The Handbook of Rational Choice Social Research 9780804785501

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The Handbook of Rational Choice Social Research

The HANDBOOK of RATIONAL CHOICE SOCIAL RESEARCH edited by Rafael Wittek Tom A. B. Snijders Victor Nee

Stanford Social Sciences An Imprint of Stanford University Press

Stanford University Press Stanford, California ©2013 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved. No part of this book may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying and recording, or in any information storage or retrieval system, without the prior written permission of Stanford University Press. Library of Congress Cataloging-in-Publication Data The handbook of rational choice social research / edited by Rafael Wittek, Tom A.B. Snijders, and Victor Nee p. cm. Includes bibliographical references and index. ISBN 978-0-8047-8418-4 (cloth : alk. paper) 1. Rational choice theory. I. Wittek, Rafael, editor of compilation. II. Snijders, T. A. B., editor of compilation. III. Nee,Victor, editor of compilation. HM495.H36 2013 330.01—dc23 Typeset at Stanford University Press in 10.5/12 Bembo

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Acknowledgments

The editors would like to thank the Russell Sage Foundation for generous support of an author conference at New York City in November 2007, Suzanne Nichols for guidance during the early phase of this project, and four anonymous reviewers for their constructive suggestions. We also would like to thank Kate Wahl from Stanford University Press for her encouragement, patience, and formidable support. Saskia Simon from the Department of Sociology at the University of Groningen deserves a very special thanks for her high-quality secretarial support in all phases of this project, including the final preparation of the manuscript. Rafael Wittek also gratefully acknowledges funding from the Netherlands’ Organization for Scientific Research (NWO) (NWO 016005-052 and 400-05-704).

Contents

Contributors

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Introduction: Rational Choice Social Research Rafael Wittek,Tom A. B. Snijders, and Victor Nee

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Part I: Rationality and Decision-making 1 Rationality, Social Preferences, and Strategic Decision-making from a Behavioral Economics Perspective 33 Simon Gächter 2 Social Rationality, Self-Regulation, and Well-Being: The Regulatory Significance of Needs, Goals, and the Self 72 Siegwart Lindenberg 3 Rational Choice Research on Social Dilemmas: Embeddedness Effects on Trust 113 Vincent Buskens and Werner Raub 4 Modeling Collective Decision-making 151 Frans N. Stokman, Jelle Van der Knoop, and Reinier C. H.Van Oosten Part II: Networks and Inequality 5 Social Exchange, Power, and Inequality in Networks Karen S. Cook and Coye Cheshire 6 Social Capital 220 Henk Flap and Beate Völker 7 Network Dynamics Tom A. B. Snijders

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Contents

Part III: Communities and Cohesion 8 Rational Choice Research in Criminology: A Multi-Level Framework 283 Ross L. Matsueda 9 Secularization: Theoretical Controversies Generating Empirical Research 322 Nan Dirk De Graaf 10 Assimilation as Rational Action in Contexts Defined by Institutions and Boundaries 355 Victor Nee and Richard Alba Part IV: States and Conflicts 11 Terrorism and the State Ignacio Sánchez-Cuenca

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12 Choosing War: State Decisions to Initiate and End Wars and Observe the Peace Afterward 411 James D. Morrow 13 Rational Choice Approaches to State-Making Edgar Kiser and Erin Powers

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Part V: Markets and Organizations 14 Market Design and Market Failure 473 Carlos Cañón, Guido Friebel, and Paul Seabright 15 Organizational Governance 513 Nicolai J. Foss and Peter G. Klein 16 Rational Choice and Organizational Change Rafael Wittek and Arjen Van Witteloostuijn Index

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Contributors

richard alba: Distinguished Professor of Sociology at the Center for Urban Research, City University of New York (CUNY). His fields of interest are race, ethnicity, and immigration. His recent books include Blurring the Color Line: The New Chance for a More Integrated America (Harvard University Press, 2009), The Next Generation: Immigrant Youth in a Comparative Perspective (coedited with Mary Waters, NYU Press, 2011), and the award-winning Remaking the American Mainstream: Assimilation and Contemporary Immigration (with V. Nee, Harvard University Press, 2003). vincent buskens: Professor of Theoretical Sociology, Utrecht University and Interuniversity Center for Social Science Theory and Methodology (ICS) and Professor of Empirical Legal Studies, Erasmus School of Law, Erasmus University Rotterdam. His main research areas are social dilemmas, cooperation, trust, social networks, mathematical sociology, complexity, experimental research, empirical studies on regulation and institutions, sociological applications of neuroscience. He is co-editor of Micro-Macro Links and Microfoundations (with W. Raub and M. van Assen, Routledge, 2012) and eTrust: Forming Relations in the Online World (with K. Cook, C. Snijders and C. Cheshire, Russell Sage, 2009). carlos cañón: Economist at the Financial Stability Division of Banco de México (Mexican Central Bank). He received his PhD from the Toulouse School of Economics with a dissertation on the Theory and Econometric Models of Platforms. His main area of interest is industrial organization, market design, and econometrics. coye cheshire: Associate professor at the UC Berkeley School of Information. He studies social exchange, interpersonal relationships, and paths of participation in computer-mediated environments. Recent articles have appeared in Personality and Social Psychology Bulletin, Daedalus, and Proceedings of the ACM Conference of Computer-Supported Cooperative Work (CSCW). karen s. cook: Ray Lyman Wilbur Professor of Sociology at Stanford University. Her fields of interest are social psychology, organizational

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Contributors

behavior, group processes, social networks, and health care. For the Russell Sage Foundation, she has edited Trust in Society (2001), Trust and Distrust in Organizations: Emerging Perspectives (with R. Kramer, 2004), eTrust: Forming Relations in the Online World (with C. Snijders, V. Buskens and C. Cheshire, 2009), and Whom Can We Trust? (with M. Levi and R. Hardin, 2009).

nan dirk de graaf : Professor of Sociology and Official Fellow, Nuffield College, University of Oxford. His main research areas are social stratification, cultural sociology, sociology of religion, pro-social behavior, and political sociology. He edited with Geoff Evans Political Choice Matters: Explaining the Strength of Class and Religious Cleavages in Cross-National Perspective (Oxford University Press, 2013). Recent articles have appeared in American Sociological Review, Sociology of Health and Illness, Journal of the Scientific Study of Religion, Research in Social Stratification and Mobility, and Journal of Quantitative Criminology. henk flap: Professor of Sociology Utrecht University and Interuniversity Center for Social Science Theory and Methodology (ICS). His main research interest is social capital. He is editor (with B.Völker) of Creation and Returns of Social Capital: A New Research Program (2005). Recent articles have appeared in Social Networks, European Sociological Review, and Social Science & Medicine. nicolai j. foss: Professor of Strategy and Organization at the Copenhagen Business School and a part-time Professor of Knowledge-based Value Creation at the Norwegian School of Economics and Business Administration. His main areas of interest are the theory of the firm, economic organization, and strategy. Among his recent book publications are Management Innovation (with T. Pedersen, J. Pyndt and M. Schultz), Opportunity Discovery and Economic Organization: Entrepreneurship and the Theory of the Firm (with P. Klein, Cambridge University Press, 2011), and Knowledge Governance: Perspectives from Different Disciplines (with Snejina Michailova, Oxford University Press, 2009). guido friebel: Professor, Department of Economics and Business, Goethe University Frankfurt. His main area of interest is applied contract theory (organizations and personnel economics), industrial organization and regulation (in particular of railroads), and institutional and transition economics. Recent articles have appeared in American Economic Journal, Journal of Economic Behavior and Organization, and Economic Journal. simon gächter: Professor of the Psychology of Economic Decision Making at the University of Nottingham, UK. His main area of interest is the role of social norms in economic decision making. He has published in Science, Nature, and economic journals such as the American Economic Review and Econometrica. edgar kiser: Professor of Sociology and Political Science at the University of Washington. His main interests are the bureaucratization of states, the development of voting institutions, the bureaucratization and centralization of tax administration, and the methodology of historical sociology. His recent articles have appeared in the Annals of the Academy of Political and Social Science, American Sociological Review, and Political Power and Social Theory. peter g. klein: Associate Professor of Applied Social Sciences at the University of Missouri. His research focuses on the economics of organization,

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entrepreneurship, and corporate strategy. His recent books include Organizing Entrepreneurial Judgment: A New Approach to the Firm (with N. Foss, Cambridge University Press, 2012), The Elgar Companion to Transaction Cost Economics (coedited with M. E. Sykuta, Edward Elgar, 2010), and The Capitalist and the Entrepreneur: Essays on Organizations and Markets (Ludwig von Mises Institute, 2010).

siegwart lindenberg: Professor of Cognitive Sociology at the Interuniversity Center for Social Science Theory and Methodology (ICS), University of Groningen. and at the Tilburg Institute for Behavioral Economics (TIBER), Tilburg University. His main interests lie in the areas of micro-foundations for theories on collective phenomena, self-regulation, pro- and antisocial behavior, groups and relationships, and governance structures in organizations. Recent articles have appeared in Science, Academy of Management Review, Criminology, PLoS ONE, and Aggressive Behavior. ross l. matsueda: Blumstein-Jordan Endowed Professor of Sociology at the University of Washington. His current research develops new methods of estimating trajectories of crime and drug use, examines social capital and informal control in neighborhoods, and estimates the effects of life course transitions on criminal trajectories. Recent articles have appeared in Journal of the American Statistical Association, American Sociological Review, Criminology, and Annals of the American Academy of Political and Social Science. james d. morrow: Professor of Political Science and Research Professor at the Center for Political Studies at the University of Michigan. His current research addresses the role of election institutions in domestic and foreign policy and the effects of norms on international politics. He is the author of Game Theory for Political Scientists (Princeton University Press, 1994) and the forthcoming Order within Anarchy: The Laws of War as an International Institution, and co-author of the award-winning The Logic of Political Survival (with B. Bueno de Mesquita, A. Smith and R. M. Siverson, MIT Press, 2003). victor nee: Frank and Rosa Rhodes Professor of Sociology, Cornell University. His areas of interest are in economic sociology, networks and institutions, and immigration. Recent articles have appeared in the Management Science, Daedalus, Social Forces, Kyklos, Journal of Institutional and Theoretical Economics, Management and Organization Review, and Research in the Sociology of Work. His books include Capitalism from Below: Markets and Institutional Change in China (with Sonja Opper, 2012), On Capitalism (co-edited with Richard Swedberg, 2007), Economic Sociology of Capitalism (coedited with Swedberg, 2005) and Remaking the American Mainstream: Assimilation and the New Immigration (with Richard Alba, 2003). erin powers: PhD candidate in Sociology at the University of Washington, is writing a dissertation on the development and effects of group solidarity and social capital in self-help groups. Her areas of interest include political sociology, collective action, and community. werner raub: Professor of Sociology, Utrecht University and Interuniversity Center for Social Science Theory and Methodology (ICS). His main research areas are theoretical sociology, organization theory and economic sociology,

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mathematical sociology, experiments and the use of complementary research designs in the social sciences, and sociological applications of neuroscience. He is co-editor of Micro-Macro Links and Microfoundations (with V. Buskens, and M. van Assen, Routledge, 2012).

ignacio sánchez-cuenca: Research Director of the Center for Advanced Study in the Social Sciences, Juan March Institute (Madrid). His areas of study include political violence, comparative politics, and democratic theory. He is the author of Controlling Governments.Voters, Institutions, and Accountability (co-edited with J. M. Maravall, Cambridge University Press, 2008) and articles published in The Journal of Conflict Resolution, The Journal of Peace Research, Politics & Society, The Annual Review of Political Science, and several others. paul seabright: Professor of Economics at the Toulouse School of Economics and Director of the Institute for Advanced Study in Toulouse. His current research lies in three areas of microeconomics: industrial organization and competition policy; the economics of networks and the digital society; and behavioral economics (especially the integration of evolutionary biology and anthropology with an understanding of the development of economic institutions in the very long run). Among his publications are The Company of Strangers: A Natural History of Economic Life (Princeton University Press, 2nd edition, 2010) and The War of the Sexes: How Conflict and Cooperation Have Shaped Men and Women from Prehistory to the Present (Princeton, 2012). tom a. b. snijders: Professor of Statistics in the Social Sciences at the University of Groningen and the University of Oxford, and Interuniversity Center for Social Science Theory and Methodology (ICS). His main research interests are in statistical methods for social networks, multilevel research / random coefficient models, mathematical sociology, and item response theory. Among his recent book publications is Multilevel Analysis: An Introduction to Basic and Advanced Multilevel Modeling (with R. Bosker, Sage, 2011). frans n. stokman: Professor of Social Science Research Methodology at the University of Groningen, The Netherlands. His main fields of interest are models of and strategic intervention in collective decision-making, social network analysis, and policy networks. Among his recent book publications is The European Union Decides (co-edited with R. Thomson, C. Achen, and T. Koenig, Cambridge University Press, 2006). jelle van der knoop: Senior consultant at dutch. Holds a PhD in sociology. His main areas of interest are in the field of collective decision making processes and negotiation. reinier c. h. van oosten: Expert for computer simulation at dutch. He holds a degree in econometrics. His main areas of interest are game theory and collective decision making. arjen van witteloostuijn: Professor of Organization and Strategy, University of Tilburg, Research Professor of Economics and Management at the University of Antwerp in Belgium, and Professor of Institutional Economics at Utrecht University in the Netherlands. His main research interest lies in the field of organizational ecology. Among his recent book publications is Nations

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and Firms in the Global Economy: An Introduction into International Economics and Business (co-authored with S. Brakman, H. Garretsen and C. van Marrewijk, Cambridge University Press, 2006).

beate völker: Professor of the Sociology of Social Capital at Utrecht University and Interuniversity Center for Social Science Theory and Methodology (ICS). Her main field of interest is the influence of contexts on social network patterns. She is editor (with H. Flap) of Creation and Returns of Social Capital: A New Research Program (Routledge, 2005). rafael wittek: Professor of Theoretical Sociology, Department of Sociology, University of Groningen and Interuniversity Center for Social Science Theory and Methodology (ICS). His main research areas are social network analysis, organization studies, and social theory. Recent articles have appeared in the Journal of Applied Psychology, Social Networks, and the Journal of Public Administration Research and Theory.

Introduction: Rational Choice Social Research rafael wittek, tom a. b. snijders, and victor nee

During the past two decades or so, rational choice theory has significantly advanced in refining its theoretical core and its empirical applications, and has made a respectable contribution to a large variety of substantive research areas (Hechter and Kanazawa 1997; Hedström and Stern 2008; Kronenberg and Kalter 2012; Macy and Flache 1995;Voss and Abraham 2000). This volume presents an overview of some of the achievements of what we call rational choice social research—empirical investigations that were guided by rational choice reasoning. In this introductory essay, we first sketch what could be described as the “Rational Choice Paradox”—that it is actually the strengths of the approach that have inhibited its further advancement. We then sketch some of the major criticisms against the approach, and then provide a very brief summary of the theoretical core of the rational choice approach. Next we outline the analytical structure and chapters of this Handbook. In the concluding section, we discuss some future perspectives for the approach, in particular its potential to develop into a full-fledged interlevel, interfield research program (Kuipers 2001).

The Rational Choice Paradox Proponents of rational choice reasoning often argue that the rational choice approach, unlike any other paradigm in the social sciences, can be characterized by a well-developed, highly consistent, and widely shared set of formalized core assumptions (Coleman 1990). They praise its emphasis on parsimonious model building, conceptual rigor, and explicit attention to micro-macro problems for theory formation (Raub, Buskens, and Van Assen 2011)—qualities that, in the eyes of its proponents, warrant claims of a “privileged role” of rational choice modeling above other approaches attempting to explain social phenomena in terms of individual action (Goldthorpe 2007: 172; Abell 1992). The rational choice approach indeed continues to attract use by increasing numbers of scholars. In more and more subfields of the social sciences, scholars realize the usefulness of the rational choice approach as a tool for theory-driven social research and interventions. It is not uncommon that empirical research,

2 Wittek, Snijders, and Nee from studies of residential segregation to warfare, draws on the rational choice approach as its implicit theory. Paradoxically enough, however, there are at least two reasons why the strengths of the RC approach (RCA) seem also to inhibit its further advancement. First, with its traditional emphasis on theory building and formal modeling, the RC approach for a long time has been associated mainly with sophisticated but arcane and highly abstract modeling efforts. As a result, one of the major criticisms against RCA has been that rational choice scholars would excel in formal modeling but fail to provide empirical evidence to support their models. Therefore, the RC approach would neither have produced or be backed by relevant empirical insights, nor would it be useful in guiding empirical social research in the first place. While RC research indeed had a strong theoretical focus in the past, this statement is certainly increasingly less true. In the last two decades, RC research has been translated into Mertonian middle-range theory oriented toward empirical social research, often with impressive results. Second, the RC approach meanwhile is probably the only paradigm that has been applied to almost all subdisciplines and subfields of the social and behavioral sciences, ranging from the modeling of markets to the study of immigration, assimilation, ethnic enterprise, race relations, trust, networks, institutions, religious behavior, emotions, terrorism, and a huge variety of other phenomena. In this sense, Goldthorpe’s call that rational choice theory would benefit from “concentrating more on the application of RAT to specific explanatory tasks, rather than on theory development for its own sake” (Goldthorpe 2007: 134) was certainly heeded. Often the use of RC models has triggered fierce but fruitful controversies in these substantive and specialized fields of application.Through these discussions with subfield-specific audiences, rational choice researchers not only advanced our substantive knowledge on specific social phenomena but also significantly enhanced and refined the RC approach itself. Nevertheless, the insights generated within the subdisciplines only rarely diffused across subfield-specific boundaries. The result is that RC research, though being one of the few paradigms with a coherent set of formalized and widely shared core assumptions, remains fragmented, with RC scholars as well as their critics in one field often remaining unaware of the empirical and theoretical progress achieved in other subfields. Consequently, both RC scholars and their critics miss important refinements and corrections of the approach as they have taken place in the past two decades. In sum, though the past two decades have seen major theoretical and empirical advancements guided by rational choice reasoning in a large variety of subfields, most of these advancements are still fragmented. Combined with the ongoing criticism against the approach as such, this fragmentation prohibits a more objective assessment of its merits and limitations.

Criticism of Rational Choice Theory There is probably no aspect of rational choice theory that has not been criticized: its model of human nature, its reductionism, its inability to deal with culture and identity, its neglect of social embeddedness. Most of these issues have been discussed in Green and Shapiro’s (1994) book Pathologies of Rational Choice

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Theory and the subsequent debate. One of their major complaints was that rational choice theory has not produced novel, empirically sustainable findings: “[S]uccessful empirical applications of rational choice models have been few and far between. . . . Part of the difficulty stems from the sheer paucity of empirical applications” (ix–x). What is more, if empirical research was inspired by rational choice theory, it is “marred by methodological defects.” When discussing criticism against rational choice reasoning, it is important to distinguish between criticism based on misconceptions and criticism directed toward real problems (Goldthorpe 2007). Much criticism indeed rests on often serious misconceptions. This holds for the assumptions that rational choice theory equals neoclassical economics, that the approach would be normative in nature, that rational choice approaches would acknowledge only instrumental rationality (ibid.: ch. 8), or that formalism would be an essential requirement of the approach (Cox 1999).The majority of these misconceptions could be invalidated in the debate following Green’s and Shapiro’s publication (Friedman 1996). Also the claim that the set of empirical tests of nonobvious rational choice hypotheses is almost empty—what most would consider the least controversial criticism—did not withstand closer scrutiny even at the time of Green’s and Shapiro’s publication (for a demonstration of this point for the political sciences, see Cox 1999). This Handbook collects additional evidence proving this point. Nevertheless, no one would deny that rational choice theory, like any other theoretical framework, has some real unresolved problems to address. Most of them are related to the highly stylized assumptions of neoclassical economics, in particular the assumption of atomized interaction between rational and selfish actors with full information, taking place in perfect markets. Rational choice scholars always acknowledged that deviations from this ideal typical construct of rationality were possible. Four different strategies to deal with such deviations can be discerned. They differ with regard to how they treat individual level deviations from rationality and its aggregate effects. cognitive anomalies The first solution, and the one usually invoked by proponents of neoclassical strong rationality assumptions, consists in classifying these deviations as “cognitive anomalies” at the level of individual actors. Such anomalies would be idiosyncratic and randomly distributed in the population, which is why they would not substantively affect the aggregated outcomes predicted by rational choice models. Adherents of this position therefore consider the neoclassical set of rationality assumptions as a valid foundation for model building, and see no need to increase cognitive complexity. Its fiercest proponents, such as Gary Becker, consider principles of strong rationality as applicable for decisionmaking in general, independent of the context in which it takes places. This position has become known as economics imperialism (Fine and Milonakis 2008): humans are general-purpose problem solvers acting according to rationality criteria, be it in choosing a mating partner or in buying a car. strong vs. weak rationality The second group of scholars suggested distinguishing between “strong” and “weak” rationality assumptions (“hyperrationality” vs. “bounded rationality”).

4 Wittek, Snijders, and Nee Strong rationality would assume, for example, perfect information of all actors, unlimited cognitive capacity to deal with information, and maximization as the decision-making criterion. Bounded rationality assumes unequal access to information, selective attention, and satisficing. Proponents of strong rationality acknowledge that the assumptions are abstractions that need not match with real-life individual decision-making processes, but emphasize that these assumptions nevertheless result in good models of aggregate outcomes (Coleman 1990; see also Buskens’s and Raub’s contribution to this volume). Bounded rationality proponents doubt this and urge scholars to make more realistic assumptions about human nature.They argue that individual deviations from strong rationality are not idiosyncratic but systematic. As a result, models that do not take such systematic deviations into account will also produce wrong aggregate level predictions.The bounded rationality approach refines the full rationality perspective by delineating a specific set of cognitive limitations. This does not mean that its proponents aim “at the construction of models of choice that are incompatible with rationality” (Rubinstein 1998: 25). market vs. nonmarket contexts The third group of scholars suggested that strong rationality assumptions would hold only in specific, usually market-related decision situations, whereas nonrational motives would dominate in noneconomic settings, such as transactions in families or within close-knit communities.This would justify the division of labor between economics studying markets and economic behavior and exchange, and the other social sciences studying social behavior. Here, increasing the “cognitive complexity” of the actor model would be considered an adequate strategy only if the phenomenon to be explained would be outside of the market or economic sphere. This approach acknowledges that there might be systematic individual-level deviations from strong rationality in specific noneconomic domains. Consequently, rational choice theory is not applicable to model behavior in these settings, since it would also lead to wrong aggregate-level predictions, but it definitely is adequate to model behavior in other settings. social rationality Finally, the fourth group of scholars opts for expanding assumptions about rationality. This builds on mounting evidence collected during the past two decades by cognitive neurosciences, behavioral economics, evolutionary psychology, and related fields. Rather than treating deviations from a strong rationality model as idiosyncratic cognitive anomalies of individuals, as applicable to only specific societal domains, or as simply limited by cognitive capacities, they should be conceived as systematic reflections and hence predictable characteristics of human nature (Ariely 2008; Thaler and Sunstein 2008; Camerer, Loewenstein, and Rabin 2004; see also Lindenberg’s contribution to this volume). This requires a refinement of microfoundations. At many points in this Handbook, two such strategies of refining the microfoundations are applied: the systematic incorporation of assumptions about human goals and preferences on the one hand, and about identities and beliefs on the other. The common denominator of these strategies consists in refining the cognitive,

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motivational, and even neurophysiological ingredients of individual decisionmaking processes. By elaborating on the cognitive foundations of human decision-making (that is, rendering assumptions about the intrapersonal antecedents of behavior more complex), research following this strategy arrives at surprising hypotheses and insights, which sometimes are at odds with the predictions of the standard model, and sometimes can be incorporated into it. Extensions of the actor model of economics—for example, through “fast and frugal” heuristics, the incorporation of loss aversion and reciprocity effects, or the assumption that actors derive utility from punishment (Fehr and Gächter 2000)—were successfully applied to explain cooperative vs. selfish behavior, such as the decision to free-ride or to allocate sanctions for noncooperation. Crucial antecedents dealt with in this context are nonpecuniary incentives, reciprocity, and social incentives (for example, altruistic punishment) in general. In sum, the past decades have witnessed many attempts to refine, specify, or relax these assumptions. The next section provides a brief structured overview of these attempts.

Core Assumptions of Rational Choice Theory Following Goldthorpe (2007), we define the rational choice approach broadly as a family of theories explaining social phenomena as outcomes of individual action that can—in some way—be construed as rational. Simon refers to substantive rationality as behavior that “is appropriate to the achievement of given goals within the limits imposed by given conditions and constraints.” In this perspective, irrational behavior is an outcome of impulsive responses without adequate intervention of thought (Rubinstein 1998: 21; but see Lindenberg in this Handbook for a different approach). As in most other theory traditions, there are many variations in how rational choice theories are constructed. Rational choice scholars differ, often considerably so, with regard to the type of assumptions they make, their behavioral “microfoundations.” Yet they also share a common core. Though explicating the behavioral microfoundations underlying a proposed explanation is crucial for any theoretical endeavor, social scientists more often than not leave many of these assumptions implicit, and rational choice scholars are no exception. For mainstream economists, this is usually believed to be not too problematic, given a widely shared consensus on the assumptions of the canonical model to which the majority of economists adhere. In these cases, tacit assumptions can often be easily reconstructed by referring to textbook knowledge. Lacking explications of assumptions is problematic in those branches of the social sciences without a consensus about the theoretical core, and sociology is certainly one of them. Misconceptions are often the consequence, with resulting debates not addressing real problems (Goldthorpe 2000: ch. 8) and creating wrong divides between theoretical approaches. The importance of explicating the microfoundations underlying an explanation has been repeatedly demonstrated, and becomes most visible in those situations in which the same explanatory variable is hypothesized to have opposite effects on an outcome, depending on the type of microfoundation that is taken as

6 Wittek, Snijders, and Nee ta bl e 0 . 1 Varieties of Rational Choice Microfoundations Assumption

Thin or strong rationality

Rationality

Full rationality

Bounded rationality

Procedural rationality

Social rationality

Opportunism

Egoism

Linked-utility

Solidarity

Tangible resources Natural

Intangible resources Social

Physical wellbeing Institutional

Social wellbeing Structural

Preferences: Selfishness Preferences: Materialism Individualism

Thick or weak rationality

a starting point (Torsvik 2000). Take the example of explaining variations in employee commitment or performance as a consequence of the amount of pay. If the microfoundation assumes that individuals care only about the amount of their own salary, the resulting prediction is that pay raises should have a positive effect on individual performance, independently of the pay raises received by other employees in the firm. If the assumption is that individuals care about relative status, a pay raise may actually have detrimental effects on performance if it compares unfavorably with what one’s colleagues earn (Frank). In the case of this second microfoundation, the assumption of “atomistic” actors underlying the first hypothesis is relaxed by assuming that individuals know what their colleagues earn (a condition that is not necessary in the first model), that they make social comparisons, and that they are driven by social motives (that is, to increase their relative status). Note that the latter is still compatible with the selfishness assumption of the standard model, since individuals are assumed to maximize not only material gain but also relative status. This thought experiment can even be extended further. Assume that individuals again care about what others earn, but that “caring” means that they are guided mainly by fairness considerations, rather than by the drive to increase their own status. In that case, the positive effect of a pay raise on individual performance would be predicted only if either the pay raise is perceived to be legitimate, or if other employees in comparable positions also receive a pay raise. In this model, one element in the microfoundation deviates from the canonical rational choice model: it drops the assumption of selfish preferences. As the contributions to this Handbook amply illustrate, many contemporary rational choice models relax some of the assumptions of the canonical model while retaining others. In what follows, we sketch three dimensions on which rational choice scholars usually differ, and along which rational choice theories can be characterized (see also Goldthorpe 2007). We refer to these domains as rationality, preference, and individualism assumptions (see Table 0.1). rationality Rationality assumptions span the range from full (or hyper-) rationality, bounded rationality, procedural rationality to social or ecological rationality. In models of full rationality, the assumption is that individuals are fully informed about all their decision alternatives, the probabilities of their outcomes, and

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their consequences. Individual decision-makers do not face any cognitive limitations or biases in perceiving or processing this information. Alternatives are evaluated against each other according to cost-benefit criteria, and actors choose the alternative with the highest (subjective) expected utility. Where outcomes depend on the decisions of other actors, full rationality is assumed to be strategic (rather than parametric) rationality, and modeled with game theoretical tools. Models of bounded rationality (Simon 1957; Rubinstein 1998) make two key assumptions in which they deviate from full rationality models. First, decision-makers are usually not fully informed about all available options: their perception of information is biased through selective attention (framing processes). Second, humans have limited cognitive capacities for processing the information that is available to them: rather than maximizing, boundedly rational actors satisfice—that is, once they detect a course of action that in their eyes is good enough to reach a goal, they won’t go on searching for a better one, even if they know that a better solution would be available. Models of procedural rationality share the assumption that many individual decisions and much behavior are guided by past experiences leading to imitation and “automatic” responses, rather than by conscious and deliberate evaluation of future costs and benefits. Such learning models consider trial and error mechanisms as crucial strategies, in particular under conditions of (radical) uncertainty where individuals do not know all possible outcomes (Knight 1921). Hedström (1998) refers to this strategy as “rational imitation.” Finally, Lindenberg’s social rationality and Todd’s and Gigerenzer’s ecological rationality approach suggest that rationality should be treated as an explanandum rather than an explanans. Building on insights from social and cognitive psychology and the evolutionary and neurocognitive sciences, which document the modularity of the brain, social rationality models try to specify under which conditions gain-maximization and other rationality traits contained in full or bounded rationality approaches will guide human decision-making, and under which conditions other processes such as learning or automatic responses will guide behavior (Lindenberg 2001; Todd and Gigerenzer 2007). The social rationality model goes furthest in relaxing the traditional rational choice core. It suggests that gain seeking is only one of three overarching goal frames, in between hedonic and normative frames. A key argument is that not gain seeking but hedonic goals—directed toward the immediate realization of pleasure, not necessarily of material gain—are the “natural default condition” (see Lindenberg’s chapter in this Handbook). preferences The second dimension on which rational choice models differ is preference assumptions. In the canonical, neoclassical rational choice model, preferences are assumed to be exogenously given and stable, and individuals are selfish egoists striving toward the maximization of material gain. Rational choice models can be distinguished based on the degree to which they relax these two preference assumptions. We refer to them as the selfishness and the materialism assumptions.

8 Wittek, Snijders, and Nee Selfishness With regard to selfishness assumptions, the following four positions can be discerned. First, on one extreme of the continuum,Williamson urged sharpening the selfishness assumption by incorporating opportunism (that is, self-seeking with guile) as an extreme form of egoism (Williamson 1975). Opportunism implies that exchange partners may deliberately break rules and cheat in order to increase their own benefits at the expense of the other party (see Foss’s and Klein’s chapter in this Handbook for a discussion of the implications of opportunism). Second, the opportunism assumption differs from a pure egoism assumption, in which contracting parties are assumed to respect the rules of the game. For example, complete contracting theories assume that rational and forwardlooking actors design and enforce these rules in such a way that they align the selfish interests between the exchange parties so that it does not pay to cheat (Milgrom and Roberts 1992). Third, some rational choice models explicitly incorporate the assumption that it might be in the best interest of an individual to take the well-being of other actors into account—that is, to link his or her utility to the utility of exchange partners. Approaches building on such linked utility assumptions argue that individuals might hold moral or partially altruistic preferences. This assumption does not require relaxing other rationality assumptions. In fact, selfishness is not a necessary component of rational choice models at all (see Gächter in this Handbook). Finally, at the other end of the selfish preference continuum, some rational choice scholars invoke goal-framing theories to argue that (social) preferences dominant in a given situation need to be endogenized. This approach suggests that under specific circumstances, humans may act in a strong solidarity frame in which no tangible direct personal benefit results from their actions. In other situations, weak solidarity (for example, in the form of direct reciprocity) may govern the behavior of individuals. For example, in many economic transactions the salient individual gain frame is tempered by fairness considerations, resulting in the more powerful exchange partner not squeezing the maximum possible out of the other party. We refer to these assumptions as solidarity assumptions (see Lindenberg in this Handbook). Materialism Although there is nothing inherent in rational choice theory that makes the assumption of material gain a necessary one, many rational choice models seem at least to build implicitly on the assumption that what drives human decisionmaking is the maximization of tangible, material resources. We refer to this as the tangible resources assumption. Such tangible resources are usually assumed to be money or other goods that may be accumulated. Somewhat less restrictive, but still in the same spirit is the intangible resources assumption: some resources are not tangible but can still constitute very valuable intangible assets, such as intellectual capital or capabilities and competencies (see, for example, Daum 2003). Social rationality approaches (Lindenberg 2001) have further relaxed the assumption that resources—be they tangible or intangible—are the major

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objective individuals strive to maximize.They argue that humans put great value on their physical and social well-being, often at the expense of material gain. The physical well-being assumption proposes that individuals will seek stimulation and comfort, whereas the social well-being assumption states that individuals may also strive for the maximization of different types of social goals such as social approval, status and prestige, or affection. In this perspective, tangible and intangible resources are seen as instrumental lower-level means of production (“instrumental goals”) that individuals use to produce the higher-level goal of well-being. individualism Although rational choice scholars might differ in the type of microfoundation they use, what unites them all is the conviction that societal phenomena at the meso or macro level can be explained in a satisfactory way only by descending to the level of the individual and specifying the microlevel mechanisms— assumptions about individual decision-makers and the decision rules they use to make their choices—that generate the macrolevel outcome. This analytical strategy is referred to as individualism (for a discussion of the ambiguities of this term and varieties of individualism, see Hodgson 2007). For most social researchers in the rational choice tradition, the theoretical primacy—the phenomena that have to be explained—is situated on the meso or macro level, whereas the analytical primacy—the social mechanisms leading to behavior of individual actors—has to be connected to the micro level of individual choices (Raub, Buskens, and Van Assen 2011; Hedström and Bearman 2009). While some form of individualism underlies all rational choice approaches, individualism assumptions come in many varieties, and different labels have been coined to characterize these variations—such as methodological, institutional, holistic, or structural individualism. Drawing on his extensive analysis of methodological individualism, Udehn (2001: 354) considers the following approach as the core of explanatory methodological individualism: “Social phenomena must be explained in terms of individuals, their physical and psychic states, actions, interactions, social situation, and physical environment.” As in the case of rationality assumptions, strong and weak versions of methodological individualism can be distinguished (Udehn 2001). They differ to the degree that macro- or mesolevel conditions (such as institutions or social structures) are incorporated as part of the explanans. Strong versions require that exogenous variables and conditions (that is, the explananda) must refer only to individuals, but not to social institutions. In weak versions of methodological individualism, this rule is replaced by the requirement that social phenomena are allowed to enter the antecedents. Rational choice models subscribing to the latter view require specifying three steps in their social mechanism explanations: a macro-micro step or “situational mechanism,” a micro-micro step or “action generating mechanism,” and a micro-macro step or “transformation mechanism” (Hedström and Swedberg 1998).This analytical strategy is of course not restricted to rational choice theory (see, for example, Gross 2009), though rational choice scholars probably had a strong impact on the refinement of social mechanism approaches. The type of rationality and preference assumptions characterize the degree

10 Wittek, Snijders, and Nee to which the canonical model’s assumptions about cognitive abilities are relaxed—that is, they introduce different degrees of cognitive complexity in the microfoundation of a rational choice explanation.Varieties of individualism reflect the degree to which the canonical model’s idea of isolated, “atomized” actors is relaxed—that is to say, they add structural complexity (Lindenberg 1992) in the form of different types of social embeddedness. Again, the assumption space can be described as a continuum, ranging from strong to weak forms of individualism (Udehn 2001: ch. 12). At one end reigns the atomism assumption of neoclassical economics and theories of general equilibrium, which model exchanges as atomized interactions on perfect markets. The most prominent assumption of this natural methodological individualism is that all parties have equal access to information, and that patterns of (social) relationships are not relevant as opportunities or constraints for economic behavior. All information is contained in the prices for the exchanged goods. This approach has been called “natural” individualism, “since nothing socio-cultural enters the explanans, or exogenous variables, of its explanations” (ibid.: 347). This unrealistic assumption has frequently been challenged, and many efforts have been made to develop a more realistic set of assumptions that can be incorporated into rational choice models. Udehn (2001) suggests that “Austrian” or social methodological individualism based on the work of Menger, Weber, von Mises, Hayek, and Schumpeter, though still representing a strong version of individualism, departs from the atomistic model in that it emphasizes the importance of subjective meaning that individuals attach to their actions. In this version, society is seen as an intersubjective reality, and humans are considered as social and cultural beings. Representatives of this approach acknowledge that social institutions, which they situate in the minds of individuals, may influence individual preferences and actions: “[S]ocial institutions are the subjective meaning individuals attach to social actions or social things like money” (ibid.: 125). A third and weak version of methodological individualism has been labeled institutional individualism. It is considered the dominant version in new institutional economics and political sciences. Here, institutions are conceptualized as objective phenomena and accepted as exogenous variables, though there are also many attempts within this tradition to endogenize institutions. More specifically, institutional embeddedness refers to rules affecting opportunities, constraints, incentives, and information of actors and their exchange partners. Institutions can have a formal or an informal basis; they can contain ambiguities, may not be known by all actors, and may or may not be enforced. Fourth, sociologists Coleman, Lindenberg, Raub, and Wippler have elaborated what now is known as structural individualism, the version most frequently applied by sociologists (for an early statement, see, for example, Wippler and Lindenberg 1987). Udehn (2001) considers it as the weakest form of methodological individualism because it leaves room for a broad set of societal-level conditions to influence individual-level choice and behavior. Social structural and institutional embeddedness enters this model in several ways.

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First, social structure—in the sense of positions in a system of relations—is assumed to influence individual preferences and beliefs. Scholars following this strategy incorporate fine-grained information on social-structural network characteristics of individual actors or their settings, and introduce learning (that is, differential access to information) and control effects (differential exposure to monitoring and sanctioning capacities) into their models. Structural embeddedness comes in two varieties (see Buskens and Raub in this Handbook): in dyadic and network forms. Dyadic embeddedness assumptions state that past, ongoing, or expected future interactions with specific other exchange parties will affect decisions, behavior, and exchanges. The focus is on the dyad—for example, the two parties in a contract governing a supplier relationship. The “tie” can take many forms, ranging from the completion of a business transaction in the past, to a friendship and family bond. Depending on the preference assumptions invoked (see above), the effects of dyadic embeddedness can be limited to, for example, information benefits (“learning”) and control (sanctioning opportunities), or can affect an individual’s inclination toward prosocial behavior as in linked utility or social rationality approaches. Ties to third parties do not affect these interactions. Network embeddedness assumptions further increase structural complexity by considering the potential influence of third parties on exchanges between two actors, because one or both of them are tied to the third party. Again, the nature of the “ties” as well as the mechanism can vary, depending on the rationality assumptions used. For example, third parties can act as intermediaries or guarantors where a potential trustor is uncertain about the trustworthiness of a trustee. Similarly, network closure may enhance sanctioning opportunities and therefore facilitate collective action. The second way to conceptualize structural individualism is in terms of social roles influencing preferences and actions. For example, individuals occupying a managerial position in a firm are supposed to maximize profits for their employer. Finally, structural individualism also acknowledges the potential impact of culture on individual preferences and beliefs.

