their noncon-tractible actions Examples include insurance and credit marketpolicies to allow the wealth-poor to overcome their limited abilityto borrow and to bear risk and thus to acquire productive assetsWhile the importance of the incentive costs of poorly designedegalitarian redistributive programs is in no way diminishedthese results do suggest the existence of a class of egalitarianwealth redistributions that may improve allocative efficiency Ifso the canonical efficiency equity trade-offmdashwhose ineluctablelogic is given prominent place in most introductory textsmdashmay beup for reconsideration

V THE WALRASIAN DETOUR

In retrospect the Walrasian model with its canonical assump-tionsmdashcomplete contracting and the conventional preferences ofHomo economicusmdashwas an intellectually exciting detour whoseglamour hid the fact that it cast little light on the time-honoredquestions of economic institutions policy and the wealth ofnations Many economists believe that the canonical Walrasianassumptions are the unavoidable price to be paid for clarity andrigor in more abstract reasoning while accepting that moreempirically grounded assumptions should inform practical inves-tigations in particular applied topics Others recognize that thetime may have come to reconsider the Walrasian approach and itsassumptions but regard it not as a detour but as having providedessential foundations for our current knowledge We disagreewith both views We need different (but not necessarily fewer)abstractions and we need not have taken the circuitous Wal-rasian route to the present

Our view that the Walrasian model is wrong not in the detailsbut in its basic abstractions is suggested by its inability to castlight on such fundamental questions as the recent contrastinggrowth trajectories of China and Russia or of the smaller EastAsian economies and those in Africa and Latin America in the


1980s and 1990s But let us consider an equally telling failure itssurprising inability to understand the shortcomings of the maincompetitor to capitalism in this century state ownership andcentral planning The basic problem with the Walrasian model inthis respect is that it is essentially about allocations and onlytangentially about marketsmdashas one of us (Bowles) learned whenhe noticed that the graduate microeconomics course that hetaught at Harvard was easily repackaged as lsquolsquoThe Theory ofEconomic Planningrsquorsquo at the University of Havana in 1969

The Walrasian model is often taken to justify the private-ownership market economy But in fact as Oskar Lange andothers demonstrated in the famous lsquolsquoplanning versus marketsdebatersquorsquo with Hayek and other supporters of laissez-faire capital-ism in the 1930s these principles can just as easily be used tojustify the social ownership of property and the control of theeconomy by the state [Lange and Taylor 1938 Schumpeter 1942]Indeed the Fundamental Theorem asserts that any pattern ofownership is compatible with economic efficiency as long as pricesare chosen to equate supply and demand

Lange pointed out that markets and private property play apurely metaphorical role in general equilibrium theory There isno competition in the sense of strategic interaction since agentsnever meet other agents and agents do not care who other agentsare or what they are doing The only factors determining indi-vidual and rm behavior are prices Nor do markets have anyfunction in the Walrasian model In Walrasrsquo original descriptionmarket clearing was not effected by markets at all but rather byan lsquolsquoauctioneerrsquorsquo who assumed that all economic agents revealedtruthfully their personal knowledge and preferences Thus pricesneed not be set by market interactions or any other particularmechanism From the standpoint of the Walrasian model acentral planner could play the part of Walrasrsquo auctioneer settingprices to clear markets in a manner that is perfectly compatiblewith economic efficiency Moreover to this day no one has suc-ceeded in producing a plausible decentralized alternative to theauctioneermdashfor instance a dynamic model of market interactionin which prices move toward their market-clearing levels Wecontrast this with contemporary agency theory in which in theabsence of complete contracting informational asymmetries arekey impediments to economic efficiency and competitive interac-tions play a central role in revealing private information

Thus it is hardly surprising that Lange and the other


socialist economists won the academic debate of the 1930s JosephSchumpeterrsquos classic Capitalism Socialism and Democracy [1942]in which this staunch supporter of capitalism predicts its immi-nent demise is perhaps the greatest tribute to the socialistintellectual victory lsquolsquoCan socialism workrsquorsquo Schumpeter asked lsquolsquoOfcourse There is nothing wrong with the pure theory ofsocialismrsquorsquo [pp 167 172]

