Misunderstood Nature of Workers

Macro theorists do not understand employee preferences. Worse, they are arrogant in their ignorance. A large, best-practices management literature provides a great deal of information on the nature of workers, but economists do not care enough to look at it. As demonstrated in the GEM Project, that condescension has significantly contributed to the mainstream failure to come up with macroeconomics that is both coherent and stabilization-relevant.

Shirking theory. When theorists do permit worker behavior to vary, they typically motivate action with the desire to shirk. In the best-known economic theory of workplace conduct, Shapiro-Stiglitz (1984) combine universal laziness on the job with monitoring costs to animate the shirking variant of efficiency-wage theory.  Wage premiums are paid to increase the employee cost of loafing, i.e., being fired if caught. The premiums are modeled to vary inversely with the unemployment rate, which reflect the ease with which fired workers can find another job. (For elaboration, see the website’s eBook, Chapter 9.)

The mainstream story is dismissed by practitioners. Truman  Bewley (1999, p.111) asked the managers of 118 companies about the Shapiro-Stiglitz shirking description of employee behavior, with the following results:

From Bewley (p.110): “Most managers insisted that the [shirking] theory did not describe their own behavior, but rather a form of bad management. They thought of punishment only as an extreme measure for dealing with antisocial behavior and said that the best results were obtained with a forthright and positive management style. Such a style is defeated by pay cuts, for they withdraw rewards and are interpreted as penalties. A small amount of evidence suggested that the shirking theory may apply at the bottom end of the labor market, especially to the market for low-paid temporary labor, where wages are downward flexible.”

It is well known, outside economics, that practitioners have long rejected shirking as a significant worker preference. They know that worker dissatisfaction is much most likely rooted in the perception of inequitable treatment by management. The critical message of the consensus labor-management literature is that equitable treatment should be added to consumption and leisure away from work when economists specify axiomatic employee preferences. Milkovich and Newman, authors of a well-known business text on wage policymaking, are typical in their first-chapter assertion: “Equity forms the building block, the foundation on which pay systems are designed.”

Ultimatum game. The preference for equitable treatment was one of the early ideas investigated in experimental economics. Güth, Schmittberger, and Schwarze (1982) constructed a famous experiment based on the “ultimatum game”. There are two players, and the first is given a sum of money and a choice. He or she has to give some part of the money to the second player, who then also has a choice. If the cash offer is accepted, both players keep the allocated money. If rejected, each gets nothing. Economists know that the subgame-perfect equilibrium of the ultimatum game dictates that the (permissible) minimum be offered and accepted. Their utility functions are motivated parsimoniously with the preference of more money to less, implying that any positive amount is preferable to nothing. Mainstream economics gives both players clear marching orders, which they then ignore.

Contrary to the predictions of economic models, Güth et al. found a strong desire for fair treatment as well as a powerful urge to retaliate when denied that outcome. Their experiment and the many that followed established the modal offer to be an even division. Inequitable offers are likely to be rejected, with the chances of rejection increasing as the second player’s share decreases. The results of ultimatum-game experiments are significant and must make economists suspicious of off-the-cuff Ptolemaic formulations of preferences and utility.

That suspicion is made acute by the ubiquitous practical application of the ultimatum game. A version of it, enriched by established workplace reference standards, incomplete information, and available gradations of retaliation, is played every day in large work establishments. In the workplace game, worker desire for fair treatment is strengthened by the near-zero expected costs associated with reciprocal reductions in cooperation if management fails to pay the established wage norm. Market opportunity cost is the minimum offer, but neither employers nor employees believe that the minimum (market-wage) offer is an optimal solution to the real-life game. In his survey of experimental economics, Larry Samuelson (2005) concluded: “… experimental evidence has mounted that people will incur costs not only to bestow benefits on others, but also to penalize others, with the preference for reward or punishment hinging upon perceptions of whether the recipient has acted appropriately or inimically.” (p.97) The evidence supports motivating worker behavior with preferences for fair treatment and, more richly, tit-for-tat strategies instead of positive-good leisure that comes from shirking on the job.

Evolutionary biology. Worker preference for equity and the proactive redress of its absence is today understood to be axiomatic, an outcome of evolutionary biology embedded by  natural selection in neural networks as our distant ancestors adapted to survival advantages from group cooperation. Read Montague (2006), a prominent neuroscientist, put it succinctly: “Our instincts for sensing and responding to fair exchange evolved in a social environment where tit for tat was king. What you did to me today was coming back to you tomorrow in kind.” (p.186) That decisionmaking biochemistry is consistent across cultures, providing model-building guidance that serious economic theorists foolishly ignore.

In closing, we look to Adam Smith. In his The Theory of Moral Sentiments, he assigned a central role in human nature to perceptions of justice, making his early work consistent with modern GEM analysis and evidence from neuroscience, sociobiology, and evolutionary psychology. Smith’s superior grasp of preferences helps explain the remarkable durability of his economic theories.

Blog Type: Wonkish Saint Joseph, Michigan