The Handbook of Rational Choice Social Research The focus of this Handbook is on Rational Choice Social Research, with the link between theory and empirical research being of central concern. This emphasis has a number of implications for the structure and content of the Volume. In this section, we first outline the rationale and overall structure of the Handbook. We then briefly sketch the content of each chapter. purpose of the handbook This Handbook attempts to provide a state-of-the-art overview of current social research guided by rational choice reasoning.The contributions structure their problem area, assess what kind of empirical regularities have been confirmed, critically discuss the scope and explanatory power of rational choice explanations of these phenomena, and sketch fruitful areas for future research in their domain. In order to achieve this aim, the chapters were written with the following guidelines in the background. First, each chapter addresses both

12 Wittek, Snijders, and Nee theoretical and empirical issues. Put differently, we did not include chapters with a purely theoretical character (for example, discussions and comparisons of theoretical debates or refinements), or chapters with a purely empirical focus (such as literature reviews or summaries of findings). Each chapter provides a sound reflection and discussion of the major theoretical and empirical achievements in a subfield. It structures this subfield, thereby providing an analytical frame of reference that allows identifying underlying overarching themes in existing research. At the same time, each chapter functions as an organizing device and point of departure for promising new research efforts by going into depth with regard to the respective rational choice models relevant for the problem under investigation. Chapters carefully reconstruct the major assumptions, causal mechanisms, and theoretical propositions of the models, point out eventual problems and discuss possible solutions. The purpose of this reconstruction is to reach a maximum of transparency, thereby enabling future researchers to apply, refine, and test the models. Hence we have opted for an intensive rather than an extensive setup of each chapter. The result is an indepth treatment of the rational choice models related to a substantive problem, rather than a general overview of and comparison with alternative theories dealing with a specific problem. Second, the Handbook covers a broad range of topics in which the rational choice approach has proven to be a powerful tool of analysis. This implies that the primary intended audiences of each chapter are scholars dealing with a wellestablished and recognizable substantive problem. Such substantive core problems will be identified by the kind of phenomena to be explained.We opted for such a problem-based approach (for example, “explaining terrorism,” “explaining war”) rather than a discipline-based approach (“political sociology”), not only because specific problems are usually studied by various disciplines but also because one of the strengths of the rational choice approach is to provide a unifying analytical framework into which insights from different fields and disciplines can be integrated. Third, the purpose of the Handbook is to provide insights into concrete societal processes and issues, and to provide templates that stimulate future research. The chapters therefore emphasize what can be learned from earlier research, and what constitutes cutting-edge theoretical and methodological tools to advance research into societal developments. That is, the theory part of the chapters is analytical in nature, rather than historical (in the sense of reconstructing or summing up intellectual history of theories). In sum, each chapter has a theoretical core in which elements of rational choice reasoning are discussed, and a substantive domain of application, reviewing studies in which the resulting hypotheses were empirically put to a test. structure of the handbook The Handbook is divided into five parts. The four chapters of Part I (“Rationality and Decision-making”) address the microfoundations of rational choice theory. They present different versions and extended discussions of rationality assumptions, and also offer an analysis of how structural embeddedness affects cooperation among rational egoists. The main “outcome domain” addressed here is individual decision-making.

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Part II (“Networks and Inequality”) provides examples for rational choice models adding structural complexity to their toolkit. The chapters share a focus on inequality as an antecedent and outcome of social processes. The main purpose of the three chapters is to explain how differences in exchange structures affect variations in power or access to valued resources. The remaining three parts focus on the role of institutional contexts governing behavior in communities, markets, organizations, and states. Individual behavior and choice differ significantly depending on the type of social context in which they take place. Rational choice scholars equate each context with a distinct form of governance—that is, a specific set of institutional rules and definitions of the situation regulating the exchanges between actors. An often-invoked distinction contrasts “spontaneous” and “constructed” social orders, considering primordial social orders such as groups and communities and markets as representing the former category, and states as well as formal organizations as representatives of the latter. While conceptually useful, this distinction also bears some risk of oversimplification: neither do markets as such emerge spontaneously, nor can states or organizations be adequately understood by looking only at their formal blueprint. Markets are designed and regulated, they are subject to institutional change, and can fail. The governance of organizations has to take into consideration that contracts tend to be incomplete. States emerge as a result of complex power struggles between and among internal and external parties. In market exchanges, gain seeking and competition are considered to be legitimate motives for exchange partners, whereas exchanges in constructed social orders are characterized by principles of authority ranking and hierarchical control. The concept of community represents the idea of primordial social orders in which the guiding principles of exchanges are social norms of communal sharing and equality. Rational choice scholars explicitly recognize that each of these types of governance can fail and that the different forms can interfere with or substitute for each other. For example, organizational governance may fail because principles of primordial social orders like friendship ties prevail or dominate the exchanges inside the organization. Likewise, where market failures occur because of externalities, organizational hierarchies or social control based on informal social relations can contribute to the solution of the resulting social dilemmas. Given their crucial role as constraints on behavior and choice, explaining the emergence, change, and eventual failure or success of each form of governance becomes an important task in itself. As a consequence, rational choice scholars have recognized the necessity of endogenizing the different forms of governance, resulting in numerous models explaining, for example, the emergence of norms or hierarchies in market settings. The three remaining sections in the Handbook are designed to account for these complications. Parts III and IV focus on the two extremes on the continuum between spontaneous and constructed social orders, addressing, respectively, communities and cohesion, and states and conflicts. Part V focuses on markets and organizations. In what follows, we will provide a structured overview of the content of each part and chapter. Drawing on the four core assumptions as they were

14 Wittek, Snijders, and Nee discussed in Part III, we will assess which type and combination of assumptions characterizes rational choice research in each of the fields. rationality and decision-making The four contributions in this part focus on the microfoundation of rational choice theory, and investigate recent advances of rational choice social research on cooperation, individual and collective decision-making, and well-being. Simon Gächter’s chapter (“Rationality, Social Preferences, and Strategic Decision-making from a Behavioral Economics Perspective”) starts with a concise introduction to the hard core of rational choice theory, the “canonical rational choice model.” It portrays strong rationality assumptions and how they can be fruitfully used for modeling purposes despite their unrealistic empirical content. In a second step, the chapter discusses the implications of relaxing one of rational choice theory’s key assumptions: the selfishness assumption. Gächter argues that rational choice theory does not require assuming self-regarding preferences, and points toward the low prediction accuracy of rational choice models based on this assumption. Using different types of social dilemma situations—including Trust, Dictator, Ultimatum, and Public Goods Games— the chapter then provides a systematic overview of the role of social preferences in game theoretical models of prosocial behavior. Most of these models have been tested in laboratory settings. The findings consistently show outcomes that would be considered at odds with selfishness assumptions in the canonical rational choice model, as in the case of altruistic punishment. Vincent Buskens’s and Werner Raub’s chapter, “Rational Choice Research on Social Dilemmas: Embeddedness Effects on Trust,” takes a different approach than Gächter’s chapter. Building on the Trust Game as their focus of analysis, the authors investigate the conditions under which selfish actors are inclined to trust others, and when this trust is likely to be abused or honored. Buskens and Raub explicitly stick to full rationality assumptions: actors in their model are assumed to be fully informed and selfish gain maximizers. Working in the tradition of structural individualism, Buskens and Raub add complexity by replacing the assumption of atomized interactions on perfect markets by assumptions specifying different types of dyadic and structural embeddedness. Embeddedness implies that actors had, have, or expect to have interactions with other actors.The chapter analyzes how embeddedness affects trust through two mechanisms—control (that is, sanctioning possibilities for trustor) and learning (availability of information about trustee). They then use game theoretical modeling to derive hypotheses about how control and learning affect trust behavior under different embeddedness conditions. Based on a systematic review of empirical findings from experimental research and survey studies— most of which related to the acquisition of tangible resources—they find strong evidence for learning effects on both the dyad and the network level. Findings for control effects were less clear-cut; in particular, research on network control produced ambiguous results. Siegwart Lindenberg’s chapter (“Social Rationality, Self-Regulation, and Well-Being”) pleads for a redefinition of the rationality concept in terms of self-regulation. Pointing toward many recent insights gathered among others within behavioral economics or evolutionary psychology, the chapter starts by

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outlining the key components of such a “social rationality” framework and its inter-relationship with self-regulation. He argues that the human brain developed as a social brain to handle three types of self-regulatory behavior. Need-related, goal-related, and self-related self-regulation are necessary to deal with complex interdependencies related to reproduction and living in groups. While sticking to the microeconomic assumption of the importance of relative prices, the social rationality framework goes beyond microeconomics by incorporating goal framing. Three master goal frames are distinguished: hedonic, gain, and normative. It is assumed that these frames are selectively— and sometimes automatically—activated. The chapter outlines the mechanism leading to the activation of goal frames, the inter-relationships between them, and their subsequent influence on (prosocial) behavior. Another key component added to the microeconomic model are variations in self-regulation ability and the idea that individuals strive for tangible resources only to the degree that they are instrumental for the realization of the higher-order goals of physical and social well-being. The chapter illustrates the implications of these assumptions with findings from recent research on prosocial behavior and sanctioning. The chapter on “Modeling Collective Decision-making” by Stokman, Van der Knoop, and Van Oosten provides a detailed reconstruction of the theoretical assumptions underlying cooperative and noncooperative bargaining models of collective decision-making, and sketches the operational steps for empirical tests of an integrated model. According to this framework, relatively accurate predictions of the outcomes of collective decision-making processes can be made based on a limited amount of information: the relevant issues, stakeholders, their policy position, their power to affect collective outcomes, and their interest in each of the issues. The chapter then describes three different bargaining processes through which collective decisions are usually reached: persuasion, logrolling, and enforcement.The model specifies under which institutional and structural conditions each of these processes is likely to be dominant. Examples from decision-making in the European Union and in firms are used to illustrate the different aspects of the model. Though building on a game theoretical and exchange theoretical framework in its core, the proposed model makes a strong point for adding cognitive and structural complexity to this core, thereby replacing the full rationality and atomism assumptions of natural individualism by a structural individualist approach based on social rationality. For example, persuasion strategies are strongly tied to framing processes and trust; differences in policy positions between stakeholders can be due to conflicting cognitive maps, and the power position of a stakeholder is likely to affect the weight other stakeholders assign to his or her opinion. The four papers vary in the degree of realism in rationality assumptions. Gächter uses a full rationality model, sticks to the atomism assumption of natural individualism, assumes tangible resources as the major goal of individuals, but relaxes the selfishness postulate in favor of linked-utility assumptions: individuals show inequality aversion and have a tendency to reciprocate. Buskens and Raub stick to the full rationality and selfishness (egoism) assumption but relax the atomistic natural individualism assumption by explicitly incorporating dyadic and network embeddedness. They implicitly assume that actors strive mainly for tangible resources. Lindenberg relaxes both

16 Wittek, Snijders, and Nee the full rationality and the selfishness assumptions. His goal-framing model assumes social rationality, which systematically incorporates different types of goal frames into the theoretical core of the approach. This allows endogenizing (selfish or prosocial) preferences. This approach emphasizes physical and social well-being as higher-level goals, and considers tangible or intangible resources as lower-level instrumental goals or endowments that can be used to realize higher-level goals. Lindenberg’s social rationality approach does not provide a fine-grained elaboration of embeddedness assumptions, though social relations and institutions are acknowledged as key context conditions influencing goal frames and the relative prices of achieving different types of goals. Both Buskens and Raub as well as Lindenberg represent structural individualism. With the incorporation of structural and institutional embeddedness as well as cognitive processes, the structural individualist model of collective decisionmaking of Stokman et al. provides an example for a thick version of rationality. With regard to rationality assumptions, Stokman et al. incorporate elements of Lindenberg’s social rationality framework when building on the distinction between ultimate and instrumental goals. The model also endogenizes preference assumptions, suggesting that under conditions of joint production, cognitive interdependence will increase the likelihood for trust and persuasion. The model is not restricted to (in)tangible resources as goals, thereby relaxing the materialism assumption. Furthermore, though it does not elaborate on finegrained variations in network embeddedness, it explicitly provides a framework for considering opportunity structures allowing for logrolling. Finally, models of collective decision-making always incorporate the institutional context, since each context has different decision-making rules under which decisions have to be taken. networks and inequality In many settings, be they markets or social groups, some actors usually have a more advantageous position in the network of (social or economic) exchanges than others. For example, they have friends in high places, or can act as a broker between otherwise unconnected players, which allows them to control the resource flow between other actors. Such advantageous positions in exchange structures allow them to make better deals than their partners, making them materially better off in the long run. The chapters in Part II (“Networks and Inequality”) deal with the inter-relationship between individual positions in exchange structures, and the differential payoffs this generates. The focus is on structural opportunities and constraints as they result from social network embeddedness. Karen Cook’s and Coye Cheshire’s chapter (“Social Exchange, Power, and Inequality in Networks”) explicates the assumptions behind different theories of social exchange, in particular power-dependence and network-exchange approaches. Their contribution reflects the structuralist perspective according to which differences in power or inequalities in resource distribution derive from an actor’s structural position. Based on a long tradition of experimental empirical studies, this research line elaborated fine-grained distinctions between different types of exchange structures and their consequences in terms of resource distributions. Exchange structures are taken as exogenously given, and

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rationality assumptions in the baseline models are straightforward: individuals are motivated by gain maximization or loss avoidance, and payoffs are subject to diminishing marginal utility. There is also no further differentiation in the type of resources: all experiments are tied to some material payoff for the subjects. The chapter also discusses the implications that different exchange structures have for cohesion and solidarity: both decrease to the degree that power is unequally distributed. The authors conclude that structuralism comes to its limits in explaining these findings, and suggest that future research might benefit from incorporating group identity and emotional reactions into their models. Henk Flap’s and Beate Völker’s chapter (“Social Capital”) introduces the social capital research program. Research in this tradition differs from exchange theory in several respects. First, it considers different types of material and immaterial resources and their inter-relationships. Issues related to the conceptualization and measurement of social capital occupy a central place in this research line. Social capital research has a strong record in empirical field research, and the chapter reviews findings related to many different types of outcomes related to inequality, ranging from occupational career to social support. Second, it also addresses the question of the creation of social relations through investment in others. The rational choice core of this program is the social resources hypothesis and the investment hypothesis: people with more social capital are better able to realize their objectives, and people will invest in others if this promises some return. Actor assumptions are again straightforward: (dis)investment in social capital depends on the expected future rewards of the tie, available alternatives, and earlier investments in the tie. With regard to context conditions, research in this program tends to focus on key characteristics of personal networks, in particular the size or density of ego-networks. Unlike power-dependence or network-exchange theory, social capital research is more sensitive to the question of why structural explanations meet so many exceptions. Pointing toward the strong influences of spatial and institutional contexts, it suggests that “pure” structural effects are likely to be the exception. Of the three chapters on social networks, Tom Snijders’s chapter on “Network Dynamics” addresses the widest range of assumptions on rationality and structural constraints. Statistical models endogenizing social network structures can be considered as one of the major advancements in social network research of the past two decades. The chapter discusses agent-based simulations, game-theoretical approaches, and stochastic actor-oriented models, all of which allow the simultaneous incorporation of change in actor characteristics and social networks. These models are very flexible with regard to the actor assumptions and structural forms that can be investigated. For example, structural positions that would be considered advantageous from a power-dependence perspective—such as being the only person linking two tightly knit cliques—can yield disutility based on the psychological mechanisms involved, and vice versa.The utility functions can be flexibly determined by the researcher, allowing to systematically test competing mechanisms. The chapter also reviews the recent and growing body of research on network formation games, where properties of whole networks—such as transitivity or centerperiphery structures—are the outcome variable.

18 Wittek, Snijders, and Nee Building on structural individualism, all three chapters go to great lengths in differentiating dyadic and network embeddedness, but they differ in their rationality and preference assumptions. Most of Cook’s and Cheshire’s models build on full rationality assumptions, assume egoistic actors, and focus on the acquisition of tangible resources as an actor’s major goal in their experimental studies. Flap’s and Völker’s work is based on straightforward rationality assumptions, including selfish preferences. Most of their assumptions in this regard remain implicit, and their position can best be characterized as somewhere between full and bounded rationality: (dis-)investments in social relations are made based on the direct costs and rewards related to the tie, and the past and expected costs and rewards. This leaves open whether the payoff is in terms of (in)tangible or physical and social well-being. Unlike the other two chapters, they also incorporate the potential influence of institutional embeddedness. Finally, the statistical models for network dynamics presented in Tom Snijders’s chapter are flexible with regard to all four dimensions. Actor-oriented models can be built by assuming utility functions with different degrees of rationality or selfishness, or social goals. Similarly, these models also allow incorporating dyadic or network embeddedness. communities and cohesion Why do people believe in a god and join a religion? How do social networks of immigrants explain their assimilation into a host culture? How useful are rational choice models of criminal behavior? The contributions in this part focus on the inter-relationship between aspects of communities (such as neighborhoods) on the one hand, and cohesion, integration, and (social control of) deviant behavior on the other. The focus of the chapters is, respectively, on joining or leaving religious communities, assimilation of migrants into their host cultures, or compliance to (legal) norms. All three phenomena can be seen as exemplary indicators of social “cohesion.” The integration of micro and macro levels of explanation is the core question underlying Ross Matsueda’s chapter on “Rational Choice Research in Criminology.” Matsueda starts with presenting the standard rational choice model of individual criminal behavior. Expected utility of the crime, the probability of getting arrested and punished, the return from crime, and the cost of punishment are the key parameters of this model. Empirical studies based on longitudinal surveys and vignettes provide consistent support for this model, in particular for the effects of the certainty of sanctions. The chapter then explores how this model of individual behavior can be integrated into an explanation of macrolevel phenomena (for example, crime rates). It pursues the idea that the degree to which a group or society is organized against rather than in favor of crime largely determines crime rates, and that a rational choice micromodel can explain variations in societal-level organization in favor of or against crime. Matsueda’s theoretical microfoundation departs from neoclassical full rationality assumptions. He assumes that individuals have limited access to information, have different initial beliefs, and are boundedly rational in the sense of responding to incentives rather than being able to engage in complex calculations of optimal solutions. This micromodel is then used to explain macrolevel variations in social capital and collective efficacy on the one hand,

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and informal norms conducive to crime on the other. Collective efficacy is conceived as a characteristic of communities (such as neighborhoods) and results from the combination of social cohesion and informal social control. Arguments related to information asymmetry and signaling are used to explain the effectiveness of organization in favor of crime. These ideas are illustrated with empirical research on the “protection industry” of the Sicilian mafia. Nan Dirk De Graaf ’s chapter on “Secularization: Theoretical Controversies Generating Empirical Research” starts with a discussion of the microfoundations and macropropositions used by Stark and other rational choice scholars to explain religious participation. Religious goods are treated as nonverifiable compensators or “otherworldly rewards,” which are limited in supply. Humans are seen as agents formulating explanations about how to gain rewards and avoid costs. On the macrolevel, a key factor is the degree of competition between religions or churches. According to the influential “supply side approach,” demand for religions is stable, and religious participation is expected to be higher to the degree that competition between religions is stronger.The chapter provides a critical discussion of the supply side approach and its major rival, the secularization thesis.The latter predicts declining religious participation resulting from modernization. It also highlights the importance of (changes in) social embeddedness (for example, devout friends) and exposure to cultural beliefs (through, for example, proreligious governmental policies). De Graaf argues that the two approaches can be compatible. The chapter concludes with an overview of empirical studies. Available evidence so far does not corroborate the assumed link between religious pluralism and religious participation; religious demand seems to be stable, though Catholic societies form an exception. Many of the behavioral microassumptions of rational choice models of secularization discussed by De Graaf remain implicit, and largely build on the full rationality and selfish preference assumptions of the canonical model. Furthermore, though referring to social embeddedness as an explanatory factor, the models also do not make an elaborate effort to incorporate different types of embeddedness. Finally, the models clearly depart from the materialism assumption by acknowledging the role of intangible resources as potentially important goals. Taking rational choice institutionalism as a point of departure, Nee’s and Alba’s chapter on “Assimilation as Rational Action in Contexts Defined by Institutions and Boundaries” develops three overarching propositions, each of which explicates one specific mechanism underlying immigrants’ assimilation decisions and practices.The three propositions build on structural individualism as an overarching framework. The purposive action proposition assumes immigrants to assimilate if opportunities are more extensive in the mainstream economy than in ethnic enclaves. The network proposition adds structural complexity, assuming that where discriminatory barriers block individual social mobility, assimilation depends on social capital–based ethnic collective action. The institutional proposition adds cognitive complexity, suggesting that if political actors credibly signal their commitment to nondiscriminatory policies and equal opportunity, the resulting reinforcement of cultural beliefs will stimulate assimilation. Evidence from a recent large-scale study on second-generation immigrants in New York City is congruent with these propositions.

20 Wittek, Snijders, and Nee Taken together, all three chapters in this part retain the full rationality and selfish preference assumptions of the canonical rational choice model, but depart from this model by taking into consideration structural and institutional embeddedness as well as nonmaterial goals. In all three chapters, the micro-macro link is a central point of concern. Matsueda’s chapter contains a formal micromodel; De Graaf ’s chapter, and that by Nee and Alba, discuss a set of micro- and macrolevel propositions. states and conflicts Why do states go to war, despite the large costs this decision usually entails? Why do some wars take longer than others? Why do people join terrorist organizations, and even commit suicide attacks in their name? These and related questions are addressed by the three chapters in this part. All of them focus on conflictive relations within or between states. States are deliberately constructed social orders that govern the interdependencies between many different types of stakeholders. Since states are also a source of revenue and a primary source for the legitimate control of resources, their creation and functioning is accompanied by conflict.The three chapters in this part focus on the antecedents of conflicts within and between states. The chapter on “Terrorism and the State” by Ignacio Sánchez-Cuenca starts by providing a theory-driven taxonomy of different forms of political violence. The chapter then critically discusses current rational choice explanations of individual motivations to join and to contribute actively to (for example, in the form of suicide actions) terrorist organizations. These models are based on assumptions either of altruistic preferences or of selective incentives. While showing that suicide may not be irrational if preferences are assumed to have specific characteristics, such assumptions are of limited use for specifying under which conditions these motivations will arise. Based on the assumption that the ultimate goals terrorist organizations are striving for can be reduced to either regime change or territorial independence, Sánchez-Cuenca subsequently elaborates formal rational choice models explaining the different strategies that follow from each of these goals: if mobilization for regime change is the major goal, the use of violence is designed to influence followers; if attrition to achieve territorial independence is strived for, violence is used as a signaling device toward the state, demonstrating the terrorist organization’s power. The chapter proceeds with a game theoretical investigation of the effectiveness of different counterterrorist policies and concludes with an assessment of the contribution of rational choice theories to the study of terrorism. The theoretical core of Sánchez-Cuenca’s approach is rooted in full rationality assumptions. It criticizes previous rational choice models for “tinkering arbitrarily with preferences” and suggests that the selfishness assumption—though not required—is a useful one to start with in this case. The formation of terrorist organizations is assumed to be subject to the classical collective action dilemma. Cognitive complexity is limited to the assumption of two ultimate goals for terrorist organizations, and the acknowledgment of ideological benefits that terrorists may derive from their actions. The models refer to information asymmetries or the degree of support for terrorist organizations in the population, but do not systematically elaborate on the role of social network embeddedness. Hence,

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structural complexity is kept low in this approach, which works in the tradition of institutional individualism. Jim Morrow’s chapter “Choosing War: State Decisions to Initiate and End Wars and Observe the Peace Afterward” starts with a sketch of three general empirical trends related to the occurrence of wars: wars are rare, escalation of disputes to war is uncommon, and frequency of wars over the long run is declining. The chapter then elaborates two rational choice theories, which are subsequently applied to model the outbreak of war, bargaining during wartime, and consequences in postwar situations. According to bargaining theory, war is the result of bargaining failure, and the chapter provides a detailed discussion of two different sources for bargaining failure: signaling problems and commitment problems. According to principal agent theory, a leader’s war-related decisions are subject to internal politics. The theoretical core behind both perspectives is noncooperative game theory. Consequently, Morrow’s structural individualistic actor model builds on full (strategic) rationality, selfishness, and materialism assumptions, and therefore keeps cognitive complexity at a minimum. Structural complexity is incorporated in form of the internal political structure shaping the principal agent relationship between the leaders and their supporters and citizens. In “Rational Choice Approaches to State-Making,” Edgar Kiser and Erin Powers use a rational choice perspective to analyze the conditions leading to the creation of states.Their chapter is organized chronologically, covering initial state formation, state formation in medieval Europe, and the formation of early modern, bureaucratic, and contemporary states. In many models of statemaking, conflict and war play a pivotal role. Explanations of initial state-making as well as of the formation of medieval states are often either based on a model of conflict over power in zero-sum games, or on models of mixed cooperation and conflict in positive sum games. The latter seem to match better with the empirical evidence than the former: rulers are assumed to be interested in both wealth and security, which they achieve by building political institutions that make possible the production of public goods in collaboration with their subjects. An agency theory is presented to model the structure of bureaucratic states. Here, rulers are seen as the principals who delegate authority to state officials for policy implementation, in particular the collection of taxes. Path dependence is considered as a major factor in the formation of contemporary states. Depending on the approach, actor assumptions in rational choice models of state-making vary from fully rational and selfish actors—as in agency theoretic models that assume self-interested, gain maximizing parties—to the more elaborate microfoundations of social production function theory, which suggests adding cognitive complexity by differentiating types of goals (for example, physical and social well-being) and fairness considerations (such as willingness to incur costs for punishing those who violate fairness rules). Though some of this work considers the role of social network embeddedness, in particular with regard to the solution of collective action problems for revolts or revolutions, fine-grained differentiation of social network structures is not at the heart of rational choice models of state-making and unmaking, the majority of which is informed by an institutional individualistic perspective. With regard to assumptions about microfoundations, both Morrow and

22 Wittek, Snijders, and Nee Sánchez-Cuenca retain the full rationality assumption, and stick to the selfish preference assumption of the canonical rational choice model. Their actors attempt mainly to maximize access to tangible resources, but their models also allow for the incorporation of intangible resources (for example, ideological benefits in the case of terrorists) as potentially important goals. Whereas Sánchez-Cuenca uses an institutional individualist framework that keeps structural embeddedness assumptions to a minimum and essentially assumes that social network structures can be neglected, Morrow’s approach, which acknowledges that principal agent relations and internal political structures matter, has more affinity with structural individualism. markets and organizations How can industrial pollution be reduced? Is there an effective way to increase compliance with hygiene requirements in restaurants? Why is there such a large variety in how business firms are structured? Why do not more firms implement High Performance Human Resource Management? The three chapters in this part address the question of how rational actors shape the institutional contexts governing behavior and interaction in markets, organizations, and states, and under which conditions these efforts succeed or fail. The difficulty of explaining institutional failure has long been considered one of the major challenges for rational choice theory: if actors are far-sighted and rational, they design institutions and governance structures that anticipate potential problems and guarantee the seamless functioning of transactions. Consequently, much previous and current rational choice theorizing attributes institutional failure to exogenous shocks. More recent approaches acknowledge cognitive limitations as potential antecedents. In “Market Design and Market Failure,” Carlos Cañón, Guido Friebel, and Paul Seabright start with an overview concerning how markets came to be established and evolved over time. Modern mass markets are a very recent innovation in this process, but one with the most far-reaching consequences, since well-being of individuals as well as the economic performance of states increasingly depends on the performance of other economies. The chapter then sketches the neoclassical assumptions about markets as they are represented by the two fundamental theorems of welfare economics. In this context they also briefly discuss the recent efforts to accommodate the limited cognitive capabilities of humans in this model. The chapter then proceeds with a description of well-known conditions for market failure: market power, contracting problems, information asymmetries, and externalities. Market design can be viewed as one of several ways to deal with market failures—the other solutions being, for example, bypassing markets through networks or organizations or regulation through government. The main part of the chapter is devoted to the analysis of different types of market failures and conscious efforts to solve these failures by comprehensive market design. The examples cover three types of market design: those related to the solution of asymmetric information problems (for example, those about product quality or personal characteristics), those for rights to inflict externalities (such as pollution), and those involving matching markets (for example, professional placements). The examples provide a vast range of different solutions, some working well, others

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being less effective. In particular, two conclusions are worth emphasizing. First, the success of market design depends on accounting for each market’s most important details. Second, once a market is created, there will be ingenious entrepreneurs who learn how to take advantage of the new market conditions. At the same time there will be political entrepreneurs who will exploit the need to “fine tune” the original market design.With regard to actor assumptions, the contribution by Cañón, Friebel, and Seabright sticks to the full rationality and selfishness assumptions of neoclassical economics, though they acknowledge cognitive limitations of actors as a potential source of market failure. Working within the tradition of institutional individualism, they pay much attention to different forms of institutional embeddedness. They assume markets with a large number of exchange partners whose individual actions do not affect prices: dyadic or network embeddedness through which actors could replace or support the market is not considered as relevant. A key problem of research on organizational governance is to explain the emergence, boundaries, and internal organization of firms. Starting with the development of a general definition of organizational governance, the first part of Nicolai Foss’s and Peter Klein’s chapter on “Organizational Governance” discusses the emergence of organizational governance, as well as its various types of problems and failures. Whereas many of the conditions causing organization failure are not specific to organizations but apply also to markets, the “costs of authority” in the form of rent seeking and selective intervention can be regarded as two causes for governance failures that are specific to organizations. The authors then summarize what they consider to be the overall characteristics of rational choice approaches to organizational governance. Their description adheres to a strong rationality view: actors are assumed to be fully rational in the sense of being selfish, being extrinsically motivated, and being able to make complex cost-benefit calculations that are not hampered by selective attention. Social network embeddedness is considered as a phenomenon needing explanation rather than a condition that should be used to explain organizational outcomes. Working within the framework of institutional individualism, the chapter proceeds with a systematic review of current theories of the firm, ranging from the nexus of contract view to formal agency theory and different versions of incomplete contract theories, and also discusses extensions as well as recent attempts toward synthesis. In their overview of applications and evidence, the authors focus on empirical research on organizational boundaries, the internal structure of the firm, mergers and acquisitions, antitrust and regulation, and public bureaucracies. The chapter concludes with a discussion of current critiques of rational choice approaches to organizational governance that urges a relaxation of the strong assumptions with regard to human cognition and (absent) network embeddedness. Rafael Wittek’s and Arjen Van Witteloostuijn’s chapter, “Rational Choice and Organizational Change,” starts with a sketch of five stylized empirical trends characterizing organizational change in advanced capitalist societies. They argue that large organizations increase in size, engage in an increasing number of mergers and acquisitions as well as internal change projects, and pay increasingly high salaries to their top-level functionaries while at the same time being reluctant to implement high-performance human resource management

24 Wittek, Snijders, and Nee practices. The chapter then sketches the little explicit theoretical work that has been done to model organizational change from a rational choice perspective, mainly from an economic point of view. The bulk of this work focuses on micro- or mesolevel antecedents and outcomes, neglecting the societal level. Their subsequent structured review of available empirical research inspired by rational choice ideas covers the antecedents and consequences of strategic change (for example, diversification), corporate restructuring (changes in form, size, and structure), and workplace transformation (such as the introduction of high-performance human resource management). Each of these sections relates to the general trends by specifying major hypotheses and empirical findings. With a sociological rational choice model of organizational change being absent, the chapter concludes with a sketch of such a theory.The guiding idea behind this model is that power is part of a manager’s utility function. The model captures most of the empirical trends discussed in the chapter, and provides many testable hypotheses for future research. The theoretical core of their model builds on straightforward rational choice reasoning, in which individual managers are assumed to maximize income and power. Apart from the inclusion of power in the utility function, the model is congruent with full rationality and selfishness assumptions, and extends the materialism assumption by incorporating power as a social goal. In sum, all three chapters in this part are concerned with institutional emdeddedness and its effects. However, with regard to the other microfoundations, most rational choice models of institutional design and failure prefer to stick closely to the canonical model: they assume selfish preferences, build on strong or bounded rationality assumptions, keep structural complexity and embeddedness assumptions to a minimum, and seldom explicate the relative importance of (in)tangible resources or well-being as goals motivating behavior.

Perspectives for Rational Choice Social Research The chapters in this Handbook amply demonstrate that the rational choice approach has produced a sizable number of empirical studies across a large variety of substantive areas of application. Like any other theoretical paradigm in the social sciences, the approach produced counterintuitive as well as more straightforward hypotheses; empirical support for these hypotheses varies from full over partial corroboration to nonconfirmation or outright rejection; topics cover areas at the center and at the margins of the current social science mainstream: there is no such thing as “the rational choice approach.” As the sixteen contributions demonstrate, there is substantial variation in the assumptions applied by different rational choice scholars. Framed in terms of our coarse-grained four-dimensional typology of microfoundations presented in Table 0.1, we find almost any combination of assumptions, ranging from hardcore neoclassical assumptions about rationality, preferences, and atomism, to full-fledged social rationality models that depart from selfishness assumptions and introduce social goals, network and institutional embeddedness, and automatic frame activation as their behavioral foundations. Two emerging strategies to deal with this variety can be discerned: the first

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one, rational choice institutionalism, opts for refining assumptions about the institutional context while keeping the rational choice microfoundations intact. The second one, the social rationality approach, consists in refining the very core of the behavioral microfoundations. rational choice institutionalism Rational Choice Institutionalism (Shepsle 2006) analyzes how institutions— the “rules of the game”—emerge and how they affect behavior and societal outcomes. It acknowledges that a large variety of formal and informal constraints shape individual decisions. “Institutional embeddedness” includes, for example, the obligations inherent in networks of social relationships or spontaneously emerging informal norms of conduct.The growing convergence between historical and rational choice institutionalism (Katznelson and Weingast 2005; Greif 2006), and between new institutional economics and sociological institutionalism (Nee and Ingram 1998), opens up fruitful areas for research. For example, by pointing to the importance of (mis-)alignment between formal rules and informal norms, rational choice institutionalists can account for outcomes—for example, organizational performance—that are otherwise difficult to explain in the context of the canonical rational choice model. Rational choice institutionalism has also successfully informed formal models of institutional change, as in Greif ’s analysis (2006) of medieval trade, which combines historical research and institutional analysis with game theoretical modeling. social rationality microfoundations The second strategy consists of relaxing the behavioral microfoundations. Many scholars would argue that such “thick” or extended rational choice models do not deserve the label “rational choice,” and question the fruitfulness of such an extension. After all, doesn’t increasing the complexity of the microfoundation of rational choice theory deprive it of its major advantage—that is, parsimony in the theoretical core? This question is at the center of a long-standing debate about the merits and limits of methodological individualism, and the key issue is of course what “parsimony” actually means in this context. The following issues seem particularly relevant here. First, a distinction should be made between ontological and methodological individualism (Udehn 2001). Ontological individualism makes statements about the nature of social reality, whereas methodological individualism is about how one should explain this reality—that is, it represents a set of rules or strategies about how to investigate social phenomena. The latter does not require explaining phenomena in terms of individuals alone. As the contributions to this Handbook amply illustrate, there are several varieties of methodological individualism, all of which share the minimum requirement that individuals should be part of the explanation. These methodological postulates are also likely to constitute the core of rational choice social research in the future. Much of the more recent research on human (ir)rationality in fact relates to ontological statements about how individual rationality and cognition work. These findings pose a challenge to the canonical model or “as if ” approaches to rational choice explanations, and may make a revision of the rational actor

26 Wittek, Snijders, and Nee model necessary. The reason is that in many situations, as some of the chapters in this Handbook have shown, rationality, preference, and individualism assumptions of the canonical model simply do not stand up any more against the state of the art in research dealing with human cognition, decision-making, emotions, or related factors. In addition, there is also increasing awareness within the field of economics about situations in which models based on the canonical microfoundations simply produce wrong predictions. This does not mean that humans are not goal oriented, or that core principles of rational choice reasoning should be discarded in their entirety. It means that rationality models need to be carefully redefined and adjusted, in order to accommodate these insights about the modular nature of the human brain. Second, the methodological individualists’ key strategy of dealing with inaccurate predictions and developing better models—in the sense of fit with the empirical data—has always been guided by what Lindenberg has called the “method of decreasing abstraction.” The guiding principle of this strategy is to start with very simple model assumptions (in the sense of an actor model), and add structural and cognitive complexity only in subsequent stages, when it becomes clear that the initial model fails to produce a satisfactory fit with the data. Many of the contributions in this Handbook implicitly or explicitly made use of this strategy. A condition that is often overlooked, however, is the principle of sufficient complexity, which needs to be met in all cases: simple model assumptions always need to be realistic enough to make possible a description of the phenomenon to be explained (Lindenberg). For example, if uncertainty is part of the explanandum, the theoretical core should not assume that actors are fully informed.

Toward an Interlevel, Interfield Research Program Rational choice social research can be seen as a developing explanatory research program in Lakatos’s sense (Kuipers 2001: ch. 1). Research programs have a hard core and are equipped with a “positive heuristic”: the hard core bears directly on the solution of the problem, whereas the positive heuristic deals with the question of how the hard core can be defended against attacks. The fruitful attempts to incorporate state of the art insights of cognitive sciences into economic reasoning can be seen as one example of such a positive heuristic (see, for example, Gächter’s and Lindenberg’s contributions to this Handbook). Furthermore, it should not be forgotten that rational choice social research—in particular its applications in social sciences other than economics—is a comparatively young program. Research programs develop in phases, and the rational choice approach is no exception. Usually, programs first go through an “internal” phase, consisting of a heuristic and an evaluation step, and then enter an “external,” or “application,” phase. The heuristic step is characterized by an elaboration and evaluation of the core idea and first attempts to develop positive heuristics to protect the core idea. In the evaluation step, the core idea is elaborated into specific theories for a limited number of subdomains or contexts. If the evaluation step yields positive results—in terms of explanatory and predictive success of the research program—“this usually leads to the more or less general acceptance of the core theory of the

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program and it becomes clear for which domain and in what sense and to what extent the core theory can be assumed to be true. It should be stressed that many, if not most, programs in the empirical sciences, not to mention philosophy, do not reach this point” (Kuipers 2001). To what degree the core theory of the rational choice research program has reached this point is of course a matter of perspective, but it cannot be denied that within the field of economics, the core theory has become widely accepted and has also generated many empirical successes. This is considered one of the conditions favoring the transition of a research program into the external or application phase: the program is directed toward questions that are prima facie independent of the program itself. In the case of rational choice research, this means application of the core to the solution of social rather than just economic problems. With this step, the program crossed the boundary to other fields of research, fields that have traditionally been covered by disciplines such as sociology, political sciences, anthropology, or related subdisciplines—in which consensus about a theoretical core so far tends to be lower, and where many research programs have not yet reached the external application phase. Perceived as an illegitimate and ungrounded expansion into forbidden territories by many, and fueled by perceived disciplinary, ideological, and existential threats (Goldthorpe 2007: 164), this move gave rise to the well-known fears about “economics imperialism” (Fine and Milonakis 2008) and “colonization” (Archer and Tritter 2000). These kinds of descriptions frame the relationship between the rational choice research program and research programs in other social science disciplines as competitive. Depending on the phases in which the competing programs are found (Kuipers 2001), competition is about the adequacy of core ideas (if both programs are in the internal phase), the suitability of a program for the solution of problems external to science (if both programs are in the external phase), or the validity or degree of accuracy of a program’s external application (if one program is in the internal and the other the external phase). Such competition can in principle be fruitful if it focuses on the solution to real problems rather than on attacks based on misconceptions, to stay with Goldthorpe’s characterization. In the former case, interaction between research programs often leads to convergence, cooperation, and synthesis. Critics of the rational choice program are suspicious of this approach, because they have perceived—and often rightly so—this cooperation to be asymmetrical in nature, with economics claiming to be able to deliver the supply program for the solution of problems that the other social sciences are unable to solve. But the past two decades have substantially transformed the major points of reference for this debate. We believe that this transformation provides a much better ground for fruitful cooperation of the rational choice research program with other social science research programs than was the case during the time when Gary Becker launched his project of economics imperialism. There are at least three reasons why there now is a better ground for fruitful cooperation of the rational choice research program with other social science research. One reason lies within economics: research especially in behavioral economics, and analyses of the developments leading to the recent economic crisis, have empirically demonstrated the limits of the canonical RC model. Another reason is within rational choice social research: the combination

28 Wittek, Snijders, and Nee of relaxations of the RC model and empirical research, as presented in this Handbook, has shown that this adapted RC approach can be empirically fruitful and conceptually plausible. A third reason is developments in the cognitive (neuro-)sciences, which have shown that human goal-directed behavior is organized not only by rational thought but also, and often more, by semiautomated processing—which moderates the goal-directed nature but does not altogether do away with it. Research programs in these fields differ from the rational choice program and its (sociological) competitors in that they focus on a different level of analysis than economics or the other social sciences, such as brain activity, hormone activity, or neural linkages: the micro-micro level, as it has also been called (Ainslie 1992). The quick rise of fields such as behavioral economics or neuroeconomics, where findings from this type of research are actively and carefully scrutinized for their potential added value (Rubinstein 2008) and are incorporated into economic models (for example, Ross et al. 2008), shows that economics as a field takes these developments seriously. The interaction between economic research programs and these cognitive research programs is a good example of interlevel asymmetric cooperation between different research programs, with the (neuro)cognitive sciences acting as supplier. The importance of the insights generated by this cooperation for the rational choice research program cannot be overestimated, since they allow us more strongly to position its actor assumptions in empirical research. Though this interfield, interlevel cooperation is just in the beginning stages, its efforts have already resulted in remarkable insights, refinements, and corrections concerning our assumptions about rationality, individualism, and preference. It may eventually serve as an empirical foundation for a revised theoretical core of rational choice social research.

