Behavioral Finance and Economics - Reciprocal Altruism and Homo Economicus

“Economic Humankind” is, according to classic economic theory, made up of individuals who possess the attributes of unbounded (1) free will, (2) self-interest and (3) rationality.  I reserve for another day an Observation on “unbounded rationality” and today take a short look at the concept in classical economic theory that we are selfish and self maximizing (unbounded self-interest).  Dr. Michael Shermer, in his book The Mind of the Market: Compassionate Apes, Competitive Humans and Other Tales from Evolutionary Economics, describes the moral emotion of “reciprocal altruism” or “I will scratch your back if your scratch mine” – to which I politely add, “or if not take a hike.”  This moral sense of fairness is hard wired into our brains and according to Dr. Shermer, present in all humans and primates tested for it.  It was developed during our formative years as “hunter-gathers” as a means of self preservation of the tribe but has continued to exist even now that we, in the words of Dr. Shermer, have morphed into “consumer-traders” in a large society. As I stated this reciprocal altruism trait has been repeatedly confirmed, more specifically, in a test dubbed the “Ultimatum Game” by behavioral economists.  In the game participants are paired up and one of each pair is given $100 with a condition.  That person is ordered to propose a split of the funds between her/himself and their game partner. If a proposal to split the money in a particular fashion is accepted by the partner then each get their agreed upon proportion.  If the proposal is not accepted then neither gets any portion.

Classical economic theory would tell us that no matter what the proposal is (assuming it was not 100 to zero) the trading partner will, without exception, accept.  The reasoning is that the partner is a Homo Economicus and will not turn down free money (no matter how small or disproportionate the share).
Results of the game in operation show that anything less than a 70 -30 split is usually rejected.  You are not surprised.  Now why would that be?  Well no doubt you have concluded that less than a 70-30 split is not viewed as fair.  No kidding. But although fairness is not a concept in classic economic theory - it is in human psychology - the moral emotion of “reciprocal altruism.” See your conclusion is really the operation of this trait and by the way it’s a reflexive action not a reflective one which once again means it’s invocation is subconscious and compulsive (don’t know it and can’t help it).

You may wish to consider the foregoing as further evidence that psychology matters when analyzing how an investor may confront economic dilemma. In addition you may wish to consider whether something you did or propose will be analyzed by others as being fair and if it’s not whether the moral emotion of reciprocal altruism will have an effect on the evaluation of your proposal (or historical action)*.
*For those of you in the dispute resolution business I bet you can see several important implications.
As a postscript today I thought I would give you the following link to Paul Krugman’s article in a Sunday edition of the New York times.   http://www.nytimes.com/2009/09/06/magazine/06Economic-t.html?_r=1&em