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Wednesday 6 January 2010

When a Dollar’s Not Just a Dollar

Reciprocity Rules

If you have nothing and someone offers you a dollar you’d take it, right? But what if you’ve just seen your aunt give your cousin $100 and told to share it between the two of you? After all, a dollar is still a dollar more than you had a moment ago.

What studies of so-called reciprocity in humans show, time and again, that while we’ll accept the dollar in the first situation we’ll refuse it in the second. Our sense of fairness is offended and, it turns out, that given half a chance half the population will seek revenge on the perpetrators of this swizz and take pleasure in it. So, sometimes, a dollar is not just a dollar.

Inveterate Non-Maximisers

The study of reciprocity has engaged and intrigued researchers for decades. The findings simply aren’t in accordance with people maximising their own utility in the form of wealth. In the above situation the person refusing to accept an extra dollar is doing themselves down. As Falk, Fehr and Fischbacher showed in On the Nature of Fair Behaviour in experimental situations when the proposer has the opportunity to offer either an equal or unequal distribution of rewards the unfair offer is rejected 44% of the time. Interestingly even when the proposer is given no choice but to offer unfair proportions this is still rejected 18% of the time, suggesting that there’s some inbuilt aversion to inequality.

All of which has puzzled economists and psychologists mightily, and they’ve spent years plaguing people with variations on these themes. A rough idea has been that the older, less evolved parts of the brain are interfering with the newer, higher functions and disrupting rational analysis. Which sounds ever so reasonable, us being all highly evolved and all and leads to the supposition that if you take the newer brain functions out of the equation we would behave even more irrationally as the dumb old irrational bits of the brain take charge.

However, when Daria Knoch and Ernst Fehr started inhibiting the newer brain functions using transcranial magnetic stimulation (T.M.S.) the rate of acceptance of the unfair offers went up, although recognition that they were unfair was undiminished. So in everyday life it appears that the newer, more “rational” processes are overriding the older parts of the brain which would quite happily take a single dollar, figuring out that a buck in the hand is better than none in the primeval swamp. Now all we have to figure out is how T.M.S. works.

Lizard Economics

All of which suggests that our higher brain functions aren’t particularly interested in selfish maximising and are more concerned with less concrete concepts like social justice. The powerful nature of social behaviour in making economic decisions comes as no surprise to many psychologists, especially those who work with children, but seems to be a shock to economists whose preferred modes of social interaction are far removed from the dirty reality of everyday life. Yes, it’s the street kids who are using their evolved frontal cortex while it’s the refined economists who are relying on lizard logic.

Once we recognise that the human brain’s new functions are mainly concerned with quickly figuring out what other people want, do and want to do rather than complex economic modelling tools then financial phenomena get displayed in a whole new light. We don’t baseline ourselves against absolute values – the fact we don’t have any money and a dollar’s better than nothing – but against relative, social ones. What matters is whether Harry next door has a bigger car not whether our twenty year old mini will get us from A to Z in a perfectly serviceable manner.

Altruistic Networkers

Casting the searchlight on stockmarket movements and assuming for a moment that people are more interested in what each other are doing than in the absolute intrinsic valuation of the market or individual stocks then we can rapidly generate an ad-hoc theory about why markets go mad. People are simply gauging the correctness of their actions by the behaviour of those around them, and those around them are doing the same. The kind of cascading network effects we saw in Sexual Trading can help with the rest as everyone tries to make sure that their portfolio is bigger than Harry’s.

Such a theory about why humans behave as they do helps to explain other things that have puzzled psychologists for years. Take altruism for example – why would anyone help another person if it doesn’t directly benefit their reproductive fitness? Evolution works by trial and error, figuring out what helps an animal improve its survival rates and breed more. It doesn’t make careful future calculations about the benefits of being nice to other creatures.

The answer, seemingly, lies in the human need to create and maintain social networks. This may be biologically mediated or simply learned behaviour passed down from generation to generation, but the benefits of sharing resources – food, water, etc – with other humans in order to create tightly bonded social groups would be an obvious benefit for a lightly armed and completely unprotected ape surrounded by hungry carnivores. Our feelings of slighted reciprocity when offered less than we think is fair seem to lie in this calculation: if I accept this then I am obliged to repay you and it’s not enough for me to want to expend energy on such a bargain.

The Power of Gifts

The nature of social reciprocity may also underpin some of the stranger behaviour of people - the mere receipt of a gift, however pathetic and pointless can trigger reciprocal tendencies. This is partly why the rising internet concept of giving things away for “free” can create viable business models: as Daniel Caldini relates in Influence, the Hari Krishna have long used such techniques to elicit donations from people who’d really rather not give them anything other than a wide berth.

Personally, I find training myself to say “No, go away before I hit you with this handy piece of street art” a lot easier than engaging in the kind of elaborate avoidance strategies erstwhile victims of “free” are inclined to use. Someone selling you something is not your friend. Unless, of course, they are your friend in which case refusing them is almost impossible – hence the wild success of Tupperware parties. Nothing, but nothing, sells like friendship.


To drop in yet another piece of the behavioural finance jigsaw, the decision to reject a dollar on the grounds of unfairness rather than to accept it on the grounds of an increase in overall wealth is clearly a framing effect. Framed in terms of overall wealth we should accept the offer but in terms of the relationship with our stingy git cousin, to whom our idiot and frankly senile aunt has given the $100, we shouldn’t. This, of course, raises the question of how frames are constructed in our wetware. The idea that we socially frame situations and then act within them on the basis of social economics rather than rational maximising would make economics a branch of social psychology. Somehow that doesn’t sound like a marriage made in heaven.

However, the study of how economics is actually created out of brain processes – so-called neuroeconomics – is in its infancy. As yet we can barely figure out which bits of the brain and which mechanisms are involved in the simplest of economic actions. Given the plasticity of the brain as soon as we do figure out how to model reciprocity it’ll reorganise itself on some other grounds.

One further finding – if men are targeted by unfair offers they will seek revenge and get pleasure from it. Women are equally offended but are less motivated by getting their own back. Hell hath no fury like a vengeful man and good negotiators will be careful to avoid triggering these effects if they think they’re going to have a long term relationship.

In the meantime, however, the lesson for sales people is easy: give stuff away for free and make sure it’s personal. Sod economics, social psychology will do the rest.

Related Articles: Investors, You've Been Framed, Sexual Trading, Bacteria, Boids and Market Instability


  1. The powerful nature of social behaviour in making economic decisions comes as no surprise to many psychologists, especially those who work with children, but seems to be a shock to economists whose preferred modes of social interaction are far removed from the dirty reality of everyday life.

    We need to persuade some psychologists to go to Investing Expert School.


  2. Cool stuff. And I just took a behavioral economics course last semester!

    The thing about analyzing belief and behavior is that often diverge. People say things and systematically act differently.

    Reminds me of financial gurus on TV. Screaming that the market is overbought while pressing the big buy button.