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Goldthorpe, J. 2007 [2000]. On Sociology. Vol. 1: Critique and Program. Stanford: Stanford University Press. Green, D., and I. Shapiro. 1994. Pathologies of Rational Choice Theory. New Haven: Yale University Press. Greif, A. 2006. Institutions and the Path to the Modern Economy. Cambridge: Cambridge University Press. Gross, N. 2009. “A Pragmatist Theory of Social Mechanisms.” American Sociological Review 74, no. 3: 358–79. Hechter, M., and S. Kanazawa. 1997. “Sociological Rational Choice Theory.” Annual Review of Sociology 23: 191–214. Hedström, P. 1998. “Rational Imitation.” In Social Mechanisms: An Analytical Approach to Social Theory, edited by P. Hedström and R. Swedberg. Cambridge: Cambridge University Press. Hedström, P., and P. Bearman. 2009. “What Is Analytical Sociology All About? An Introductory Essay.” In The Oxford Handbook of Analytical Sociology, edited by P. Hedström and P. Bearman, 3–24. Oxford: Oxford University Press. Hedström, P., and C. Stern. 2008. “Rational Choice and Sociology.” In The New Palgrave Dictionary of Economics, edited by S. N. Durlauf and L. E. Blume, 872–77. Basingstoke, UK: Palgrave Macmillan. Hedström, P., and R. Swedberg, eds. 1998. Social Mechanisms. An Analytical Approach to Social Theory. Cambridge: Cambridge University Press. Hodgson, G. 2007. “Meanings of Methodological Individualism.” Journal of Economic Methodology 14, no. 2: 211–26. Katznelson, I., and B. Weingast, eds. 2005. Preferences and Situations: Points of Intersection between Historical and Rational Choice Institutionalism. New York: Russell Sage. Knight, F. 1971 [1921]. Risk, Uncertainty, and Profit. Chicago: Chicago University Press. Kronenberg, C., and F. Kalter. 2012. “Rational Choice Theory and Empirical Research: Methodological and Theoretical Contributions in Europe.” Annual Review of Sociology 38: 73–92. Kuipers, T. 2001. Structures in Science. Dordrecht: Springer. Lindenberg, S. 1992. “The Method of Decreasing Abstraction.” In Rational Choice Theory: Advocacy and Critique, edited by J. S. Coleman and T. J. Fararo, 3–20. Newbury Park, NJ: Sage. ———. 2001. “Social Rationality versus Rational Egoism.” In Handbook of Sociological Theory, edited by J. Turner, 635–68. New York: Kluwer Academic/Plenum. Macy, M., and A. Flache. 1995. “Beyond Rationality in Models of Choice.” Annual Review of Sociology 21: 73–91. Milgrom, P., and P. Roberts. 1992. Economics, Organization, and Management. Englewood Cliffs, NJ: Prentice Hall. Nee, V., and P. Ingram. 1998. “Embeddedness and Beyond: Institutions, Exchange, and Social Structure.” In The New Institutionalism in Sociology, edited by M. Brinton and V. Nee, 19–45. New York: Russell Sage. Raub,W.,V. Buskens, and M. van Assen. 2011.“Micro-Macro Links and Microfoundations in Sociology.” Journal of Mathematical Sociology 35, no. 1: 1–25. Ross, D., C. Sharp, R. E. Vuchinich, and D. Spurret. 2008. Midbrain Mutiny: The Picoeconomics and Neuroeconomics of Disordered Gambling: Economic Theory and Cognitive Science. Boston: MIT Press. Rubinstein, A. 1998. Modeling Bounded Rationality. Cambridge, MA, and London: MIT Press. ———. 2008. “Comments on Neuroeconomics.” Economics and Philosophy 24: 485–94. Shepsle, K. A. 2006. “Rational Choice Institutionalism.” In Oxford Handbook of Political Institutions, edited by S. Binder, R. Rhodes, and B. Rockman, 23–38. Oxford: Oxford University Press.

30 Wittek, Snijders, and Nee Simon, Herbert. 1957. “A Behavioral Model of Rational Choice.” In Models of Man, Social and Rational: Mathematical Essays on Rational Human Behavior in a Social Setting. New York: Wiley. Thaler, R., and C. Sunstein. 2008. Nudge: Improving Decisions about Health, Wealth, and Happiness. London: Penguin. Todd, P., and G. Gigerenzer. 2000. “Précis of Simple Heuristics That Make Us Smart.” Behavioral and Brain Sciences 23, no. 5: 727–80. ———. 2007. “Environments That Make Us Smart: Ecological Rationality.” Current Directions in Psychological Science 16, no. 3: 167–71. Torsvik, G. 2000. “Social Capital and Economic Development—A Plea for the Mechanisms.” Rationality and Society 12, no. 4: 451–76. Udehn, L. 2001. Methodological Individualism: Background, History, and Meaning. London: Routledge. Voss, T., and M. Abraham. 2000. “Rational Choice Theory in Sociology: A Survey.” In The International Handbook of Sociology, edited by S. R. Quah and A. Sales, 50–83. London: Sage. Williamson, O. 1975. Markets and Hierarchies. New York: Free Press. Wippler, R., and S. Lindenberg, S. 1987. “Collective Phenomena and Rational Choice.” In The Micro Macro Link, edited by J. C. Alexander, B. Giesen, R. Münch, and N. J. Smelser, 135–52. Berkeley: University of California Press.

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Rationality, Social Preferences, and Strategic Decision-making from a Behavioral Economics Perspective

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simon gächter

Introduction The central assumption of the rational choice approach is that decisionmakers have logically consistent goals (whatever they are), and, given these goals, choose the best available option.This model, in particular its extension to interactive decision-making (game theory), has had a tremendous impact in the social sciences, in particular economics, and has allowed for great theoretical progress in the latter. For instance, the model and its formalization have led to important insights into the functioning of economic systems (see Mas-Colell, Whinston, and Green [1995] for a leading textbook account). They have also shed new light on numerous nonmarket processes, such as crime, addiction, family behavior, political decision-making, and organizational behavior (Coleman 1990; Becker 1993; Hechter and Kanazawa 1997; Gintis, Bowles, Boyd, and Fehr 2005). Rational choice theory in the form of game theory is now the core theoretical tool of economics. It is therefore certainly justified to speak of the rational choice model as a “success story.” Rational choice models often assume that agents are “unboundedly rational” and always know what is best for them. This assumption has long found many critics (Simon 1982). A further assumption that is not part of the canonical rational choice model but is frequently invoked in applications is that agents are primarily self-regarding. This assumption has been challenged in particular in the last decade through the accumulation of empirical, in particular experimental, evidence that has shown substantial and robust deviations from what selfishness predicts. In the past the discussions about the fruitfulness of the rational choice approach were based largely on philosophical convictions and less on facts. In this chapter I will argue on the basis of insights from behavioral economics that the usefulness of the rational choice approach is also an empirical question and not just a philosophical one. My approach is related to that of Hechter and Kanazawa (1997), who argue for the fruitfulness of rational choice explanations by discussing its empirical successes across a large variety of interesting

34 Simon Gächter sociological domains. My arguments are based on data from many laboratory experiments which all share the feature that the theoretical predictions are derived from rational choice models (typically game-theoretic models) and that decisions in the experiments have financial consequences for the participants, which give them an incentive to take decisions seriously. Specifically, I will use experimental results to argue that one can acknowledge that humans are boundedly rational and nevertheless appreciate the predictions made by rational choice models that at times rest on unrealistically strong assumptions. Moreover, I argue that a rational choice approach does not imply assuming that everyone is selfish. I start by giving a short characterization of the canonical rational choice model, including the selfishness assumption. With the help of one famous research program on the functioning of experimental markets I will illustrate one main point that will recur several times. I argue that one can fruitfully use rational choice theory to predict social outcomes even if the assumptions entering the model are empirically invalid. I will first discuss the success and limits of the rational choice approach. Then, I focus attention on the empirical investigation of the selfishness assumption. I will present evidence from several economic experiments that have been used as tools to uncover the structure of people’s “social preferences.” Numerous experiments have shown that the selfishness assumption is invalid as a description of typical behavior, although in all experiments we do find selfish people.The results on social preferences raise the challenge of how to model them, and I will sketch some attempts.

Rational Choice and Homo Economicus the rational choice model My main goal here is to set the stage for the subsequent analysis. For fuller accounts of various aspects and criticisms of the rational choice approach I refer to Coleman (1990); Hedström (2005); Elster (2007); Lindenberg (2008); and Gintis (2009). The rational choice model aims to explain the decisions of individuals and the individual and, in particular, the social consequences of those decisions. Figure 1.1 illustrates the core elements of the rational choice model. It is useful to distinguish two conceptual buildings blocks: decision theory and equilibrium theory. Decision theory describes how decision-makers should make decisions (normative approach), or actually do make decisions (positive approach). In case individuals interact, a so-called solution concept describes the predicted social outcome. The usual assumption is that the resulting outcome will be an equilibrium. Decision theory typically makes a conceptual distinction among preferences, beliefs, and constraints. Preferences describe how individuals rank the available alternatives according to their subjective tastes. Beliefs are the second conceptual building block behind the rational choice model. For instance, in which stocks you invest will probably depend on your expectations about the future earnings potential of that stock. However, choice depends not only on one’s subjective taste and beliefs but also on constraints. Constraints are the set of alternatives that are available to an individual. For instance, you might prefer a Ferrari to

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a Ford, but your available income might constrain you from buying a Ferrari. After specifying preferences, beliefs, and constraints, the analysis proceeds by assuming that individuals choose a feasible option that best satisfies the individual’s preferences (“the utility-maximizing choice”). The rationality assumption enters the picture on the conditions that are placed on preferences.The typical rationality assumptions are that (i) preferences are complete, which means an individual can compare all relevant alternatives and rank them, (ii) preferences are transitive—that is, if an individual prefers alternative A over B, and B over C, then that individual should also prefer A over C, and (iii) preferences are independent of irrelevant alternatives—that is to say, the relative attractiveness of two options does not depend on other options available to the decision-maker. This rationality assumption ensures that preferences are noncyclical and therefore contain a “best element,” which will be chosen if available. Notice that the rationality assumption is nothing more than a consistency requirement and is completely mute on the content of preferences. This has not gone without criticism. For instance, Amartya Sen, in an influential article, has mocked this conception of economic man as being a “rational fool” (Sen 1977). Rational choice theory becomes a theory of social interactions if the individual decision-makers interact with each other. The social sciences are typically interested in the social outcomes of the interaction of individuals. One particularly important approach, especially in economics, is to analyze social outcomes from an equilibrium perspective. An equilibrium is a situation in which, given the decisions of all other decision-makers, no agent has an incentive to change behavior. If there is still an incentive to change behavior for at least one decision-maker, then the resulting outcome of the social interaction cannot be an equilibrium. Two important classes of social interaction are markets and (small) group interactions. In markets decision-makers face prices and have to decide how much they want to produce or buy at given prices and income. In the prototypical case a single individual cannot affect prices and thus takes them as given. An equilibrium is a situation in which at given prices agents want to change neither their production plans nor their demands (for a comprehensive textbook account, see Mas-Colell et al. 1995). In strategic situations an equilibrium is reached if, given the strategic behavior of other players, no one wants to change strategy. Thus, in many social science applications the analysis

36 Simon Gächter does not stop after looking at individual decisions but proceeds to predicting social consequences under the assumption that the resulting outcome will be an equilibrium. Of course, it is an empirical question whether the equilibrium prediction (which is derived for specific assumptions about people’s preferences) is consistent with the data. the selfishness assumption The rational choice approach is a flexible framework that can account for any preferences as long as they obey the consistency axioms. This flexibility is also a weakness, because if almost any preferences are permissible almost anything and therefore nothing can be explained. For that reason economists very often made additional preference assumptions to give the rational choice analysis more structure or assume that people have the same preferences (see, for example, the influential discussion by Stigler and Becker 1977). The most common and long-standing assumption is that decision-makers are selfregarding. Self-regarding agents will take the welfare of others into account only for instrumental reasons to increase their own well-being. In essence there are two justifications for the selfishness assumption. A first justification is tractability in modeling, as selfishness can simplify the analysis considerably. The selfishness assumption often allows for exact predictions, which can be confronted with appropriate data that might refute the selfishness assumption. Moreover, it is often of independent interest to understand what would happen if everyone were selfish. Understanding the consequences of selfishness serves therefore as an important benchmark for understanding nonselfish behavior. I have already alluded to a second justification of the selfishness assumption, that assuming nonselfish preferences, although logically possible, is tantamount to opening “Pandora’s Box”—which in this case means that any bizarre behavior can be rationalized. This argument has considerable merit in the absence of empirical means to assess the structure of people’s social preferences. Yet, as I will demonstrate below, the development of experimental tools allows us to observe people’s social preferences under controlled conditions. Behavioral scientists have lately even added neuroscientific tools to understand the neural mechanisms behind people’s social preferences (Fehr 2009b). five methodological remarks on the rational choice model I conclude this discussion with five methodological remarks and refer the interested reader to Gintis (2009) for a more in-depth discussion of the issues raised here. The first remark concerns the selfishness assumption, to which we will return in more detail below. Nothing in the rational choice framework dictates that preferences have to be self-regarding; the only necessary assumption is that preferences obey some consistency axiom such that optimal choices are logically possible. Thus, a rational decision-maker can have other-regarding preferences and still obey all the rationality axioms. As we will show below, there is substantial experimental evidence for both that many people are not purely self-regarding and that other-regarding preferences often do obey consistency axioms (at least in simple situations).We will also show evidence that behavioral

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patterns in experiments in which social preferences are important are consistent with predictions derived from rational choice models. Second, one may criticize the rational choice approach as being unrealistic in the sense that human decision-makers do not reason and behave like those portrayed in the theory.This argument has a lot going for it, as has been pointed out emphatically from different angles by Simon (1982); Gigerenzer and Selten (2001); or Loewenstein (2007). The limits of the rational choice approach can be discussed with the help of Figure 1.1. Psychologists and other behavioral scientists have long argued that people are faulty statisticians, as they often do not update information rationally and therefore hold nonrational beliefs, they overweigh small probabilities and underweigh large probabilities, and they fall prey to various framing effects (see, for example, Kahneman and Tversky 2000; Lindenberg 2008). Furthermore, people are often swayed by their emotions and evaluate options differently depending on whether they are in a “hot” or a “cold” state (see, for example, Vohs, Baumeister, and Loewenstein 2007). People make mistakes in predicting their future utility (for example, Loewenstein, O’Donoghue, and Rabin 2003) and are often too impatient and show weaknesses of will (Loewenstein, Read, and Baumeister 2003). These are all important findings.They have been possible because exact model predictions as derived from formalized rational choice theories were confronted with appropriate data. These findings have stimulated extensive research in all social sciences. In economics they have helped to pave the way for “behavioral economics,” which is the integration of psychological and sociological insights into economics. Behavioral economics is now branching out into the various subdisciplines of economics and transforming them by integrating psychological and sociological insights into rational choice frameworks (see Camerer, Loewenstein, and Rabin 2004; Diamond and Vartiainen 2007).This development would not have been possible without the rational choice approach, which helps pinpoint the problems in standard theory. Yet, as I will demonstrate by way of an example below, a rational choice analysis often makes surprisingly accurate predictions despite considerable violations of some assumptions that underlie the theory. This point has already been made by Becker (1962). Such a viewpoint does not necessarily imply discarding the importance of the empirical findings mentioned above, or a methodology that cares only for prediction accuracy and not so much for the empirical validity of the underlying assumptions. Quite the contrary, I will discuss evidence that points to the violation of the selfishness assumption as being a cause of a failure of prediction accuracy in several games of interest to social scientists. It is an empirical question how sensitive theoretical predictions are to particular violations of underlying assumptions. The rational choice approach provides theoretical rigor in uncovering which violations matter for prediction accuracy and which not. Moreover, very often we are interested in the comparative statics prediction of a model and, as we will see throughout this chapter, these predictions are often empirically validated. Third, and somehow relatedly, equilibrium theory does not explain how a particular equilibrium is actually reached.Yet evolutionary game theorists have shown that equilibria may be reached through a process of trial and error or

38 Simon Gächter other adaptive processes (Gintis 2000a). Moreover, behavioral game theorists, who study actual human decision-making in strategic contexts, have devised theoretical and empirical learning models that help us understand and predict how and when equilibria are approached under a given learning dynamic (see Camerer 2003 for a comprehensive overview). Fourth, equilibria need not be socially optimal, despite the fact that they arise from all players choosing their individually optimal action. The “tragedy of the commons” or the famous prisoner’s dilemma are prime examples. Moreover, even in games with multiple equilibria (“coordination games”), inefficient equilibria can result from individually optimal interaction, and players can even be fully aware that they are playing an inefficient equilibrium. In general, a very important task of modern social science is to understand inefficient social outcomes (Bowles 2003). Fifth, the rational choice approach does not necessarily advocate methodological individualism, although most defenders of rational choice probably believe that social phenomena should be explained solely from the actions of individuals. Gintis (2009) argues convincingly against this doctrine. In his view individuals’ common understanding (coordinated beliefs) is crucial to understand many important social phenomena such as social norms, which coordinate the interaction of rational individuals.

The Success of the Rational Choice Model and an Illustrative Example Despite some important limits I have discussed briefly above, I believe the rational choice model is a considerable success story, both theoretically and empirically. First, the breakup of the model into three conceptual building blocks, coupled with an equilibrium analysis (and in some cases powerful mathematical tools), has allowed for the development of a consistent (unified) theoretical framework to address many important topics of social interactions and economic decision-making in formalized theories. This is certainly true in economics, where modern theory provides a framework for the analysis of such diverse topics as international trade, public finance, consumer behavior, production theory and investment behavior, financial decision-making, retirement decisions, labor market behavior, and so forth. This framework has led to a unified discourse in economics, and prevented a fragmentation into disconnected subdisciplines. On a related note, the rational choice approach has also led to the development of game theory (discussed in greater detail by Buskens and Raub, this volume; for textbook accounts see, for example, Colman 1999; Gintis 2000a). Game theory is particularly promising, as it can serve to unify the discourse about human behavior among all the behavioral sciences (Gintis 2009). The interdisciplinary discourse based on experimental games as tools for empirical investigations has already started. Experimental games are used by political scientists (Morton and Williams 2010), anthropologists (for example, Henrich et al. 2004), primatologists (such as Jensen, Call, and Tomasello 2007), cognitive neuroscientists (Camerer 2009), and evolutionary biologists (Hagen and Hammerstein 2006).

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Second and well known to (empirical) sociologists working in the rational choice framework, the scope for applying rational choice approaches extends way beyond economics (Hechter and Kanazawa 1997). Rational choice approaches have been applied to issues that were long seen as outside the realm of economics, such as criminal behavior, human capital formation, education, family decision-making, addiction, organizational behavior, and the like. Thus, the rational choice model has enhanced our understanding of social processes way beyond market transactions (Coleman 1990; Becker 1993; Bowles 2003; Gintis et al. 2005). an illustrative example In this section, I illustrate the empirical success of the rational choice approach by briefly discussing an influential research program initiated by experimental economist and Nobel laureate Vernon Smith half a century ago. This exemplary discussion serves two purposes. It illustrates how a theoretical paradigm can be tested in the laboratory and how theoretical predictions can be contrasted with the data. It also illustrates that the rational choice predictions are met surprisingly well by the data, although the assumptions that enter the model are invalid. Thus this example illustrates one argument of this chapter, that rational choice predictions can be useful even if one believes that agents are boundedly rational. The example concerns a research program on one of the most important models in economics: the model of supply and demand and the theory of perfect and imperfect competition that builds on it. The goal is to explain the coordination of supply and demand under complete contracts. Complete contracts are contracts in which the terms of the exchange are comprehensively specified and are enforceable by third parties, such as the courts. One of the most important results of modern economic theory is that under complete contracts and the assumptions of rationality and price-taking behavior (agents have no market power and therefore have to take prices as given), coordination of prices is possible such that on all markets supply equals demand. Such an allocation is efficient in the sense that no economic agent can be made better off without making someone else worse. This model is the building block of much of modern economic theory and policy advice. It is therefore of considerable interest to understand whether this theory predicts correctly, and whether unregulated competitive markets actually clear—that is, whether prices are such that supply equals demand. Testing this model is a big challenge, as in reality prices are formed in market institutions, like stock exchanges or posted-offer markets (where suppliers announce a price and customers decide whether they buy at that price or not). Moreover, to test the model the researcher would need to know supply and demand, which rest on unobservable preference and cost parameters. Finally, if one has just price and quantity data, an identification problem exists because, if the theory holds, all price and quantity combinations are on both the demand and supply curve. Smith (1962) found an ingenious solution to solve the problem of knowing supply and demand. His idea was to endow experimental participants with valuations for an artificial commodity for which people have no “homegrown” preference that is unobservable to the experimenter. These induced valuations

40 Simon Gächter given to the buyer can be interpreted as demand (“maximum willingness to buy”) and those given to sellers as supply (“minimum selling prices”). Since the experimenter knows these induced values, the experimenter can calculate the market clearing price and quantity and therefore compare the results in an experiment with these predictions. Furthermore, as mentioned, trade takes place within a market institution, and the experimenter can fix this institution, to test what impact institutional rules have on price formation and market clearing, independent of supply and demand parameters (see Smith 1986 for a comprehensive discussion of this methodology). Smith’s experimental methodology started a long stream of experimental papers that investigated how prices are formed in diverse market institutions and to what extent the theory of supply and demand actually can predict final allocations. Discussing this literature is beyond the scope of this chapter. The interested reader should consult Kagel and Roth (1995). The upshot of many of these studies is that the competitive market equilibrium predicts the results in experimental markets surprisingly well. Figure 1.2 illustrates the results of an experiment I ran with the purpose of replicating a particularly interesting experiment by Davis, Harrison, and Williams (1993). The top part of the figure shows the “induced” supply and demand schedules. Take the demand schedule labeled “lowest demand” and the supply schedule labeled “supply” first. For instance, there was a buyer whose maximal value for one unit was 250, so this buyer had an incentive to buy for a price of at most 250 because the buyer’s earnings were 250 minus the price paid; for another buyer the maximal willingness to buy was 245, and so on; the buyer with the lowest maximal willingness to pay had a valuation of only 175. Similarly, there was a seller for whom the induced reservation price was 100 and any price above that resulted in a gain of “price—100.” Other sellers had higher reservation prices, which together constitute the supply curve. The market equilibrium (where supply equals demand) predicts a price of 225 and that six units will be traded. The market was run as a so-called double auction market whereby both buyers and sellers can submit prices according to some prespecified rules; each can accept the other’s offer at any time. The experimental participants traded in this market for fifteen periods. The supply function stayed constant during the whole experiment—that is, participants in the role of a seller always kept their given valuations. By contrast, in the third trading period the participants in the role of buyers received new valuations, such that the whole demand function was shifted upward. This shifted the predicted prices and quantities to 250 and 7, respectively. In the subsequent periods, demand was shifted up every period, until in period 8 the highest demand illustrated in Figure 1.2 was implemented. From then on the demand function was shifted down every period until the lowest demand was implemented again in period 15. This up- and downward shifting of the demand function resulted in predicted prices and quantities illustrated in the lines without symbols in the bottom panel of Figure 1.2. It is important to notice that participants in this market did not know the whole supply and demand schedules and how demand was shifted; in every trading period they knew only their own valuation. The results, illustrated in the bottom panel, are striking and replicate

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the findings of Davis et al. (1993). Transaction prices were very close to the equilibrium price in all periods; and the traded quantities were near to their equilibrium quantities as well, with the exception of the first two trading periods. This is just one result in an impressive stream of research initiated by Smith (1962). Smith and many collaborators as well as other researchers investigated the robustness of these results in various directions (see Kagel and Roth 1995 for an overview).The surprising finding is that with some small caveats the data are consistent with the equilibrium predictions. This is a remarkable result because the equilibrium prediction was derived under the assumption that supply and demand are known to all traders (and the “auctioneer”), and everyone is a price-taker. By contrast, in the experiments (and in many real world markets), traders were as much price-makers as price-takers and knew only their own valuations, and not the whole supply and demand schedule. Moreover, learning

42 Simon Gächter opportunities were rather limited. Thus the conditions assumed in theory are not necessary for achieving equilibration. In summary, rational choice predictions can organize the data and predict changes even if not all assumptions in the underlying theory are met. The relevance of this argument extends beyond markets. For instance, mixed strategy equilibrium predictions are often surprisingly good predictors of (aggregate) behavior, even though the mixed strategy equilibrium rests on psychologically implausible assumptions (see, for example, Camerer 2003: ch. 3). Other examples of when the data confirm surprisingly closely to rational choice predictions are oligopoly games (Huck, Normann, and Oechssler 2004), or tax-subsidy mechanisms for the provision of public goods (Falkinger et al. 2000).

Homo Economicus Put to Test—Social Preferences and Rationality At face value the selfishness assumption behind many applied rational choice models seems to be violated already by the fact that many people vote even in anonymous situations, take part in collective actions, often manage not to overuse common resources, care for the environment, mostly do not evade taxes on a large scale, donate to public radio as well as to charities, and so forth. Yet the selfishness assumption cannot be dismissed so easily. In reality many factors might give even selfish individuals an incentive to behave prosocially, although they are not so motivated. Thus the exact incentives people face must be fully controlled to gain conclusive evidence about the validity of the selfishness assumption. In principle, methods such as controlled attitude surveys using vignettes (see, for example, Kahneman, Knetsch, and Thaler 1986), or interviews (Bewley 1999) are possible sources of evidence for tests of the selfishness assumption. However, the drawback is that these instruments do not measure behavior but attitudes that might even be clouded by a social desirability bias. Laboratory experiments with decision-dependent financial incentives have the advantage that they measure people’s behavior in situations in which true opportunity costs for their decisions exist and are known by the researcher. laboratory experiments as test instruments and behavioral models The most important advantage of an experiment is that relevant parameters can be controlled by the experimenter. This allows for stringent tests of the selfishness assumption (and any other assumption of any model one wants to test) (see Friedman and Sunder 1994 for practical details; and Guala 2005; Bardsley et al. 2009; Falk and Heckman 2009; and Morton and Williams 2010 for the methodology of [laboratory] experiments; Croson and Gächter 2010 describes my own views). Experimental practices differ somewhat across disciplines (see, for example, Hertwig and Ortmann 2001). Here I briefly describe the standards that have emerged in experimental economics, as most of the experiments I will discuss below have been conducted according to those standards. First, the experiment runs according to a fixed protocol. Second, the participants receive written rules of the game. Third, decisions are usually anonymous, at least among participants. Most of the time experiments are computerized and

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take place in laboratories in which subjects are separated by partitions. Fourth, subjects get paid depending on their decisions (that is, they do not simply receive a flat payment for their participation). The level of payments is usually commensurable with what a participant could earn elsewhere in about the time it takes to participate in an experiment. Finally, there is no deception. The major reason for not using deception is to ensure the internal validity of the experiment, which might be compromised if the participants were to become suspicious about the experiment and a reputation that deception is being used were to develop (ibid.).The internal validity is compromised because subjects might effectively play another game than the experimenter thinks they are playing. The experiments I will discuss below are now classic instruments or behavioral models to measure various aspects of people’s social preferences.The Dictator Game measures the simplest form of other-regarding preferences. The Ultimatum Game has been used to study norms of fair sharing and negative reciprocity. The Gift Exchange Game measures positive reciprocity. The Trust Game helps us to study trust and trustworthiness (and positive reciprocity). The Public Goods Game is a tool for studying cooperation. The Public Goods Game with costly punishment allows for negative reciprocity. A skeptic might argue that the information we can gain from artificial laboratory experiments with undergraduates is limited. These skeptics should keep in mind that the most important results I will report below have been replicated across many participant pools, sometimes in representative surveys (Fehr, Fischbacher, Rosenbladt et al. 2002; Bellemare and Kröger 2007; Ermisch et al. 2009); and increasingly in field experiments (for example, Frey and Meier 2004; Falk 2007; and Shang and Croson 2009). Moreover, the findings from the lab are consistent with survey evidence (see, for example, Dohmen et al. 2009). Lab experiments can also be used to predict field experimental outcomes (for example, Karlan 2005; Benz and Meier 2008; Rustagi, Engel, and Kosfeld 2010; Carpenter and Seki 2011). My discussion here will be necessarily selective and my criteria are as follows. I will highlight evidence from one-shot experiments that were designed to test for the relevance of social preferences in an environment in which confounds with strategic incentives are excluded by design. These experiments help testing the selfishness assumption discussed above. I will also briefly discuss the role of sociodemographic background characteristics in experimental choices. A second emphasis is on experiments where the relevance of strategic effects can be gauged from comparisons with behavior in one-shot games. Thirdly, I will discuss findings from experiments that highlight the tradeoffs people make between behaving proselfishly and prosocially. These latter two selection criteria help me to shed light on the relevance of rational choice approaches in explaining the data. For more comprehensive treatments and discussions about the various purposes for which these experiments have been used, I refer the reader to Camerer (2003): ch. 2; and to Chaudhuri (2009). altruism the dictator game One of the first studies of the Dictator Game is by Forsythe et al. (1994). It is a two-player game in which players are randomly allocated to one of two

44 Simon Gächter roles: the “dictator” receives an amount of money and is asked how much he or she wants to give to a passive recipient, who has to accept what is offered. A rational and selfish dictator will keep all the money. Positive sharing is seen as evidence for altruism, or other-regarding preferences in general. The results in Forsythe et al. (ibid.) do not support the selfishness prediction. Twenty-two percent of the participants transferred a positive amount to the powerless recipient. Across a large set of dictator experiments, Engel (2011) finds that dictators share about 28 percent of their allocated sum with the recipient.The results vary greatly across different treatments, however. It matters strongly who the recipient is (see, for example, Carpenter, Connolly, and Knowles Myers 2008). Transfers are higher if the recipient is a charity rather than another participant. The sociodemographic background characteristics matter as well. In particular, as Carpenter et al. (ibid.) show from data of representatively selected participants, older “dictators” transfer more money than younger ones. Another variable that matters is the degree of social distance to the experimenter (Hoffman, McCabe, and Smith 1996). The availability of various outside options (Dana,Weber, and Kuang 2007) also influences transfers substantially. From the evidence that many contextual variables matter one might conclude that the Dictator Game does not provide a coherent measure of altruism. Such a conclusion would be premature, however. Behavior might be very sensitive to many contextual details and, nevertheless, for a given contextual frame behavior follows rationality principles. The data of Andreoni and Miller (2002) are clearly consistent with altruism being a taste that obeys important rationality axioms. fair sharing the ultimatum game The Ultimatum Game was first studied by Güth, Schmittberger, and Schwarze (1982). It is a simple bargaining game between two players, a proposer and a responder. As in the Dictator Game, the proposer receives a sum of money, let’s say $10, to split with the responder. But unlike the Dictator Game, here the responder may reject or accept the offer. In case the responder accepts, the offered division is implemented; if the offer is rejected, both get nothing. In the usual implementation of this game, the proposer does not know who the responder is, and vice versa, so all decisions are anonymous, to control for social approval effects. A rational choice analysis under the assumptions of rationality and selfishness makes an unambiguous prediction: if the responder is motivated solely by monetary payoffs, he or she will accept every offer. Therefore, the proposer will offer only the smallest money unit. The results across a wide range of Western subject pools reject this prediction unequivocally (see Camerer 2003; Oosterbeek, Sloof, and van de Kuilen 2004; and Chaudhuri 2009 for overviews). On average, proposers offer 30 to 40 percent of the available amount. The median and the mode are at 40 and 50 percent, respectively. Very few offers are at 10 percent, or above 50 percent. Offers below 20 percent or less will be rejected with a high probability, while equal splits are almost always accepted. Contextual variables are much less relevant than in the Dictator Game. These results also hold if substantial amounts are at stake (Cameron 1995), or if the experiment is played with

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nonstudents across different age groups (Güth, Schmidt, and Sutter 2003). Güth et al. (ibid.) found these results in a particularly innovative study with more than a thousand readers of a German newspaper.They also elicited expectations about the acceptance probability of a given offer. It turned out that people have quite good estimates about the actual rejection rates. The results of the Ultimatum Game appear inconsistent with rational choice theory, as recipients reject offers and proposers offer nonminimal amounts. However, these results are only partially inconsistent with rational choice theory. This is easiest to see for the proposer. If the proposer expects that a low offer might be rejected, it is rational to make an offer that is more likely to be accepted. Since people have quite realistic expectations about rejection rates, low offers should be less frequent in the Ultimatum Game than in the Dictator Game.This is the case, as shown by Forsythe et al. (1994), who found that offers in the Ultimatum Game are substantially higher than in the Dictator Game.The fact that people reject offers poses a bigger challenge. One explanation is that people make errors that are, however, much less likely the more costly it would be. To see this, notice that rejecting a low offer is a “cheap mistake,” whereas offering little is a big one. Thus, recipients might learn to reject and proposers might learn to make sufficiently high offers. In a modified Ultimatum Game, Eckel and Grossman (1996) also showed that rejections are less likely the more costly they are. People might reject for emotional reasons, because they feel unfairly treated and therefore want to punish the greedy intention (after all, the role allocation was random). This hypothesis is hard to test from behavioral data alone (although attempts exist; see, for instance, Abbink et al. 2001). Data from emotion self-reports support the emotion hypothesis (Pillutla and Murnighan 1996). Sanfey et al. (2003) applied neuroscientific methods to understand rejections in the Ultimatum Game. They found that low offers activated areas of the brain associated with anger and disgust, but also areas involved in information processing and decision-making. The strength of the activation of these areas also predicts the probability of rejections quite well. This evidence suggests that the interpretation of rejections in terms of learning and errors is much less appropriate than explanations in terms of social preferences: People reject low offers because they consciously want to reject them. positive reciprocity the gift exchange game The Gift Exchange Game was developed by Fehr, Kirchsteiger, and Riedl (1993). In the Gift Exchange Game there are two roles, employers and employees. Each employer can hire only one employee, and there are more employees than employers. The sequence of events is as follows. Participants in the role of employer make wage offers in a competitive market institution. Wages are between 20 and 120. Employees see these wage offers and can accept any wage offer that is still available. Acceptance of a wage offer concludes an employment contract. Contracts are incomplete because employers can offer only a fixed wage but cannot specify a particular effort; effort is therefore not contractible. In the next step employees choose their effort and the game ends. There are ten different effort levels. “Effort” in this experiment means choosing a number with the consequence that the higher the chosen number, the higher

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is the employer’s profit and the higher are the employee’s effort costs. The payoff of employers increases with the effort of the employee and decreases with the wage paid to the employee. The employees’ payoffs increase in wage and decrease in effort. Parameters are such that maximal effort would maximize the total surplus available. Thus the Gift Exchange Game can be seen as a generalized version of a sequential Prisoner’s Dilemma. The experiment is conducted under anonymity and the market interaction described above is repeated for ten periods. This setup ensures that there are no strategic reasons for gift exchange. If we assume that all players are rational and self-interested payoff maximizers, then employees will, irrespective of the wage, choose the minimum effort because effort is costly. Employers therefore have an incentive to pay the lowest wage, because higher than minimal wages cannot trigger gift exchange from selfish employees. Since there are fewer employers than employees, employers are in a stronger position and should be able to push wages down to the lowest possible level of 20. However, the norm of reciprocity (Gouldner 1960) predicts that effort and wages should be positively correlated. Numerous experiments have been conducted in this framework. Figure 1.3 shows the results of the gift exchange experiments of Fehr et al. (1998). The left panel shows a bubble plot of the wage effort combinations and a regression line. Overall, the self-interest prediction is clearly refuted, because there is a highly significantly positive relation between wage and effort. Despite the monetary incentive to choose minimal effort, experimental subjects in the role of the employee tend to reward generous wage offers by high efforts. This is unambiguous evidence for positive reciprocity, found in numerous experiments (for an overview, see Fehr and Gächter 2000b). However, the figure also shows that there is substantial heterogeneity. Irrespective of the wage paid by the firm there is always a fraction of workers who choose minimal effort. I chose to discuss Fehr et al. (1998) because this experiment allows me to connect to the market experiments described below. Recall that in these experiments contracts were always complete and prices converged to the predicted levels. The right-hand panel of Figure 1.3 shows that contractual incompleteness makes a decisive difference: wages are far above the predicted level of 20 and even increase over time. Further analyses showed that the average wage observed in these markets was indeed the profit-maximizing wage, given the employees’ average wage-effort relationship. But are gift exchange and contractual incompleteness the cause behind this finding? To investigate this crucial question, Fehr et al. (ibid.) included a further treatment in their design, called the “Complete Contracts Market.” In this treatment effort is fully contractible (set exogenously at the highest effort level). Thus, the contract is complete because there is no effort discretion any longer. The results, also depicted in the right-hand panel of Figure 1.3, show that wages are dramatically different when contracts are complete: wages are substantially lower from the start and, as in numerous comparable experiments, converge toward the predicted level of 20 by the end of the experiment.

48 Simon Gächter trust and trustworthiness the trust game In economics, the now classic experiment to measure trust and trustworthiness is the work of Berg, Dickhaut, and McCabe (1995). The Trust Game (or the “investment game,” as Berg et al. call it) is a two-player game in which subjects are randomly and anonymously allocated to their roles as trustors and trustees (often called investor and recipient). The investor has an endowment of, say, $10. The investor’s task is to decide how much of this endowment to transfer to the recipient. Any amount x the investor transfers gets tripled by the experimenter—that is, the recipient receives 3x. The recipient has then to decide on the amount y (between 0 and 3x) to back transfer to the investor, who receives y. Selfish recipients would not return anything irrespective of the amount received; rational and selfish investors would foresee this and invest nothing. Why does this game measure trust? Given the fact that any amount invested is tripled, transferring the whole endowment would maximize the joint income of both players. Yet transferring x pays off to the investor only if he or she receives at least x back. Since communication is not possible, and, even more important, any promised back transfer would not be enforceable, sending a positive amount signals trust. Whether trust pays off depends on the back transfer. Therefore, the back transfer is a measure of trustworthiness. The Trust Game by Berg et al. (ibid.) offers therefore a measure of both trust and trustworthiness. This argument is not without problems, and I briefly mention some of them below. Berg et al. (ibid.) ran this experiment with sixty-four participants. The participants in the role of a trustor sent on average $5.16, although the whole range of possible transfers (between $0 and $10) was observed. Only two trustors chose to transfer $0.The trustees returned on average $4.66. Among the thirty trustees who received a positive transfer, twenty-four returned a positive amount and fourteen returned an amount that exceeded the sent amount. Because the Trust Game gives an intuitive and simple measure of trust and trustworthiness, it has been replicated numerous times in various treatment variations.The main result described above was always confirmed (see Camerer 2003; Chaudhuri 2009; and Johnson and Mislin 2011 for overviews). I highlight two studies for their methodological inventiveness. Sutter and Kocher (2007) used the Trust Game to study whether trust and trustworthiness change with age.They conducted experiments with more than six hundred participants from six different age cohorts. It turned out that both trust and trustworthiness exist in all age cohorts, even the youngest one (six- to eight-year-olds). However, both trust and trustworthiness increase with age, although the increase beyond the twenty-five- to thirty-five-year-olds is small. Sutter’s and Kocher’s study is not drawn from a representative sample, however. It is therefore an interesting question how trust and trustworthiness are distributed in representative subject pools.The pioneering studies of Fehr, Fischbacher, Rosenbladt et al. (2002) and Bellemare and Kröger (2007) integrated trust experiments into representative surveys in Germany and the Netherlands, respectively. Ermisch et al. (2009) investigated people’s trust in the British population. In all studies age emerges as an important demographic variable, in particular with regard to trusting behavior: older people trust more.

