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Identity in Choice

Identity Economics: How Our Identities Shape Our Work, Wages, and Well-Being by George A Akerlof and Rachel E Kranton (Princeton: Princeton University Press), 2010; pp 185, Rs 1,195

Identity in Choice

Priyodorshi Banerjee

B
y the mid-20th century, the idea that the subject of economics should be based primarily on the study of the choices made by individual economic decision-making agents, possibly embellished by postulations regarding unobservable motivations or behavioural imperatives, had gained pre-eminence. Powerful mathematical theories of individual behaviour began to be established, with each such theory adopting a set of explicit assumptions (or postulates or axioms), many of which were about the motivations of economic actors. These assumptions were then used to deduce various implications or propositions regarding actual choices, which may be thought of both as predictions on what choices would be made in given circumstances, as well as frameworks to start analysing data on past choices.

Some of these theories (as a cluster, often called choice theory) proved to be extremely influential. By the end of the 1960s, they had succeeded in establishing themselves as one of the main pillars of a newly coalesced dominant school of thought, neoclassical economics. Typically, such a theory used fairly sophisticated mathematics, displayed analytical elegance, and often derived implications which were relatively simple and intuitive, at least within the accepted framework of economic thought. Also, as far as the fundamental motivational issue was concerned, the typical assumption was that an agent received satisfaction (or utility or payoff) if and only if he consumed physical goods and services. A singular advantage of this generation of theories was their structural sparseness and consequent analytical sharpness.

Even from the end of the 1950s, however, various criticisms began to emerge, both of the mathematical choice-theoretic structure as a class, as well as of individual theories. The critiques typically focused on the framework of assumptions in a given theory. Since any set of assumptions

book review

Identity Economics: How Our Identities Shape Our Work, Wages, and Well-Being by George A Akerlof and Rachel E Kranton (Princeton: Princeton University Press), 2010; pp 185, Rs 1,195.

used was based on what became known as “intuition” (of the proposer of the theory), one line of critique developed by pointing out that in fact any given set of assumptions was fairly arbitrary, i e, any such set left out several seemingly intuitive (i e, intuitive to the critic) features of reality in a manner not at all well-explained, to the extent that the selection of assumptions sometimes seemed fairly unintuitive. Some of these critiques then proposed alternative, typically more expansive, assumptions, and/or direct representations of utility functions, etc, which could in theory be used to predict or analyse choice.

Choice Theory

Akerlof and Kranton’s book is a summary of their own prior work on choice theory which constructively develops a critique along these lines. The main intention of their research effort is to extend choice theory by integrating the notion of identity or norms into the traditional framework. Akerlof himself is a pioneer in this field. (He was awarded the Bank of Sweden Prize for Economic Sciences in memory of Alfred Nobel some years ago, though for unrelated work.) The two together have also co-authored many papers on the subject over the years. The authors suggest that their framework is more realistic and while remaining analytically tractable, can be used to analyse a wider variety of situations compared to traditional choice theory. They further argue that their analytical framework can be used to study, in a unified manner, identity together with some of the other non-economic motives studied by economists, such as “morality, altruism and concern for status” (p 7).

Their work is an example of a kind of critique that started emerging from the end of the 1970s when some economic theorists, in response to the perceived empirical weakness of received choice theory, started introducing non-economic dimensions into utility. That is, either they allowed a social dimension to the process by which an individual economic agent received satisfaction (for example, an agent could derive satisfaction not only from the consumption of physical goods and services by himself, but also from consumption by some other agent), or they allowed agents to obtain satisfaction from the consumption of something that would not easily be identified as an economic good or service in the traditional sense (for example, marriage, education, etc).

As far as identity is concerned, it is difficult to deny that it is important, even if, as the authors point out, it may be quite difficult to define, especially formally. Examples range from a sense of identity with other supporters of a professional sports club or with salary-receivers from the same employer, to members of a race or followers of a religion. The authors’ objective is to show that identity is important not just in the abstract, but also specifically as far as economic decisionmaking is concerned, and to analyse the implications of introducing a link between identity and utility for standard neoclassical choice theory.

In a sense, this movement is in keeping with the march of neoclassical economics, which over the last 30 or 40 years has started applying the decision-theoretic and game-theoretic tools it developed in the context of price analysis to non-traditional domains, such as economic analysis of law, finance, etc. As far as the notion of identity is concerned, it has long been the focus of attention of various social sciences such as sociology and psychology, and to some extent political science. The authors acknowledge this literature, and say they use the insights developed in these fields to effect a radical departure in choice theory within neoclassical economics.

It is certainly true that questions such as what identity is and how it affects economic decision-making, if at all, have not

Economic & Political Weekly

EPW
july 23, 2011 vol xlvi no 30

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been asked within neoclassical economics, interesting, if not absolutely new, innovawhile analogous questions have on occasion tion and allows a neat, if slightly mechan

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received sustained attention from other social scientists. To that extent, asking how a theoretical decision-making unit’s economic choices are affected by its senses of identity certainly constitutes a significant departure from the perspective of neoclassical econo mics, even if it does not open substantive new avenues for the social sciences as a whole. Two attendant questions are immediately raised, however: first, is there a substantial methodological departure, and second, do the answers and insights generated differ enormously from those arising from a more traditional analytical approach?