The late-classical (and socialist sympathizer) contemporaryof Marx John Stuart Mill [1976 pp 115ndash136] had more to sayabout the incentive and information problems of socialism thandid the conservative neoclassical Schumpeter Hayek himselfapparently concluded that it had been a mistake to conduct thedebate in Walrasian terms and in the late 1930s and early 1940sdeveloped the analytical foundations of a more plausible Austrianalternative to the Walrasian model [Hayek 1945] In a footnote tothis paper Hayek claims that lsquolsquoProfessor Schumpeter is theoriginal author of the myth that Pareto and Barone have lsquolsquosolvedrsquorsquothe problem of socialist calculationrsquorsquo Hayekrsquos appreciation of theimportance of information allowed him to pinpoint a decisiveweakness of central planning unavailable to the Walrasian econo-mist namely the plannersrsquo inability to acquire the informationnecessary to determine socially efficient prices Recent ap-proaches using principal-agent models have illuminated othersocialist shortcomings obscured by the Walrasian model Summa-rizing these insights Joseph Stiglitz [1994 p 10] wryly observedlsquolsquoif the neoclassical model were correct market socialismwould have been a success [and] centrally planned socialismwould have run into far fewer problems rsquorsquo

The record of the Walrasian model is no better in explainingthe wealth and poverty of nations and people But did it not laythe foundations for a more adequate approach Perhaps the fulldevelopment of the Walrasian model was a necessary preconditionfor developing analytical models of incomplete contracts andbroader models of human behavior Perhaps such modern notionsas costly contracting asymmetric information endogenous prefer-ences and strategic interaction were widely appreciated byneoclassical economists but they lacked the tools to model suchphenomena But the founding contributions to incomplete con-tracts game theory and behavioral economics did not await thedevelopment of the Walrasian model Rather the foundations of anon-Walrasian approach laid down by prominent economists inthe period from 1937 to 1957 precisely the period in which the


Marshallian paradigm was displaced by the nascent Walrasianparadigm subsequent to which two generations of economistswere taught Walrasian general equilibrium as the core of moderneconomic theory Ronald Coasersquos seminal analysis of the interplayof market exchange and hierarchical command appeared in 1937(lsquolsquoThe Nature of the Firmrsquorsquo) and F A Hayek clearly expressed theproblem of incomplete information in his 1945 American Eco-nomic Review article lsquolsquoThe Uses of Knowledge in Societyrsquorsquo JohnNashrsquos solution concept appeared in Econometrica in 1953 and RDuncan Luce and Howard Raiffarsquos quite sophisticated Games andDecisions was published in 1957 Finally Herbert Simonrsquos lsquolsquoAFormal Theory of the Employment Relationrsquorsquo appeared in 1951and his Models of Man in 1957 In short all of the underpinningsof a non-Walrasian economics had been set in place by 1960Walrasian economics was not the precondition of these innova-tionsmdashit was their competition

Most neoclassical economists in the postwar period wereactively hostile to broader models of human behavior and tointroducing strategic interaction into economic theory We do notrecall our teachers bringing these issues to our attention in theearly 1960s and when some years later Becker and Stigler wrotetheir famous paper [1977] we do not recall any of the greatsdisputing the assertion that lsquolsquode gustibus non est disputandumrsquorsquoNone of these ideas made it into the curriculummdashnot even Bowlesrecalls when he cotaught the graduate PhD microeconomicscourse with Tibor Scitovsky whose subsequent Joyless Economywould mount a compelling critique of the behavioral assumptionsof economics When Gintis used Coase Simon and Marx tochallenge exogenous preferencesmdashthe relevant portion eventu-ally appearing as Gintis [1972]mdashPaul Samuelson singled out thiswork for criticism in his 1970 Nobel Prize speech in Stockholm Inresponse to the proposal that a notion of power be introduced intoeconomic theory Abba Lerner [1972 p 259] responded by sayinglsquolsquoAn economic transaction is a solved political problem Economicshas gained the title of Queen of the Social Sciences by choosingsolved political problems as its domainrsquorsquo Lerner went on to explainthat third-party enforceable contracts make the exercise of powerirrelevant

Our preferred explanation of the Walrasian Detour involves aconuence of forces Perhaps most important midcentury neoclas-sical economists while aware of the degree of abstraction of theirmodel of the economy believed that transaction costs asymmetric


information endogenous preferences and the like were of minorimportance in a competitive economy and were accustomed totreating unemployment inertial prices the business cycle creditrationing and similar phenomena as disequilibrium phenomenaexplicable by Keynesian and other short-term models Moreoverthey doubtless expected lsquolsquonormal sciencersquorsquo to add such elements ofrealism to their models just as they expected a reasonabletreatment of the stability of general equilibrium to emerge If thisis what they expected they were wrong The reader mightcomplain that we do an injustice to Walrasian theory by notrecognizing the strides taken in recent years in modeling incom-plete contracts (see Magill and Quinzii [1996] Geanakoplos andPolemarchakis [1996] and the references cited therein) Howeverthese contributions deal almost exclusively with nancial mar-kets whereas our concern is with the portrayal of real markets ingeneral equilibrium theory Here there have been few contribu-tions that model strategic interaction within a general equilib-rium setting