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I conclude with three remarks. First, the observation that people across all age cohorts and many social groups (see, for example, Buchan, Croson, and Dawes 2002; Fehr and List 2004; Carpenter, Daniere, and Takahashi 2004) show trust and trustworthiness even in one-shot situations is a stark result.Yet in daily life the largest part of trust is probably created through repeated interactions or within networks—that is, trust occurs in embedded relationships. If trust is combined with reputational incentives, trust and trustworthiness should increase.The reason is that now also selfish individuals have an incentive to trust and to behave trustworthily. The presence of reputational incentives should not undermine trust and trustworthiness of nonselfish individuals. This is indeed the case across different versions of Trust Games (Cochard, Van-Nguyen, and Willinger 2004; Bohnet and Huck 2004) and the related gift exchange games (Gächter and Falk 2002). Buskens and Raub (this volume) provide a comprehensive discussion of this line of research. Second, consistent with rational choice prediction, trust and trustworthiness respond to the parameters of the Trust Game. If trustworthiness becomes more costly, it occurs less and people trust less (Snijders and Keren 2001; Buskens and Raub, this volume). Third, researchers have challenged the view that this version of the Trust Game really measures trust and trustworthiness. In economics, for example, on the basis of Dictator Game results Cox (2004) argues that the fact that people send money to a recipient or return money to a trustor could also be the result of altruism. Another argument has to do with the riskiness of trusting decisions. Does a trusting decision reflect the trustor’s risk attitude, or do trusting people require a “trust risk premium” because they are “betrayal averse”? In a series of experiments Iris Bohnet and her coworkers demonstrate that trusting decisions are closely related to betrayal aversion (see, for example, Bohnet et al. 2008). Thus, trust and trustworthiness are more than just calculative behavior and reciprocity. Further illuminating discussions from various angles about the nature of trust can be found in, for example, Bacharach and Gambetta (2001); Ostrom and Walker (2003); Fehr (2009a); and Vieth (2009). cooperation and free riding the prisoners’ dilemma and public goods game The most important vehicles for studying cooperation problems in controlled laboratory experiments are the “prisoner’s dilemma” and the “public goods experiment.” The Prisoner’s Dilemma Game is probably one of the most extensively investigated games and a comprehensive discussion of the experimental results exceeds the scope of this chapter. The interested reader should consult Colman (1999), who discusses the results at great length. I concentrate on two aspects of main interest in this chapter: the extent of cooperation in one-shot games and the importance of strategic incentives. Figure 1.4 illustrates the results of two studies that highlight these issues (Cooper et al. 1996; Andreoni and Miller 1993). In both studies the participants played the game ten times under two different conditions. In one condition, called the “Stranger” condition, each player was matched with a new player in each of the ten periods. In the second condition, called “Partner,” the opponent stayed the same throughout all repetitions of the

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game. The subjects were informed about this. Thus, under the assumption of selfishness and rationality, all players in both conditions are predicted to defect. In the “Stranger” condition this prediction holds because each play of the game is against a new opponent and hence “one-shot.” In the “Partner” condition the prediction holds with backward induction: in the last period both players (who are assumed to be rational and selfish) will defect.Therefore, in the penultimate period, there is no incentive to cooperate, since players will surely defect in the last period. Hence, there is also no incentive to cooperate in the period prior to the penultimate one. Continuing this logic implies that rational and selfish players will defect throughout. By contrast, if people are not completely sure that everyone is selfish, then it might pay to build up a reputation by cooperating if others cooperate until the final rounds, where a selfish player should defect for sure (see Kreps et al. 1982 for a game-theoretical explanation, and Selten and Stoecker 1986 for a bounded rationality approach). In both studies the results in the “Stranger” condition are at odds with this prediction. People cooperate on average in slightly more than 20 percent of the cases. A common future, if only for ten rounds, increases cooperation substantially. In the “Partner” condition, the average cooperation rate is at least 50 percent. Thus, (i) people are prepared to cooperate even in one-shot games, and (ii) the possibility to behave strategically strongly increases cooperation. This evidence is consistent with the findings from Trust Games discussed above. Clark and Sefton (2001) studied an interesting variation of the game of Figure 1.4. Instead of playing the game simultaneously, their subjects played the game sequentially—that is, player 1 first made a choice, which was then observed by player 2 before deciding whether to cooperate or to defect. The subjects also played the game for ten rounds in the “Stranger” setup. Clark and Sefton (ibid.) found that between 37 and 42 percent of the subjects cooperate conditionally on the cooperation of others. Such conditional cooperation is also observed in two further treatments—“double temptation,” in which the defection payoff was doubled, and “double stakes,” in which all payoffs were doubled. A statistical analysis shows that “double stakes” did not significantly affect the extent of conditional cooperation. By contrast, under “double temptation” the fraction of conditional cooperation is reduced relative to the baseline. This latter finding is consistent with rational choice theory: as cooperating becomes more expensive, it will occur less. The results from Prisoner Dilemma Games are interesting, because the prisoner’s dilemma is such a simple cooperation game. The fact that people cooperate even in one-shot games casts doubt on the selfishness assumption. The observation that there are strong effects of repeated interaction suggests that straightforward strategic incentives are very helpful for successful cooperation. There can thus be no doubt that the strategic gains from cooperation that come from repeated interactions are a powerful force in explaining real-world cooperation in small and stable groups. However, the success of repeated game incentives in sustaining cooperation may be limited if groups become larger.The intuition is as follows. In the bilateral prisoner’s dilemma a player can punish a defector by defecting as well. In larger groups such targeted punishment is not possible: defection punishes not only defectors but also other cooperators, who,

52 Simon Gächter as a consequence, might then defect as well. For this reason it is worthwhile to move beyond dyadic relationships. The most commonly used game for studying n-person cooperation problems is the Public Goods Game. In contrast to a private good, a public good is a good that can be consumed even if one has not contributed to its provision. Common examples of public goods are clean air, environmental quality, and national security, but also collective reputations or team output. The Public Goods Game is an economic model of public good provision. This game underlies many experiments that study cooperation for the provision of public goods. In a typical public goods experiment, four people form a group. All group members are endowed with 20 tokens. Each member i has to decide independently how many tokens gi (between 0 and 20) to contribute to a common project (the public good).The contributions of the whole group are summed up. The experimenter then multiplies the sum of contributions by 1.6 and distributes the resulting amount equally among the four group members. Thus each group member’s payoff is πi = 20 − gi +

1.6 4 ∑g 4 j =1 j

The first term (20 – gi) indicates the payoff from the tokens not contributed to the public good (the “private payoff ”). The second term is the payoff from the public good. Each token contributed to the public good becomes worth 1.6 tokens. The resulting amount is distributed equally among the four group members—irrespective of how much an individual has contributed. Thus, individuals benefit from the contributions of other group members, even if they have contributed nothing to the public good. Therefore, a rational and selfish individual has an incentive to keep all tokens, since the “return” (that is, the personal benefit) per token from the public good for him- or herself is only 0.4 (1.6/4), whereas it is 1 from keeping the token. By contrast, the group as a whole is best off if everybody contributes all 20 tokens. Since the Public Goods Game is an n-person cooperation problem that is easy to implement, and since it reflects as well the tension between individual incentives and collective benefits, it has been frequently used in experimental studies (see Gächter and Herrmann 2009; and Chaudhuri 2011 for overviews). Again, my review of results is selective and illustrates the main variables of interest. Figure 1.5 depicts a typical finding from a public good experiment, where the same game is repeated ten times and subjects know this. In each period subjects receive 20 tokens and decide how many of them to keep or to contribute to the public good. After each round subjects are informed about what the other group members have contributed. Figure 1.5 shows the resulting cooperation patterns in a “Stranger” condition, where group members change randomly from round to round, and a “Partner” condition, in which groups remain the same for all rounds. Figure 1.5 illustrates three stylized facts from dozens of public goods experiments. First, as in the prisoner’s dilemma experiments reported above, people make positive contributions to the public good even in one-shot

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games. Sociodemographic variables influence this baseline cooperativeness: older people are somewhat more cooperative than younger ones, and rural residents contribute more to the public good than urban residents (see, for example, Gächter and Herrmann 2011). Second, strategic incentives matter also in the Public Goods Game: “Partners” (in most experiments) contribute more than “Strangers” (see Andreoni and Croson 2008 for an overview). A third stylized fact is that contributions decline over time to very low levels.This is true in almost every subject pool studied (see, for example, the cross-cultural experiments of Herrmann, Thöni, and Gächter 2008). The question why this happens is not yet settled in the literature. I will address some explanations below. altruistic punishment One important reason why contributions in the Public Goods Game deteriorate is that the only way a duped cooperator can avoid being “suckered” is by reducing cooperation, thereby punishing everyone, even other cooperators. This raises the question of whether targeted punishment (whereby group members can identify a defector and punish him or her) actually can solve the free rider problem and prevent the breakdown of cooperation. Yamagishi (1986) and Ostrom, Walker, and Gardner (1992) were among the first to allow for punishment in interesting games. Yamagishi (1986) looked at people’s willingness to provide a sanctioning system that itself is a public good. Ostrom et al. (1992) studied punishment in a common pool extraction system. Both studies found a substantial willingness to punish defectors. Fehr and Gächter (2000a) developed an experimental design that allowed studying punishment in a one-shot and repeated Public Goods Game. After subjects had made their contributions to the public good, they entered a second stage, in

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which they were informed about each individual group member’s contribution. They could then assign up to ten punishment points to each individual group member. Punishment was costly for the punishing subject, and each received punishment point reduced the punished subject’s income from the first stage by 10 percent. Fehr and Gächter (ibid.) played this experiment under two treatment conditions—a “Partner” treatment, in which group members knew that they were playing the game with the same four group members for ten periods, and a “Stranger” treatment, where group composition was changed from period to period. Fehr and Gächter (ibid.) also ran control experiments in which punishment was not possible (see Figure 1.5). Figure 1.6 shows the results in the treatments with punishment. Compared with the data in Figure 1.5, contributions to the public good are strongly increased in the presence of a costly punishment opportunity. This is true for both the “Partner” and the “Stranger” treatment. In the case of the “Partner” treatment, contributions approach almost 100 percent of the endowment; in the “Stranger” treatment contributions amount to 60 percent of the endowment. Thus, again we see that “Partners” contribute more than “Strangers.” From the very first period onward contributions are significantly higher in the “Partner” treatment than in the “Stranger” treatment. Strategic incentives also matter in the presence of punishment. A theoretically important question concerns the relevance of future interactions. In the “Partner” treatment, the likelihood of future interaction is 1; in the “Stranger” treatment, where groups are randomly rematched, it is much smaller (depending on the size of the pool from which groups are rematched), but still positive. An interesting benchmark case is the situation

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figure 1.7. Mean contributions to the public good among “Perfect Strangers” in the absence and presence of a punishment option. N = 236 participants. Open squares refer to the condition where participants first played six periods of the punishment condition and then changed to the no-punishment condition. The black triangles refer to the reverse sequence. Source: Fehr and Gächter (2002).

in which the likelihood of future interaction is zero—that is, groups play a one-shot game. This situation is interesting because evolutionary theories of cooperation (see Nowak 2006 for a succinct summary) predict no cooperation in this case. Therefore, Fehr and Gächter (2002) set up a socalled Perfect Stranger design where in each of the six repetitions all groups were composed of completely new members, and participants knew this. Participants played six one-shot games with no punishment and six one-shot games with punishment. Half of the participants started without a punishment opportunity and then were introduced to the punishment condition. For the other half this order was reversed. Figure 1.7 contains the results on the cooperation rates achieved. When punishment is not available, cooperation collapses, as in all previous experiments.The picture changes dramatically when punishment is possible. For instance, in the experiments that started with the punishment option (symbolized by open squares), contributions in the first period were significantly higher than in the experiment that started with no punishment option (symbolized by black triangles). In the experiments in which punishment was introduced in the second sequence, cooperation jumped up immediately. This is remarkable because in this sequence subjects experienced a strong decline in the games with no punishment. Still, after punishment had been introduced cooperation jumped up to a level that even exceeded cooperation in the first period. In both

56 Simon Gächter 10 Mean punishment expenditures

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sequences, cooperation in the presence of a punishment opportunity strongly increased over time. Thus, contrary to theoretical predictions, cooperation can flourish in the presence of punishment even in one-shot interactions. Is this result of sustained cooperation inconsistent with rational choice predictions? The answer is no, if enough people are prepared to punish. Figure 1.8 shows the punishment expenditures for a given deviation from the other group members’ average contributions. I distinguish between the “Partner,” the “Stranger,” and “Perfect Stranger” experiments. A couple of observations can be made from Figure 1.8. First, the more a subject’s contribution falls short of the average contribution of the other group members, the stronger is punishment for the deviating group member. This holds true in all treatments. Second, with the exception of very strong negative deviations (which constitute only a few cases, however), punishment is very similar across treatments. This is remarkable because cooperation levels differ strongly between the “Partner,” “Stranger,” and “Perfect Stranger” treatments. Thus, punishment is to a large degree nonstrategic: people punish deviations, and punishment is largely independent of the absolute level of cooperation. This view is also corroborated by the fact that the punishment pattern of Figure 1.8 is temporally stable—that is, even in the final periods some people are prepared to harm a free rider. By now these results have been replicated by many researchers (see Gächter and Herrmann 2009; Chaudhuri 2011; and Balliet, Mulder, and van Lange 2011 for overviews). But why do people punish free riders? Several motives may underlie punishment. First, punishment reduces the inequality between the “sucker” and the free riders (Fehr and Schmidt 1999). Second, free riding indicates a greedy intention, which is punished for reasons of negative reciprocity (Falk, Fehr, and Fischbacher 2005).Third, being duped might trigger negative emotions (Fehr and Gächter 2002). Recent neuroscientific evidence

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suggests furthermore that taking “revenge” by punishing a free rider might be experienced as rewarding (de Quervain et al. 2004). Why is punishment so successful in increasing cooperation? The most important reason is probably that it gives the selfish people—who care most about their individual payoff—a material incentive to cooperate. Since altruistic punishment is frequent it apparently is a credible threat and induces selfish individuals to cooperate. This feature makes punishment altruistic—a punished free rider might in the next encounter abstain from defecting, which benefits future interaction partners. A rational choice analysis of the consequences of punishment predicts that the severity of punishment should matter for the cooperation level that can be achieved. The reason is that (rational) free riders will weigh costs and benefits of contributing to the public good. If punishment is low, free riding pays off; otherwise it is better to cooperate. Nikiforakis and Normann (2008) tested this argument by varying the “punishment effectiveness”—that is, the income reduction per punishment unit inflicted on a punished subject. Nikiforakis and Normann (ibid.) had four levels of punishment effectiveness—ranging from 1 to 4. The unit cost of punishment was always 1. The results are in line with the predictions: the higher the punishment effectiveness is, the higher are cooperation rates. Egas and Riedl (2008) have a related design (they also vary the cost of punishment). Their results are consistent with the findings of Nikiforakis and Normann (2008). The final issue I discuss here is whether punishment also follows some rationality principles or whether it is an impulse that is immune to cold calculations of costs and benefits. To appreciate this question, notice that one of the most fundamental concepts in economics is the “Law of Demand,” according to which people will demand less of a certain commodity or activity the higher its price. Does the Law of Demand also hold for punishment? Figure 1.8 and all papers that studied punishment in the context of a cooperation game confirm that many people actually do have a “demand for punishment,” in the sense that they are willing to pay a certain amount of money to inflict punishment on others (that is, they “buy” punishment). The more a subject free rides, the higher is the demand for punishment. However, studying the Law of Demand requires a systematic variation of the cost of punishment. This is what Anderson and Putterman (2006) and Carpenter (2007) did. Their subjects played the cooperation and punishment game in the “Stranger” setup to minimize strategic effects. In each of the games, subjects faced different costs for inflicting a punishment unit on the punished subject. The results confirm that for a given amount of free riding people demand less punishment the higher the costs of punishing are. Thus punishment, although most likely emotion-driven, follows the Law of Demand, a hallmark principle of rational choice economics. micromotives and macrobehavior The juxtaposition of results in the Public Goods Game without punishment (where cooperation invariably declines) and with punishment (where cooperation is stabilized or even increases over time) also allows us to shed some light on a long-standing question in the social sciences: what is

58 Simon Gächter the relationship between micromotives and macrobehavior (Schelling 1978; Coleman 1990)? The starting point for my illustrative discussion is the observation that cooperation in repeated public good experiments tends to collapse with repeated interactions (see Figure 1.5). Why is this so? One explanation is that people have to learn how to play this game. Since errors can go in only one direction, any erroneous decision looks like a contribution. Over time, people learn and commit fewer errors, which is why contributions decline. The problem with this explanation is that it is inconsistent with the fact that after a so-called restart (after the tenth-round participants are told that they will play another ten rounds) cooperation jumps up again and basically starts at the same level as in the first period (see Cookson 2000 for a particularly impressive illustration). If learning would explain the decay in cooperation, then after the restart, cooperation should have continued at the level at which cooperation was in the tenth round. Another explanation is that people are heterogeneous with respect to their cooperative inclinations. Some people are free riders who try to maximize their monetary income, irrespective of other group members’ contribution. Other people are “conditional cooperators,” who cooperate if others cooperate. These differences in microlevel motivations produce a macrolevel outcome in which everyone eventually free rides. Fischbacher and Gächter (2010) test this idea with the goal of tracking the influence of micromotivations on the macrolevel outcome. To measure individual cooperative motivations, Fischbacher and Gächter (ibid.) use a design developed by Fischbacher, Gächter, and Fehr (2001).Their design allows measuring the “type” of a player by observing each participant’s contribution to the public good as a function of other group members’ contribution. Specifically, subjects are asked to indicate for each possible average contribution of the other group members how much they would like to contribute to the public good. Thus, participants submit a whole contribution schedule, not just one contribution. The payoff function is the same as in the other public goods experiments—that is, incentives are such that, given others’ average contribution, the monetary income is always highest if one contributes nothing. Thus a free rider type will always contribute zero to the public good. A conditional cooperator type will increase the contribution according to the average contribution of others. Fischbacher et al. (2001) found that 30 percent of the subjects are “free rider types” who contribute nothing for all contributions of the other group members. Fifty percent show contributions that increase with others’ contributions—that is, they are “conditional cooperators.” The rest show other, more complicated patterns. Fischbacher and Gächter (2010) replicate these findings. How can the heterogeneity of individual motivations explain the fragility of cooperation (see Figure 1.5) that is so typical of repeatedly played cooperation experiments? The idea is simple. Conditional cooperators are prepared to cooperate if others cooperate. If they realize that others take a free ride, they reduce their contribution because they do not want to be “suckered.” Moreover, most people are also “imperfect conditional cooperators” who contribute more the more others contribute, but with a self-serving bias. Therefore, cooperation

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is bound to be fragile, even if most people are conditional cooperators. Free riders will speed up the decline of cooperation. Fischbacher and Gächter (ibid.) test this argument in two steps. They first show that players in a subsequent Public Goods Game make contributions that are largely consistent with their elicited contribution schedule. In the second step Fischbacher and Gächter (ibid.) use simulation methods. In the simulations, players are assumed to behave exactly according to their elicited contribution schedule. The interaction structure in the simulation is the same as in the experiment. The results show that the simulated contributions track the actual contributions surprisingly well. The relevance of this result is twofold. First, it shows that social preferences, rather than bounded rationality and learning, can explain the decay of cooperation. Second, the conceptual separation of motivations and outcomes, given the interaction structure in this public good experiment, has revealed that even though not everyone is motivated selfishly, the aggregate outcome is nevertheless one in which eventually everyone behaves selfishly. In the public goods experiment with punishment things are turned around. Here a few dedicated punishers suffice to give the free riders a selfish incentive to cooperate. Thus, in this case, it is the altruistic punishers who shape the aggregate outcome. As a last example we turn to the gift exchange experiments discussed above. Given the sequential structure of interactions in the Gift Exchange Game (contracts are concluded before effort decisions are made), profit-maximizing employers are well advised not to pay too low wages, for in that case effort levels will be low. Notice that employers do not have to be motivated by fairness, or any other-regarding motive to come to this conclusion; profit maximization suffices. As a consequence of these microlevel motivations the macrolevel outcome will be wage rigidity at nonmarket clearing levels (Figure 1.3). If contracts are complete, wages do converge toward market clearing levels. This observation, in combination with the findings under incomplete contracts, suggests two things. The microstructure of interaction (complete vs. incomplete contracts in this case) is decisive for the aggregate outcome. A second insight of these and numerous other experiments is that under complete contracts, social preferences do not matter for shaping the aggregate outcomes in competitive markets (recall Figures 1.2 and 1.3). Put differently, despite the fact that on average people are not selfish but motivated by gift exchange, markets with complete contracts are likely to converge to predictions derived under selfishness. See Gächter and Thöni (2011) for further examples and a more extensive discussion of these issues. discussion I have reviewed evidence from the most important games used to understand people’s social preferences and the interplay with material (selfish) incentives. The broad picture that emerges is as follows: 1) Many people behave in a nonselfish way even in one-shot games, although selfishness clearly exists. People transfer money in the Dictator Game, reject low offers in the Ultimatum Game, are trustworthy in the Trust Game, cooperate

60 Simon Gächter in the prisoner’s dilemma, contribute to public good, and punish free riders. These findings are evidence for the existence of “strong reciprocity”—that is, reciprocal behavior (rewarding nice acts and punishing mean ones) that is not motivated by strategic concerns (Gintis 2000b; Fehr, Gächter, and Fischbacher 2002). However, in all games, a non-negligible fraction of people also behave in a selfish way. Sociodemographic variables, in particular age, matter for the extent of prosocial behavior. Older people are on average more prosocial than younger ones. Put differently, since most experiments are done with undergraduates, results with students most likely measure a lower bound of the prevalence of prosocial motivations in the broader population (Falk, Meier, and Zehnder (forthcoming). 2) Strategic incentives matter. In sequential games, first movers have an incentive to take the motivations of their followers into account, irrespective of their own motivation. In games people play repeatedly with the same player or the same set of players, more prosocial behavior is typically observed, because selfish people also have an incentive to cooperate. Such effects are easily predicted within a rational choice framework. 3) If prosocial behavior becomes more expensive, it is less likely to occur. This observation is entirely consistent with a rational choice approach. The reason is that almost all people also value the payoff they can achieve in an experiment— that is, their utility is a function of their own payoff, as well as the payoffs of others (and possibly some other motivation, such as “doing the right thing,” being honest, and so forth). Thus there is often a tradeoff involved between one’s own welfare and the welfare of others; the more costly this tradeoff in favor of others becomes, the less likely it is going to be made. Taken together, observations 1 to 3 suggest first, substantial evidence for the relevance of social preferences and, second, that the existence of social preferences is not incompatible with a rational choice approach. Given the regularities, it is a fruitful avenue to develop theories of social preferences within a rational choice approach, because this approach allows investigating how social preferences and incentives to behave selfishly interact. In the next section, I will therefore discuss some influential attempts at modeling social preferences.

Modeling Social Preferences in a Rational Choice Framework Before embarking on specific theories of social preferences it is worth considering what these theories should be able to explain. The biggest challenge is to show why in some situations the outcomes of interactions appear consistent with predictions derived under the selfishness assumption, whereas in other situations behavior is clearly inconsistent with selfishness. For instance, in competitive market experiments, outcomes correspond largely to rational choice predictions under selfishness. Similarly, in the Public Goods Game without punishment, cooperation collapses and everyone appears as a free rider. By contrast, people are often trustworthy in the Trust Game, reject unfair offers, and punish free riders. These facts appear inconsistent, and any theory of social preferences should be able to address them in one framework. Theories of social preferences are typically rational choice theories that

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assume that people behave according to the rational choice framework. The only assumption that is changed is the selfishness assumption. The evidence reported above that behavior in simple experimental games is largely consistent with rational choice predictions, but inconsistent with selfishness in many games, justifies the methodological choice to retain the rationality framework and to amend the preference assumption. Changing preference assumptions is potentially problematic from a methodological point of view (Stigler and Becker 1977). However, unlike in the past, where no experimental data were available on which to base modeling assumptions, modelers can now use experimental data to justify their assumptions. Amending preferences requires not only basing them on psychologically plausible mechanisms but also on keeping the parameters fixed across games, at least for theoretical purposes (it is an empirical question whether this is a tenable assumption). In my discussion I will concentrate on models of inequity aversion, for two reasons: first, they are the most popular models to date, and second, they are easier to understand than other models developed later. An important element of scientific progress is testing theories and improving them in light of the empirical findings. After discussing inequity aversion I will therefore sketch some attempts to test elements of this theory and how these tests have influenced newer models. I refer the reader to Camerer (2003): ch. 2; Sobel (2005); and Fehr and Schmidt (2006) for comprehensive discussions. theories of inequity aversion The two major models of inequity aversion (which have been developed simultaneously and independently of each other) are due to Fehr and Schmidt (1999), and Bolton and Ockenfels (2000). I discuss the issues with the help of the widely used Fehr-Schmidt model. For simplicity, I confine my attention to two-player games, but note that the theory has been formulated for n-person games. The central assumption of models of inequity aversion is that players draw utility from their own payoff and disutility from unequal payoffs between comparison partners (“inequity aversion”). Inequity aversion exists in two forms, aversion to disadvantageous inequity and aversion to advantageous inequity. Aversion to disadvantageous inequality means that a player suffers from getting a lower payoff than the player’s opponent receives. Aversion to advantageous inequity means that a player also suffers from getting a higher payoff. Based on research by psychologists interested in social comparisons (Loewenstein, Thompson, and Bazerman 1989), the Fehr-Schmidt model assumes that the aversion to disadvantageous inequity is stronger than the aversion to advantageous inequity. Formally, the Fehr-Schmidt utility function for two players looks as follows: U i (πi, πj) = πi – αi max[πj – πi, 0] – βi max[πi – πj, 0], where πi (πj) denotes player i’s (player j’s) payoff, αi is the parameter that captures the strength of player i’s aversion to disadvantageous inequality, and βi measures the aversion to advantageous inequality. According to the results

62 Simon Gächter of Loewenstein et al. (ibid.) it is plausible to assume that αi ≥ βi. The model contains selfish preferences as a special case (αi = βi = 0). Notice also that the preference parameters can be different across individuals. The ambitious goal of this model is to explain the stylized facts outlined above. Going through all of them is beyond the scope of this chapter. I refer the reader to Fehr and Schmidt (1999) for further details. The idea of the model can be most easily explained with the help of the Ultimatum Game. Since the model retains the rationality assumption, the game is solved by backward induction. That is, we first analyze the responder’s behavior. Suppose the proposer (player j) offers a share s < 0.5 (of a pie of size 1). Will the responder i accept? According to the general Fehr-Schmidt utility function, player i’s utility is s – s] if i accepts. {s −α [1– 0 if i rejects.

Ui =

i

i

If player i rejects, that player’s utility will be zero. Accepting yields player i utility from the share s but disutility from receiving a lower payoff than the proposer j. The total disutility is the payoff difference weighted by the strength of aversion to disadvantageous inequity. The payoff difference between the responder and the proposer is πj – πi = 1 – s – s = 1 – 2s; the total disutility is therefore αi [1 – 2s]. Player i will accept if s – αi [1 – 2s] ≥ 0 ⇔ s / (1 – 2s) ≥ αi. If player i is not inequality averse (αi = 0), he or she will accept any offer s. If player i is inequality averse, αi will put a lower bound on which offer to accept. A rational proposer will therefore offer a share s that makes player i just indifferent between accepting and rejecting the offer. One can also look at the inverse problem of what the minimal acceptable offer s* is as a function of αi. It is easy to see that s* = αi / (1 + 2αi); s* = 0 if αi = 0 and s* approaches 0.5 if αi becomes very large. Thus a very strongly inequality averse player will accept nothing less than the equal split, whereas a selfish player will accept every offer. The Fehr-Schmidt model can explain not only the Ultimatum Game data; it can also explain why people punish free riders (to reduce their unfair payoff advantage) and why cooperation is increased (because free riders are better off cooperating to avoid punishment). But can it explain why competition in experimental markets seems to make social preferences irrelevant (Figure 1.2)? More generally, in games of competition very unequal payoffs are frequently accepted that are clearly unacceptable in two-player interactions. As an example, take the Ultimatum Game with responder competition. In this game there is one proposer and there are several responders. The rules are as follows. The proposer makes an offer and the responders decide simultaneously whether to accept or reject the offer. If more than one responder accepts the offer, it is randomly allocated to one of the accepting responders. The subgame perfect Nash equilibrium outcome of this game is the same as in the twoplayer case—the proposer reaps almost the whole pie and the responders all accept the lowest share possible. Fischbacher, Fong, and Fehr (2009) compared an Ultimatum Game with five responders to one with only one responder.

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The results are striking: in the treatment with five responders, responders accept very low offers (20 percent of the pie), which are clearly unacceptable in bilateral Ultimatum Games. The intuition for how the Fehr-Schmidt model explains these results is simple (the math is more involved). In the bilateral Ultimatum Games an inequity averse responder can punish a greedy proposer by rejecting the offer, which in turn gives the proposer an incentive to make a sufficiently high offer. The threat of punishment is much less severe if there are more responders. The reason is that people differ in their degree of inequity aversion—some are very inequality averse, whereas others are selfish and accept any positive amount. Since rejecting the offer will not change the fact that there will be inequity (given that some less inequity-averse responder will accept), even a very inequality averse player has an incentive to accept an unfair offer, to secure at least the utility from the material payoff. testing and theory development The impressive feature of the theories of inequity aversion by Fehr and Schmidt (1999) and Bolton and Ockenfels (2000) is the large range of experimental results they can explain. The parsimonious assumption of these models is that in addition to their own payoffs, decision-makers care only about inequity. How restrictive is this assumption? Charness and Rabin (2002) and Engelmann and Strobel (2004) designed simple allocation tasks in which participants have to choose between allocations with different payoff consequences.Take the following simple example: you have to choose between allocation A = (400, 400) and allocation B = (750, 400)—that is, in allocation A both get 400, and in B you get 400 but your coplayer gets 750. Inequity aversion suggests that you will choose A, because in B you get the same material payoff of 400 but you have to suffer from disadvantageous inequity. However, by choosing B you can help your coplayer at no cost to yourself, and this maximizes total payoff. Thus, concerns for efficiency might induce people to disregard inequity aversion. And indeed, Charness and Rabin (ibid.), who ran this experiment, found that 69 percent of their subjects chose B. The upshot of these experiments is that concerns for efficiency and “minimax preferences” (helping the least well off) are sometimes at least as important as inequity aversion. Another fundamental assumption in the theory explained above is that inequity aversion is solely “outcome-oriented,” by which I mean that players care only about what they get and not what they could have gotten (relative to others). Take the following example. Suppose that you are the recipient in a “mini-Ultimatum Game.” The proposer can choose between two allocations (8 for the proposer, 2 for you) or (5 for both). Consider a second game, in which the proposer can choose between (8,2) and (10,0). Now imagine you are confronted with the (8,2) offer in both cases. How do you decide in each of these cases? The theory of inequity aversion outlined above suggests that whether you accept or reject depends on your degree of disadvantageous inequity aversion (“your α” in the Fehr-Schmidt model).You will reject if your α > 0.33 and accept if α ≤ 0.33, and this is true in both games, irrespective of whether the alternative offer was (5,5) or (10,0); after all, the relevant outcome is (8,2) in both games. The data (by Falk, Fehr, and Fischbacher 2003) show

64 Simon Gächter that this prediction is clearly refuted: when the alternative is (5,5), 44.4 percent of people reject the (8,2) offer, whereas only 8.9 percent of people reject the exact same (8,2) offer if the alternative is (10,0). Thus, contrary to the FehrSchmidt model, alternatives matter, not just outcomes. How can we interpret this finding? When the alternative is (5,5) an (8,2) offer appears quite greedy, but the very same offer appears generous if the alternative is (10,0): choices from available alternatives reveal intentions and intentions matter. Theories of reciprocity build on the intuition that intentions and the perceived kindness of actions matter. Reciprocity means that a kind action is matched by a kind action and an unkind action with an unkind one. Rabin (1993) was the first to formalize this idea. For example, suppose I believe that you will cooperate in a prisoner’s dilemma I play with you. I might perceive your cooperation as a nice act and might reciprocate by cooperating as well. If our reciprocal motivations are strong enough, cooperation can be an equilibrium outcome. Defection remains an equilibrium too: if I believe you will defect, I think that is unkind and I reciprocate by defecting as well. Rabin’s theory is confined to static games such as the prisoner’s dilemma, and Dufwenberg and Kirchsteiger (2004) generalize it to dynamic games, such as the Ultimatum Game or the sequential prisoner’s dilemma.These approaches are motivated by experimental findings, but unlike the theories of inequity aversion by Fehr and Schmidt (1999) and Bolton and Ockenfels (2000), the theories of reciprocity are not meant to explain various games.The main goal of these theoretical approaches is to provide a coherent theoretical formalization of kindness and “reciprocity.” By contrast, Falk and Fischbacher (2006) developed a theory of reciprocity that is intended to predict better across various games than theories of inequity aversion by incorporating reciprocal motivations in addition to inequity aversion. For example, Falk and Fischbacher (ibid.) can explain the difference in rejections in the mini-Ultimatum Games reported above, whereas theories of inequity aversion cannot. However, the additional explanatory power comes at a cost of increased complexity of the theoretical framework. Probably the most important achievement of all these formal theories of social preferences is that they provide a precise language within a rational choice framework with which to talk about social preferences that did not exist prior to these theories. More generally, theories are useful not only for their predictive power but also for the insights they produce. These theories also demonstrate that one can do rational choice analyses of various social situations of interest and that such an analysis does not imply that rational agents are selfish. Rationality and selfishness are orthogonal to one another.

Conclusions The gold standard of science is empirical evidence. In this chapter I have discussed the usefulness of a rational choice approach for collecting empirical knowledge in various social situations of interest to behavioral and social scientists. I have concentrated on the empirical relevance of the selfishness assumption behind many applied models. My approach was mainly experimental.

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I hope that I have convinced the reader of two things: first, the rational choice approach is foremost a useful framework with which to analyze social situations of interest. It is useful, despite sometimes being descriptively inaccurate because this framework forces the researcher to ask the right questions. Without an exact theory about what selfishness entails and what would refute selfishness, this research program could not have succeeded. The debates would still be mainly philosophical rather than empirical. Second, the experiments have uncovered numerous regularities. As is common in the natural sciences, empirical regularities that are in contradiction to a particular theory can be used to improve theory. I have presented one approach and mentioned a few others, theories of nonselfish “social preferences” that have been developed on the basis of experimental regularities. These theories can be tested as well and improved on the basis of new evidence. The endeavor continues.

Note I am grateful for comments I have received from Siegwart Lindenberg, Manuela Vieth, and workshop participants at the Russell Sage Foundation in New York.

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70 Simon Gächter Johnson, Noel D., and Alexandra A. Mislin. 2011. “Trust Games: A Meta-analysis.” Journal of Economic Psychology 32, no. 5: 865–89. Kagel, John, and Alvin E. Roth. 1995. The Handbook of Experimental Economics. Princeton: Princeton University Press. Kahneman, Daniel, Jack L. Knetsch, and Richard H. Thaler. 1986. “Fairness as a Constraint on Profit Seeking—Entitlements in the Market.” American Economic Review 76, no. 4: 728–41. Kahneman, Daniel, and Amos Tversky, eds. 2000. Choices,Values, and Frames. Cambridge: Cambridge University Press. Karlan, Dean. 2005. “Using Experimental Economics to Measure Social Capital and Predict Financial Decisions.” American Economic Review 95, no. 5: 1688–99. Kreps, David, Paul Milgrom, John Roberts, and Robert Wilson. 1982. “Rational Cooperation in the Finitely Repeated Prisoners’ Dilemma.” Journal of Economic Theory 27, no. 2: 245–52. Lindenberg, Siegwart. 2008. Social Rationality and Well-being. Manuscript, University of Groningen, Department of Sociology. Loewenstein, George F. 2007. Exotic Preferences: Behavioral Economics and Human Motivation. New York: Oxford University Press. Loewenstein, George F., Ted O’Donoghue, and Matthew Rabin. 2003. “Projection Bias in Predicting Future Utility.” Quarterly Journal of Economics 118, no. 4: 1209–48. Loewenstein, George F., Daniel Read, and Roy F. Baumeister, eds. 2003. Time and Decision: Economic and Psychological Perspectives on Intertemporal Choice. New York: Russell Sage Foundation. Loewenstein, George F., Leigh Thompson, and Max H. Bazerman. 1989. “Social Utility and Decision Making in Interpersonal Contexts.” Journal of Personality and Social Psychology 57, no. 3: 426–41. Mas-Colell, Andreu, Michael D. Whinston, and Jerry R. Green. 1995. Microeconomic Theory. Oxford: Oxford University Press. Morton, Rebecca B., and Kenneth C.Williams. 2010. From Nature to the Lab: Experimental Political Science and the Study of Causality. Cambridge: Cambridge University Press. Nikiforakis, Nikos, and Hans-Theo Normann. 2008. “A Comparative Statics Analysis of Punishment in Public Goods Experiments.” Experimental Economics 11, no. 4: 358–69. Nowak, Martin A. 2006. “Five Rules for the Evolution of Cooperation.” Science 314, no. 5805: 1560–63. Oosterbeek, H., R. Sloof, and G. van de Kuilen. 2004. “Cultural Differences in Ultimatum Game Experiments: Evidence from a Meta-analysis.” Experimental Economics 7: 171–88. Ostrom, Elinor, and James M. Walker, eds. 2003. Trust and Reciprocity: Interdisciplinary Lessons from Experimental Research. New York: Russell Sage Foundation. Ostrom, Elinor, James M.Walker, and Roy Gardner. 1992. “Covenants with and without a Sword—Self-governance Is Possible.” American Political Science Review 86, no. 2: 404–17. Pillutlaa, Madan M., and J. Keith Murnighan. 1996. “Unfairness, Anger, and Spite: Emotional Rejections of Ultimatum Offers.” Organizational Behavior and Human Decision Processes 68, no. 3: 208–24. Rabin, Matthew. 1993. “Incorporating Fairness into Game-theory and Economics.” American Economic Review 83, no. 5: 1281–1302. Rustagi, Devesh, Stefanie Engel, and Michael Kosfeld. 2010. “Conditional Cooperation and Costly Monitoring Explain Success in Forest Commons Management.” Science 330, no. 6006: 961–65. Sanfey, Alan G., James K. Rilling, Jessica A. Aronson, Leigh E. Nystrom, and Jonathan D.

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Social Rationality, Self-Regulation, and Well-Being: The Regulatory Significance of Needs, Goals, and the Self

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siegwart lindenberg

Introduction Clearly, humans influence their own well-being, by and large in a way that is positive for their well-being, albeit not always for their well-being in the long run. Another way of saying this is that humans are bent upon improving their condition in an agentic way; they are thus self-regulators, and maybe this is the root meaning of “rationality.” In fact, this paper suggests that when we speak of rationality we should actually refer to self-regulatory processes. But then, the important question is of course how humans self-regulate. It seems to be a complex combination of processes, and this paper is devoted to presenting them in some detail. Any theory that would answer the question how humans self-regulate has to deal with what self-regulation may actually do. What are the recurrent problems that impact the well-being of humans and about which they can do something by self-regulation? For example, do humans need the subjective experience of needs? Do they have to be able to pursue goals? Do they have to deal with possibly conflicting goals? Do they have to deal with regulating their emotions? Do they have to deal with uncertainty? Do they have to have a sense of self? Do they have to understand other minds? The more we simplify the list of problems, the simpler the theory can be. However, if we make the list too simple, we will miss out on important aspects of how people influence their own well-being and how the environment helps or hinders them in this regard. For example, there are versions of rational choice theory that would assume that there is no other goal than maximizing one’s own utility (which is fully defined by stable preferences and given constraints) and that there are no preferences that could create problems of inner conflict. The theory also assumes that even though there are emotions, uncertainty, and problems with understanding other minds, one can safely abstract from these issues. This kind of rational choice theory then boils down to a theory of self-regulation for which almost all the problems about influencing one’s own well-being are shifted to the constraints—that is, to dealing with external resources, given the

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(shadow) prices of relevant goods, linked to a uniform self-regulatory capacity. The implication is that one can safely disregard differences in self-regulatory capacity. However, given such differences, the perceived constraints also differ. For example, for somebody with low self-regulatory capacity, changing longterm opportunities are not likely to have much effect.Worse, all constraints that affect self-regulatory capacity itself are ignored. Thus, for example, if somebody is surrounded by others with low self-control, his own self-regulatory ability will suffer (see Christakis and Flower 2007; Evans and Kutcher 2011). There is overwhelming evidence that self-regulatory capacity differs and that it matters for income, status, health, crime, and many other important outcomes of behavior that would possibly be covered by rational choice theory (see, for example, Moffitt et al. 2011). It differs as a trait but also by circumstance and by development over the life course. For social policy this may be a very important issue. As Moffit et al. (ibid.: 2697) put it: “Understanding the key ingredients in self-control and how best to enhance them with a good costbenefit ratio is a research priority.” We need a more complex theory of selfregulation, and I suggest that it is one that fully acknowledges the social roots of human rationality.