Methodological Approach

Methodologically, the authors’ approach is as follows. First, they introduce the idea that there are two broad types of goods which agents can consume and derive satisfaction from – one that satisfies basic tastes, and another that is not so basic, and whose value derives from norms, i e, social rules regarding behaviour. Second, they expand the idea of the utility function to take into account this second type of good. One part of the utility function is exactly as in traditional models, and describes how goods satisfying basic tastes contribute to satisfaction, while a new term is additively introduced to describe the relationship between utility and consumption of goods satisfying non-basic tastes. The innovation thus lies in the introduction of this second term, which follows the form of what in the technical literature is called a “loss function”. In other words, there is a predefined optimal level of consumption, and any deviation from that level leads to a loss of utility. This is, of course, quite different from the other (traditional) part of the utility function, where there is no such predefined optimum, and indeed, more consumption always leads to higher levels of utility. The predefined optimum is interpreted as the norm or the socially specified level, as given by an agent’s identity grouping. So the closer an agent is to the consumption level specified by the identity marker, the higher the satisfaction that is received.

Introducing these kinds of loss functions as part of the utility function is an ical, interpretation of identity and norms and their relationship to utility, and by extension, to decision-making. However, this particular way of thinking of two kinds of goods, with distinct roles and effects, which respond to different environmental stimuli, does not appear to sit well with the idea that identity or other non-economic variables are as important as the ones that traditional theories focused on. No justification is provided as to why there are two (and only two) types of tastes nor why goods satisfying such tastes have such different impacts upon utility. There is also no discussion on how to empirically identify such tastes, or how to determine when a good satisfies one type of taste versus the other. Despite these weaknesses, the approach does have the advantage of providing a simple inter pretive link between traditional utility theory and the notion of identity. It also has the advantage of being a relatively simple technical extension of received structure, thereby allowing comparability and retaining tractability.

As far as the explicatory or predictive aspects of their ideas are concerned, the rewards seem to be more in the domain of the promised than of the present. The authors propose that their approach is (more) intellectually satisfying (than others), and that it will lead to “more reliable” and “sturdier” economic models (pp 7-8). Thus, while a significant part of the book (especially parts two and three) comprises applications, the focus seems to be more on the presentation of simple illustrative examples, rather than detailed analysis. The authors apply the framework developed in part one to various problems in the economic analysis of education, race, gender and organisations.

Overall, these four chapters contain many interesting examples, but tend to get a little repetitive. The most interesting is chapter five on organisations. Organisations can be viewed as informationally closed collections of economic agents who despite differences, and possibly conflict, of interest among themselves, have voluntarily associated with each other for some common purpose. Most commonly, the organisational form receiving theoretical attention from economists is the firm. There has been rapid development

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july 23, 2011 vol xlvi no 30

EPW
Economic Political Weekly

BOOK REVIEW

of this field in the last 15 years or so, and a lot of the new choice-theoretic work discussed earlier has grown using empirical observations from firms, and seeking applications in organisational contexts.

Issue of Compensation

A significant part of the economic theory discussion is organised around the issue of compensation. Dominant theories tend to show that firms should provide highpowered incentives to their workers to perform optimally. Yet empirical evidence suggests strongly that while highly incentivised compensation schemes are not absent, they tend to be far less common than what the theory suggests. The authors’ theory of identity provides an explanation. They argue that firms would be better off trying to build identity, i e, align workers’ incentives with that of management/ ownership in non-monetary ways. They give several examples to suggest that empirical reality is more closely aligned with their view. There are three problems with their examples. First of all, the discussion is entirely informal, so the link between their formal methodology and their results is not clear. However, this is not a huge problem

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-as the book is entirely non-technical and meant for a general audience. A more serious problem is that there are several alternative explanations which have been proposed within neoclassical economics over the last 25 years or so for the prevalence of low-powered incentives in firms: it is not clear how their framework performs when compared to some of the others. Finally, the idea that organisations tend to devote a fair amount of attention attempting to align minor constituents’ interests with that of major stakeholders is something that sociologists and psychologists have been saying for some time. The authors also cite some of this literature. But then the question comes up as to whether the authors have something terribly new to say.

Part four of the book is the concluding section, in which some of the key issues discussed in the book are summarised. Chapter nine in this section contains a philosophical discussion on the methodology of economic theory. It is an excellently written chapter, and covers a fair amount of ground, and some of the topics are general and extend to arenas beyond the main context of the book.

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Overall, Identity Economics is an interesting book and contains a good discussion of some new research in the subject and lots of interesting case studies. One question that is not well-addressed, and one that traditional choice theorists often ask when confronted with these kinds of critiques, is whether issues such as identity can at all be incorporated meaningfully within the mathematical paradigms neoclassical economics is bound by. Suitable extensions of utility functions using appropriate functional forms or parameter values can end up explaining a lot, as long as sufficient leeway is allowed in the choice of parameters or functional forms. But such explanations can be quite mechanical, and it is not clear whether deep insights are generated on all occasions. However, Akerlof is one of the most imaginative thinkers in neoclassical economics, and his earlier work on information economics essentially sparked off a revolution which dramatically changed the nature of the subject. Any work by him is worth pursuing.

Priyodorshi Banerjee (banpriyo@gmail.com) is with the Economic Research Unit, Indian Statistical Institute, Kolkata.

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Economic Political Weekly

EPW
july 23, 2011 vol xlvi no 30

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