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The invisibles

Human qualities like altruism, integrity, and appropriate social norms and institutions are vital for economic development, writes Kaushik Basu.

india Updated: Sep 11, 2009 21:32 IST

One disservice to development that traditional economic theory has done is to place self-interest on a pedestal. One of the key propositions that Adam Smith had developed in his classic book published in 1776 was that, if each individual in an economy pursued his or her self-interest — consumers maximising utility, entrepreneurs maximising profit — society would automatically achieve optimality, with the “invisible hand” of the market doing the job. Smith made this claim with lots of provisos, but, over time, all the caveats fell by the wayside, and the invisible hand doctrine became an alibi for narrow economism and the single-minded pursuit of self-interest.

Fortunately, modern research in economics and psychology is making it clear that our other human qualities, such as altruism, personal integrity, and appropriate social norms and institutions are vital for economic development.

In India, today, there is worry about our high growth not being sufficiently inclusive, and leaving segments of the population abysmally poor. Some clues to this lie in our neglect of non-economic factors. Consider the simple act of trying to bring marginalised people into the mainstream of the economy. This is, of course, something that we should aim for; but, if this is done without giving these people basic education, a sense of their fundamental rights, a modicum of understanding of how the modern economy functions, and also some basic health facilities, there is a risk that they will get no benefit by being drawn into the market economy, and may actually lose out.

We have historical research documenting how the Native Americans lost their land to the settlers from Europe. There were battles, but much more important was the use of ‘voluntary’ contracts, where the natives were simply being outwitted or plain deceived. There was, first of all, wanton use of the age-old technique of giving superficially attractive loans and then when the borrowers could not pay back, foreclosing on their property — the sub-prime crisis of the 17th century.

The other method was to take advantage of the fact that Native Americans did not understand land sales since in their own society there was no custom of selling land. Hence, there were incidents, such as in 1755 in South Carolina, when more than 500 Cherokees met with a similar number of settlers. Gifts were exchanged and meals were served in silver bowls and cups. The Cherokees were very happy and declared that the tribe wished to give “all their Lands to the King of Great Britain” and make him “the owner of all their Lands and Waters”. This was a metaphorical use of language, a way to be nice to outsiders. This was especially clear when the Cherokees refused to take any payment for their offer. But the offer was too good for the settlers to allow qualms about metaphorical speech to get in the way. To make it into a contract, the settlers persuaded the Cherokees to take a small payment, which they accepted out of politeness. Little did they realise that they were about to lose all their land.

I mentioned at the start how altruism is important for economic prosperity but, in our literal interpretation of the invisible hand proposition, this has been overlooked. There is now a lot of research highlighting the importance of “pro-social” behaviour. Let me close by presenting the reader a game that I published in 1994 called the Traveler’s Dilemma. The game has come to acquire a bit of a life of its own, with laboratory experiments run on it in several American universities. What has, however, not been talked about enough is the role of altruism it highlights.

In the Traveler’s Dilemma, two travelers (who do not know each other) happened to have gone to a remote island and bought an identical antique each. When they arrive at their home airport, they discover that the airline has mishandled the baggage and that their antiques are broken. So they ask for compensation. The airline manager, not knowing the value of these “strange objects,” offers them the following payment scheme. Each passenger, without consulting with the other, has to write down a number (an integer) between 2 and 100. If they both write the same number, the manager will pay them both that number in rupees. If the two write different numbers, he will give both travelers the lower number but with a correction. He will give the “good” person who wrote the lower number an extra two rupees, and the “bad” person who wrote the higher number two rupees less. So, if person A writes 47 and B writes 60, A gets Rs 49 and B Rs 45.

If both players want to make the most money for themselves what should they write?

Note that if they both write 100, each gets Rs 100. But, in that case, if one player deviates to 99, he will get Rs 101. By this reasoning both will change to 99. But, now, if one player changes to 98, she can do better. By this logic both will switch to 98. This logic turns out to be relentless. If each traveler single-mindedly tries to make as much money as possible for himself, they will both end up writing 2 and earning only Rs 2. If each showed some respect for and altruism towards the other and not “ditch” the other passenger for a single rupee, they could both have earned Rs 100. The invisible hand of self-interest drives them not to prosperity but indigence.

Kaushik Basu is Professor of Economics and Chairman, Department of Economics, Cornell University