Social Rationality and Self-Regulation Maybe the best starting point to think about self-regulation is human evolution: due to evolutionary pressures, self-regulation and social regulation are intimately intertwined for human beings. The basic idea of a sociologically informed evolutionary theory is twofold: (a) there have been selective pressures concerning the individual with regard to self-regulation, but (b) for primates and especially for humans, living in groups has individual adaptive advantages if the groups can deliver collective goods. For primates, and humans in particular, the processes of getting offspring to be reproductive is much too complex to allow simple solutions to the collective good problem (such as protective advantages of swarms or the workings of chemical signals as in ant colonies; see Cacioppo et al. 2006; Hrdy 2009). This makes it likely that for humans, there was also group selection with regard to groups being able to make individuals contribute to collective goods (Wilson 2006). Dunbar (2003) has provided evidence for the fact that the human neocortex (which contains the frontal lobes with the “command post” of self-regulation [see Goldberg 2009]) has evolved mainly to allow higher primates to function in groups. For this reason Dunbar calls the neocortex “social brain.” Human neural, hormonal, cognitive, and motivational structures thus coevolved with the relational and group contexts, and there is a functional relationship between these individual and social structures in the sense that the human capacities developed for the sake of adaptive advantages that can be derived from the social context. In other words, much of human self-regulatory capacity is dedicated to making humans able to take care of themselves, to elicit the cooperation of others, and to be able to adequately cooperate with others. The functionality of self-regulation for one’s own well-being (one could say “one’s rationality”) is thus thoroughly social in nature. As a result of these evolutionary selective processes, there are many evolved

74 Siegwart Lindenberg and more or less automatic self-regulatory processes that make people want to do what is socially expected or socially adaptive. For example, bonding with one’s infant and mating are adaptively and socially very important processes that are to a considerable degree influenced by physiologically triggered shifts in preferences. Plasma oxytocin stimulates bonding behavior by the mother with her infant (Feldman et al. 2007). Oxytocin also affects interpersonal trust (Kosfeld et al. 2005). Various hormones thoroughly affect preferences when people fall in love (Fisher, Aron, and Brown 2006). Also, the brain works very much with cost/benefit calculations. Many animals, including humans, deal with scarcity of energy in such a way that exertion of energy is related to hardwired processes of cost-benefit analysis (via dopaminergic processes; see Denk et al. 2005; Niv 2007). In turn, what an individual considers cost and what benefit and the subjective expectations concerning cost and benefits are wide open to social influence. For example, in the evolutionary environment it was often adaptive to follow those who are visibly more successful than oneself. This leads to social imitation from the top down and to a probably hard-wired tendency to have one’s likes and dislikes be influenced by those one admires (status effect; see, for example, Cohen and Prinstein 2006; Galliani and Vianello 2012), by the group one identifies with (for example, Cohen 2003), and by how useful or thwarting things are for one’s goal pursuit (Ferguson and Bargh 2004). Similarly, the expectations about costs and benefits are heavily influenced by the stereotypes about social categories such as status, race, gender, and age groups; these stereotypes steer expectations about the competence of self and others, likelihood of success, trustworthiness, effort level, helping behavior, and so forth (Shelly 2001; Tiedens, Ellsworth, and Mesquita 2000). The development of the social brain went hand in hand with the development of quite a variety of self-regulatory processes. Self-regulation is thus not a uniform capacity. Rather, for each individual, there are multiple self-regulatory systems, subject to different degrees of volitional control. They may or may not act in harmony and answer different problems. For example, at one end of the continuum of volitional control, there is the autonomic nervous system, which regulates bodily functions such as heart rate but also sexual desire. Then there are processes like motivated cognition that serve selfenhancement and that are partially open to volitional control. At the other end there are highly controlled actions, such as suppressing a negative utterance in the face of the boss. In the following, I will try to sketch the architecture of selfregulatory processes. To simplify things, I will dichotomize the continuum and distinguish only between lower- and higher-order self-regulation. The lowerorder self-regulatory processes, such as self-enhancing biases, belong mostly to the “old” brain (for example, basal ganglia, thalamus). The higher-order regulatory processes, such as emotion regulation, belong mostly to the “new” brain (the neocortex, especially the frontal lobes) and govern (a) the situational appropriateness of lower-order self-regulation, (b) the balance between various lower-order self-regulatory processes, (c) resource-oriented behavior, and (d) norm-oriented behavior. The higher-order regulation steers processes in just about every region of the brain, while the lower-order regulation operates in a more localized manner. Even though they both steer self-regulation, there is an important difference: the degree to which context is taken into account

Social Rationality, Self-Regulation, and Well-Being Goal-related self-regulation

Need-related self-regulation

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Self-related self-regulation

figure 2.1. Three inter-related sets of self-regulatory processes

(Goldberg 2009). For example, the more hungry people are, the more they will focus just on eating and the less they will consider matters of taste, ownership, etiquette, longer-term health effects, and the like. By contrast, higher-order processes push back this immediacy and singular focus in favor of attention to ownership, etiquette, health, and so on. The social brain is involved in a number of different sets of self-regulatory processes that are interrelated but should also be studied separately. There are features of human functioning that are not traditionally looked at as belonging to self-regulation but that in fact can fruitfully be treated as such. For example, needs themselves, not just need satisfaction, can be interpreted as part of selfregulation. I will discuss three sets (see Figure 2.1): need-related self-regulation, goal-related self-regulation, and finally self-regulation dedicated to stabilizing the self. In each set, we find lower- and higher-order self-regulatory processes that are of great importance for the work of sociologists because they strongly affect social and institutional problems and problem solutions.

Fundamental Needs as Self-Regulatory Mechanisms The concept of “need” (as different from “want”) is not very sharply defined, but it basically refers to the combination of finding something rewarding, being aroused to seek satisfaction, and experiencing pathological effects from deficits in satisfaction (with the last characteristic missing in wants; see Deci and Ryan 2000; Baumeister and Leary 1995). A person whose basic needs are unfulfilled will have a low score on well-being. This view is by now widely shared (Deci and Ryan 2000; Lyubomirsky, King, and Diener 2005; Maslow 1971; Baumeister and Leary 1995; Steverink, Lindenberg, and Slaets 2005). The self-regulatory aspect of needs is that they are cognitively represented and set in motion action toward their satisfaction. Thus having a certain need also means having a self-regulatory mechanism to do something about its satisfaction (not necessarily consciously; see Tiffany and Conklin 2000). Adaptation to a changing environment under selective pressures can thus lead to the development of new needs. These new needs make the organism find things rewarding that are adaptive in the new environment and to go after the new rewards. From the point of view of the social brain, the main innovation in needs for primates and especially for human beings is social needs, and needs concerning resources that are, to a large extent, tied to the social context. Thus we have to identify what these needs are. For this purpose, we also have to identify physical needs, because their satisfaction is likely to interact with the satisfaction of social and resource-related needs.

76 Siegwart Lindenberg The identification of needs from this evolutionary view has been worked out over the years under the name of social production function theory (SPF theory).1 In order to stress the important role of resources and of self-regulation concerning the acquisition and use of resources, the approach taken by SPF theory is that need satisfaction can best be viewed in terms of production functions (see also Stigler and Becker 1977). Human beings are producers of their own well-being in terms of need satisfaction. A particular level of need satisfaction (the output) is “produced” by a particular input. For this reason, we will first deal with production needs, before we come to discuss substantive needs. production needs: autonomy, competence, safety⁄security, and structure Self-regulation by needs first of all focuses on needs that are related to the quality of the production function (improvement of the input/output ratio in production functions). Because deficits in need satisfaction are damaging, effectiveness of given resources is of great importance and has found its way into self-regulation by needs. First of all, autonomy is essential for choosing inputs in production functions (according to their effectiveness), and Ryan and Deci claim that autonomy is a basic need even in collectivist cultures (see Chirkov et al. 2003; see also Leotti, Iyengar, and Ochsner 2010). Secondly, competence is important for resource use (see also Deci and Ryan 2000). To improve one’s competence is to improve the amount of output (need satisfaction) for a given amount of input. For example, improving one’s social skills allows one to gain social approval with less effort or fewer resources. This need to improve one’s competence may be strongest in childhood. White’s view of “mastery” (1959) and Bandura’s concept of “self-efficacy” (1997) refer to the result of the satisfaction of this need. In certain cultures, this need for improving one’s competence can become strongly emphasized and linked to identity formation, in which case it would cover what Maslow (1971) called “self-actualization” (see Lindenberg 1996). The quality of a production function also depends on stability conditions. For example, when the effectiveness of a given means changes in unpredictable ways, self-regulation becomes difficult or impossible. Highly insecure property rights or random violence paralyze self-regulation and even reduce cognitive abilities. For being able to invest in the future, predictability is especially important. Human beings need a certain amount of safety/security (including stability/predictability) with regard to their production functions and, being bent on improvement, they will do something about it (Heiner 1983; Maslow 1971; Mendes et al. 2007). This need can also be interpreted as a desire for the world to conform to expectations about possibilities for goal achievement. Related to safety/security is the need for structure (or order), which has been given a prominent place in the literature. It is also a production need in the sense that agentic need satisfaction depends on having or creating “meaningful” situations—that is, situations with discernible structure (Neuberg and Newsom 1993; Proulx, Heine, and Vohs 2010). This need may actually be in the service of aiding predictability. In short, striving for autonomy, competence, safety/security (with stability, predictability), and structure can be taken to be basic human “production

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needs” that evolved through the adaptive advantage of individuals who are bent on improving their condition in an agentic way. substantive needs: physical and social well-being Already in Durkheim we find a strong emphasis on what he calls “the dual character” of humans: “man is double, that is, social man superimposes himself on physical man” (Durkheim 1951 [1897]: 213). Both sides have their own needs. This is also the view derived from the social brain hypothesis. Small wonder that in one way or another, this dichotomy keeps turning up.We find it in Maslow’s need hierarchy (1971) (physiological needs and love/belonging and esteem needs). We also find it in Ford’s taxonomy (Ford and Nichols 1987; and Ford 1992), which is based on a dichotomy of “within person” (for instance, arousal, physical well-being), and “person-environment” needs (for instance, superiority, belongingness). Physical needs What are the most plausible candidates for universal physical needs? There is, of course, a question about the level of abstraction. A great number of concrete needs can be taken together under the concept of comfort. “Comfort” refers to the degree to which a person is free of noxious stimuli (such as hunger pangs, thirst, pain, and so forth).There is a general need to increase one’s own comfort. This is not exclusively a human need, but some stimuli that create discomfort may be specific to humans (such as sympathetic reactions vis-à-vis suffering others), or even specific to cultures (such as reactions to being exposed to certain sounds). A second plausible candidate for a universal physical need is the opposite of tension reduction: seeking excitement, arousal, satisfying curiosity. Ford and Nichols (1987) list both arousal and exploration as basic needs. There is overwhelming evidence that individuals seek arousal, which led Hebb (1958), Berlyne (1960), and others to abandon the classical drive theories in favor of a theory of arousal, or electrical activity of the brain. Far from seeking either comfort or arousal, individuals often seek both at the same time. A need for arousal and exploration can be covered by the concept of the need for stimulation (see also Scitovsky 1976;Wippler 1990).These needs can be reliably measured (see Nieboer et al. 2005). Social needs The needs on which social well-being depends have been variously identified by philosophers, anthropologists, sociologists, and psychologists.There is a great deal of convergence among them, in the sense that everybody is agreed on the fact that human beings crave a positive opinion from other human beings. The universality of a need is best examined from the point of view of evolution. From this and, as we will see, also from a sociological point of view, it makes sense not to lump all forms of social approval into one. There are first the two quite distinct approval needs, variously identified in the literature as status (domination, prestige) and affection (love, attachment, intimacy). This distinction also links to Bakan’s concepts (1966) of agency and communion needs. However, for Bakan (ibid.) and his followers (such as McAdams et al. 1996), agentic needs covered both production needs (for example, autonomy) and substantive needs (such as

78 Siegwart Lindenberg status) under one concept. As already mentioned, from a self-regulatory point of view, it is useful to separate these needs (see Steverink and Lindenberg 2006). Let me begin with status. Status. The evolutionary view that status is a universal human need may have become established with Barkow (1989), who pointed to the importance of relative standing for preferential access to resources (for example, mating opportunities, food, allies) and the likelihood that primates have been selected to seek higher relative standing. It is important to observe that for humans, the basis for status differences has shifted in the course of evolution from domination toward prestige, with a related shift in strategies to achieve and maintain status (Gilbert 2003). In dominance hierarchies, status is related to coercion, threats, and inspiring fear, whereas in prestige hierarchies, status is related to the display of competence and talent and to eliciting positive affect (such as admiration; see also Gilbert and McGuire 1998, Galliani and Vianello 2012; van Vugt 2006). However, even among humans, domination hierarchies have not vanished and may even merge with prestige hierarchies (see Fessler 2004; Halevy et al. 2012). Besides the evolutionary research, empirical evidence for the ubiquity of status striving comes from various contemporaneous sources. For one, there is historical evidence, such as the research by Max Weber concerning the importance of “honor” in virtually every society. Second, Steverink and Lindenberg (2006) found that older people who don’t seem to care about status anymore, do care and profit for their own well-being from status pursuit, if the opportunity for such pursuit arises. Third, Frank (1985) provides much evidence for the ubiquity of status striving in contemporary society. Fourth, the claim that status as a goal in itself is universal has recently received experimental support by a study of Huberman, Loch, and Önçüler (2004). All in all, the evidence strongly speaks for the assumption that status striving is a universal need. However, there is also the other side. In order to get status that is not based on threat or fear, there must be people who grant status. Social needs must have evolved with their counterpart, so the need for acquiring status must have evolved with the need to evaluate others in terms of their valued skills and possible or actual contribution to the collective good, flanked by emotions (such as deference and admiration, superiority) (Ridgeway et al. 1998; Galliani and Vianello 2012; Halevy, Chou, and Galinksy 2011). Affection. The insight that affection is a need may seem obvious today (see review by Pendell 2002), but there were times when influential people were convinced of the opposite. Orphanages and charity for adults in the nineteenth and first half of the twentieth century were mainly focused on physical aid, and expert opinion even found affection a potential danger (see Blum 2002). In the early 1940s, Maslow (1943) presented a very different picture. He described love and affection as basic needs and maintained that “practically all theorists of psychopathology have stressed love needs as basic in the picture of maladjustment. Many clinical studies have therefore been made of this need and we know more about it perhaps than any of the other needs except physiological ones.” Despite this pronouncement, the need for affection became widely accepted only after the famous study of rhesus monkey infants by Harlow (1958), Maslow’s teacher. Roughly at the same time, Bowlby and Fry (1953) researched the importance

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of secure attachment of children to certain adults. Even though attachment (as protection against threat) is not exactly the same as affection (see MacDonald 1992), the two concepts are often confounded, and Bowlby’s research helped to draw professional and public attention to the importance of affection. Many have since proclaimed a need for affection (Schultz 1958). Seen from an evolutionary point of view, the important role of affection (warmth) is connected to the social brain (Dunbar 2003). The relatively larger neocortex of human beings allows living in larger groups but also necessitates what MacDonald (1992) calls “high-investment parenting.” The long period of dependency of the infant requires prolonged parental care (especially motherchild) and support from the male partner, secured through pair bonding (see also Buss 1994), and from others (Hrdy 2009). Affection facilitates both pair bonding (Weisfeld 1999) and positive parenting (Russell 1997), including nurturance, empathy, and transfer of scarce resources, and it increases a child’s willingness to be influenced by the adult (Eberly and Montemayor 1999). Cultural transmission, so important for culling adaptive advantages from living in groups, is greatly aided by this willingness to be influenced (Euler, Hoier, and Rohde 2001). There is also considerable evidence that deprivation of affection leads to psychopathology and ill health. For example, Uchino, Cacioppo, and KiecoltGlaser (1996) and Cacioppo et al. (2000) review a great number of studies which show that affection (emotional support) has reliable positive effects on physiological functioning, and lack of affection has negative effects (impaired cardiovascular functioning, hormonal functioning, immune functioning). Behavioral confirmation. In evolutionary terms, the great importance of group membership for one’s own adaptive advantages makes it likely that there has been a selective pressure to be sensitive to signals about one’s standing in the group and that a need has developed to feel accepted by the group. Baumeister and Leary (1995: 497) had called this “need to belong” a “powerful, fundamental, and extremely pervasive motivation.”They too link this need to its evolutionary roots about the importance of belonging to a group. Because the “need to belong” is actually a mixture of the group-related need and affection, and because the two should be treated separately, I use a different term, “behavioral confirmation” (see Lindenberg 1996), even though that term is also used in the literature to indicate a specific aspect of the sensitivity to the opinion of others—namely, that people become what they believe others think of them (see Snyder and Klein 2005). The term “behavioral confirmation” as used here refers to the fact that in virtually everything they do (including uttering opinions and expressing feelings), people seek the confirmation of others. Status and affection are something else. Status is a relative standing within the group, and affection is social approval central to close relationships and generally more unconditional than behavioral confirmation (see Baldwin and Sinclair 1996). Feeling accepted and confirmed by the group (irrespective of one’s status position and irrespective of affection in close relationships within the group)2 is a separate social need. Failure to conform to group standards is often accompanied by negative emotions, prominent among them shame (Fessler 2004; de Hooge, Breugelmans, and Zeelenberg 2008). All three social needs can be reliably measured (see Nieboer et al. 2005).

80 Siegwart Lindenberg Lower-order and higher-order need-related self-regulation Lower-order self-regulation via needs consists most of all of the ability of need states to affect cognitive and motivational processes in the service of adaptive behavior.This is not a conscious process, and it can go wrong (Tiffany and Conklin 2000). For example, there is much research on people not knowing what they want (Ariely, Loewenstein, and Prelec 2006; Hsee and Hastie 2006), or people being subjectively wrong about thinking they want something (Gilbert and Wilson 2000). A related lower-order self-regulatory process has to do with a particular sensitivity to situational opportunities. It works via cues in the environment that trigger urges. The limbic system can amplify the incentive salience of reward cues in the environment, which makes a person temporarily change preferences as a result of the opportunity of getting a particular reward at that moment. Since lower-order self-regulatory processes disregard the wider context (such as longer term behavioral consequences), this cue sensitivity can also be the source of adaptive problems that have to be dealt with by higherorder self-regulation (see, for example, Bernheim and Rangel 2004). Social emotions are self-regulatory devices to help satisfy social needs and to indicate that behavior might have to be changed for better need satisfaction. For example, the negative affect produced by social disapproval helps alert people to the danger of being rejected by the group and to adapt their behavior in such a way that they are accepted. Leary (see Leary et al. 1995; Leary and Baumeister 2000) has called this mechanism “sociometer.” The sociometer effect, however, is limited. As mentioned above, it is one of the defining characteristics of a need that a deficit in need fulfillment will lead to pathological consequences. Thus, if for example behavioral confirmation is a need, then deprivation in this area can also lead to pathological consequences rather than to functional repair work. Once the deficit in behavioral confirmation is large (for example, when one is fully rejected by one’s ingroup), there is little impetus left to make amends. At best, if one is optimistic about success, one seeks new circles (Maner et al. 2007). A large deficit in behavioral confirmation may altogether reduce goal-directed behavior at restoring it.Thus one may lose agentic pursuit of need satisfaction (say, through becoming lethargic; see Twenge, Catanese, and Baumeister 2003), become hostile toward one’s own (former) ingroup (Twenge et al. 2001; Maner et al. 2007), and become less likely to act in a prosocial way, even to others outside one’s former group (Twenge et al. 2007). Higher-order need-related self-regulation An important higher-order form of self-regulation is the ability of the brain to deal with scarcity of resources, especially energy (see Denk et al. 2005; Niv 2007). Humans (and also other animals) deal with scarcity of energy in such a way that exertion of energy is related to hard-wired processes of cost-benefit analysis. However, these cost-benefit calculations are often not conscious. For humans, in any case, the inputs into these calculations, such as expectations and evaluations, are subject to influence from the environment. Other important higher-order need-relational forms of self-regulation concern the ability to be agentic and stay agentic in the face of failure and the ability to balance the satisfaction of needs (Steverink, Lindenberg, and Slaets 2005).

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The ability to be and stay agentic refers to the capacity to gain and maintain a belief in personal competence, control, or self-efficacy (Bandura 1997). It also refers to the ability to keep a positive frame of mind, even in adversity. People with a positive frame of mind are less likely to be discouraged and to become paralyzed in the face of rejection (Pass, Lindenberg, and Park 2010) or failure (Taylor et al. 2003), whereas negativity can create emotional and behavioral disorders (Lengua and Long 2002). The ability to balance need satisfaction concerns the capacity to seek out synergetic satisfaction of various fundamental needs and the capacity to balance needs satisfaction now and in the future. A synergetic kind of need satisfaction (also called “multifunctionality”; see Steverink, Lindenberg, and Slaets 2005) leads to higher levels of well-being (Sheldon and Niemiec 2006) and makes resources that allow multifunctional satisfaction of physical and social needs (such as intimate partners) particularly important (Nieboer and Lindenberg 2002). The definition of a good intimate relationship is virtually identical with multifunctionality: the relationship is stimulating, physically comforting, socially affectionate, and it increases both a feeling of self-worth (status) and a sense of belonging (behavioral confirmation). The satisfaction of each of these needs can aid the satisfaction of the other needs (synergy). This implies that multifunctionality is particularly productive of subjective well-being and that loss of multifunctional relationships belongs to the most dramatic reductions in subjective well-being (see Nieboer, Lindenberg, and Ormel 1998–99; Lane 2000). Balancing short-term and longer-term need satisfaction has important positive effects on well-being (Prenda and Lachman 2001).When impaired, this kind of self-regulation may be the most damaging for well-being (see Moffitt et al. 2011), and it does not concern only the satisfaction of needs but also the balance of overarching goals (see below). Disturbances in need-related self-regulation (and thus deficits) can derive from highly asymmetric salience of one of the needs. For example, substance addiction will increase the need for comfort to a degree that it interferes with multifunctionality (Hirschman 1992). Also, a particularly high need for stimulation creates high risk taking and jeopardizes the satisfaction of the other needs (see Sijtsema et al. 2010). People with a particularly high need for status tend to dominate and thereby reduce the ability to realize both affection and behavioral confirmation (see Sijtsema, Veenstra, Lindenberg, and Salmivalli 2009).

Self-Regulation via Goals Self-regulation concerning needs overlaps with another set of self-regulatory processes that are distinctive enough to be treated separately: goals. Goals are mental representations of desired states, but they are at the same time elaborate processes of self-regulation. Lower-order goal-related self-regulatory processes contain (a) the ability to monitor the degree to which a goal that is presently focal has been achieved, to detect errors, and to react to this information in such a way that, when the goal is realized, one turns to another goal, or, when progress is not satisfying, to take action for improvement (see Carver

82 Siegwart Lindenberg and Scheier 1998). They also contain (b) emotional responses to success and failure in goal-pursuit that aid in a quick determination of the direction of action (approach or avoidance, see ibid.). Finally (c), they contain the ability to deal with goal conflicts by inhibiting incompatible goals. Goal pursuit is not necessarily conscious (see Bargh et al. 2001). overarching goals and goal-framing theory Other self-regulatory functions of goal-processes (including higher-order self-regulation) are particularly present in overarching goals. Overarching goals are all by themselves a form of self-regulatory devices because, when they are activated (“focal”), they coordinate a great number of cognitive and motivational processes. This allows the individual to be focused and prepared for action (all the way to the motoric level) at the same time. When such a goal is focal, it organizes cognitions and evaluations in a semimodular way and it selectively activates hardwired and learned modules. A focal high-level goal can thus be seen as a composite module, comprising a particular selection of semimodules and hardwired and learned submodules. In that sense, goals create domain specificity and selective sensitivity to specific inputs. For example, the highlevel goal “to act appropriately” is likely to make situationally relevant norms more cognitively accessible; make people particularly sensitive to information about what is expected; activate the modules to process information on gaze and on certain facial expressions of approval and disapproval; and activate response tendencies and habitual behavioral sequences concerning conformity to norms (such as facial expression, shaking hands, keeping a certain distance to the other person, helping in need, and so forth). It also activates expectations about how other people are likely to act and positive evaluations of the means to reach the goal (Ferguson and Bargh 2004). This power of overarching goals to coordinate a large number of cognitive and motivational processes is the basis for the goal-framing theory on overarching goals (Lindenberg 2001b, 2006, 2008; Lindenberg and Steg 2007).This theory specifies three goal-related self-regulatory processes: a. the ability to have goals that set the mind by coordinating cognitive and motivational processes (“overarching goals” called “goal-frames” when activated); b. specific overarching goals that regulate tasks that are instrumental but different from need satisfaction; c. processes that balance the relative strengths of overarching goals in favor of adaptive behavior. Three goal-frames Goal-frames are activated (that is, focal) overarching goals; they “frame” the mind. Need satisfaction refers to many different needs, but the overarching goal with regard to need satisfaction is to improve (or maintain, as the case may be) the way one feels at the moment. Thus the most basic goal-frame is what is called a hedonic goal-frame. It activates one or more subgoals that promise to improve the way one feels in a particular situation (such as avoiding effort, avoiding negative thoughts and events, avoiding direct uncertainty, seeking direct pleasure, seeking direct improvement in self-esteem, seeking excitement,

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and the like). Its time horizon is very short and the criterion for goal realization is an improvement in the way one feels. People in a hedonic frame are also especially sensitive to what increases and what decreases their pleasure and affects their mood. For example, in a hedonic goal-frame, people are likely to react much more strongly to being made to feel bad, say, by being treated unfairly, than in the other two goal-frames. As overarching goal, the hedonic goal-frame is not purely a lower-order self-regulatory process but, surely in comparison with the other two overarching goals, it is strongly linked to lowerorder processes (McClure et al. 2004). The hedonic goal-frame is oriented toward the here and now. The ability to be concerned about resources in a focused way comes from another overarching goal, which, when activated, is called a gain goal-frame. It will make people very sensitive to changes in their personal resources. Its time horizon is middle- or long-term, and the criterion for goal realization is an improvement of (or prevention of decrease in) one’s resources or efficiency of resources. When this goal is focal, subgoals having to do with resources (such as saving money, increasing one’s income, dealing with threats to one’s financial security) will be easily activated; and subgoals, having to do with the way one feels and with normative behavior (see below), will be more or less inhibited—that is, they are pushed into the cognitive background. Even though both hedonic and gain goal-frames can be said to be linked to rewards, they are linked to different kinds of rewards and to different time perspectives, even in the neural systems (McClure et al. 2004). Note that norms can play an important role in a gain goal-frame to the degree that the individual is focused on costs for norm-conformity. For example, cheating is against the established norms, but in a gain goal-frame only the expected costs (say, in terms of a fine or reputational damage) of cheating will be considered, not any feeling of “obligation.” For people in gain goal-frame, when a particular good in the supermarket is more expensive than another of comparable quality, not much attention will be paid to the fact that one was produced in an environmentally friendly way while the other was not, even if the person values a sustainable environment. In short, in such a goalframe, norms play a role only as sources of constraints (such as disapproval or a fine). A gain goal-frame flanks need satisfaction in the sense that it focuses on the resources necessary for need satisfaction. However, the social brain also contains a goal-modus in which individuals focus on being members of a group. When activated, it is called a normative goal-frame, which covers all sorts of subgoals associated with appropriateness (such as behaving the right way, contributing to a joint project, showing exemplary behavior). It will make people especially sensitive to what they think one ought to do. When in a normative goalframe, the important aspects of a situation are normative, both in the sense that one is sensitive to “oughts” according to self or others and in the sense that one is sensitive to what one observes other people do (corresponding to the distinction made by Cialdini, Reno, and Kallgren [1990] on injunctive and descriptive norms). For example, a person in a normative goal-frame is not likely to throw a piece of trash on the street because that is inappropriate.When people are in a normative goal-frame, subgoals having to do with the way one

84 Siegwart Lindenberg feels and with personal resources are pushed into the cognitive background. Thus, for example, people who see a situation as a joint project (in a normative goal-frame) will contribute more to a collective good than people who see the situation as an “economic” one (in a gain goal-frame, see, for example, Pillutla and Chen 1999). A normative goal-frame is linked to feelings of “oughtness” about situationally relevant norms. This feeling contains at least three elements: the subjective importance of the norm; the tendency to react negatively to norm violations by others; and a tendency to feel obliged to follow the norm oneself. Like the other two goal-frames, the normative goal-frame is also linked to a particular neural system (Mendez 2009; Moll et al. 2005). Balance: background goals and the a priori strength of goal-frames There are two important additional points to be made about the goal-frames that have to do with higher-order self-regulation. The first point concerns the fact that the modularity of goal-frames is porous, that it is open to some influence from the background goals, an important reason for modularity to be “semi.” This makes possible the advantage of focus and coordination derived from overarching goals without the cost of complete neglect of the other two overarching goals. From the cognitive background, the other two overarching goals can strengthen or weaken the relative weight of the foreground (focal) goal. Motivations are thus rarely totally homogeneous, as we know from experimental evidence and daily experience. More often than not they are mixed, and it depends on the relative strength of the foreground and background goals to determine what the final effect will be. For example, the goal to eat (a hedonic goal) may be focal and the goal to remain healthy (a gain goal) may be in the background. Köpetz et al. (2011) showed that when the goal to eat is activated and its salience is boosted, then subjects, asked to choose between various kinds of foods, do not make much difference between high- or low-caloric foods; they eat almost everything that is equally tasty. By contrast, when the focal goal to eat is not boosted, then subjects are still focused on food, but the background goal (health) becomes relatively stronger and subjects become quite discriminating: they choose more low-caloric food. These effects of background goals imply that even in a dominant normative goal-frame considerations about gains are not completely gone. Conversely, experimental evidence shows that people rarely act completely egotistically, even if their main goal is gain. Rather, even then they seem to be somewhat restrained by normative concerns (see Camerer 2003; Ligthart and Lindenberg 1994). At any time, one goal is focal and influences cognitive process the most (that is, it is a goal-frame), while other goals are in the background and increase or decrease the strength of the focal goal to a greater or lesser degree. How does this work? Often the goal-frame and background goals will be in conflict. For example, if being cooperative is quite expensive, the normative goal-frame and the gain goal in the background are incompatible. This may not change the goal-frame from a normative one to a gain goal-frame—that is, the background motive may not affect the orientation (the ordering of alternatives is still in terms of appropriateness, not in terms of price), but it may lead to the choice of a less appropriate (but cheaper) alternative. In this case, price will affect the choice

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but less than appropriateness. If goal-frame and background were reversed in this example, appropriateness concerns would affect the choice less than price (see examples below). The background goals do not necessarily weaken the workings of the goalframe. When they are compatible with the goal-frame, they strengthen it. This is particularly important for the normative goal-frame, which, as I will discuss in a moment, is a priori the weakest goal-frame that needs the most support (from compatible background goals) in order to withstand the weakening effect of conflicting background goals. What actually happens is that alternatives may serve both the focal and the background goal(s) to various degrees. For example, up to a point, community pharmacists may both advance their professionalism and commercial interests. But when making profit becomes more prominent, the two goals become conflictual (see Cancrinus et al. 1996). When there is a conflict, alternatives that serve background goals the best serve the focal goal quite badly, and vice versa. When there is compatibility, alternatives that serve the focal goal well will also serve the background goal well. As will be shown, this is the basis for balancing the overarching goals. Often, both compatible and incompatible background goals will be present. In sum, motives are mostly mixed in the sense that both foreground and background goals are operative. For example, the normative and gain motives often mix, but it makes a big difference whether people are in a gain goalframe and don’t go all out in the pursuit of gain, or whether they are in a normative goal-frame and cut corners because of the influence of gain motives. This difference lies in the fact that the focal goal, and not the goal(s) in the background, governs the selection and representation of preferences and constraints. Second, a priori, the three goal-frames are not likely to be equally strong.This asymmetry is a lower-order self-regulatory device that makes great evolutionary sense. The hedonic goal-frame, being directly related to need satisfaction and thus being the most basic, is very likely to be a priori the strongest of the three goal-frames. In other words, in order to displace the hedonic goal from the foreground, the gain and normative goals must have additional supports. Because, in evolutionary terms, the group is there for the adaptive advantage of the individual and not the other way around, the normative goal-frame is, a priori, the weakest. The gain goal-frames, being linked to one’s own resources, is in between. In order to withstand the onslaught of conflicting hedonic goals, gain and normative goal-frames need to be supported by compatible goals in the background. These supportive background goals are, in turn, often dependent on institutional arrangements. As Weber (1961) has shown, the gain goal-frame needs institutions (such as religion or secure property rights) that allow the individual to act on behalf of a reasonably well-established future self. The normative goal-frame is even more dependent on external support, be it through institutions and moralization (see Lindenberg 1983, 1992; Rozin 1999), or explicit disapproval for not following the norm (see Tangney and Dearling 2002). Just how precarious the normative goal-frame is can be demonstrated with an experiment we performed, concerning the norm of stealing (Keizer, Lindenberg, and Steg 2008). We placed a very noticeable envelop with a

86 Siegwart Lindenberg transparent window in a public mailbox, but we did it in such a way that it stuck out and people walking by could clearly see what was inside. What they could see was a five Euro bill peaking through the window of the envelope. The question was how many people who passed the mailbox would go so far as to take the envelope with them. The results showed that without graffiti 13 percent of all passersby took the envelope, and that with graffiti this percentage more than doubled (27 percent). Thus, if one lives in an environment with many indicators of low concern for acting appropriately, there is a risk that self-regulation will be impaired simply because of disorder in the social environment. Balance: changing the relative weight of gain and normative goal-frames The relative weakness of the gain and normative goal-frames compared with the normative goal-frame would mean a permanent dominance of the hedonic goal-frame were it not for the higher-order self-regulatory capacity to seek and or create extra support for the a priori weaker goal-frames. Goalframes cannot be directly chosen, but they can be made more likely or more stable by changing the environment, by distraction, or by conjuring up images (Mischel and Ebbesen 1970). In the literature, this is often referred to as “selfdiscipline”—that is, an effortful resistance to being tempted by hedonic goals at the expense of gain or normative goals (Baumeister and Vohs 2007). But because the gain goal is still relatively stronger than the normative goal, selfdiscipline is also applied to situations in which people are tempted by personal advantage not to act normatively (Keizer et al. 2008). Self-discipline is thus a particular kind of self-regulation that has to do with balancing the overarching goals by effortful control. When the weaker overarching goals have relatively little support, they can be strengthened somewhat by effortful control. However, this uses both physical and mental energy and leads to depletion, which in turn diminishes the relative weight of the normative goal-frame (DeWall et al. 2008) or of the gain goal-frame vis-à-vis the hedonic goal-frame by increasing risk-taking (Freeman and Muraven 2010). The ability to regulate one’s emotions also belongs to this realm of self-regulation. Emotions such as fear or anger make it difficult to sustain a gain or normative goal-frame, and they can be socially very disruptive. Emotion regulation is a crucial element in social competence (see Denham et al. 2003; Schultz et al. 2001), and lack of it can have severe longterm consequences in terms of occupational downward mobility, erratic work lives, and problematic partner relationships (see Caspi, Elder, and Bem 1987). The inability to self-regulate hedonic goal-frames also makes people smoke and eat more than they would like to, lowering their subjective well-being (see Stutzer and Frey 2007). The point is not that successful self-regulation does away with the hedonic goal-frame. Not showing emotions when it is called for (say, when your mother dies) is socially also inadequate. Some people have managed to stabilize their normative goal-frame to such an extent that they have to plan times for hedonic experiences (see Kivetz and Simonson 2002). Conversely, temptations are not always a danger for the stability of a normative goal-frame. It has been shown that being exposed to temptations can actually strengthen the normative

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goal-frame (see Fishbach, Friedman, and Kruglanski 2003), so that normative goal-frames in very sheltered environments may be particularly susceptible to the rare intrusion of hedonic or gain opportunities (think of Dürrenmatt’s play “The Visit of the Old Lady”). There are supports for the weaker goal-frames that lower the needs for effortful control and thus also lower depletion effects.3 From what was said above about the power of cues that show deviant behavior, it follows that a very important source for weakening or strengthening the normative goal-frame is the behavior by others. In other words, very important social influences derive from the fact that the goal-frame of people in the surrounding also influences the stability of one’s own goal-frame (“goal-frame resonance,” see Lindenberg 2000; and “goal contagion,” see Aarts, Gollwitzer, and Hassin 2004). Hence, one of the most basic forms of self-regulation is to remove oneself from unwanted sources of influence, either physically or by shifting attention (Hoch and Loewenstein 1991; Mischel and Ebbesen 1970), or by removing the unwanted sources of influence themselves.Thus, for example, cleaning up physical disorder is likely to stabilize people’s self-regulation (by removing cues of other people’s transgressions; see Keizer et al. 2008). But there is also social disorder, and one may or may not be able to clean it up. For example, the behavior of high-status people showing disrespect for norms has a particularly strong effect on the normative goal-frame (Cohen and Prinstein 2006). This means that politicians and celebrities can have a considerable negative influence on people’s selfregulatory ability, an effect that is exacerbated by the fact that the powerful often use norm violations to demonstrate their power (Van Kleef et al. 2011). Peers may be individually less influential than high-status people, but then they mostly come in groups and thus exert considerable power over goalframes of the members. For example, being in a group of peers who seek fun and entertainment (a hedonic goal-frame), it is difficult to keep up a normative goal-frame (Sentse et al. 2010). If one wants to keep up a normative goal-frame, one is likely to proactively avoid the group, or if one is already in it, to leave it, if possible. Here, timing is of the essence. If one waits too long, the contagion will have progressed beyond the point at which self-control is likely to be strong enough to battle the effect of goal contagion and make one leave the group. For good or bad, the company one keeps may thus have a lot to do with the goals one pursues. The same effect has been observed with moods (Neumann and Strack 2000). Goals and expectations are influenced by one’s mood. If one is in a group of people who are in a bad mood, one’s own mood is likely to be negatively affected, and one would have to remove oneself early on from the group in order to escape this influence. James (1890), always attentive to issues of self-regulation, advises people to “accumulate all the possible circumstances that re-enforce the right motives” (123). Yet, some influences are difficult to escape. Children rarely can escape the influence of their parents, even if these parents beat them, are neglectful, and humiliate them. Even if they could escape, they often would not be able to improve their condition much by doing so, because they have a high chance of ending up in institutionalized care or no care at all. This does not only hamper the execution of self-regulation, but also the development of self-regulatory abilities. School contexts can help in this regard. Coleman and Hoffer (1987)