The absence of such developments as well as the collapse ofthe Keynesian paradigm in the late 1970s suggested to a youngergeneration of economists that the Walrasian model should betaken with a grain of salt Thus while during the 1960s and 1970sonly a few economists developed the insights of Coase SimonNash and other midcentury forerunners (among them KennethArrow Gary Becker Armen Alchian Harold Demsetz JosephStiglitz and Oliver Williamson) in the 1980s and 1990s thetrickle of post-Walrasian models swelled to a ood It is too early totreat these heterogeneous contributions some of which we havesummarized above as a new paradigm but the return from theWalrasian detour has already yielded important insights

As we have seen principal-agent models of the employmentrelationship together with gift-exchange explanations of theabsence of bonding explain the widely observed excess supply oflabor in equilibriummdashincluding open unemployment and a gen-eral excess of agents competing for desirable career-enhancingpositions Second they provide a plausible account of why cen-trally planned economies eventually failed one stressing informa-tion asymmetries in principal-agent relationships Third theyprovide a reasonable if not fully documented as yet account ofwhy the relationship between equality and efficiency (or productiv-ity growth) may be of either sign in contradiction to the conven-tional trade-off Fourth Walrasian models have difficulty explain-


ing why Homo economicus would vote and what he votes for whenhe does For example there are signicant levels of support forredistributive expenditure among people who are sufficiently richthat they do not anticipate becoming recipients of programs thatthey support By contrast behavioral models explain such phenom-ena by demonstrating that under a variety of conditions (eg inthe Dictator Game often studied by experimentalists) economicactors choose to share gains with other even unrelated andunknown individuals Finally these models allow a naturalrepresentation of markets as disciplining devices an aspect ofmarkets that is obscured in Walrasian reasoning In the modernapproach [Holmstrom 1979 1982] by contrast rm managershave private information concerning their behavior that they canbe induced to provide to outsidersmdashrm owners consumers andgovernmentmdashin a least-cost manner by rewarding them accord-ing to their relative success in a competitive framework Similarlythe disciplinary nature of markets gives us a much richer theoryof consumer sovereignty based on the notion of endogenousquality enforcement which implies that consumers have short-side power in dealing with their suppliers much as employershave short-side power in dealing with their employees [Gintis1989 Bowles and Gintis 1993]

VI CONCLUSION THE ECONOMISTrsquoS CRAFT

The intellectual and practical lessons of the twentieth cen-tury have enriched the discipline but also immeasurably compli-cated the task of becoming a good economist or learning theeconomistrsquos craft After decades of Walrasian respite complexinstitutions and multifaceted people again intrude on our think-ing forcing a retreat from the elegant but misleading abstractionsthat once monopolized economic theory

Recent decades have seen a signicant increase in economicinputs and outputs that are difficult to contract formdashquintessen-tially information but services more generally forcing incompletecontracting and strategic interaction to center stage Moreovereconomists are increasingly concerned with social problems reect-ing dimensions of human behavior and well-being that are notcaptured by conventional models of lsquolsquoeconomic manrsquorsquo and hence forwhich Homo economicus offers a limited and sometimes mislead-ing basis for social policy Among these are the management ofcommon pool resources the nature and value of social capital


crime addiction discrimination risky behaviors and welfaredependency These new interests are partially due to GaryBeckerrsquos inuence but doubtless more important economists areincreasingly called upon to offer economic advice in these areaswhere the limitations of Homo economicus as a model of behaviorare particularly transparent

Partly as a result of these changes many economists haveshifted their attention from markets in general to the peculiari-ties of particular markets each governed by distinct rules andevoking particular behavioral responses from their participantsThis move returns us to Marshall who was the last greatnineteenth century economist to attend to the particularities ofhuman motivations and institutions Increasing recognition of theimportance of positive feedback effects and generalized increasingreturnsmdashin areas such as growth divergence among nationsneighborhood effects and technological lock-insmdashhas motivated aconcern with the multiplicity of equilibria and the likelihood thatmany outcomes are path dependent [Arthur 1994 Durlauf 1996]As a result contemporary economic history may exhibit aninterplay of local uniformity coupled with global institutional andbehavioral diversity rather than global convergence and unifor-mity [Young 1998]

As a consequence the economistrsquos craft has been transformedin two ways First the disciplinary boundaries between economicsand the other behavioral sciences including biology as well ashistory now appear more to impede rather than promote learningBehavioral economics draws on all of the social sciences andbiology as well and the modern theory of contracts is hobbledwithout the insights of political science sociology and socialpsychology The reader may wonder why we do not just pack upand become sociologists The answer we think is that thedistinctive strengths of economicsmdashexplaining prices and quanti-ties as well as exploring the complex and often unexpected waysthat countless uncoordinated actions generate sometimes unantici-pated aggregate outcomes and dynamicsmdashis no less relevanttoday than when it was pioneered by the classical economists twocenturies ago The inadequacy of Walrasian general equilibriumin no way diminishes the importance of general equilibriumthinking

