Economics 101: How you can tell feigned righteousness from the real thing

In business and elsewhere, interacting repeatedly with someone helps you to overcome the temptation to behave opportunistically – you fear the consequences of such opportunism, including direct punishment (see last week's article in this series). Having your reputation tarnished is a more subtle mechanism for motivating good behaviour, and it is one that has a rich history in traditional GCC commerce. How exactly does it work in the prisoner's dilemma (PD)?

Recall that the PD is a situation where individuals pursuing their own interests leads to the worst outcome for the group. Repetition allows you to retaliate against selfish behaviour with selfish behaviour; if being selfish is sufficiently damaging to the other party and they care enough about future consequences, then the threat of punishment will induce good behaviour. But sometimes the threat is too weak, as demonstrated by Opec’s historic inability to effect coordinated output cuts.

In the 1980s, economists working in the field of game theory articulated a different way in which repetition induces cooperation. Imagine that the world is populated by the selfish, Hobbesian beings considered in the original PD, who struggle – and typically fail – to resist the temptation to behave selfishly. But imagine that there is also a small proportion of righteous people, who refuse to behave selfishly in a PD regardless of the material benefits that opportunism confers upon them, because they care so much about “doing the right thing” (cooperating). Economists showed how the presence of a small number of such saints can be sufficient to convince all the Hobbesian wretches to behave well.

The key condition is that when you enter a PD scenario with someone, you cannot be sure if they are righteous or selfish. The uncertainty creates an incentive for people to want to pretend that they are righteous, even if they are actually worthless misanthropes, because everyone wants to do business with the righteous and avoid the selfish.

While your righteousness cannot be ascertained by others based on your physical appearance, your behaviour is a giveaway: since righteous people always cooperate, anyone observed behaving selfishly is guaranteed to be a selfish type, and one slip is all that is necessary for you to be branded. If the benefits of being perceived to be righteous, including repeat business and new opportunities, are sufficiently large, then it becomes optimal for selfish people to cooperate in PD settings because they are so keen on having others treat them as potentially righteous.

If this incentive is strong enough, then everyone behaves righteously, and everyone continues to be treated as if they might be righteous, but nobody is ever sure who the actual righteous people are.

We see this principle regularly in our day-to-day lives. Some GCC companies are owned and operated by genuinely righteous people, and this is reflected in charitable contributions and good treatment of employees. Such acts confer a potential advantage upon the company as customers and workers like to be associated with ethical businesses. The vast majority of companies, however, prioritise profits, but they also want to secure the benefits associated with projecting an image of ethical operations. As such, even ruthlessly capitalistic firms might run large corporate social responsibility programmes as part of an elaborate masquerade, fearing the adverse commercial consequences of being branded an “unethical” company.

However, sometimes the fear of punishment and of having one’s reputation tarnished are still not enough to ensure cooperation, as reflected in the case of Opec and output cuts. Some members have actually cultivated a reputation as being egregious quota violators, apparently without any adverse consequence. Maintaining our Hobbesian theme, achieving the best outcome in certain PD scenarios, especially in GCC commerce, is possible only via some sort of leviathan, which we discuss next week.

Omar Al Ubaydli is the programme director for international and geopolitical studies at the Bahrain Center for Strategic, International and Energy Studies, and an affiliated associate professor of economics at George Mason University in the US. He welcomes economics questions from readers via email ([e-mail]) or tweet (@omareconomics).

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