88 Siegwart Lindenberg found that in the United States children from disadvantaged family backgrounds do better when they are placed in school environments that require disciplined work (such as much homework, participation in academic programs, provided by Catholic schools compared with private and public schools). Another example is the finding that the adult time horizon for financial planning is strongly influenced by early parental influences on the child’s extension of the self into the future (Hershey, Henkens, and van Dalen 2010). A low extension hampers self-regulatory ability (see Nenkov, Inman, and Hulland 2008).Thus the inability to escape certain environments as a child can have long-term consequences. There are also path-dependent effects regarding opportunities and the ability to use them. If the environment is not conducive to the consideration of future consequences, be it because of goal contagion or of highly uncertain futures, people will be more frequently confronted with negative life events, at least a good deal of which are likely due to failures of self-regulation (see Brady and Matthews 2002). Research shows that people from lower income classes have more difficulty dealing with reasoning that is related to a gain-goal frame and necessary for handling economic decisions (such reasoning in terms of costs and benefits and ignoring sunk costs; see Larrick, Nisbett, and Morgan 1993). Such influences are not just concerning the future orientation (gain goalframe) but also the normative goal-frame. For example, lower class youth have been found to have much more trouble recognizing general social norms (see Parker and Fishhoff 2005). In part, the described effects can also be circular. For example, socioeconomic status can be interpreted as an indicator of influential environments with regard to health-related lifestyles (smoking, drinking, eating, sleep habits). In turn, negative health indicators (such as obesity) may contribute to locking people even more into a lower socioeconomic status (Mulatu and Schooler 2002). Probably even more important for self-regulation is the exemplary behavior of others as a cue that strengthens one’s own normative goal-frame. Thus exposing oneself selectively to influences on one’s overarching goals is perhaps the most important part of one’s ability to regulate oneself via goals (Lindenberg 2008; Dohmen and Falk 2011). Among these influences, probably the most prominent is having (and making oneself vulnerable to the influence of) significant others that represent normative claims. For this reason, I will dedicate a longer paragraph to that form of support. The important role of significant others. Not everybody is equally important for one’s self-regulatory abilities. In the course of their development, people acquire significant others (such as mother, partner, close friends, religious leaders) whose opinions and standards weigh heavily and who can be called upon especially to strengthen the normative goal-frame. Of course, some of the most important significant others are the direct socializers in early childhood, and especially the mother. They represent norms and standards, and in interaction with them the ability to stabilize the normative goal-frame is developed (see Gralinski and Kopp 1993; Kochanska 2002). However, the significant others are not just important in the formative years (and for the internalization of substantive norms), but also for the inner dialogue that keeps going on. They remain in the person as a private audience to which the self turns and virtually interacts

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(see Baldwin and Holmes 1987).Thus a significant other does not even have to be physically present to influence one’s behavior. Experimental research shows that when certain significant others have been made salient in somebody’s mind, their norms will influence behavior quite strongly (see Baldwin, Carrell, and Lopez 1990; Baldwin and Holmes 1987; Fitzsimons and Bargh 2003; and Shah 2003a,b). Significant others also influence the readiness to follow social norms in general, not just specific norms. Thus having significant others on one’s mind helps stabilize the normative goal-frame. Shah (2003a) has shown that thinking of significant others can influence a person’s goals, in the sense that goals attributed to the significant other activate the same goals in the attached person, and also in the sense that goals the significant other is thought to disapprove of are inhibited. For example, Shah could show that individuals primed with father-related words were more committed to goals the father valued and also performed better at reaching those goals, the more so, the closer they felt to the father. Conversely, the closer they felt to the father, the more goals he disvalued were inhibited for them. Shah (2003b) also showed that the effect of significant others on one’s behavior does not run only via goal activation or inhibition, but also via self-appraisal and the emotional response to goal achievement or achievement failure. For example, if your mother thinks you can achieve a goal, then thinking of your mother will positively affect the appraisal of your own ability to achieve it. The converse holds for negative expectations. In addition, the more important the mother finds the goal, the more satisfied you will be by achieving it, and the more dissatisfied by a failure to achieve it (see also Baldwin, Carrel and Lopez 1990). Self-regulation thus involves a “psychological presence,” an inner meeting and dialogue of the self with significant others. Persons who have significant others who believe in their abilities and who find their goals important have a definite self-regulatory advantage in pursuing those goals. Yet having or not having significant others for self-regulation is often subject to self-regulation itself. For example, it has been found that people motivate themselves to achieve a valued goal by seeking out significant others that are successful at achieving the goal as role models (Lockwood, Jordan, and Kuna 2002). When people cannot attach to significant others (especially those that represent important social norms), the normative goal-frame cannot easily be strengthened by alternative means to the same degree. As a result, self-regulatory capacity is likely to be lower and depletion effects higher. For example, Gestsdottir and Lerner (2007) show how important self-regulation is for a positive development of youths.Yet children may have systematic disadvantages with regard to self-regulation. An important case in point is attachment problems in early childhood resulting from aggressive parenting. Children with attachment problems will grow up with a deficit in significant others and thus a deficit in self-regulation (see Calkins 2004). However, this problem is not randomly distributed but occurs more in low Socioeconomic Status (SES) families (see Pinderhughes et al. 2000; Raikes and Thompson 2005; Shaw et al. 2001). Thus children from low SES backgrounds run the risk of lower selfregulation capacity, as well as later in life, and bear the risk of lower well-being (see also Hart, Atkins, and Matsuba 2008). Note that self-regulatory ability has an impact on problem behavior and performance quite different from general

90 Siegwart Lindenberg intelligence, so that it is not simply a matter of a negative correlation between SES and intelligence (see Ayduk et al. 2007; Blair and Razza 2007; Moffitt et al. 2011). Lack of self-regulatory ability is also likely to affect status (see Bear and Rys 1994; Moffitt et al. 2011), so that, as already mentioned above, we get a vicious circle that may trap people in a low-status position. A similar effect can be expected for the children of immigrants. They are better integrated into the new culture than the parents, and are often confused about who their significant others are.This negatively affects their self-regulatory abilities, which makes it more difficult to break out of low-status positions. An important consequence of these phenomena is that paying attention to significant others will often work better than punishments or rewards. For example, Sampson, Laub, and Wimer (2006) show that being married (that is, having a close significant other who cares) has a considerable effect on reducing criminal activity. By contrast, it is by now well known that the interventions directed individually at problem youths (such as incarceration, probation, shocking youth by the experience of brief incarceration or by having criminals tell them about the horrors of prison [“scared straight”], courtordered school attendance) don’t work very well (see Kazdin and Weisz 1998; Lipsey and Wilson 1998; Sherman et al. 1997). Where the traditional rational choice models would assume that negative incentives (such as incarceration or shock experiences) steer behavior away from trouble, the social rationality approach, with a central place for self-regulation, would look first of all at the functioning of significant others for self-regulation capacity. Incarceration is likely to increase self-regulation problems because it reinforces the importance of delinquent peers and decreases the importance of adults in authority as significant others (see Huey et al. 2000). What is likely to help is to improve the positive role parents and teachers can play as significant others by focusing intervention on teacher and family functioning (Kazdin and Weisz 1998) and to coordinate the role teachers and parents can play as significant others (Eddy, Reid, and Fetrow 2000). This also involves communicating clear rules and expectations that emanate from the significant others (see Sherman et al. 1997: ch. 5). Conversely, changing one’s ways in order to become a better significant other for somebody else requires that, for example, a parent improve his or her own self-regulation by accepting therapists as significant others (Kazdin and Whitley 2006). Self-regulation is a socially embedded process and thus needs continuous social support. Thus it also helps to make the youths more susceptible to the influence of relevant significant others. For example, training in cognitive problem-solving skills (prominently including perceiving how others feel and anticipating the effects of one’s behavior on others) seems to be quite effective in reducing antisocial behavior in (pre)adolescents (see Kazdin and Weisz 1998). Note that this reasoning is not just based on the workings of social influence or “social integration” (as social control theory would have it; see Hirschi 1969). For example, the attempt to change youth violence by redirecting highrisk youth through enriching their recreational activities in the peer group context (for example, by midnight basketball games) did not work (Elliot and Tolan 1999; Patterson et al. 1998). Such interventions do not establish links to significant others who strengthen the normative goal-frame.

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Meaningful need states. A more “radical” way to increase goal-related selfregulation is to change not just the environment but also the goal at the same time.When self-regulation is lacking, people can experience extreme frustration at not doing what they set out to do, or not knowing what to do, or feeling bereft of meaningful activity. By contrast, being eager to achieve a meaningful goal, knowing what steps to take, feeling efficacious to take those steps: jointly, these things give one a feeling of being in control, being part of something meaningful, and of being motivated to go forward. This is what may be called a “meaningful need state,” and it can be more or less actively sought as a way to increase the balance of the goal-frames. Often, but not always, it is also linked to significant others. The advantage of such a state is that when it is active, people feel that they have a purpose, they feel energized to pursue it, have feelings of deprivation if they cannot pursue it, are frustrated if they fail at pursuing it, and experience satisfaction by making progress in their pursuit. In short, meaningful need states provide both self-regulatory capacity (direction, planfulness, link to norms) as well as sources of satisfaction.When such a state is active, a normative goal-frame is strongly supported by a hedonic goal from the background, or (less advantageous for self-regulation, as we will see later), a hedonic goal-frame is strongly supported by a normative goal in the background. Bunderson and Thompson (2009) provide a graphic example of this combination: zookeepers, and how they experience both a deep moral duty to follow this “calling” and a passion for their calling. The concept of intrinsic motivation (as traditionally employed) is not suitable to cover meaningful need states because it lacks the normative element necessary for the meaningfulness besides enjoyment (see Lindenberg 2001b). It is probably difficult to overestimate the importance of the search for meaningful need states in society for both people’s attempts at increasing their self-regulatory capacity and also their sense of purposefulness and well-being. Very likely it is ubiquitous and much in need to be studied. How do people get into such a state? The basis of its working is the possibility that goals can acquire a needlike urgency. The assumption here is that when goals are considered meaningful and they are stated in such a way that they have a clear end state and clear steps that lead toward the end state, they can create an especially strong goal-gradient effect. The closer to the end state, the stronger the motivation to reach the end state (Kivetz, Urminsky, and Zhang 2006). Such goals open, as it were, a space for purposeful and worthy pursuit with the built-in driver of structured approximation toward a good end. A situation could trigger such a need state, but it is more likely that people, in search for sources of purpose and self-regulatory capacity, find themselves gradually in a situation in which they discover, welcome, and embrace the tug of a meaningful need state. Projects can be organized to grip people in such a way. For example, many people in the Netherlands work overtime. A survey (OSA 2003) reports that in the Netherlands, 25 percent of the Dutch labor force work paid overtime, and 27 percent put in unpaid overtime. Why do so many people put in unpaid overtime? It cannot be the lumpiness of labor supply in which the job with the exact preferred number of hours is unavailable. In the Netherlands a new law, the Working Hours Adjustment Act (Wet Aanpassing Arbeidsduur) was

92 Siegwart Lindenberg introduced in 2000 that gives employees the right to reduce or increase their contractual working hours. Generally, organizations comply with this law. We have looked into this question and found that it is also not the improved chances of promotion that drive unpaid overtime. Rather, our research shows that it is the project organization that does it (van Echtelt, Glebbeek, and Lindenberg 2006).The most likely circumstance leading to the decision to work overtime is that there are clear steps that have to be taken toward the completion of a project and that these steps do not get quite finished during regular time. Something presumably worthy has to be brought to a good end, and the steps in between may be such that they act as their own motivators. In other words, the unpaid overtime is very likely the result of the workings of meaningful need states. Even though organizations make strategic use of this effect (van Echtelt, Glebbeek, Lewis, and Lindenberg 2009), it can work only because people let themselves be swept into the self-motivating and self-constraining stream of a project because they profit from it in terms of self-regulatory capacity and satisfaction. Hobbies are another common source of meaningful need states. Hobbies are often quite socially regulated and organized in such a way that they provide purpose and at the same time embedded and often concatenated end states. For example, stamp collectors create worthiness of their pursuit by the networks and communities that exchange information and provide standards of competence and value, as well as opportunities to demonstrate (more or less competitively) expertise, stamina, and cunning with communal appreciation. In addition, the stamp collector community and the postal authorities that partially cater to this community create embedded meaningful end states by defining sets of stamps that belong together. There is in principle no end to this pursuit, because by new groupings, the end states are inexhaustible and, at least in part, also concatenated by sequences. Another example is bird watching, which is also socially organized and structured in terms of projects each one of which can be brought to a good end, only to be followed by another. Socially embedded hobbies are likely to be linked to particular significant others who represent the worthiness and normative standards for this form of improving one’s selfregulatory capacity. This means that both forms of support for self-regulation are mostly interlinked. The downside of meaningful need states. The positive side of the meaningful need states can also be their downside: they have a hold on people, especially if the significant others are lacking or not demanding with regard to social norms. Since the meaningful need states are actually activated goals, they tend to inhibit possibly competing goals (in case of overtime work, it is goals such as family obligations and leisure time that get sidelined; see Caruso et al. 2004; Dembe et al. 2005; and Dahlgren 2006). There can even be a reversal of hedonic and normative goals, such that the hedonic goals are in the foreground. For example, this might happen with computer games that are structured to create seemingly worthy, embedded, and concatenated end states. However, the emphasis is on embedded end states with relatively low standards for meaningfulness, which allows a preponderance of the hedonic goal. The significant others may be nonexisting or linked only to normative standards that are internal to the game structure and thus do not help with the self-regulation of social contacts. In

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terms of self-regulatory capacity, such versions of meaningful need states may thus be counterproductive.

Self-Related Processes of Self-Regulation The very basis of top-down forms of self-regulation is that individuals are able and motivated to distinguish between self and nonself, to be selfreflective (that is, they can become an object of their own attention), and to be agentic—that is to say, feel themselves as the cause of changes in the world and changes in their own inner states. This process requires elaborate cognitive and motivational processing (Christoff et al. 2011; Jeannerod and Anquetil 2008; Lieberman 2007). The self has occupied a central place in both psychological and sociological theorizing, resulting in many different theories of the self; this is not the place to review that literature. However, there is considerable consensus about the fact that the development of the self is itself a social process, and so is the maintenance of the self. In fact, people are treated and evaluated as selves by others, and they evaluate themselves as selves, compare themselves with others, try to maintain a positive view of themselves, have ideas about their ideal selves, and strive to reduce the discrepancy between their present and their ideal selves. In all this, people are able to bridge the gap between self and social nonself with a theory of mind, perspective taking, and affective empathy—that is, with processes in which they experience others also as selves (Malle and Hodges 2005). Social interactions and evaluative processes (both of which are also relevant for satisfying fundamental needs) thus heavily lean on “selves” and their maintenance (see also Erikson 1964;Vygotsky 1978). From the foregoing, it is clear that the integration and maintenance of the self and the capacity to bridge the self and (social) nonself are important. But what exactly is so special about the self? What gives it such an important place? The main reason for this important place is the fact that individuals must be able to have internal representations of themselves and their own mental states (Frith and Frith 1999; Goldberg 2009; Greenwald and Breckler 1985). This is important for self-monitoring, for plans, and for reacting to one’s own prepotent impulses and the feedback from others. For adaptive behavior, individuals must be able to keep track of themselves, demand things of themselves, and respond to their own representations. Importantly, this response is also evaluative, creating more or less self-esteem. Individuals must also be able to project themselves into the future, make plans, and pursue interrelated goals. The quality of their decision-making depends to a large extent also on the way they feel about things. Inconsistencies or ambiguities in feelings will in many cases also negatively affect the quality of decision-making (see Bechara and Damasio 2005). In addition, there are constraints resulting from reaction to others. What feedback should an individual react to, and how? How to avoid impressions of arbitrariness or lack of direction? All these points are negatively affected when the self-nonself distinction is in flux, or when the self is experienced as fragmented or uncertain or unworthy. There is also yet another reason for the importance of the self. It is likely that perspective taking and empathy (putting oneself into the shoes of the other, both cognitively and affectively) depends on the ability to simulate what

94 Siegwart Lindenberg might go on in the other, which, in turn, requires a sense of self (Lieberman 2007; Uddin et al. 2007), all the more since the observer might have to imagine the situation of the other without having experienced it (Eisenberg and Sulik 2012). Schematically, the process of self-formation can be described as follows (see also Markus and Cross 1990). The child learns early on to demand things from the social environment. It is also genetically equipped with the ability to distinguish social from nonsocial objects and pays special attention to social objects (Wynn 2007). Later, it also learns to put itself into the shoes of significant others in the social environment, which presupposes some cognitive separation of self and others and the understanding of the other as intentional being (Malle and Hodges 2005). It also requires the ability to see itself through the eyes of others (Mead 1934). The child thereby also learns that things are demanded of it. The child develops self-representations and experiences itself as causal and agentic (Jeannerod 2003). It also develops shared representations with others (for example, joint attention; Tomasello and Carpenter 2007). In a further step, the ability to put oneself into the shoes of others is applied to oneself, as the child also learns to put itself into the shoes of its own future self, and also into the shoes of itself as member of a collective (dyad or group). This is also the basis for the overarching gain goal and normative goal, described earlier. Thus the child learns to be represented to itself in a need-related, resource-related, or collective guise. The ability to demand and respond to demands is present in these different selves. In this sense, the person is a social system. As the child begins to talk, it eventually also learns to talk to itself from different perspectives and to demand and suggest things to itself, in private speech (aloud but directed to itself) and later also in inner speech (Dias and Berk 1992), including nonverbal inner communication such as conjuring up images and auditions (Barkley 2004). For example, the child learns to demand from itself to block aggressive emotions from arising, and has the capacity to influence its own electrochemical processes in the brain (see Banks et al. 2007). In this development, the child will evaluate various aspects of itself (or of its various selves), and as the child grows up there is increasing internal and external pressure to integrate these aspects in a more or less harmonious way (Erikson 1964; Nowak et al. 2000). lower-order self-regulatory processes concerning the self There are at least two important lower-order self-regulatory processes that kick in when the self feels either invulnerable or threatened.With regard to the feeling of invulnerability, the self-regulatory tendency is to lower the degree to which one is socially influenced. In terms of evolution, this makes sense. The less dependent one is on others, the more adaptive it is not to use scarce resources on them. Yet high-order self-regulatory processes are needed to contextualize this tendency because it may lead to the negative consequences in the long run (say, because ignoring people may turn them against you and thus increase interdependency). This possible dysfunctional side of the lowerorder reaction to the feeling of invulnerability shows up in research on power. For example, powerful people tend to be worse at perspective-taking (Galinsky et al. 2006) and tend to be overconfident in their decision-making (Fast et al.

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2012). Organizations can greatly suffer from these tendencies (Bunderson and Reagans 2011). Probably the two most important lower-order self-regulatory processes concerning threats to the self are (a) self-defense, in which a particular selfimage is defended against (mostly external) threats; and (b) cognitive egoenhancing biases. Self-defense is a regulatory process that involves both cognitive and affective aspects. Cognitively, it is linked to closing one’s mind to threatening information, or denying evidence (for example, denying that smoking is dangerous if smoking is part of one’s self-image). Affectively, self-defense is linked to avoidance or approach tendencies, and both can be mediated by a sense of shame (de Hooge, Zeelenberg, and Breugelmans 2010). There can be attempts to make amends, but, as people react defensively to a threatened selfimage, there can also be aggression and violence (Baumeister, Smart, and Boden 1996). For example, people may aggressively blame others in order to protect an unblemished self-image against threatening accusations. Negative feedback from others (such as disapproval) can be experienced as being directed against a particular kind of behavior (in which case it lowers satisfaction of the need for behavioral confirmation and may lead to repair behavior), or it may be experienced as being directed at the person, in which case it threatens the self and may lead to aggressive self-defense (see, for example, Bagozzi,Verbeke, and Gavino 2003). If the approach reaction is not feasible or too risky, then shame may lead to denial, withdrawal, or escape. Ego-enhancing biases consist of people’s tendency to see things such that it enhances their self-image, especially after it has been threatened (Dunning, Leuenberger, and Sherman 1995). Many such biases have been identified (Dunning 2002). One example is the better than average effect, which makes people assume that, regarding traits that are important to their self-image, they are better than the average other.This kind of assessment is not just for the sake of impressing others. It is a truly lower-order self-regulatory mechanism such that people believe their self-enhancing assessment (Williams and Gilovich 2007). In-group favoritism is another form of self-enhancement (Gramzow and Gaertner 2005). I will not list all the self-regulatory strategies to enhance one’s ego, especially after the ego is being threatened. However, all these forms share the basic mechanism of defending a positive self-image. Even though people with a negative self-image also tend to enhance their ego, they are also prone to seek validation of their low estimation of their self and thus have mixed self-regulatory ego-defensive strategies (Sherman and Cohen 2006). higher-order self-regulatory processes concerning the self For sociology, the higher-order self-regulatory processes concerning the self are even more important, because they are crucial for battling the negative side of the lower-order self-regulation and for a smoother running of social interaction in virtually all contexts. In the literature we find many different theories about high-order self-regulation concerning the self; however, the three sociologically most important groups of self-regulatory processes are likely to be the following:

96 Siegwart Lindenberg a. The search for clarity of core aspects of the self, b. The search for harmony among aspects of the self, c. The search for positivity concerning the self. I will briefly discuss them in order. Clarity. Even though there are many partial selves, there are aspects that are likely to belong to what Markus (1977) called “self-schema.”This core contains aspects that one considers particularly important about oneself. No matter what goal-frame is salient, persons will always be particularly sensitive to information about themselves. Aspects that belong to the self-schema are more accessible and thus come to mind more easily.They are also better remembered and better linked to other parts of one’s knowledge structure. For example, if somebody talks about your qualities as a father, it may make you particularly vigilant about what is said because your being a good father belongs to your self-schema. A poorly defined self-schema (that is, confusion about who you are) creates less focused and consistent guides to attention and retention (Campbell et al. 1996) and thus weaker tendencies to override lower-order self-regulatory processes. It also lowers self-esteem and well-being (Sheldon et al. 1997; Stinson,Wood, and Doxey 2008). For the establishment and maintenance of clarity of core aspects of the self, the search for and availability of significant others (including role models) have been identified as particularly important (Bosma and Kunnen 2001; DuBois et al. 2002; Meeus, Oosterwegel, and Vollebergh 2002). People search for support from significant others and look at role models in order to find out what may be the core aspects of their personal identity (Markus and Cross 1990). This holds for all phases of life, even though the significant others and role models may change. For example, for adolescents it may be parents, peers, teachers, or celebrities; for adults it may be partners, supervisors, colleagues, or friends; and for elderly people it may be partners, friends, or spiritual leaders (Carstensen 2006). Such search is intensified in times of negative life events (Thoits 1991). In short, the degree of identity clarity heavily depends on having supporting significant others and role models, especially when doubt about one’s identity is most salient (as in times of negative life events). People who have reduced access to such significant others are likely to have more problems with maintaining identity clarity. Another factor that has been identified as playing an important role is cultural clarity. This concept refers to clarity about one’s cultural group (whatever that group may be). Clarity in this area has a positive impact on the clarity of one’s personal self (Usborne and Taylor 2010). Thus cultural confusion is likely to lead to confusion about one’s personal identity. Self-regulation is thus likely to focus also on cultural clarity, for example by culture-relevant selectivity in interaction and negative out-group attributions. Harmony. Even with clear core aspects of the self, there are many partial selves (that also overlap with important roles), and they may be more or less in conflict with one another or in harmony. For example, one’s self as a mother and wife may be in conflict or harmonious, as is one’s present self in relation to one’s possible self (Markus and Nurius, 1986). Conflict may create difficulties

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in making plans, in fulfilling obligations, in emotion regulation, and in selfesteem. Harmony refers to the compatible combinations (not necessarily to the integration) of partial selves. A higher degree of harmony has been associated with better resource use and higher well-being (Brook, Garcia, and Fleming 2008). Self-regulation with regard to harmony focuses on compatibility in terms of activities, circles of interaction, plans, and so forth. For example, creating a career is an important process for young adults, and thus it is important which aspects they can pursue without conflict (see, for example, Syed 2010). Part of their career planning will be dedicated to creating harmony among their partial selves, both in terms of identity-relevant roles and traits. Ideologies, narratives, and “self-portraits” are ways to help create and maintain harmony, and the higher the need for harmony the more likely that people will make use of these tools for self-regulation (see Habermas and Bluck 2000; Harter and Monsour 1992). Again, significant others are an important potential source of harmony (Chen, Boucher, and Tapias 2006). Positivity. Even though self-regulation focuses on clarity and harmony, this does not mean that an individual thereby automatically has a positive view of the own core self.Yet, since the core self is the basis of one’s agency, one’s plans, dreams, and hopes, one would like to be able to have a high regard for it (Jones 1973; Tesser 1988). This regard is not simply given. In comparison to the lowerorder self-defensive strategies, these higher-order strategies do not work via biased cognitions and aggressive outbursts. They involve strengthening a core sense of self in an agentic rather than reactive way, even when threats to the self are involved (Leary 2007).The strategies for this purpose include self-categorization into groups that can add positivity to the sense of self (Turner 1985). Then there is social comparison, which can be used to enhance one’s sense of self, both downward (Gibbons et al. 2002) and upward social comparison, depending on what works best for the positive sense of self. Two self-regulatory strategies are particularly important for overpowering the lower-level self-defensive strategies (and many of their negative consequences) and will therefore be discussed with a bit more detail. It is self-affirmation and self-presentation. When people reflect on what their personal values are and on how they lived up to those values, they strengthen their core self by affirming it (Steele 1988). They thereby reduce the often dysfunctional lower-level self-regulatory processes of self-defense and the concomitant closing of the mind in the process. Self-defensive strategies imply, for example, not changing one’s beliefs in the face of contrary evidence, not heeding negative health information, misperceiving one’s capacities, and jeopardizing one’s relationships with others (Sherman and Cohen 2006). Ironically, self-affirmation does not seem to work if the situational cues appeal to one’s being rational and pragmatic. Nor will the appeal to rationality and pragmatism prevent closing of the mind. Thus, for example in negotiations, appeals to the parties to be rational and pragmatic can be highly counterproductive (see Cohen et al. 2007). The explanation for this ironic result may be that making one’s rational identity salient implies lessening the focus on values and identity, thereby suppressing effects of affirming values. Threats to identity are then not buffered and therefore might trigger selfdefensive strategies.

98 Siegwart Lindenberg Self-regulation can stabilize the self-evaluation by influencing the evaluative feedback from others. Goffman has worked out this aspect of self-regulation in terms of what he called impression management (see Goffman 1959; Schlenker 2003). The presentation covers aspects that people deem important to their identity, possibly including physical appearance (dress, hair, posture) and facial composure, but also proper attention, orientation, and conversational focus, and especially clear signs of being a purposeful person. Take an example of appearing purposeful. Imagine that a person walks in the street and realizes that he has forgotten his bag in a store a block behind him. It is unlikely that he will just turn around and walk in the opposite direction, looking as if he had no purpose walking in either direction. Rather, his expressions and gestures will indicate that he has forgotten something before he turns back (for instance, he may briefly put his hand to his forehead, visibly shake his head, stop for a moment, and then reverse his direction). Other people expect to see purposefulness, and they react negatively when a person appears to lack that quality (see Gigerenzer 2002). The idea of impression management has long roots in sociology (see Cooley 1922), but in the past the literature focused less on social factors influencing self-related self-regulation. For example, social networks can be far more than sources of information or social support in times of trouble; they can be important stabilizers of one’s identity. Lacking social networks or having the wrong social networks can thus also impair one’s self-regulatory abilities via its impact on the self, not just via the impact on goal-contagion.

Conclusions When human rationality is seen as having evolved together with the problems that needed solving for adaptive behavior in changing environments, it basically comes down to a social kind of rationality that is linked to self-regulation adapted to the complex social interdependencies of human reproduction, socialization, and collective efforts.Viewed in this way, self-regulation, not consistency, should be the core meaning of human rationality. The human brain developed as a sophisticated social brain to be able to handle self-regulatory behavior in such contexts and to overrule, if need be, more basic (less context-dependent) forms of self-regulation. This led to three different evolved sets of self-regulatory processes that are interconnected but can be usefully distinguished and looked at by themselves: need-related, goal-related, and self-related self-regulation. These capacitates differ by person, but also by circumstance, and by lifelong development. This paper has discussed all three separately, but it is important not to forget their interrelation. For example, deficits in the satisfaction of fundamental needs lead to pathological behavior that negatively affects the other sets of self-regulatory processes. As we have seen, an insecure sense of self, in turn, negatively affects the balancing of overarching goals and thus leads to lower levels of self-discipline. Lower levels of self-discipline with regard to normative behavior lower in turn the satisfaction of fundamental social needs because these needs are best fulfilled obliquely, as a side effect of normative behavior (Lindenberg 1989; Sheldon 2004). When fundamental needs are being satisfied, the sense of self is strengthened (Luyckx et al. 2009). In addition to these interrelations, there are social events that disturb all three sets of self-regulation

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at the same time. Lack or loss of significant others is such a factor. Another prominent example of this is social exclusion. A modest negative feedback is useful as a corrective for performance, especially if it supports one’s autonomy (Buckley,Winkel, and Leary 2004; Mouratidis, Lens, and Vansteenkiste 2010), but a feeling of being rejected by or excluded from the group seemingly leads to a decrease in the satisfaction of social needs, in the secure sense of self (provoking self-defensive behavior), and in self-discipline (Twenge, Catanese, and Baumeister 2003). It is important to realize that all three sets of self-regulatory processes heavily depend on social supports, be it in the form of informal relationships, organizational contexts or of formal institutions. Because these interrelated processes of self-regulation are rather complex, one may want to reduce the complexity by simplifying. This is perfectly legitimate, and one may concentrate on only one of the three sets (because they are interrelated), or focus only on higher-order processes because they often trump the lower-order processes. But, as sociologists, it is not advisable to simplify by focusing on situations in which self-regulation has been made trivial, in the sense that there are presumably no needs involved and no goal conflicts, there are presumably no threats to the self and no emotional reactions to success or failure. Standard models of rational choice are rudimentary theories of self-regulation in the sense that they assume agency and top-down regulation of behavior. However, in these models virtually all aspects of selfregulation are made trivial: no attention to needs or goal conflicts (thus an assumed chronic gain goal-frame), no changes in the level of rationality due to lower-order self-regulation, no emotional responses to success or failure (but instead undisturbable Bayesian updating). Such a rudimentary theory may be useful as ideal type (see Gächter, this volume), as a benchmark against which the actual complexity of self-regulation is being brought into profile, but by and large, this view of a restricted usefulness in terms of self-regulation has not yet received wide acceptance. Of course one has to simplify, but there is also a principle of sufficient complexity (Lindenberg 2001a). Many social situations and institutions are either a problem for or a solution to (or both) self-regulatory problems. In order to understand these situations and institutions, we would do well to make self-regulatory processes and their social embedding a core business in sociology.

Notes 1. See, for example, Lindenberg 1996; Ormel et al. 1999; Steverink, Lindenberg, and Ormel 1998; Nieboer and Lindenberg 2002; Nieboer, Lindenberg, Boomsma, and van Bruggen 2005; Steverink and Lindenberg 2006. 2. When the group concerned consists of just a close relationship, then behavioral confirmation and affection often blur, and so does the way they are talked about in the literature (see, for example, Baumeister and Leary 1995: 505; and Murray et al. 2003: 63). 3. For reasons of space, I will concentrate mainly on the supports of the normative goal-frame, even though equal space could be allotted to the strengthening of the gain goal-frame. With regard to the latter there is, however, less need of elaboration, as the work of Max Weber and contributions such as Williamson’s exposition (1985) of the institutional and organizational supports of capitalism provide important insights into the conditions that potentially strengthen the gain goal-frame.

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Rational Choice Research on Social Dilemmas: Embeddedness Effects on Trust

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vincent buskens and werner raub

Introduction social dilemmas by example: trust in economic exchange Consider economic exchange through the Internet. July 18, 2007, was the end date on which to purchase a copy of the first edition of Theory of Games and Economic Behavior by John von Neumann and Oskar Morgenstern at eBay from the seller “bibliomonster” for U.S.$1,900.00. The item had a fixed price listing (using eBay’s “Buy It Now” option) and could be purchased only without bidding in an auction. Assume that the seller did own the copy, that the description of the copy was accurate (“Bound in original publishers red cloth a bit rubbed at head of spine. Black (ink?) mark on top board. Minor shelf wear, else very good. Internally, clean and free of ink, marginalia and soiling. No dog-eared pages or tears. Includes the often missing corrigenda leaf. A nice, collectable copy.”), and that the accompanying photos were not misleading. Assume that a buyer existed who would have preferred purchasing the copy as described for the price mentioned. The buyer had to pay the price before the seller would ship the book. Thus, the buyer had to trust the seller that the copy would indeed be shipped. If the buyer decided not to pay, there would be no transaction. If the buyer decided to pay, the seller had to decide whether or not to ship the copy. As a benchmark scenario, imagine an “isolated encounter”—that is, a oneshot transaction in the sense that buyer and seller of the book have never done business with each other before, do not expect to do business with each other in the future, and that verifying the seller’s identity is prohibitively costly for the buyer. For the benchmark, imagine further that eBay would not maintain its feedback forum that allows buyers to evaluate sellers, with evaluations being publicly available and easy to access. As a second and less artificial scenario for buying antiquarian books, consider that websites of antiquarian booksellers typically offer indications of their identity, such as information on the physical location of their shop. Imagine, too, that the buyer has purchased antiquarian books from the seller in the past, and the seller expects that the buyer may also

114 Vincent Buskens and Werner Raub purchase such books in the future. Finally, consider a third scenario that takes a core feature of the eBay platform into account—namely, eBay’s feedback forum, which provides information on the seller from other buyers. On July 16, 2007, the seller of the first edition of Theory of Games and Economic Behavior had positive feedback from 386 other eBay members and negative feedback from 5 members, resulting in an eBay feedback score of 381, with 98.7 percent positive feedback. trust as a social dilemma Our example of the purchase of a first edition of Theory of Games and Economic Behavior represents a trust problem between the buyer and the seller in Coleman’s sense (1990: 97−99), with the buyer in the role of the trustor and the seller in the role of the trustee. Coleman emphasizes four points that characterize a trust problem: (1) Placing trust by the trustor allows the trustee to honor or abuse trust, while this alternative is not available for the trustee without placement of trust. In the example, if the buyer decides to buy, the seller can ship the copy of the first edition or can abstain from shipping. In addition, while Coleman does not mention this explicitly, it is important that the trustee has not only an opportunity but also an incentive to abuse trust. For example, the seller could change his or her virtual identity and offer the book once again through the Internet. (2) Compared to the situation with no trust placed, the trustor is better off if trust is placed and honored but is worse off if trust is abused. The buyer prefers to purchase the first edition to, say, owning only the 1980 Princeton paperback edition, while owning the paperback only is most likely still preferred by the buyer to paying U.S.$1,900.00 without receiving the first edition. Again in addition to Coleman’s characterization, the trustee is better off if trust is honored than if no trust is placed. Selling the book for U.S.$1,900.00 is profitable for the seller. (3) There is no “real commitment” (ibid.: 98) of the trustee to honor trust. Thus the trustor voluntarily places resources in the hands of the trustee. In the benchmark scenario, since the buyer cannot verify the identity of the seller, the buyer is not able to enforce shipment of the copy after payment. (4) There is a time lag between placement of trust by the trustor and the action of the trustee. The buyer first pays the price and, subsequently, the seller decides on whether or not to ship the book. In the benchmark scenario resembling a one-shot transaction, it seems intuitive that incentive-guided and goal-directed behavior of trustor and trustee implies that the trustee would indeed abuse trust, if trust is placed. Assuming that the trustor anticipates this, the trustor does not place trust in the first place. If trust is not placed, however, both trustor and trustee are worse off than when trust is placed and honored. Technically speaking, the no trust outcome is Pareto-suboptimal. As Rapoport (1974) aptly put it, individual rationality in the sense of incentive-guided and goal-directed behavior can lead to collective irrationality in the sense of Pareto-suboptimality. Such a “conflict” between individual and collective rationality is the core feature of a social dilemma, and trust relations are a paradigmatic example of a social dilemma involving two actors. While “social dilemma” is a label commonly used in social psychology and also sociology, such a situation is often referred to as a “problem of collective

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action” or the “tragedy of the commons” in political science and as a “public goods problem” in economics (see Ledyard 1995: 122). Social dilemmas are intimately related to the problem of order in Parsons’s sense (1937). After all, in Hobbes’s “naturall condition of mankind” (1991 [1651]: ch. 13), actors are interdependent in a world of scarcity, while binding and externally enforced contracts are unfeasible. They may thus end up in the “warre of every man against every man.” In that situation, the life of man is “solitary, poore, nasty, brutish, and short,” and everybody is worse off than in a peaceful situation. This is a social dilemma among many actors. Parsons (1937: 89−94) posed the challenge to specify conditions such that individually rational actors solve the problem of order. He thus referred to the problem of order as “the most fundamental empirical difficulty of utilitarian thought” (ibid.: 91). In his meanwhile classic early contribution to rational choice social research, Coleman (1964: 166−67) clearly realized the challenge and formulated it even more radically than Parsons: “Hobbes took as problematic what most contemporary sociologists take as given: that a society can exist at all, despite the fact that individuals are born into it wholly self-concerned, and in fact remain largely self-concerned throughout their existence. Instead, sociologists have characteristically taken as their starting point a social system in which norms exist, and individuals are largely governed by those norms. Such a strategy views norms as the governors of social behavior, and thus neatly bypasses the difficult problem that Hobbes posed . . . . I will proceed in precisely the opposite fashion . . . . I will make an opposite error, but one which may prove more fruitful . . . . I will start with an image of man as wholly free: unsocialized, entirely self-interested, not constrained by norms of a system, but only rationally calculating to further his own self interest.” While it is part of the sociological folklore that Parsons’s challenge focuses on how rational choice social research can cope with social dilemmas, it is less well appreciated that Durkheim put forward a similar argument in his analysis of the division of labor in society (1973 [1893]: bk. I, ch. 7) that relates to the antiquarian book example. Durkheim’s point is that economic transactions often deviate from what is conventionally assumed in standard neoclassical models of spot exchange on perfect markets. Durkheim argued that the governance of transactions exclusively via bilateral contracts requires that the present and future rights and obligations of the partners involved in the transaction are specified explicitly for all circumstances and contingencies that might arise during and after the transaction. Anticipating much of the modern economic and game-theoretic literature on incomplete and implicit contracts, Durkheim pointed out that such purely contractual governance of economic transactions is problematic: typically, many unforeseen or unforeseeable contingencies could or actually do arise during or after a transaction. Negotiating a contract explicitly covering all these contingencies would be unfeasible or at least prohibitively costly. Likewise, renegotiations in the case that contingencies arise are also costly (for similar arguments on the limits of contractual governance, see Weber 1976 [1921]: 409 in his sociology of law). Such renegotiations characteristically offer incentives for opportunistic behavior, since an unexpected contingency will often strengthen the bargaining position of one partner while weakening the position of the other. Hence Durkheim argues that mutually beneficial

116 Vincent Buskens and Werner Raub economic exchange presupposes the solution of a trust problem and thus involves a social dilemma. focus of the chapter Game-theoretic models have emerged as a tool for the analysis of social dilemmas in rational choice social research. This is not accidental. Interdependence between actors is a core feature of a social dilemma. For example, the behavior of the trustor has effects for the trustee, and vice versa. Game theory is the branch of rational choice theory that models interdependent situations, providing concepts, assumptions, and theorems that allow specifying how rational actors behave in such situations. The theory assumes that actors behave as if they try to realize their preferences in decision situations with restrictions, taking their interdependencies as well as rational behavior of the other actors into account (see, for example, Harsanyi 1975: 89−117). It is therefore natural that applications of game-theoretic models figure prominently in rational choice social research on social dilemmas. Moreover, one should observe that interdependencies between actors and actors taking their interdependencies into account are likewise the core of Weber’s famous definition of social action (1947: 88, emphasis added): “Sociology . . . is a science which attempts the interpretive understanding of social action in order thereby to arrive at a causal explanation of its course and effects . . . . Action is social in so far as . . . it takes account of the behaviour of others and is thereby oriented in its course.”This is a reason why social dilemmas are a strategic research site not only for rational choice social research but also for sociology in general, and why game theory is an important tool, too, for sociological analyses in the spirit of Weber. Reviews of social dilemma research are readily available that highlight how social psychological theory and other approaches with a firm basis in methodological individualism can be used in this field that differ from rational choice assumptions (for example, Kollock 1998). Somewhat suprisingly, though, there is no systematic review of applications of game theory in this field with a focus on how sociologically informed hypotheses can be derived from these models, and how these hypotheses fare in empirical research. This chapter contributes to filling that gap. We do so by reconstructing research strategies that are often employed in applications of game theory for the analysis of social dilemmas, as well as reconstructing core assumptions and implications, including testable hypotheses. The chapter is analytical in nature, trying to structure the field, rather than providing a general overview of and comparison with alternative theories. Suggesting that theoretically and empirically informed middle range theory on social dilemmas has emerged from applications of game theory in this field, empirical insights generated by theoretical models are a core topic of the chapter. In the spirit of Goldthorpe’s plea (2000: ch. 5) for an alliance between rational action theory (RAT) and the quantitative analysis of data (QAD), we explore how research in this field can contribute to narrowing the gap between rational choice models and empirical research (Green and Shapiro 1994). The review emphasizes that relevant empirical research in the field includes survey designs, quasi-experimental designs, and more qualitative case studies in addition to experimental designs. Such a “multimethod”

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perspective conceives QAD broadly and is particularly appropriate when it leads to testing similar hypotheses with complementary empirical designs, thus providing an indication of the robustness of empirical findings. This Handbook (see Introduction) focuses on two strategies through which rational choice theory has been extended beyond the highly stylized assumptions of neoclassical economics—namely, atomized interaction on perfect markets of rational and selfish actors with full information. One strategy involves making the assumptions on the actors more complex by relaxing the rationality assumption or the selfishness assumption (see Gächter’s chapter in this Handbook on how this strategy can be usefully employed for improving on standard models and applications of game theory in rational choice social research).The other strategy aims at using more complex and more appropriate assumptions on the social context by replacing the assumption of atomized interactions on perfect markets. This chapter highlights the second strategy.1 It does so by combining strong assumptions on individual rationality with assumptions on the “embeddedness” of action in ongoing relations and networks of relations, showing that embeddedness crucially affects behavior of rational actors in social dilemmas. This is in line not only with Coleman’s heuristic advice (1987) to combine robust assumptions on rational behavior with more complex assumptions on social structure. Also Granovetter (1985) advocated precisely such a combination of assumptions in his often cited programmatic sketch. Granovetter’s criticism of the shortcomings of the neoclassical model of perfect markets with atomized actors has often been taken to imply that one had better abandon rational choice models in favor of more “realistic,” socially inspired models of man. It has been widely overlooked, though, that Granovetter sharply opposes “psychological revisionism,” characterizing it as “an attempt to reform economic theory by abandoning an absolute assumption of rational decision making” (ibid.: 505). Rather, he suggests maintaining the rationality assumption: “[W]hile the assumption of rational action must always be problematic, it is a good working hypothesis that should not easily be abandoned. What looks to the analyst like nonrational behavior may be quite sensible when situational constraints, especially those of embeddedness are fully appreciated” (ibid.: 506). He argues that investments in tracing the effects of embeddedness are more promising than investments in the modification of the rationality assumption: “My claim is that however naive that psychology [of rational choice] may be, this is not where the main difficulty lies—it is rather in the neglect of social structure” (ibid.). This chapter explores the potential of such an approach for the analysis of social dilemmas. We use trust problems as a paradigmatic example of social dilemmas, sometimes indicating generalizations of results for other types of social dilemmas. Trust problems involve two actors. We thus largely neglect social dilemmas involving many actors (see Gächter’s chapter in this Handbook for some references, as well as the chapter by Kiser and Powers). We illustrate how game-theoretic tools can be used for modeling trust problems and other social dilemmas and sketch the logic of deriving testable hypotheses from game-theoretic models. We then turn to theory and hypotheses on how social structure—that is, embeddedness of a trust problem or, more generally, embeddedness of a social dilemma—affects behavior in such situations. The review of empirical research

118 Vincent Buskens and Werner Raub takes stock of evidence for and against hypotheses on embeddedness effects, with an emphasis on results obtained from complementary research designs and an emphasis on applications to the Internet economy and other economic exchange that resembles a social dilemma. Some directions for future research are also suggested.