Second taking account of the institutional and behavioralpeculiarities dening a problem as well as the possibility of manyequilibrium outcomes often requires close attention to empirical


details that were abstracted from in the Walrasian approach Wesuspect that continuing progress in economic theory will drawmore heavily on historical econometric and experimental datafor the simple reason that we may be encountering sharplydiminishing returns in generating valuable insights from just afew abstract assumptions about behavior and institutions Know-ing a lot about how some part of the economy actually works orabout some aspect of economic behavior may provide both astimulus to good theory and a valuable discipline to theorybuilding

The imperative for a more multidisciplinary and empiricallybased knowledge has obvious implications for the recruitment andeducation of the next generation of economists The discrepancybetween these imperatives and the common practice of graduateand undergraduate education in economics hardly needs to bepointed out

We have stressed progress in economics over the past centurybut there is much that we have not learned Over a century ago inthe opening pages of his Principles Marshall dened one of thechief tasks of our discipline this way

Now at last we are setting ourselves seriously to inquire whether it isnecessary that there should be any so called lsquolsquolower classesrsquorsquo at all that iswhether there need be large numbers of people doomed from their birth tohard work in order to provide for others the requisites of a rened andcultured life while they themselves are prevented by their poverty and toilfrom having any share or part in that life the answer depends in a greatmeasure upon facts and inferences which are within the province ofeconomics and this is it which gives to economic studies their chief and theirhighest interest [1930 (1890) pp 3ndash4]

We suspect he would be disappointed in what economics hasaccomplished toward this end over the intervening centuryparticularly if he considered the poor and low paid workersthroughout the world That governments resist economic advicecan hardly be the reason for there is all too much evidence thatthey avidly implement policies designed by economistsmdashwhetherinterventionist or market-basedmdashsometimes with disastrous con-sequences Economics is still far from mastering the problem ofalleviating poverty and providing economic security for the leastwell off although it is closer today than when Marshall wrote

DEPARTMENT OF ECONOMICS

UNIVERSITY OF MASSACHUSETTS

AMHERST MASSACHUSETTS 01003


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Akerlof George A An Economic Theoristrsquos Book of Tales (Cambridge UKCambridge University Press 1984)

Alchian Armen lsquolsquoUncertainty Evolution and Economic Theoryrsquorsquo Journal ofPolitical Economy LVIII (1950) 211ndash221

Alchian Armen and Harold Demsetz lsquolsquoProduction Information Costs andEconomic Organizationrsquorsquo American Economic Review LXII (December 1972)777ndash795

Aoki Masahiko lsquolsquoAn Evolving Diversity of Organizational Mode and its Implica-tions for the Transitional Economiesrsquorsquo Center for Economic Policy ResearchStanford University May 1995

Arrow Kenneth J lsquolsquoPolitical and Economic Evaluation of Social Effects andExternalitiesrsquorsquo in M D Intriligator ed Frontiers of Quantitative Economics(Amsterdam North-Holland 1971) pp 3ndash23

Arthur Brian Increasing Returns and Path Dependence in the Economy (AnnArbor University of Michigan Press 1994)

Axelrod Robert The Evolution of Cooperation (New York Basic Books 1984)Banerjee Abhijit and Maitreesh Ghatak lsquolsquoEmpowerment and Efficiency The

Economics of Tenancy Reformrsquorsquo Massachusetts Institute of Technology andHarvard University 1996

Bardhan Pranab Samuel Bowles and Herbert Gintis lsquolsquoWealth Inequality CreditConstraints and Economic Performancersquorsquo in Anthony Atkinson and FrancoisBourguignon eds Handbook of Income Distribution (Dortrecht North-Holland 2000)

Barro Robert lsquolsquoAre Government Bonds Net Worthrsquorsquo Journal of Political EconomyLXXXII (1974) 1095ndash1117

Barry III Herbert Irvin L Child and Margaret K Bacon lsquolsquoRelation of ChildTraining to Subsistence Economyrsquorsquo American Anthropologist LXI (1959)51ndash63

Becker Gary S lsquolsquoIrrational Behavior and Economic Theoryrsquorsquo Journal of PoliticalEconomy LXX (February 1962) 1ndash13 A Treatise on the Family (Cambridge MA Harvard University Press 1981) Accounting for Tastes (Cambridge MA Harvard University Press 1996)

