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THE INTERACTION BETWEEN NORMS AND ECONOMIC INCENTIVES^
By DAVID M. KREPS *
According to social psychologists and sociologists, a norm is a somewhat general rule of voluntary behavior. Examples range from the very general norm of reciprocity-treat others as they treat you-to more specific rules such as tip 15 percent and face the front in a crowded elevator.
Why do people adhere to norms? Economists have available four answers: (i) Adherence is costless relative to violation and so, why not? (ii) Adherence is immediately personally beneficial because it permits coordination (e.g., bear to the right in a crowded walkway) . ( iii) Adherence, while immediately costly, leads to better treatment by others than will violation. (iv) Adherence is desirable per se.
I reject (i) as uninteresting. Norms to achieve coordination, also called customs or focal points, are interesting, but I will not discuss them further here. Explanation (iii) spins out into the usual game-theoretic story that employs folk-theorem/reputation constructions for repeated games. Predictable commentary about observability being crucial, noise being inimical, and so on may be taken as read. As for (iv), since choice/utility theory is based on revealed preference, this involves making adherence (either to norms in general or to this specific norm) an argument in the individual's utility function.
When norms and economic incentives interact, the distinction between explanations (iii) and (iv) can be important. For example, Assar Lindbeck et al. (1996) study how the political economy of welfare is affected by the social norm that individuals should earn their own bread. In their model, adherence to this norm enters the utility function directly [they use explanation (iv)] but their analysis would not change much if they followed instead the lead of Douglas Bernheim ( 1994), who uses the desire to obtain social esteem [a type- (iii) rationale] as the basis for adherence. Imagine, however, that welfare payments can be hidden (in specific cases) from the general public. (Imagine combining workfare and earnedincome tax credits.) Such "opacifying" institutional features may be desirable, because they shield the truly unfortunate from social stigma. But how do they affect the welfare rolls? If the good opinion of others keeps people off the "dole," then opacifying welfare administration leads to a large (equilibrium) increase in...