Trust in Isolated Encounters the trust game Game theory provides tools for the analysis of situations with interdependence of two or more actors: choices of an actor affect the other actor(s), and vice versa. We sketch the analysis of trust situations in different social contexts, without elaborating on game-theoretic principles underlying the analysis.2 Consider the standard Trust Game (Camerer and Weigelt 1988; Dasgupta 1988; Kreps 1990; Snijders 1996: chs. 1−4; Buskens 2002: chs. 1−3), which models trust problems as outlined above. The game (see Figure 3.1) involves two actors, the trustor and the trustee. The game starts with a move by the trustor, who can choose between placing or not placing trust. If trust is not placed, the interaction ends and the trustor receives payoff P1, while the trustee receives payoff P2. If trust is placed, the trustee chooses between honoring and abusing trust. If the trustee honors trust, the payoffs for trustor and trustee are Ri > Pi, i = 1,2. If trust is abused, the payoff for the trustor is S1 < P1, while the trustee receives T2 > R2. The Trust Game models the benchmark scenario of a one-shot transaction between a buyer and a seller of an antiquarian book. The buyer is the trustor and chooses between placing trust by paying the price for the book and not placing trust by not buying. The seller is the trustee, who can honor trust by shipping the book or abuse trust by not shipping. Under standard gametheoretic assumptions, the payoffs in the game represent utilities for the actors, there is common knowledge implying that all actors know that all actors know all elements of the game, and the actors are rational in the sense that they maximize utility, given their expectations on the behavior of other actors. Using game-theoretic tools, one can then find a solution for the Trust Game. Such a solution implies equilibrium behavior—that is, each actor plays a best reply, given the behavior of the other actor(s) (Nash 1951). Under these assumptions, it is easy to see that the trustee would abuse trust if the trustor would place trust. The trustor, being able to anticipate this, will not place trust. This equilibrium is indicated by double lines in Figure 3.1. Trustor Trust

No trust

Trustee

figure 3.1. The Trust Game (S1 < P1 < R1, P2 < R2 < T2).

Abuse trust P1 P2

S1 T2

Honor trust R1 R2

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A slightly more complex model of a trust problem is the Investment Game (Berg, Dickhaut, and McCabe 1995; Ortmann, Fitzgerald, and Boeing 2000; Barrera 2005). Again, the game is played by two actors. However, while in the Trust Game the actors make binary choices, in the Investment Game the trustor now chooses the degree to which the trustee will be trusted, and the trustee chooses the degree to which that trust will be honored. More precisely, the trustor has an endowment E1 and chooses an amount M1 to send to the trustee (0 ≤ M1 ≤ E1).This “investment” M1 is then multiplied by m > 1, and the trustee receives mM1. The parameter m can be seen as indicating the trustee’s returns resulting from the trustor’s investment. Subsequently, the trustee chooses an amount K2 to return to the trustor, with 0 ≤ K2 ≤ mM1. Afterward, the game ends with the trustor receiving V1 = E1 − M1 + K2 and the trustee receiving V2 = mM1 − K2. While M1 indicates how much the trustor trusts the trustee, K2 indicates how trustworthy the trustee is. Both the Trust Game and the Investment Game represent the time lag between placing trust and the trustee’s response. In both games trust is risky because the trustor regrets being trusting if the trustee turns out not to be trustworthy. The games thus model risks for the trustor in the sense of “opportunistic” or “strategic” behavior of the trustee, who has an incentive for abusing trust. deriving testable hypotheses from game-theoretic models How to use game-theoretic models for generating empirically testable hypotheses on social dilemmas? For answering this question, one can use Coleman’s scheme (1990: ch. 1; see also Raub, Buskens, and Van Assen 2011) for relating macro- and microlevel propositions in social science explanations (see Figure 3.2). First, the specification of the game includes social conditions in the sense of opportunities and restrictions for the actors’ behavior represented by the top-left node of Coleman’s scheme. The specification of the game also comprises assumptions on “independent variables” of rational choice theory, such as preferences of the actors that are represented by the actors’ payoffs.These are the microlevel assumptions related to the bottom-left node of Coleman’s scheme. Furthermore, the specification of the game includes assumptions on macro-micro transitions that are summarized by the vertical arrow 1 in Coleman’s scheme: note that the specification of the game models how an actor’s payoffs and information depend on social conditions. For example, an actor’s payoff function is a function of the possible choices of all actors—that is, a function of interdependencies. Thus, the specification of a game refers to empirical assumptions on the macrolevel of social conditions, on the microlevel of the actors’ preferences and information, and on macro-micro transitions. Rationality assumptions are microlevel assumptions that are summarized in Coleman’s scheme by arrow 2. These are assumptions such as that the solution has to be an equilibrium. Game-theoretic analysis then comprises deriving propositions on equilibria of the game and on properties of these equilibria. This allows one to derive implications concerning the behavior of rational actors. These implications are represented by the bottom-right node in Coleman’s scheme. In a final step, one can derive propositions on macrolevel effects—for example, on Paretooptimality or suboptimality of the outcomes that result from the behavior of

120 Vincent Buskens and Werner Raub Macro conditions

Macro outcomes

1

Micro conditions

3 2

Micro outcomes

figure 3.2. Coleman’s Scheme.

the actors.We illustrate below the derivation of hypotheses along these lines for trust situations under different social conditions. deriving hypotheses for trust in isolated encounters We briefly consider trust in isolated encounters.Two actors play the Trust Game once and only once. Neither the two actors, nor other actors, can condition behavior in future interactions on what happens in the Trust Game. Isolated encounters are hardly a standard feature of interactions in social and economic life. After all, eBay’s feedback forum implies that buyer and seller are not involved in an isolated encounter. Hence, isolated encounters are typically studied in the laboratory and are used to study nonstandard assumptions on preferences, because other factors such as the social embeddedness can be controlled in the laboratory. More precisely, assume that subjects play the Trust Game from Figure 3.1, with payoffs S1 < P1 = P2 < R1 = R2 < T2 in terms of monetary incentives or points converted into money at the end of the experiment. As explained above, the standard prediction is no trust, and, if trust were to be placed anyway, it would be abused. For the Investment Game, the analogous prediction is that the trustor sends nothing and, if the trustor were to send anything, the trustee would never return anything. Clearly, these are very strong predictions for the behavior of any subject in the laboratory. The predictions are clearly rejected (see Snijders 1996; Snijders and Keren 1999, 2001, on the Trust Game; Berg, Dickhaut, and McCabe 1995, on the Investment Game; and Camerer 2003: ch. 2.7, for an extensive review). Experiments show that substantial percentages of subjects trust in the Trust Game and send positive amounts in the Investment Game. Also, many subjects in the role of trustee honor trust and return substantial amounts. More generally, opportunism is not ubiquitous in isolated encounters resembling a social dilemma. Different approaches can be envisaged that account for such empirical regularities (see Fehr and Schmidt 2006 for an instructive overview). Each of these approaches involves making the assumptions on the actors more complex in one way or the other. First, one could relax the rationality assumption and employ a bounded rationality perspective. For example, one could assume that subjects are used to repeated interactions in life outside the laboratory. As we will see below, placing and honoring trust as well as other forms of cooperative, nonopportunistic behavior can be a result of equilibrium behavior in repeated interactions. The assumption then is that subjects erroneously apply rules in isolated encounters that are appropriate when interactions are repeated (see Binmore 1998 for a sophisticated discussion of such approaches). Second,

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there are approaches that maintain the rationality assumption but modify the selfishness assumption. These approaches thus abandon the assumption that subjects care exclusively about their own material resources (“utility = own money”). Rather, it is assumed that subjects, or at least some subjects, have other-regarding preferences. It is quite often argued (see, for example, Fehr and Gintis 2007) that such preferences are the result of socialization processes and internalized social norms and values. Also, it is often assumed that subjects may differ with respect to their other-regarding preferences—there may be selfish subjects as well as subjects with other-regarding preferences—and that subjects are incompletely informed on the preferences of other subjects. To get the flavor of how assumptions on other-regarding preferences can be used to account for placing and honoring trust in a Trust Game as an isolated encounter, consider a simple version of a social preferences model—namely, Snijders’s guilt model (1996; see also Snijders and Keren 1999, 2001), a simplified version of the Fehr-Schmidt (1999) model of inequity aversion. Assume that actor i’s utility is given by Ui(xi,xj) = xi − βimax(xi − xj, 0) with monetary payoffs xi and xj for the actors i and j and βi ≥ 0 a parameter representing i’s guilt resulting from an inequitable allocation of monetary payoffs. Hence, in a Trust Game with payoffs in terms of money and P1 = P2 and R1 = R2, the trustee’s utility from abused trust would be T2 − β2(T2 − S1), while utilities correspond to own monetary payoffs in all other cases. Furthermore, assume actor heterogeneity with respect to the guilt parameter βi in the sense that there are actors with a large guilt parameter, while βi is small or even equals zero for other actors—namely, those with selfish preferences. Finally, denote by π a trustor’s belief of the probability that the trustee’s utility from abusing trust is smaller than his utility from honoring trust—that is, T2 − β2(T2 − S1) < R2. Equilibrium behavior now requires that a trustee with β2 > (T2 − R2)/(T2 − S1) honors trust, while a trustor places trust if π > (P1 − S1)/(R1 − S1). We can assume that placing trust becomes more likely when the condition π > (P1 − S1)/(R1 − S1) becomes less restrictive. Similarly, we can assume that honoring trust becomes more likely when the condition β2 > (T2 − R2)/(T2 − S1) becomes less restrictive. Furthermore, we can assume that π depends on the trustee’s incentives and hence decreases in (T2 − R2)/(T2 − S1). It follows from this model that the likelihood of placing trust decreases in the trustor’s risk (P1 − S1)/(R1 − S1), as well as in the trustee’s temptation (T2 − R2)/(T2 − S1), and that the likelihood of honoring trust decreases in the trustee’s temptation (T2 − R2)/(T2 − S1). These implications correspond with experimental evidence (see Snijders 1996; Snijders and Keren 1999, 2001). Obviously, assumptions on other-regarding preferences should be used with care (see Camerer 2003: 101; Fehr and Schmidt 2006: 618): (almost) all behavior can be “explained” by assuming the “right” preferences and adjusting the utility function.Thus, one would prefer first of all parsimonious assumptions on other-regarding preferences, adding as few new parameters as possible to the model. Second, when assumptions on other-regarding preferences are employed, one should aim at using the same set of assumptions for explaining behavior in a broad range of different experimental games. Third, one should not only account for well-known empirical regularities but also aim at deriving and testing new predictions. It is therefore important from a methodological

122 Vincent Buskens and Werner Raub perspective that the same set of assumptions on other-regarding preferences is consistent with empirical regularities of behavior not only in Trust Games but also in other social dilemmas, in games involving distribution problems such as the Ultimatum Game (Güth, Schmittberger, and Schwarze 1982; see Camerer 2003 for a survey), or the Dictator Game (Kahneman, Knetsch, and Thaler 1986; see Camerer 2003 for a survey), and in market games. We refer to Gächter’s chapter in this Handbook for a careful discussion of how to refine the model of rational and selfish actors (another useful overview for sociologists is Fehr and Gintis 2007). In the subsequent sections we return to employing standard assumptions on the level of individual behavior—namely, assumptions on game-theoretic rationality as well as basically selfish preferences. We now refine a standard assumption on the social context in neoclassical economics. Rather than assuming atomized interactions—in our case, “isolated encounters”—we explore the implications of “embeddedness” for rational and selfish behavior in social dilemmas.

Theory and Hypotheses on Effects of Social Embeddedness Roughly, embeddedness (Granovetter 1985) can mean that the actors involved in a focal Trust Game maintain an ongoing relation with prior and expected future interactions. We refer to this as dyadic embeddedness. An example is the second scenario for the purchase of the antiquarian book in which the buyer repeatedly purchases from the same antiquarian. Furthermore, a focal Trust Game can be related to interactions of trustor or trustee with third parties. We refer to this as network embeddedness. The buyer of the antiquarian book may happen to know others who purchase books from the antiquarian, or may obtain third-party information about the antiquarian’s behavior in the past through an institution that enhances network embeddedness. An example is our third scenario for purchasing the antiquarian book where eBay’s feedback forum provides network embeddedness for the transaction. We distinguish two mechanisms, control and learning, through which dyadic and network embeddedness may affect trust. Control refers to the case in which the trustee has short-term incentives for abusing trust, while some long-term consequences of his behavior in the focal Trust Game depend on behavior of the trustor. More precisely, if the trustee honors trust in the focal Trust Game, the trustor may be able to reward this by applying positive sanctions in the future. Conversely, if the trustee abuses trust in the focal Trust Game, the trustor may be able to punish this by applying negative sanctions. Given dyadic embeddedness, the trustee has to take into account that honoring trust in the focal Trust Game may affect whether or not the trustor places trust again in the future. Given network embeddedness, the trustee has to take into account that a trustor can inform third parties about the trustee’s behavior in the focal Trust Game, such as other trustors with whom the trustee may be involved in future Trust Games. Again, whether or not other trustors are willing to trust the trustee may depend on honoring or abusing trust in the focal Trust Game.Thus, the trustee has to trade off the short-term incentives to abuse trust against the long-term benefits of honoring trust and the long-term costs of abusing trust. This mechanism is also known as conditional cooperation (Taylor 1987) or reciprocity (Gouldner 1960; Blau 1996 [1964]; Diekmann 2004). Reciprocity

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tab le 3 .1

Types of Embeddedness and Mechanisms through which Embeddedness Affects Trust Two types of embeddedness Two mechanisms

Control

Learning

Dyad

Sanctioning possibilities of the trustor without involving third parties. Information about the trustee from past experiences of the trustor.

Network

Sanctioning possibilities of the trustor that involve third parties. Information about the trustee from third parties.

in this sense (sometimes labeled “weak reciprocity”—see, for example, Fehr and Schmidt 2006: 620; Fehr and Gintis 2007) can be driven exclusively by long-term, “enlightened” self-interest of the actors. Thus reciprocity in this sense differs fundamentally from reciprocal behavior of the trustee in isolated encounters based on other-regarding preferences (“strong reciprocity”). Embeddedness may affect trust through a second mechanism—namely, learning. The trustor need not be completely informed on the behavioral alternatives and incentives of the trustee. Beliefs by the trustor on the trustee’s characteristics can be affected by information regarding past interactions. This information can be obtained from past interactions of trustor and trustee—that is, through dyadic embeddedness. Given network embeddedness, information can also be obtained from third parties who have interacted with the trustee in the past. If a trustee has been trustworthy in past interactions, a trustor might be more convinced that the trustee will be trustworthy again in the focal Trust Game than if information on untrustworthy behavior of the trustee in the past has been revealed. Table 3.1 summarizes our distinction between dyadic and network embeddedness, as well as between learning and control (Buskens and Raub 2002; see Yamagishi and Yamagishi 1994: 138−39 for a similar discussion of learning and control effects through network embeddedness). Our sketch indicates that embeddedness may help actors to mitigate social dilemmas such as trust problems (see Taylor 1987; Kollock 1998 for an overview of different ways in which social dilemmas can be mitigated). Note that embeddedness effects on social and economic interactions and exchange are a common theme of the sociological literature. However, clearly disentangling different types of embeddedness effects and the underlying mechanisms theoretically as well as empirically is often neglected.We now show how gametheoretic tools allow for modeling embeddedness and, more important, for deriving hypotheses on effects of embeddedness on trust. This can be done by “embedding” a focal Trust Game in a more complex game. Subsequently, one establishes conditions for an equilibrium of the more complex game such that trust is placed and honored in the focal Trust Game. Propositions on such conditions yield hypotheses on embeddedness effects on trust. a simple model of dyadic control: conditional trust in the indefinitely repeated trust game To see how trust can be a result of purely selfish rational actors who are “enlightened” in the sense that they take long-term effects of their behavior into account, we consider a model of control effects through dyadic

124 Vincent Buskens and Werner Raub embeddedness—namely, Kreps’s model (1990) of a repeated Trust Game (see also Gibbons 2001). In this model, the Trust Game is played repeatedly in rounds 1, 2,…, t,… By way of example, a buyer purchases repeatedly from the same seller of antiquarian books. More precisely, after each round t, another round t + 1 is played with probability w (0 < w < 1), while the repeated game ends after each round with probability 1 − w.The focal Trust Game is thus embedded in a more complex game in which the Trust Game is repeated indefinitely often. In each round, trustor and trustee observe each other’s behavior. In the repeated game, an actor’s behavior in each round t may depend on the behavior of both actors in the previous rounds. An actor’s expected payoff for the indefinitely repeated Trust Game is the discounted sum of the actor’s payoffs in each round, with the continuation probability w as discount parameter. For example, a trustor who places trust throughout the repeated game, with trust being honored throughout, receives payoff R1 + wR1 + … + wt−1R1 + … = R1/(1 − w). Thus, using the apt label coined by Axelrod (1984), the continuation probability w represents the “shadow of the future”: the larger w, the more an actor’s payoff from the repeated game depends on what the actor receives in future rounds. In the indefinitely repeated Trust Game, the trustor can exercise control by employing conditional behavior that rewards a trustee who honors trust in a focal Trust Game by placing trust again in future games. Conversely, conditional behavior of the trustor can imply punishing the trustee’s abuse of trust in the focal Trust Game by not placing trust in at least some future games. If the trustor uses weak reciprocity in the sense of implementing conditional behavior, the trustee can gain T2 rather than R2 in the current Trust Game by abusing trust. However, abusing trust will then be associated with obtaining only P2 in (some) future encounters with no trust placed by the trustor, while honoring trust will result in larger payoffs than P2 in those future encounters if the trustor goes on placing trust. Moreover, the larger the shadow of the future, the more important are the long-term effects of present behavior. Thus, anticipating that the trustor may employ conditional behavior, the trustee has to balance short-term (T2 − R2) and long-term (R2 − P2) incentives. It can be shown that weak reciprocity can be a basis for rational trust in the sense that the indefinitely repeated Trust Game has an equilibrium such that trust is placed and honored in each round. Consider conditional behavior of the trustor that is associated with the largest rewards for trustworthy behavior of the trustee and with the most severe sanctions for untrustworthy behavior. This is realized if trust is placed in the first round and also in future rounds, as long as trust has been placed and honored in all previous rounds. However, as soon as trust is not placed or abused in some round, the trustor refuses to place trust in any future round. Straightforward analysis shows that always honoring trust (and always abusing trust as soon as there has been any deviation from the pattern “place and honor trust”) is a best reply of the trustee against such conditional behavior of the trustor if and only if w ≥ (T2 − R2)/(T2 − P2).

(1)

This condition requires that the shadow of the future is large enough compared with (T2 − R2)/(T2 − P2), a convenient measure for a selfish trustee’s temptation to abuse trust. The condition refers exclusively to the incentives of

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the trustee and not at all to the incentives of the trustor.3 This highlights that placing and honoring trust in the indefinitely repeated Trust Game is driven by the strategic interdependence of the actors. If condition (1) applies, the indefinitely repeated Trust Game has an equilibrium such that trust is always placed and honored. Enlightened selfinterest can thus be a basis for trust among rational actors in the sense of placing and honoring trust being equilibrium behavior.4 The equilibrium, however, is not unique. For example, never placing trust, while placed trust would always be abused, is always an equilibrium of the indefinitely repeated game. The “folk theorem” (see, for example, Fudenberg and Maskin 1986; Rasmusen 2007: ch. 5.2) for repeated games implies that the indefinitely repeated Trust Game has many other equilibria, too, for large enough w. Thus, an equilibrium selection problem emerges. A typical, though sometimes implicit, argument in the literature on equilibrium selection in this context is “payoff dominance.” An equilibrium is payoff dominated if there is another equilibrium that is associated with higher payoffs for at least some actor and is not associated with lower payoffs for any actor. In the indefinitely repeated Trust Game, an equilibrium that implies placed and honored trust throughout the game is evidently not payoff dominated by other equilibria, while the notrust-throughout equilibrium is payoff dominated. Rather than claiming that actors indeed follow the very strict behavioral rules described above, we can use condition (1) to derive more qualitative predictions about behavior in the indefinitely repeated Trust Game. If one proceeds from the observation that condition (1) is a necessary and sufficient condition for equilibria in the indefinitely repeated Trust Game such that trust is placed and honored throughout the game, one could then assume that placing and honoring trust becomes more likely when the condition becomes less restrictive. This leads directly to testable hypotheses on control effects through dyadic embeddedness. Specifically, one would expect that the likelihood of placing and honoring trust increases in the shadow of the future w and decreases in the temptation (T2 − R2)/(T2 − P2) for a selfish trustee. The results for the indefinitely repeated Trust Game can be generalized. For example, analogous results hold for an indefinitely repeated Investment Game. Friedman (1971, 1990) shows that analogous results apply to a broad class of indefinitely repeated 2- and n-person games. Roughly speaking, if a social dilemma is repeated indefinitely often and the shadow of the future is large enough relative to the short-term incentives of the actors, there exists an equilibrium of the indefinitely repeated game such that the actors cooperate: the equilibrium of the repeated game induces a Pareto-optimal outcome and a Pareto-improvement compared with the Pareto-suboptimal solution of the original dilemma. Of course, these generalizations should be interpreted with care. For example, conditional behavior requires the observability of the behavior of other actors. Hence, the underlying assumption that each actor receives reliable information on each other actor’s behavior in each round of the game is crucial, while such an assumption will often be rather problematic from an empirical perspective in games with many actors (see Bendor and Mookherjee 1987).

126 Vincent Buskens and Werner Raub network control Models of repeated Trust Games can be extended to account for control effects resulting from network embeddedness in addition to dyadic embeddedness. In these extended models, the trustee interacts with a set of trustors, while the trustors are connected through a network that allows for communication about the behavior of the trustee. The focal Trust Game is now embedded in a more complex game that comprises Trust Games of the trustee with different trustors. The important feature is that the trustor in a focal Trust Game can transmit information on the trustee’s behavior in that game to other trustors. Next to direct reciprocity exercised by the trustor who interacts personally with the trustee in the focal Trust Game, network embeddedness allows for indirect reciprocity exercised by other trustors. A trustee contemplating honoring or abusing trust in a focal Trust Game now has to consider future sanctions by the trustor with whom he interacts in the focal Trust Game, as well as sanctions that can be applied by other future trustors who receive information on the trustee’s behavior in the focal Trust Game and who may condition their future behavior on that information. In terms of our example of purchasing antiquarian books, we thus now consider variants of an eBay feedback forum. First, such network embeddedness can be a substitute for dyadic embeddedness (see Kreps 1990: 106−8). Assume that the trustee interacts with a different trustor in each round of the indefinitely repeated Trust Game in the previous section. Thus each trustor plays the Trust Game only once with the trustee. Dyadic embeddedness is then removed completely from the repeated game and has been replaced by network embeddedness. However, if the trustor in a given round is reliably informed of what has happened in previous rounds, all trustors can condition their behavior in a given round in the same way as a trustor who plays in each round: trust is placed if and only if there is no information that trust has not been honored before. Evidently, the trustee’s best reply against such behavior of the trustors is again to honor trust in each round if condition (1) is fulfilled. Conversely, placing trust is indeed then the best reply behavior also for the trustors. Hence, we see that network embeddedness can induce trust among rational and selfish actors. Dyadic as well as network embeddedness is included in more complex models (for example, Weesie, Buskens, and Raub 1998; Buskens and Weesie 2000a; Buskens 2002: ch. 3; see Raub and Weesie 1990 for a related model of network embeddedness for the Prisoner’s Dilemma). In these models, a trustee interacts with a trustor in an indefinitely repeated Trust Game. After the interaction with a given trustor ends, the trustee goes on playing an indefinitely repeated Trust Game with another trustor, while information on behavior in the Trust Games with the first trustor is communicated to the second trustor with some probability. Interactions with a third trustor start after the interactions with the second trustor have ended, and so forth.These models are relatively general and allow for quite some heterogeneity with respect to various features: the incentive T2 for abusing trust varies between games, the probability of starting interactions with the trustee as well as the continuation probability for these interactions varies between trustors, and the probability of information transmission varies between pairs of trustors. One can then

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study equilibria such that trustors place trust if T2 is not “too large” and if they do not have information that trust has ever been abused. A nice feature of these models is that they account for the intuition that trust will not always be placed. In addition to hypotheses on how the likelihood of trust is affected by the shadow of the future and the short-term incentives of the trustee, such models allow for deriving hypotheses on effects of network characteristics. Specifically, the likelihood of placing and honoring trust in a focal Trust Game increases in the density of the network of trustors as well as in the trustor’s outdegree—that is, the probability that the trustor will transmit information to the next trustor who interacts with the trustee. This is intuitively plausible, since network density as well as outdegree increase the sanction possibilities of the trustor. Hence, if the trustee thinks in terms of long-term consequences, higher network density and outdegree allow for placing and honoring trust even if the trustee’s short-term incentive to abuse trust is fairly large. A problem of these models is that they assume that information is reliable and that incentive problems associated with the supply of information are neglected (see Lorenz 1988; Raub and Weesie 1990: 648; Williamson 1996: 153−55; Blumberg 1997: 208−10; Buskens 2002: 18−20). However, supplying information on the trustee’s behavior is a contribution to a public good— namely, enforcing trustworthy behavior of the trustee. Such contributions are problematic: after all, public good production is itself a social dilemma when contributions are costly (this feature is often discussed as a major problem of institutions such as eBay’s feedback forum; see Bolton and Ockenfels 2009). Moreover, information from third parties can be inconsistent with one’s own experiences. Also, information from third parties can be problematic because of misunderstanding or strategic misrepresentation: imagine that the trustors are competitors who purchase the same goods from the same seller. In a nutshell, one would expect that effects of network embeddedness are attenuated when such problems become more serious. Notice, too, that we have focused on the case of network control in the sense that other trustors can sanction the trustee in future interactions. This is control through “voice,” in Hirschman’s sense (1970). A different case of network control is that a trustor has access to alternative trustees and can exercise control through “exit”: whether or not the trustor interacts again with the trustee in the future depends on the trustee’s behavior in the focal Trust Game. Modeling network control through exit opportunities for the trustor is not trivial (see Hirshleifer and Rasmusen 1989; Schüßler 1989; Vanberg and Congleton 1992 for related models), but one would expect in general that the likelihood of placing and honoring trust increases in the trustor’s exit opportunities. game-theoretic models of trust based on learning and control The game-theoretic models of embeddedness effects on trust discussed above have been (repeated) games with complete information: roughly speaking, each actor is informed on the behavioral alternatives and incentives of all actors. Specifically, trustors are completely informed on the behavioral alternatives and the incentives of the trustee. Hence, there is no need—and no opportunity— for trustors to learn during the game about unobservable characteristics of

128 Vincent Buskens and Werner Raub the trustee. This means that these models do not yield hypotheses on learning effects of embeddedness.5 Hypotheses on control as well as learning effects can be derived from models of games with incomplete information. Typically, these are models of finitely repeated games. To get a flavor of these games, consider first of all a finitely repeated game with complete information. Assume that trustor and trustee play the Trust Game from Figure 3.1 repeatedly—namely, N times. Clearly, in the final round, equilibrium behavior requires that trust would be abused and no trust will be placed. This means that behavior in the last but one round cannot have effects on behavior in the final round. Hence, no trust will be placed in the last but one round and so forth, back to the first round. This backward induction argument shows that placing and honoring trust cannot be a result of rational and selfish behavior in a finitely repeated Trust Game with complete information. Things change by introducing incomplete information in the finitely repeated Trust Game (see Camerer and Weigelt 1988; Dasgupta 1988; Neral and Ochs 1992; Bower, Garber, and Watson 1997; Buskens 2003). Introducing incomplete information means relaxing another core assumption of the standard rational choice model. Assume that there is a positive ex-ante probability π that the trustee actually has no incentive to abuse trust—that is, his payoff from abusing trust is T ∗2 < R2 (an alternative assumption leading to essentially the same results would be to assume that the trustee has no opportunity to abuse trust with probability π). The trustor knows the probability π but cannot directly observe whether the trustee’s payoff from abusing trust is T2 or T ∗2 . Now, if the trustor places trust in some round of the repeated game that is not the final round, trust may be honored for one of two very different reasons. First, the trustee’s payoff could be T ∗2 < R2 so that there is no incentive at all for the trustee to abuse trust. Second, the trustee’s payoff could be T2 > R2 but the trustee follows an incentive for reputation building. The trustee knows that if he abuses trust, the trustor can infer for sure that the trustee’s payoff from abusing trust is T2 > R2 and will thus never place trust again in future rounds. On the other hand, if the trustee honors trust, the trustor remains uncertain about the trustee’s incentives and may place trust again in the future. Conversely, the trustor can anticipate such behavior of the trustee and may therefore indeed be inclined to place trust. In this game the trustor can control the trustee, in that placing trust in future rounds depends on honoring trust in the current round and the trustor can learn about the incentives of the trustee from the trustee’s behavior in previous rounds. The result is a subtle interplay of a trustor who tries to learn about and to control the trustee, taking the trustee’s incentives for reputation building into account, and a trustee who balances the long-term effects of his reputation and the short-term incentives for abusing trust, taking into account that the trustor anticipates on this balancing. It can be shown that the game has an equilibrium (Kreps and Wilson 1982) that does involve placing and honoring trust in some rounds of the repeated game. More precisely, in that equilibrium, the game starts with trust being placed and honored in a number of rounds. Afterward, a second phase follows in which the trustor and the trustee with T2 > R2 randomize their behavior until the trustor does not place trust or the trustee abuses trust. After trust has

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not been placed or has been abused for the first time, the third and last phase starts, in which no trust is placed until the end of the game. A remarkable feature of the model is that quite some honored trust can be induced by equilibrium behavior even if the probability π that the trustee has no incentive to abuse trust is small. In the equilibrium, learning occurs—in the sense that the trustor updates her belief about the probability that she is playing with a trustee without an incentive to abuse trust—if trust is abused, and in the second phase as long as trust is honored. Learning is rational in the sense of Bayesian updating. The first phase of the game with trust being placed and honored is shorter, the higher the risk (P1 − S1)/(R1 − S1) for the trustor, the smaller the number of rounds of the repeated game, and the smaller the ex-ante probability π. While the risk for the trustor is a driving force of the model, the trustee’s temptation (T2 − R2)/(T2 − P2) only affects behavior in the second randomization phase of the repeated game. Quite counterintuitively, the probability that the trustor places trust in that phase increases (!) in the trustee’s temptation (see Buskens 2003: 239 for an explanation). Game-theoretic models with incomplete information such as the finitely repeated Trust Game are complex. They become even more complex by including learning resulting from network embeddedness. A shortcut linking learning effects of network embeddedness to such models would be to assume that the trustor’s ex-ante probability π of interacting with a trustee who would never abuse depends on information the trustor receives from third parties such as other trustors who played Trust Games previously with the trustee. Specifically, based on information diffusion models in networks of trustors (see, for example, Buskens 2002: ch. 4) and assuming that the information about the trustee is positive (it is information that the trustee has honored rather than abused trust), one would expect that the ex-ante probability π increases in the density of the network of trustors as well as in the extent to which the trustor in the focal Trust Game receives information about the trustee from other trustors—that is, increases in the trustor’s indegree. A more explicit game-theoretic model of network effects in games with incomplete information has been provided by Buskens (2003). In that model, the trustee plays Trust Games with two different trustors, A and B. With some probability, each trustor can inform the other trustor on the trustee’s previous behavior. We can conceive of the probability that trustor A transmits information to trustor B as A’s outdegree and B’s indegree (and vice versa). Thus, trustor A controls the trustee through her outdegree and learns from B about the trustee through her indegree. If each trustor transmits information to and receives information on the trustee from the other trustor with sufficiently high probability, the first phase of the repeated game such that trust is placed and honored becomes longer and in this sense network embeddedness increases trust. Counterintuitively, in the randomization phase, the probability of placing trust decreases (!) in the probabilities of information transmission. Summarizing and interpreting the results of the game-theoretic models for learning effects through dyadic and network embeddedness yields the hypotheses that the likelihood of placing and honoring trust decreases in the trustor’s risk (P1 − S1)/(R1 − S1) and increases if the trustor’s previous experiences with the trustee are positive (the trustee honored trust) rather

130 Vincent Buskens and Werner Raub than negative (the trustee abused trust). Furthermore, assuming that the trustor receives positive information about the trustee from other trustors, the likelihood of placing and honoring trust increases in the density of the network of trustors, and in the trustor’s indegree. These are relatively robust hypotheses that lend themselves also to empirical research outside the laboratory. The counterintuitive hypotheses on behavior in the randomization phase of the games are clearly best tested in lab experiments. Models for control and learning effects of embeddedness in games with incomplete information are not only problematic in that they use very strong assumptions on the actors’ rationality including rational (Bayesian) updating of beliefs.These models are also problematic in that they neglect learning on other features than unobservable characteristics of the trustee. For example, a trustor could try to use information received from other trustors for inferring how to reasonably cope with trust problems. Also, past interactions may give rise to other effects than exclusively learning. For example, actors may have pledged investments in their relation through past interactions, and these investments affect the incentives in the focal Trust Game. The attractive feature of game-theoretic models involving incomplete information is that control and learning can be analyzed simultaneously. The price tag attached to these models is a set of rather strong assumptions on the actors’ rationality. Alternatives are “pure” learning models in which actors adapt their behavior based on past experiences. Actors try to optimize short-term outcomes, while not (or “hardly”) looking ahead. This implies, too, that actors do not take other actors’ incentives into account (see Camerer 2003: ch. 6 for a useful overview of learning models; Macy and Flache 1995, 2002; Flache and Macy 2002 provide applications to social dilemmas; Buskens 2002: ch. 4 is an example of a model of learning in networks). Hence, these models neglect control effects. Typically (see Buskens and Raub 2002: 173−76), learning models yield hypotheses that the likelihood of placing trust decreases in the trustor’s risk (P1 − S1)/(R1 − S1). Also, the trustor’s estimation of the probability π that trust will be honored will typically increase with positive information about the trustee’s behavior in previous interactions, be it information from the trustor’s own previous interactions with the trustee or information from third parties.Therefore, one would again hypothesize that more positive information increases the likelihood of placing trust. Table 3.2 summarizes the hypotheses discussed in this section.

Empirical Research on Effects of Social Embeddedness We organize our overview of empirical evidence on effects of social embeddedness by type of research design, focusing on evidence closely related to the hypotheses summarized in Table 3.2. First, lab experiments are used for testing hypotheses on embeddedness effects (see Cook and Cooper 2003 for an overview of experimental studies on how other elements in the social context can affect trust). Experiments allow for control over the variation in important independent variables, and the causal relation between manipulations and outcome differences is mostly obvious.The disadvantage is that setups are often rather artificial. Subjects are typically students who are engaged in abstract

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tab le 3 .2

Hypotheses on Effects of Social Embeddedness. Two types of embeddedness Two mechanisms

Control

Learning

Dyad

1. Trust and trustworthiness decrease with the temptation to abuse trust for the trustee and increase with the likelihood that an interaction is repeated. 2. Trust and trustworthiness decrease with the trustor’s risk and increase with positive experiences with a trustee.