Becker Gary S and George J Stigler lsquolsquoDe Gustibus Non Est DisputandumrsquorsquoAmerican Economic Review LXVII (March 1977) 76ndash90

Benabou Roland lsquolsquoInequality and Growthrsquorsquo NBER Macroeconomics AnnualMarch 1996

Bewley Truman F lsquolsquoA Depressed Labor Market as Explained by ParticipantsrsquorsquoAmerican Economic Review LXXXV (1995) 250ndash254

Blanchower David G and Andrew J Oswald The Wage Curve (Cambridge MAMIT Press 1994)

Blau Peter Exchange and Power in Social Life (New York John Wiley amp Sons1964)

Blount Sally lsquolsquoWhen Social Outcomes Arenrsquot Fair The Effect of Causal Attribu-tions on Preferencesrsquorsquo Organizational Behavior amp Human Decision ProcessesLXIII (August 1995) 131ndash144

Boehm Christopher lsquolsquoEgalitarian Behavior and Reverse Dominance HierarchyrsquorsquoCurrent Anthropology XXXIV (June 1993) 227ndash254

Bowles Samuel lsquolsquoThe Production Process in a Competitive Economy WalrasianNeo-Hobbesian and Marxian Modelsrsquorsquo American Economic Review LXXV(March 1985) 16ndash36 lsquolsquoEndogenous Preferences The Cultural Consequences of Markets and OtherEconomic Institutionsrsquorsquo Journal of Economic Literature XXXVI (March 1998)75ndash111 lsquolsquoGroup Conicts Individual Interactions and the Evolution of Preferencesrsquorsquoin Stephen Durlauf and Peyton Young eds Social Dynamics (CambridgeMIT Press 2000) Economic Institutions and Behavior An Evolutionary Approach to Microeco-nomics (Princeton NJ Princeton University Press 2001)


Bowles Samuel and Herbert Gintis lsquolsquoThe Problem with Human Capital TheoryrsquorsquoAmerican Economic Review LXV (May 1975) 74ndash82

Bowles Samuel and Herbert Gintis Schooling in Capitalist America Educa-tional Reform and the Contradictions of Economic Life (New York BasicBooks 1976)

Bowles Samuel and Herbert Gintis lsquolsquoThe Revenge of Homo Economicus Con-tested Exchange and the Revival of Political Economyrsquorsquo Journal of EconomicPerspectives VII (Winter 1993) 83ndash102

Bowles Samuel and Herbert Gintis lsquolsquoThe Evolution of Strong Reciprocityrsquorsquo SantaFe Institute Working Paper No 98-08-073E 1998

Bowles Samuel and Herbert Gintis lsquolsquoReciprocity Self-Interest and the WelfareStatersquorsquo Nordic Journal of Political Economy XXVI (January 2000)

Bowles Samuel David M Gordon and Thomas E Weisskopf lsquolsquoHearts and MindsA Social Model of U S Productivity Growthrsquorsquo Brookings Papers on EconomicActivity 2 (1983) 381ndash450

Bowles Samuel David M Gordon and Thomas E Weisskopf lsquolsquoBusiness Ascen-dancy and Economic Impassersquorsquo Journal of Economic Perspectives III (Winter1989) 107ndash134

Boyd Robert and Peter J Richerson Culture and the Evolutionary Process(Chicago University of Chicago Press 1985)

Boyd Robert Joe Henrich Samuel Bowles Ernst Fehr and Herbert GintislsquolsquoStrong Reciprocity and Experimental Anthropologyrsquorsquo Volume in Preparationforthcoming

Calvo Guillermo lsquolsquoQuasi-Walrasian Theories of Unemploymentrsquorsquo American Eco-nomic Review LXIX (May 1979) 102ndash107

Camerer Colin and Richard Thaler lsquolsquoUltimatums Dictators and MannersrsquorsquoJournal of Economic Perspectives IX (1995) 209ndash219

Carmichael H Lorne lsquolsquoCan Unemployment Be Involuntary The SupervisionPerspectiversquorsquo American Economic Review LXXV (1985) 1213ndash1214

Cavalli-Sforza Luigi L and Marcus W Feldman Cultural Transmission andEvolution (Princeton NJ Princeton University Press 1981)

Coase Ronald H lsquolsquoThe Nature of the Firmrsquorsquo Economica IV (November 1937)386ndash405

Dawes Robyn M J C Van de Kragt and John M Orbell lsquolsquoNot Me or Thee butWe The Importance of Group Identity in Eliciting Cooperation in DilemmaSituations Experimental Manipulationsrsquorsquo Acta Psychologica LXVIII (1988)83ndash97

Dickens William T Lawrence F Katz Kevin Lang and Lawrence H SummerslsquolsquoEmployee Crime and the Monitoring Puzzlersquorsquo Journal of Law and EconomicsVII (1989) 331ndash347

Durham William H Coevolution Genes Culture and Human Diversity (Stan-ford Stanford University Press 1991)

Durlauf Steven lsquolsquoNeighborhood Feedbacks Endogenous Stratication and In-come Inequalityrsquorsquo in Dynamic Disequilibrium Modelling (Cambridge UKCambridge University Press 1996)

Edgerton Robert B The Individual in Cultural Adaptation (Berkeley Universityof California Press 1971)

Fehr Ernst andArmin Falk lsquolsquoWage Rigidity in a Competitive Incomplete ContractMarketrsquorsquo Journal of Political Economy CVII (February 1999) 106ndash134

Fehr Ernst and Simon Gachter lsquolsquoCooperation and Punishmentrsquorsquo AmericanEconomic Review XC (2000) forthcoming

Fehr Ernst Georg Kirchsteiger andArno Riedl lsquolsquoGift Exchange and Reciprocity inCompetitive Experimental Marketsrsquorsquo European Economic Review XLII (1998)1ndash34

Fehr Ernst Simon Gachter Erich Kirchler and Andreas Weichbold lsquolsquoWhen SocialNorms Overpower CompetitionmdashGift Exchange in Labor Marketsrsquorsquo Journal ofLabor Economics XVI (April 1998) 324ndash351

Fong Christina lsquolsquoSocial Insurance or Conditional Generosity The Role of Beliefsabout Self- and Exogenous-Determination of Incomes in Redistributive Poli-ticsrsquorsquo Washington University Department of Political Science 2000

Gachter Simon lsquolsquoDo Workers Pay Entrance Fees in Efficiency Wage MarketsrsquorsquoUniversity of Zurich 1998


Gachter Simon and Ernst Fehr lsquolsquoCollectiveAction as Social Exchangersquorsquo Journal ofEconomic Behavior and Organization XXXIX (July 1999) 341ndash369

Geanakoplos John and Heraklis M Polemarchakis lsquolsquoExistence Regularity andConstrained Suboptimality of CompetitiveAllocations When the Asset MarketIs Incompletersquorsquo in Gerard Debreu ed General Equilibrium Theory Vol 2(Cheltenham UK Elgar 1996) pp 67ndash97

Gintis Herbert lsquolsquoA Radical Analysis of Welfare Economics and Individual Develop-mentrsquorsquo Quarterly Journal of Economics LXXXVI (November 1972) 572ndash599 lsquolsquoThe Nature of the Labor Exchange and the Theory of CapitalistProductionrsquorsquoReview of Radical Political Economics VIII (Summer 1976) 36ndash54 lsquolsquoThe Power to Switch On the Political Economy of Consumer Sovereigntyrsquorsquoin Samuel Bowles Richard C Edwards and William G Shepherd edsUnconventional Wisdom Essays in Honor of John Kenneth Galbraith (NewYork Houghton-Mifflin 1989) pp 65ndash80 Game Theory Evolving (Princeton NJ Princeton University Press 2000)

Glaeser Edward L David I Laibson Jose A Scheinkman and Christine LSoutter lsquolsquoMeasuring Trustrsquorsquo Quarterly Journal of Economics CXV (August2000) 811ndash846

Guth Werner and Reinhard Tietz lsquolsquoUltimatum Bargaining Behavior A Surveyand Comparison of Experimental Resultsrsquorsquo Journal of Economic PsychologyXI (1990) 417ndash449

Hamilton W D lsquolsquoInnate Social Aptitudes of Man An Approach from EvolutionaryGeneticsrsquorsquo in Robin Fox ed Biosocial Anthropology (New York John Wiley ampSons 1975) pp 115ndash132

Hayami Yujiro lsquolsquoCommunity Market and Statersquorsquo in A Maunder and A Valdeseds Agriculture and Governments in an Independent World (Amherst MAGower 1989)

Hayek F A lsquolsquoThe Use of Knowledge in Societyrsquorsquo American Economic ReviewXXXV (September 1945) 519ndash530

Henrich Joe lsquolsquoDoes Culture Matter in Economic Behavior Ultimatum GameBargaining among the Machiguenga of the Peruvian Amazonrsquorsquo AmericanEconomic Review XC (September 2000) forthcoming

Hoff Karla and Andrew B Lyon lsquolsquoNon-Leaky Buckets Optimal RedistributiveTaxation and Agency Costsrsquorsquo Journal of Public Economics XXVI (1995)365ndash390

Hoffman Elizabeth Kevin McCabe Keith Shachat and Vernon L Smith lsquolsquoPrefer-ences Property Rights and Anonymity in Bargaining Gamesrsquorsquo Games andEconomic Behavior VII (1994) 346ndash380

Holmstrom Bengt lsquolsquoMoral Hazard and Observabilityrsquorsquo Bell Journal of EconomicsX (Spring 1979) 74ndash91 lsquolsquoMoral Hazard in Teamsrsquorsquo Bell Journal of Economics VII (1982) 324ndash340

Hume David Essays Moral Political and Literary (London Longmans Green1898 [1754])

Kahan Dan M lsquolsquoSocial Inuence Social Meaning and Deterrencersquorsquo Virginia LawReview LXXXIII (1997) 349ff

Kahneman Daniel Jack L Knetch and Richard H Thaler lsquolsquoFairness and theAssumptions of Economicsrsquorsquo Journal of Business LIX (1986) S285ndash300

Kohn Melvin Class and Conformity (Homewood IL Dorsey Press 1969)Kohn Melvin et al lsquolsquoPosition in the Class Structure and Psychological Function-

ing in the U S Japan and Polandrsquorsquo American Journal of Sociology XCV(January 1990) 964ndash1008

Kollock Peter lsquolsquoThe Emergence of Exchange Structures An Experimental Study ofUncertainty Commitment and Trustrsquorsquo American Journal of Sociology C(September 1994) 313ndash345 lsquolsquoTransforming Social Dilemmas Group Identity and Cooperationrsquorsquo in PeterDanielson ed Modeling Rational and Moral Agents (Oxford Oxford Univer-sity Press 1997)

Laffont Jean-Jacques and Mohamed Salah Matoussi lsquolsquoMoral Hazard FinancialConstraints and Share Cropping in El Ouljarsquorsquo Review of Economic StudiesLXII (1995) 381ndash399

Lange Oskar and F M Taylor On the Economic Theory of Socialism (Minneapo-lis University of Minnesota Press 1938)


Ledyard J O lsquolsquoPublic Goods A Survey of Experimental Researchrsquorsquo in J H Kageland A E Roth eds The Handbook of Experimental Economics (PrincetonNJ Princeton University Press 1995) pp 111ndash194

Lerner Abba lsquolsquoThe Economics and Politics of Consumer Sovereigntyrsquorsquo AmericanEconomic Review LXII (May 1972) 258ndash266

Loewenstein George lsquolsquoExperimental Economics from the Vantage Point of View ofBehavioural Economicsrsquorsquo Economic Journal CIX (February 1999) F25ndashF34

Loury Glenn lsquolsquoIntergenerational Transfers and the Distribution of EarningsrsquorsquoEconometrica XLIX (1981) 843ndash867

Luce R Duncan and Howard Raiffa Games and Decisions (New York John Wileyamp Sons 1957)

MacLeod W Bentley and James M Malcomson lsquolsquoWage Premiums and ProtMaximization in Efficiency Wage ModelsrsquorsquoEuropean Economic Review XXXVII(August 1993) 1123ndash1249

Magill Michael and Martine Quinzii Theory of Incomplete Markets (CambridgeMA MIT Press 1996)

Marglin Stephen lsquolsquoWhat Do Bosses Dorsquorsquo Review of Radical Political EconomicsVI (Summer 1974) 60ndash112

Marshall Alfred Principles of Economics (eighth edition) (London Macmillan1930)

Mill John Stuart On Socialism (Buffalo Prometheus Books 1976)Nash John F lsquolsquoTwo-Person Cooperative Gamesrsquorsquo Econometrica XXI (1953)

128ndash140Ostrom Elinor Governing the Commons The Evolution of Institutions for

Collective Action (Cambridge UK Cambridge University Press 1990)Ostrom Elinor James Walker and Roy Gardner lsquolsquoCovenants with and without a

Sword Self-Governance Is Possiblersquorsquo American Political Science ReviewLXXXVI (June 1992) 404ndash417

Robbins Lionel An Essay on the Nature amp Signicance of Economic Science(London Macmillan 1935)

Ross L and A Ward lsquolsquoNaive Realism Implications for Social Conict andMisunderstandingrsquorsquo in E S Reed E Turiel and T Brown eds Values andKnowledge (Mahwah NJ Lawrence Erlbaum Associates 1996)

Roth Alvin E Vesna Prasnikar Masahiro Okuno-Fujiwara and Shmuel ZamirlsquolsquoBargaining and Market Behavior in Jerusalem Ljubljana Pittsburgh andTokyo An Experimental Studyrsquorsquo American Economic Review LXXXI (Decem-ber 1991) 1068ndash1095

Sally David lsquolsquoConversation and Cooperation in Social Dilemmasrsquorsquo Rationality andSociety VII (January 1995) 58ndash92

Schumpeter Joseph Capitalism Socialism and Democracy (New York Harper ampRow 1942)

Shapiro Carl and Joseph Stiglitz lsquolsquoUnemployment as a Worker DisciplineDevicersquorsquo American Economic Review LXXIV (June 1984) 433ndash444

Siamwalla Ammar lsquolsquoFarmers and Middlemen Aspects of Agricultural Marketingin Thailandrsquorsquo Economic Bulletin for Asia and the Pacic XXXIX (June 1978)38ndash50

Simon Herbert lsquolsquoA Formal Theory of the Employment Relationrsquorsquo EconometricaXIX (1951) 293ndash305 Models of Man (NY John Wiley amp Sons 1957)

Smith Vernon lsquolsquoMicroeconomic Systems as an Experimental Sciencersquorsquo AmericanEconomic Review LXXII (December 1982) 923ndash955

Sober Elliot and David Sloan Wilson Unto Others The Evolution and Psychologyof Unselsh Behavior (Cambridge MA Harvard University Press 1998)

Solow Robert The Labor Market as a Social Institution (Cambridge UK BasilBlackwell 1990)

Stiglitz Joseph lsquolsquoThe Causes and Consequences of the Dependence of Quality onPricersquorsquo Journal of Economic Literature XXV (March 1987) 1ndash48 Whither Socialism (Cambridge MA MIT Press 1994)

Stiglitz Joseph and Andrew Weiss lsquolsquoCredit Rationing in Markets with ImperfectInformationrsquorsquo American Economic Review LXXI (June 1981) 393ndash411

Taylor Michael lsquolsquoGood Government On Hierarchy Social Capital and theLimitations of Rational Choice Theoryrsquorsquo Journal of Political Philosophy IV(March 1996) 1ndash28


Trivers R L lsquolsquoThe Evolution of Reciprocal Altruismrsquorsquo Quarterly Review of BiologyXLVI (1971) 35ndash57

Tversky Amos and Daniel Kahneman lsquolsquoJudgment under Uncertainty Heuristicsand Biasesrsquorsquo Science CLXXXV (September 1974) 1124ndash1131

Walras Leon Elements of Pure Economics (London George Allen and Unwin 1954[1874])

Williamson Oliver E lsquolsquoThe Economics of Governance Framework and Implica-tionsrsquorsquo Journal of Institutional and Theoretical Economics CXL (1984)195ndash223 The Economic Institutions of Capitalism (New York Free Press 1985)

Young H Peyton Individual Strategy and Social Structure An EvolutionaryTheory of Institutions (Princeton NJ Princeton University Press 1998)


consider for instance how different post-World War II textbookswould have looked if they had addressed as the standard caseindividuals with socially formed and not always selsh prefer-ences whose exchanges are governed by incomplete contractsrequiring strategic interaction in markets that need not clear incompetitive equilibrium

The Walrasian assumptions about preferences and contract-ing have recently come under scrutiny and now command lessassent than in the days when the Marshallian variant of neoclas-sical economics was rejected in favor of Walrasian wisdom Wehere explore recent contributions to economic theory that attemptto correct the weaknesses of Walrasian economics The lack ofrealism of the complete contracting assumption is hardly in doubtand we will do little more than mention the now familiarconsequences of the failure of this Walrasian assumption amongthem the fact that competitive equilibria may be Pareto-inefficient and include credit-constrained borrowers and unem-ployed (or misemployed) workers unable to make the transactionsthey desire at the going rates of interest and wages We will focusinstead on some unexpected implications of abandoning thefamiliar terrain of complete contracts

The rst implication (Section II) is that where some aspect ofan exchange is not subject to a costlessly enforceable contractsocial norms and psychological dispositions extending beyond theselsh motives of Homo economicus may have an importantbearing on outcomes even in competitive markets The secondimplication (Section III) is that market outcomes depend onstrategic interactions in which something akin to lsquolsquopowerrsquorsquo in thepolitical sense is exercised Where contracts are complete asOliver Hart remarked there is nothing for power to be about butwhere much remains to be determined after the handshake theinstitutional details of the exchange process determine the strate-gic opportunities and effectiveness of the parties concerned Theresult of these two consequences of incomplete contracts is thateconomic analysis must become more social and psychological inits treatment of the human actor more institutional in itsdescription of the exchange process yet no less analytical in itsmodel-building and no less dedicated to the construction ofgeneral equilibrium models In Section IV we discuss the problemof public policy and institutional design observing that we mustjudge policies and institutions not by how closely they approxi-mate the assumptions of the fundamental theorems of welfare

















































































































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walrasian economics in retrospect - bowles & gintis

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