Network

3. Trust and trustworthiness increase with the density of the trustor’s network, her outdegree, and the availability of institutions that provide information. 4. Trust and trustworthiness increase with the density of the trustor’s network, her indegree, and the availability of institutions that provide information (given that information about the trustee is predominantly positive).

interactions. This questions external validity. Therefore, evidence from settings beyond the lab is a complement to experimental evidence. In the second part, we thus review evidence from survey studies, with some emphasis on evidence from on-line transactions. It is typically difficult to disentangle learning and control effects of embeddedness in these studies. We conclude our overview with a brief sketch of two vignette experiments that were specifically designed to overcome this problem. Clearly, vignette experiments have their limitations, too. For example, incentives for subjects are problematic, since vignette designs involve hypothetical decisions in hypothetical situations. One may thus conclude that it makes sense to employ different and complementary research designs, each having specific strengths and shortcomings, for testing hypotheses on embeddedness effects in order to assess the robustness of empirical findings. laboratory experiments Effects of dyadic embeddedness Camerer and Weigelt (1988) initiated experimental research that aims at carefully testing hypotheses on behavior in finitely repeated Trust Games with incomplete information, with follow-up studies by Neral and Ochs (1992), Anderhub, Engelmann, and Güth (2002), and Brandts and Figueras (2003). See Camerer (2003: 446−53) for a more detailed overview of these experiments.6 While experiments on one-shot Trust Games focus on payoff effects and reveal that these effects, in particular effects of risk and temptation, are strong, experiments on repeated Trust Games focus on embeddedness effects. Experiments confirm that trust as well as trustworthiness are high in early rounds and decrease when the end of the repeated game approaches (dyadic control). Trust is almost absent after any abuse of trust, while trust remains relatively high as long as trust has been honored (dyadic learning). However, the trustor’s tendency to place trust as long as trust has been honored does not increase as the end of the game comes nearer.This is consistent with the theory, since trustors have to realize that trustees with an incentive to abuse trust also

132 Vincent Buskens and Werner Raub have an incentive to make trustors believe that they do not abuse trust, while these trustees will in fact abuse trust toward the end of the game. Brandts and Figueras (2003) also find that trust and trustworthiness increase with the probability that a trustee has no incentive to abuse trust. Summarizing, the equilibrium described above for the finitely repeated Trust Game predicts quite some global patterns of behavior reasonably well. However, the experiments of Neral and Ochs (1992), Anderhub, Engelmann, and Güth (2002), and Brandts and Figueras (2003) also show that behavior of subjects does not completely follow the predicted equilibria. For example, it is predicted that in the second phase of the game in which trustors and trustees with an incentive to abuse trust both randomize, the probability that trustors trust increases (!) with the temptation for the trustee to abuse trust. This implication is not only counterintuitive but also inconsistent with experimental findings. Results from some other experiments are quite in line with these findings. Gautschi (2000) reports findings for finitely repeated Trust Games that comprise two or three rounds of play. He finds that positive past experience matters (dyadic learning) and that the number of remaining rounds to be played also increases trust (dyadic control). For a more contextualized setting with buyers and sellers and an incentive structure similar to the Trust Game, Kollock (1994) finds similar evidence. Still, the studies by Gautschi and Kollock report quite some untrustworthy behavior by trustees very early in the games. This can be explained by the difference that subjects in the studies of Gautschi (2000) as well as Kollock (1994) play relatively few games, while subjects in the studies by Camerer and Weigelt (1988) and the related follow-up studies play very many games. Camerer and Weigelt (1988) as well as their followers analyze mainly the later games in the experiment. In this way, suboptimal behavior is minimized. For example, if trustees build up more experience, they “learn” that they actually earn less if they behave opportunistically too early. In the studies by Gautschi (2000) and Kollock (1994), subjects have much less opportunities for this type of learning. Engle-Warnick and Slonim (2004, 2006) compare finitely and indefinitely repeated games. In principle, the trustor’s opportunities to exercise control in an indefinitely repeated game with constant continuation probability are the same in round t and in round t + 1. Still, the authors find decreasing trust over time in such games. However, this decrease is much smoother than in the finitely repeated games. This can be understood in the sense that learning effects in terms of negative experiences reduce trust over time, and subsequently trust seems to be difficult to restore. On the other hand, trust remains reasonably high because control opportunities do not diminish over time and enable some pairs to continue to trust each other. An additional explanation for decreasing trust in indefinitely repeated games might be that subjects believe that after many repetitions of the game the probability increases that a specific round will be the last one, even if experimenters do their very best to make it apparent that the continuation after every round is constant (for example, by using a publicly thrown die). While there are many experiments on the Investment Game, only few use the finitely repeated Investment Game. The findings of Cochard, Nguyen Van, and Willinger (2004) are in line with empirical regularities that have been

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found for the Trust Game. Subjects send more in the Investment Game if there is a longer future ahead (dyadic control), but if receivers do not return enough they stop sending (dyadic learning). In early rounds, trustors send more if the trustees return more. While Cochard, Nguyen Van, and Willinger refer to this finding as a reciprocity effect, it can also be interpreted as a learning effect. Again, there is a strong endgame effect, although it is observed very late in the games. Trustees start to return less in the last-but-one round. Trustors react on low return rates by sending less in the last round, but there is no significant evidence that trustors send less as a pure result of being in the last round.7 Effects of network embeddedness Experiments with Trust Games or Investment Games that include network embeddedness are still rare. Bolton, Katok, and Ockenfels (2004; see also Bolton and Ockenfels 2009) compare one-shot Trust Games that are isolated encounters in the strict sense, finitely repeated Trust Games (with the same partner), and a third treatment in which subjects play multiple one-shot Trust Games with different partners but obtain information about the past behavior of their partners in interactions with other subjects (for a similar setup and results, see Bohnet and Huck 2004). In the one-shot Trust Games, trust and trustworthiness decline quickly after subjects have some experience. Trust and trustworthiness remain high in the repeated Trust Games and collapse only in the last couple of rounds. This finding resonates with evidence on effects of dyadic embeddedness. In the third treatment, there is initially less trust and trustworthiness than in the finitely repeated Trust Game setting, but trustees apparently learn fast enough that they have a considerable problem if they do not honor trust. In this treatment, trust and trustworthiness stabilize for some time in the middle of the series of interactions, although at a somewhat lower level than in the repeated Trust Game setting. Again, trust collapses in the last few rounds. Bolton, Katok, and Ockenfels (2004) interpret their third treatment as an experimental implementation of an institutionalized reputation system that is common for on-line transactions.The treatment could also be interpreted as a complete network in which information diffusion is perfect. Below we will come back to this. Note that the Bolton, Katok, and Ockenfels reputation treatment involves opportunities for learning as well as control through third parties.While indicating that network embeddedness matters, it remains unclear to which mechanism—learning or control or both—trust can be attributed. Buskens, Raub, and Van der Veer (2010) introduce a network setting with subjects playing finitely repeated Trust Games in groups of three (see also Barrera and Buskens 2009 for a related study on the Investment Game). There are two trustors and one trustee. Both trustors play with the same trustee. The design varies whether or not trustors obtain information about transactions from the other trustor who plays with the trustee. It turns out that there is more trust in the condition in which trustors do know what happens in the games of the other trustor. Similar to findings from other experiments, within dyads, trustors send more after positive experiences with the trustee, and trust as well as trustworthiness collapse near the end of the game. This is once again evidence for dyadic control, as well as dyadic learning. Buskens (2003) implies that the decrease in trust and trustworthiness should start later with increasing

134 Vincent Buskens and Werner Raub network embeddedness because of the network control effect. Buskens, Raub, and Van der Veer (2010) do not find evidence for this network control effect on the trust of the trustor. Still, they do find evidence for network control on trustworthiness of the trustee. They offer a bounded rationality argument why network control has an effect only for trustees and not for trustors: the trustee needs to anticipate third-party sanctions, while the trustor needs a further step of strategic reasoning—namely, anticipating that the trustee anticipates the third-party sanctions. survey studies There is quite some qualitative evidence that dyadic embeddedness (for example, Uzzi 1996) and network embeddedness (for example, Wechsberg 1966) affect trust. We focus on more quantitative evidence from surveys. As we will see, although many surveys offer evidence for effects of embeddedness, it is hardly ever the case that we can determine whether the effects are the result of learning, control, or a combination of the two mechanisms. Effects of dyadic embeddedness Gulati (1995a, 1995b) employs data on strategic alliances between business firms. Such alliances typically involve incentives for opportunism and trust problems between the partners. He finds that the probability that firms will form alliances is larger if they have been previously involved in alliances with the same partner. Gulati interprets this as an indication that previous and presumably positive experiences enlarge trust among partners. Moreover, the probability that partners in alliances use equity as a formal governance mechanism and commitment device decreases with the number of previous alliances between the partners. Using other data, Gulati and Wang (2003) show that joint ventures with a longer positive relation generate more value than joint ventures with less dyadic embeddedness. This is another indication that dyadic embeddedness helps to reach more efficient solutions in the social dilemmas the partners face. More precisely, it is tempting to assume learning effects resulting from dyadic embeddedness as an underlying mechanism. Baker, Faulkner, and Fisher (1998) find that interorganizational ties between advertising agencies and their clients have a smaller probability of being dissolved if they have existed for a longer period. Although these findings are interpreted in terms of learning— positive past experience increases trust, while trust enlarges the probability of staying together—a control interpretation seems likewise plausible. After all, the increased probability of staying together improves control opportunities. Some studies on trust in interfirm relations are noteworthy for addressing the effects of embeddedness at the dyadic level on the investment in formal arrangements such as investments in contracting. We consider investments in formal contractual arrangements as an indication for lack of trust among partners, since such arrangements provide, for example, compensation for the trustor in case of untrustworthy behavior by the trustee. This can also be interpreted as that there exist substitution effects between contracting and embeddedness in facilitating transactions that involve trust problems. In a study on seventy-two subcontracting relationships, Lyons (1994) finds that the probability for arranging the relationship with a formal contract decreases with

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the number of years subcontractors have been trading with their most important customers. Similarly, Corts and Singh (2004) find that repeated interactions between oil companies and off-shore drillers reduce the probability that they choose fixed-price contracts to arrange the transaction. Blumberg (1997: ch. 4.2) uses the investment in formal arrangements and the extensiveness of the contract as measures for distrust in R&D-relations. He finds that both measures decrease and, thus, that trust increases with the extent to which the partners had transactions in the past. These results support the learning hypothesis that positive experiences increase trust. Blumberg actually distinguishes between the effect of past transactions and transactions expected with the partner in the future, but he does not find an effect of the transactions partners expect in the future. Batenburg, Raub, and Snijders (2003) study relations between buyers and suppliers of IT products. Their dependent variable is a combination of time and money spent in partner search, negotiating with the partner, and the extensiveness of the contract.This dependent variable represents investments in the ex-ante planning of transactions. They find that these investments decrease if the partners had transactions in the past. Furthermore, they find that the investments decrease even more if the partners already had past transactions and expect more transactions in the future. They do not find an effect of expected future transactions if the partners had no previous transactions.Their explanation employs two arguments. First, costly investments in ex-ante planning are less necessary if more future transactions are expected because of the sanction opportunities from subsequent transactions. This is a control effect based on the expectation of future transactions. Second, however, it is worthwhile to invest more in formal arrangements if more future transactions are expected, because these investments can be used again in subsequent transactions. This is an investment effect brought about by the expectation of future transactions. The driving force of this effect is that relation-specific investments associated with a focal transaction affect the incentive structure of future transactions. Combining the arguments on control and on the investment effect, it is unclear what the total effect of future transactions is. However, a negative interaction effect between past and future on ex-ante planning is indeed expected, since the investment effect will be larger in initial transactions than in later transactions. Another explanation for such an interaction effect could be that control plays a role only if the partners have sufficient information about each other and that uncertainties about an unknown partner are simply too large to allow for reliance on control through future sanctions already in the first transaction. Effects of network embeddedness Buskens, Raub, and Weesie (2000) use the same data as Batenburg, Raub, and Snijders (2003). They address the effects of network embeddedness on trust.They find that there are fewer issues addressed in the contract if the buyer and supplier are located closer to each other. An interpretation of this finding is that buyers and suppliers who are located closer to each other are probably embedded in a denser network. Although alternative explanations might be possible, this is a first indication that network embeddedness increases trust. Obviously, being located close to one another improves learning as well as

136 Vincent Buskens and Werner Raub control opportunities, so that it is unclear whether this effect is the result of learning or control. Rooks, Raub, and Tazelaar (2006) also use the same data to study trustworthiness of the supplier by analyzing how many ex-post problems arise in an IT-transaction.They find evidence that fewer ex-post problems arise in a transaction if the buyer knows more other buyers of the supplier, if the supplier is more visible, and if the buyer has more alternative suppliers to choose from. While the first and the second effect can be interpreted as learning as well as control effects of network embeddedness, the third effect is a network control effect on trustworthiness of the supplier. This pattern of findings is consistent with the experiment of Buskens, Raub, and Van der Veer (2010), showing that the control effect of network embeddedness is more apparent for the trustee’s than for the trustor’s behavior. Gulati (1995b) argues that social networks help firms to obtain information about facilities and the abilities of potential partners. He indeed finds that alliances occur more often among partners who have more common ties with third parties. Gulati and Gargiulo (1999) is one of the studies which shows that specific network properties—in this case, centrality—are related to the likelihood of alliance formation. These findings can be interpreted as a result of learning as well as control effects of network embeddedness, because central actors potentially receive more information and they can also transmit information more widely in the network. Using data on strategic alliances in the biotechnology sector, Robinson and Stuart (2007) try to disentangle the effects of different mechanisms based on network embeddedness. Their dependent variable is equity participation, which is a measurement for mistrust, because it reduces incentive problems and increases formal control opportunities. Their important independent variables related to our study are the centrality of the trustor (“client”) and trustee (“agent” or “target”) in the network; third parties trustor and trustee share in the network; and past alliances among the two partners. Robinson and Stuart provide strong evidence for effects of dyadic embeddedness and network embeddedness on trust by explaining the use of informal network management mechanisms rather than equity participation for partners with repeated interactions, partners that are more central in the network, and partners that have more other partners in common. Again, however, it is impossible to distinguish clearly between learning and control effects, because Robinson and Stuart use centrality measures such that the ties considered are symmetric and can be used for sending as well as receiving information. Moreover, the evidence in these network studies is based on the assumption that the network structure related to actual alliances corresponds largely with the network structure of communication among the relevant firms. If this assumption does not hold, learning and control can be the result of ties other than the alliance ties. Thus these studies provide at best indirect evidence for the mechanisms implied by the theory, because there is no information on how actual information about behavior of the firms is spread among other firms. The Internet economy confronts exchange partners with trust problems and illustrates how actors try to solve trust problems through institutionalized information exchange that improves network embeddedness in a setting in which direct face-to-face contact is not sufficient. An important advantage of

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studies on the Internet economy is that for transactions at eBay and other platforms, researchers know which information the buyers have about sellers. In addition, the large number of transactions provides good opportunities for quantitative analyses. Both selling probability and selling price can be interpreted as measures of trust. First, if trust is too low, the transaction will not take place. Second, a good reputation of the seller increases the buyer’s trust and the expected value of the product for the buyer, implying that she is willing to pay more. In one of the earliest studies, Kollock (1999) claims preliminary evidence that reputation scores have an effect on price. Resnick and Zeckhauser (2002) conclude from an overview of studies on eBay auctions that good reputation scores increase the likelihood that a product is sold, but that there is no evidence that reputation scores affect price. In subsequent studies, various statistical pitfalls in the analyses of Internet auctions are addressed. Resnick et al. (2006) develop a field experiment in which they use an experienced seller who sells under different identities and with different reputation scores. In this way, they keep constant many confounding factors—for example, seller’s experience. Indeed, they find a large price premium related to the better reputation score. Also, in their extensive review of existing empirical work, Resnick et al. show that the price effect becomes more apparent in the more sophisticated studies. In addition, Snijders and Zijdeman (2004) show that unobserved heterogeneity can obscure the effect of reputation on price (see also Diekmann, Jann, and Wyder 2009). Lucking-Reiley et al. (2007) find evidence that looking only at the net reputation score—that is, positive minus negative evaluations—is not sufficient, because negative evaluations have a much larger impact on the price than positive evaluations. Most data collected from eBay and other standard auction sites have another problem—namely, that they include information about completed deals, while there is no, or at best limited, information about the alternatives buyers had. This implies that the actual choice problem of buyers cannot be properly evaluated, which might lead to serious selection problems. Snijders and Weesie (2009) solve this problem by looking at a different type of site at which producers of software can offer their services for specific demands by the buyer. At the end of the auction, the buyer chooses a producer. Snijders and Weesie (ibid.) again find that better reputation scores have a positive effect on price. The evidence on Internet auctions shows that institutionalized information exchange indeed improves trust of buyers in sellers. Clearly, this can be interpreted as a learning effect: positive past information convinces buyers that a seller will act in a trustworthy way. Still, institutionalized information exchange is likewise related to control through network embeddedness. Given that positive reputations have a price premium, buyers can damage reputations of sellers if sellers do not perform well. However, the evidence on how negative evaluations should be weighted against positive ones and whether negative evaluations have a larger negative impact on price for sellers with good reputations than for sellers with less well developed reputations is not so clear yet. Note that we do not address the question of why people provide feedback at all. Clearly, this involves a collective good dilemma in itself, since providing feedback is costly, while there is no direct benefit for oneself in

tab le 3.3

Key References on Evidence about Embeddedness Effects;Type of Data in Brackets. Research designs and mechanisms

Experiments Control

Learning

Surveys Control

Control and/or learning

Learning

Two types of embeddedness Dyad

Network

Camerer and Weigelt 1988; Neral and Ochs 1992; Anderhub et al. 2002; Brandts and Figueras 2003 (finitely repeated Trust Game) Engle-Warnick and Slonim 2004, 2006 (indefinitely as well as finitely repeated Trust Game) Cochard et al. 2004 (finitely repeated Investment Game)

Bolton et al. 2004; Bolton and Ockenfels 2009; Bohnet and Huck 2004 (one-shot Trust Game finitely repeated within a group, while new partners obtain information about everyone’s behavior in the past) Buskens et al. 2010; Barrera 2005; Barrera and Buskens 2009 (finitely repeated Trust Game, trustors also obtain information about behavior of their trustee with another trustor) Bolton et al. 2004; Bolton and Ockenfels 2009; Bohnet and Huck 2004 (one-shot Trust Game finitely repeated within a group, while new partners obtain information about everyone’s behavior in the past) Buskens et al. 2010; Barrera 2005; Barrera and Buskens 2009 (finitely repeated Trust Game, trustors also obtain information about behavior of their trustee with another trustor)

Camerer and Weigelt 1988; Neral and Ochs 1992; Anderhub et al. 2002; Gautschi 2000; Brandts and Figueras 2003 (finitely repeated Trust Game) Kollock 1994 (experimental buyer-seller market) Engle-Warnick and Slonim 2004, 2006 (indefinitely as well as finitely repeated Trust Game) Cochard et al. 2004 (finitely repeated Investment Game) Blumberg 1997 (R&D alliances) Batenburg et al. 2003 (IT transactions) Gulati 1995a, 1995b (strategic alliances) Gulati and Wang 2003 (joint ventures) Baker et al. 1998 (advertising agencies and their clients) Lyons 1994 (subcontractors) Corts and Singh 2004 (off-shore drillers and oil companies) Robinson and Stuart 2007 (strategic alliances)

Blumberg 1997 (R&D alliances) Batenburg et al. 2003 (IT transactions)

Buskens et al. 2000; Rooks et al. 2006 (IT transactions, proximity, third-party relations, exit opportunities) Gulati 1995b; Gulati and Gargiulo 1999 (R&D alliances, third-party relations, centrality) Robinson and Stuart 2007 (strategic alliances, centrality, proximity) Resnick and Zeckhauser 2002; Diekmann et al. 2009; Snijders and Zijdeman 2004; Resnick et al. 2006; Lucking-Reiley et al. 2007; Snijders and Weesie 2009 (Internet auctions)

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providing feedback. Solving this dilemma would bring us into the literature on self-organizing institutions (see Ostrom 1990; and Janssen 2006 for a specific model related to Internet auctions). The evidence on learning and control effects on trust through social networks or more formal institutions that facilitate information exchange is still far from conclusive. While there is evidence that trust can emerge in dense social networks, it remains unclear what drives the emergence of trust. Is it learning, or is control through the promise of positive and the threat of negative sanctions more important? Presumably, the empirical evidence is also limited because of scarce theoretical explanations that can guide the search for empirical evidence. Researchers have focused primarily on establishing the relationship between network embeddedness and trust considering at most one mechanism that drives this relationship. The distinction between learning and control effects of embeddedness proposed here and the fact that embeddedness facilitates learning as well as control, however, asks for an integrated approach that allows for disentangling these two mechanisms.Table 3.3 offers a summary of key references to empirical research on embeddedness effects. vignette experiments for disentangling control and learning effects of embeddedness Distinguishing empirically between control and learning effects of embeddedness is a complex task. While laboratory experiments mostly allow variation in only a small number of variables, survey research often lacks the necessary control on causes and consequences. As a complement to lab experiments and survey studies, we discuss two vignette experiments in which subjects are presented with hypothetical economic transactions that involve trust problems. The subjects answer questions about their behavior related to these transactions (see Rossi and Nock 1982 on vignette experiments). Vignette experiments are useful in providing more control over the variation of somewhat more key variables, as well as over what the causes of changes in the dependent variable are. In addition, in surveys and experiments, actors are engaged in series of transactions in which opportunities for learning and control often co-occur, while in vignette experiments it is more straightforward to vary opportunities for learning and control independently. These advantages of vignette designs, however, come with two disadvantages. First, the choices are purely hypothetical, which implies that the choices do not have actual consequences for the decision-makers. This questions the actual incentives to choose one or the other option. Second, given that the decision situations are hypothetical, it can be a problem that the decision situation is rather artificial for the decision-maker, which compromises the validity of the decisions. In the vignette experiments, subjects have to imagine themselves in the role of buyers in economic transactions. The description of the situation makes it plausible that buyers face a trust problem by indicating that the transaction partner might have an incentive to behave opportunistically in the transaction. In the first experiment, purchase managers of Dutch companies are asked to answer questions about hypothetical transactions with suppliers (see Rooks et al. 2000). The description of the transactions comprises information about transaction characteristics such as price and specific investments of the buyer associated with the transaction, but also about the relationship of the buyer

140 Vincent Buskens and Werner Raub with the supplier. Four variables are varied that are related to embeddedness: (1) The extent to which the buyer did business with the same supplier in the past (dyadic learning); (2) The extent to which the buyer expects to do business with the supplier in the future (dyadic control); (3) The extent to which the buyer and supplier have common business partners (network embeddedness that provides opportunities for learning as well as control); and (4) The availability of alternative suppliers for the buyer (network control). The dependent variable is lack of trust of the buyer, measured by the extent to which the buyer wants to invest in safeguards (for example, contractual agreements) before the transaction takes place. Results reveal a strong effect of embeddedness on trust resulting from learning within a dyadic relation. Positive past experiences reduce the investment in safeguards. Although there is no main effect of expected interactions in the future, there is indeed a negative interaction effect of past transactions and expected future transactions, indicating that the use of control opportunities is contingent on some previous learning opportunities. This finding is in line with the results of the survey on IT transactions of Batenburg, Raub, and Snijders (2003) discussed above, notably employing a very different research design. Concerning third-party effects, results show that knowing other business partners of the supplier increases trust. It is unclear whether this effect is the result of learning or control, since these third parties can be used to obtain information on previous behavior of the supplier, but they also can be informed on behavior of the supplier in the focal transaction, thus extending control opportunities for the buyer. There is indeed a negative effect of the availability of alternative trading partners on investments of the buyer in safeguards for the transaction. This supports the interpretation that purchase managers realize that alternative suppliers provide them with sanction opportunities, implying that suppliers are less likely to act in an untrustworthy way if they have more competitors. In another vignette experiment, students are asked to compare situations for buying a used car (see Buskens and Weesie 2000b for more details). Students are offered pairs of vignettes describing such a transaction, and they are asked which one they prefer. Five embeddedness variables are varied at the vignettes: (1) Whether the buyer has bought a car from the dealer before and was satisfied, or never bought a car from the dealer (dyadic learning). (2) Whether or not the buyer expects to move to the other side of the country soon (dyadic control). The probability that the buyer has future transactions with the dealer is smaller if the buyer moves. Hence, control is more difficult for a buyer who moves. Theoretically, the effect of expected future transactions is based on the sanctions of the buyer anticipated by the dealer. Therefore, strictly speaking, expected future transactions can be expected to affect the behavior of buyer and dealer only if the dealer is informed about the buyer’s plans to move. (3) Whether the dealer is or is not well known in the neighborhood of the buyer (network density). Again, learning as well as control of a well-known garage through the network of customers can be more effective than learning about or control of a garage that is not well known. (4) Whether or not the buyer has information from friends about transactions of these friends with the garage (network learning), with a focus on the difference between no information and positive information. (5) Whether or not both the buyer and the dealer are members of the same sports team (network control). This measures network

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control because the number of acquaintances the buyer and dealer have in common is expected to be larger if the buyer and dealer are members of the same sports team. Common membership provides the buyer with possibilities of controlling the dealer through positive or negative reputational sanctions both in business and as a team member. An advantage of this operationalization is that the theoretical assumption of “common knowledge about the network” is unlikely to be violated because the buyer and the dealer both know that they are members of the sports team. Results show that all five embeddedness variables have positive effects on the likelihood that subjects prefer a vignette that includes the respective type of embeddedness over the one in which that type of embeddedness is not available. The strongest effects seem again to be those of dyadic and network learning variables. Positive information clearly enhances trust. Dyadic control, density, and network control likewise have positive effects on trust, which implies that control is important at the dyadic as well as at the network level. The evidence for a control mechanism is somewhat problematic, since these variables are subject to alternative explanations. There might be other disadvantages of buying a car just before you move, for example, because you need to find another garage if there is any problem with the car in the future. Although our arguments and results for network control are in accordance with DiMaggio and Louch (1998), we cannot exclude that actors prefer to trust well-known others over unknown others for other reasons than the control reasons advocated here. Summarizing the evidence from studies employing different research designs, we have quite unambiguous support for hypotheses on learning effects at the dyadic and network level. Also, hypotheses on effects of control opportunities at the dyadic level are quite consistently supported, as can be seen from endgame effects in finitely repeated Trust Games, surveys on transactions as well as the vignette experiments. Network control is less well studied and the evidence is more ambiguous. We would expect that these results might generalize to other kinds of social dilemmas, but we do not know about systematic studies that have compared embeddedness effects for other social dilemmas, including experimental as well as survey studies and distinguishing between different types of embeddedness effects.

Conclusions and Directions for Further Research We have provided a survey of rational choice research on social dilemmas by focusing on how game theory can be used to model social dilemmas, how testable hypotheses can be generated from game-theoretic models, and what empirical evidence tells us about those hypotheses. Trust problems have been our paradigm case of a social dilemma. In terms of the strategies for refining the model of atomized interactions on perfect markets of rational and selfish actors with full information, we have focused on models that retain the rationality assumption. In fact, game-theoretic models often employ particularly strong rationality assumptions. We have briefly considered how relaxing selfishness assumptions by including other-regarding preferences can help in accounting for behavior in social dilemmas and specifically in dilemmas that are isolated encounters. Our main focus, however, has been on effects

142 Vincent Buskens and Werner Raub of social embeddedness. We have concentrated on game-theoretic models that allow for an analysis of how embeddedness affects behavior in social dilemmas. Hence, the bulk of the models surveyed in this chapter relax the assumption of atomized interactions and often also the assumption of full information. We have stressed that game-theoretic models allow us to systematically distinguish different kinds of embeddedness and also to distinguish different mechanisms such as control and learning through which behavior in social dilemmas depends on embeddedness. From the empirical end, we have stressed the need for research designs that make possible discrimination between different types of embeddedness, as well as disentangling control and learning effects. We have also argued for using complementary research designs such as experiments, surveys, vignette studies, and the like as a strategy for establishing the robustness of empirical findings (see Levitt and List 2007 for a thorough discussion of this issue, as well as Falk and Heckman 2009 and Gächter and Thöni 2011). Our overview of studies shows that there is quite some empirical evidence for embeddedness effects. When research designs are employed that do allow for disentangling different kinds of embeddedness effects and mechanisms through which embeddedness works, hypotheses based on game-theoretic models often succeed in predicting the signs of coefficients (see Grofman 1993; Green and Shapiro 1994 for related discussions on the merits and problems of qualitative predictions on changes “at the margin” using comparative statics versus quantitative point predictions from rational choice models). Nevertheless, there is clearly much room for improvement in the predictions of game-theoretic models on behavior in social dilemmas. Roughly speaking, the overall impression is that assuming game-theoretic rationality as well as selfish actors (“utility = own money”) cannot account for quite some nonopportunistic behavior in social dilemmas that are isolated encounters, while it also often predicts “too much” cooperative behavior in repeated social dilemmas (see Bolton and Ockenfels 2009 for a similar point in the context of research on reputation systems in the Internet economy). Developing game-theoretic models on the interplay of social embeddedness and other-regarding preferences may be useful in this respect (see Gintis 2000: ch. 11 for related arguments). With respect to research on social embeddedness, theoretical as well as empirical work reviewed in this chapter assumed embeddedness characteristics as exogenously given. Using a notion that has become popular, embeddedness can be conceived as social capital of actors (see, for example, Coleman 1990). We have focused on the returns on social capital: embeddedness allows for overcoming Pareto-suboptimal outcomes in social dilemmas. What we have neglected are actors’ investments in their social capital (see Flap 2004 and the chapter by Flap and Völker in this Handbook for the distinction between returns on and investments in social capital). However, given the returns on embeddedness in social dilemmas, actors do have an incentive to invest in their embeddedness by strategically establishing, maintaining, or deleting ties to others, including search for potential interaction partners. One would thus like to endogenize embeddedness characteristics. Research on strategic network formation based on game-theoretic models is rather novel but meanwhile rapidly developing (see the textbooks Goyal 2007; Jackson 2008). Such work

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on returns on and investments in social capital can likewise benefit from the development of “actor-driven” statistical models for the dynamics (“coevolution”) of networks and behavior (see Snijders 2001; Snijders’s chapter in this Handbook). How embeddedness can contribute to trust and cooperation has been a core topic of our chapter. We have thus highlighted the beneficial effects of embeddedness for the actors involved in a social dilemma. Beneficial effects for the actors directly involved can have negative effects for others. From the perspective of third parties or from a societal perspective, undermining rather than fostering cooperation is often the aim. It should be noted, too, that embeddedness can also have adverse effects for the actors who are themselves directly involved in social dilemmas. Focusing on learning and information diffusion rather than game-theoretic rationality as a driving force of behavior, Burt and Knez (1995) have shown that dense networks can amplify trust as well as distrust. The core argument is that because of the homogeneity of opinions in a dense network, actors become convinced about some information because they receive the information disproportionately often. Coethnics may be able to solve trust problems in economic exchange by transacting with each other, but this may lead to entrapment and missing opportunities from outside networks (see, for example, Portes 1998). Flache (2002) offers a game-theoretic model of how informal social ties between the members of a team can undermine cooperation between the members of the team since they have to trade off the benefits of sanctioning team members who do not cooperate against the costs of deteriorating informal social ties through negative sanctions. While there is quite some empirical research on adverse effects of embeddedness, more systematic theoretical modeling of such effects is needed. With respect to theoretical modeling, relaxing strong game-theoretic rationality assumptions or showing that and when equilibrium behavior in accordance with such assumptions is a—possibly long-term—result of bounded rationality and evolutionary or learning processes (for example, Fudenberg and Levine 1998; Gintis 2000) may have useful implications for research on social dilemmas, too. We would like to conclude, though, with a more specific suggestion.We have seen that, in principle, games with incomplete information are a tool for analyzing embeddedness effects in social dilemmas through control and learning in an integrated way. However, as we have also seen, it is difficult to strike a fruitful balance of analytic tractability and realistic assumptions about what information actors have and how they use relevant sources of information. On the one hand, models with more realistic informational assumptions are often difficult to analyze. On the other, knowledge about what realistic informational assumptions would be is limited, because most empirical research has not succeeded in clearly disentangling the effects of learning and control mechanisms. Disentangling the effects could provide some evidence on the relative importance of these mechanisms and evidence about changes in the importance of different effects related to different circumstances. To overcome these limitations, we propose a two-step empirical and theoretical approach. More experimental research is necessary to obtain better insights in the relative importance of the different mechanisms. For example, experiments should be designed such that subjects are involved in abstract Trust

144 Vincent Buskens and Werner Raub Games embedded in a social context that allows for communication among trustors. The experiments should explicitly provide insights in how subjects use information they obtain from other subjects in the network and whether or not they try to sanction by informing other trustors in the network. In this way, the experiments make possible the development of new models built on assumptions, for example, about information exchange that have an empirical basis rather than on assumptions chosen exclusively on the basis of introspection of researchers and mathematical tractability. Moreover, the experiments can be used to obtain initial insights in circumstances that affect the importance of control versus learning. The results of such experiments can inspire new theoretical models on the relative effects of learning versus control. Based on these models, survey designs can then be developed that allow for variations in learning and control variables such that the predicted effects can be distinguished.

Notes The order of authorship is alphabetical. Stimulating comments of and discussions with Jeroen Weesie and other members of our Utrecht group, Cooperation in Social and Economic Relations, are gratefully acknowledged. We also acknowledge helpful comments from participants of the Rational Choice Social Research Workshop and specifically from our discussant, Simon Gächter. Financial support for Buskens was provided by the Royal Netherlands Academy of Arts and Sciences (KNAW) for the project Third-Party Effects in Cooperation Problems, and by Utrecht University for the High Potential-program Dynamics of Cooperation, Networks, and Institutions. Financial support for Raub was provided by the Netherlands Organization for Scientific Research under grants S 96-168 and PGS 50-370 for the PIONIER-program The Management of Matches, and under grant 400-05-089 for the project Commitments and Reciprocity. 1. See Ostrom (2003) for first steps toward a theoretical framework combining both strategies. 2. For a textbook accessible to readers with modest training in formal theoretical model building and no prior exposure to game theory, see Rasmusen (2007). 3. In contrast, the expression derived for the temptation in isolated encounters using guilt incorporates also the trustor’s payoff S1. 4. Coleman, in his meanwhile classic sketch, clearly intuited this result when he argued that an important feature of socialization is “coming to see the long-term consequences to oneself of particular strategies of action,” rather than the internalization of norms (1964: 180).Voss (1982) seems to be the first sociologist who realized explicitly that the theory of repeated games has important implications for the problem of order and cooperation in social dilemmas. 5. One might argue that learning is still possible in these models, since there are many equilibria and it is not clear why actors should choose the same equilibrium to start with. We disregard this issue, assuming that actors coordinate instantly on the same equilibrium (see Fudenberg and Levine 1998: 20). 6. There are sizable parallel literatures on experiments with repeated social dilemmas like the Prisoner’s Dilemma (see Dawes 1980; Colman 1982: ch. 7; Sally 1995 for overviews), Public Goods Games (overview: Ledyard 1995), and still other strategic interactions (overview: Camerer 2003). 7. Experiments employing the closely related Gift-Exchange Game (Van der Heijden et al. 2001; Gächter and Falk 2002) likewise show that repeated play increases the efficiency of outcomes and that endgame effects occur in a similar manner.

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chapter

Modeling Collective Decision-making

4

frans n. stokman, jelle van der knoop, and reinier c. h. van oosten

What kind of mental switch is flipped that changes people’s attitudes? And what kind of switch turns chimpanzee group mates into each other’s deadliest foes? I suspect the switches operate similarly in humans and apes and are controlled by the perception of shared versus competing interests. So long as individuals feel a common purpose, they suppress negative feelings. But as soon as the common purpose is gone, tensions rise to the surface. —Frans De Waal, Our Inner Ape (London: Granta Books, 2005), 135–36.

From Power Studies to Modeling Fundamental Processes When in the 1950s empirical studies on local power started, their main topic was the distribution of power in local societies. It gave rise to a huge debate about the concepts and measurement of power and influence. Ideological, theoretical, and measurement issues colored the empirical results and made them incomparable. The debate concentrated around two empirical local studies in that period, the study of Hunter (1953) in Atlanta and the New Haven study of Dahl (1958, 1961). Hunter represents the group of scholars who believed that the United States was ruled by a power elite, a group that was strongly inspired by the work of C. Wright Mills, best known by his later book The Power Elite (Mills 1956). Dahl represents the group of scholars who strongly believed that the United States is ruled by a plurality of groups. Starting from these opposite perspectives in the so-called elitist-pluralist debate, their definitions and measures of power could hardly do anything else than confirm their view of American politics. But the main benefit of the debate is that it revealed the necessity to reflect about different dimensions in the concepts of power and influence and how these dimensions have to be represented in measures. The first important distinction concerns the question of whether power and influence have to be defined as capacities (Hunter 1953) or as actual effectuation (Dahl 1958, 1961). As effectuation of power and influence depends heavily on the amount of perceived interest of the stakeholder in the problem and the issues involved, it is important to differentiate between the two and to define and measure power and influence as capabilities. The perceived interest

152 Stokman,Van der Knoop, and Van Oosten of an actor in the problem can then be characterized as the percentage or fraction of potential resources that a stakeholder will mobilize. Moreover, there are other restrictions that might hinder the actual effectuation of a stakeholder’s influence. Second, are the concepts of power and influence interchangeable, or do they refer to different phenomena? In more complex contexts, collective outcomes become binding through institutional arrangements. The formal aspects of decision-making consist of the identification of the actors who are legally or otherwise formally charged with taking the decision. This is particularly obvious in political decision-making. Such formal procedures often mean that stakeholders who have no formal right to codetermine the decision outcomes have very high stakes in those decisions. In Western democracies final decisionmaking is allocated to parliaments, composed of elected representatives who take the final decisions. Some political theories, such as the one of Schumpeter (1943), identify democratic decision-making with democratically taken decisions. Other theories stress that democratic procedures are only a necessary, but not a sufficient, condition for democratic decision-making (Bachrach and Baratz 1962; Lukes 1974). They stress that content and quality of decisions should be part of the evaluation of the democratic character of decisions. In their view, a decision should be based on a “balanced” weighing of different interests in a society. To arrive at such a balanced weighing, democracies recognize the right of assembly and free expression of opinion and often require certain consultations and hearings as part of the decision-making process. Particularly within this normative frame, we expect that authorities receive social approval when they weigh the intensity of interests and relative influence of different societal actors properly. Errors, particularly frequent errors, will result in serious social conflicts and poor implementation, which will reduce the likelihood of the authorities being re-elected. The power of actors in social systems is consequently not based solely on their voting power in the final decisionmaking stage, but also on actors’ ability to have their interests reflected in the final decisions. The latter we denote influence (Mokken and Stokman 1976). Third, should influence be measured as a relational variable, or as a characteristic of the stakeholder, or as a combination of the two? Influence is strongly determined by direct or indirect access to authorities, those actors who are formally empowered to take decisions. The increasing analytic possibilities of social network analysis gave rise to a large number of network studies to investigate power centers among large corporations (Mintz and Schwartz 1984; Stokman et al. 1985; Mizruchi 1982; Heemskerk and Fennema 2009; Windolf 2009), intellectual groups (Kadushin 1968), and between large corporations and government agencies (Mokken and Stokman 1979). On the other hand, influence also depends on resources of actors they can mobilize, resources to persuade authorities or to force them to take certain interests into account. One essential resource is information, particularly very specialized information. Numbers might also matter, such as the number of people a stakeholder, such as a trade union for example, can mobilize. The importance of different resources depends on the context in which the collective decision is taken. For example, a country’s military resources are unlikely to be relevant when international banking regulations are being debated. The three essential elements of power

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and influence in collective decision-making are, therefore, voting power in final decision-making, timely access, and resources. Voting power, access, and resources determine the potential power and influence of actors. In the bargaining stage, the actual mobilization of an actor’s potential influence depends on three other elements. First of all, it depends on how strongly the decision affects important goals of an actor, the issue salience of the decision for the actor. The other two elements are: (a) the degree to which actors expect the outcome will deviate from their preferred outcome, and (b) whether their participation is expected to have a positive effect through the mobilization of their resources (Zelditch and Ford 1994; Stokman and Stokman 1995). This implies that theories of collective decision-making cannot be based only on the three power elements of the actors, but also have to take into account their issue salience and their preference regarding the outcome. Power becomes visible only if actors have diverging preferences regarding decisions of sufficiently high salience to them. Similarly, if the status quo reflects the interests of the powerful, they are likely to prevent decision-making rather than exercise voting power and influence in the decision-making process. This phenomenon is called “non–decision making,” now better known as “agenda setting” (Cobb and Elder 1972; Kingdon 1995 [1984]; Ordeshook 1992; Tsebelis 1994; and many others). The distinction between power and influence is strongly related to the common conception of collective decision-making in many political systems, consisting of an influence stage followed by a voting stage. Achen (2006a: 86) notes that this general conception has been shared by a broad range of studies, including the work of Bentley (1967). Stokman and Van den Bos (1992) formalized this conception in their two-stage model of policy-making. At the bargaining stage, actors attempt to win support for the decision outcomes they favor most (denoted their policy positions). During this bargaining stage, actors employ a range of strategies in pursuit of this goal. As a consequence of bargaining, actors may end up supporting policy positions other than those they originally took. We refer to these new positions as actors’ voting positions. In the second stage, the voting stage, the process consists of the transformation of the voting positions into one outcome that is binding for all. This implies that the processes in the two stages are fundamentally different. In the bargaining stage policy positions are transformed into voting positions; in the voting stage voting positions are transformed into binding decisions. In complex systems, a final outcome may well be based on a repeated chain of these two stages, such as a decision-making process at three levels in the government and in two chambers of Parliament. Collective decision-making is necessary in any situation in which people wish to achieve things that can often only be achieved, or can be achieved more efficiently, with the contributions of others. This is referred to as joint production (Lindenberg and Foss 2011). Joint production requires collective decisions about what actions should be taken to realize shared interests: who should deliver which contributions, and how should the added value of the joint production be divided. But collective decision-making itself is also a special case of joint production, because individuals involved in such decisions are mutually dependent in making the required decisions. The joint product in

154 Stokman,Van der Knoop, and Van Oosten collective decision-making is a collective decision that is binding for all actors in the social system. Consider the wide range of situations in which people take collective decisions. Families take collective decisions about how to spend and save, where to live, and about the distribution of household tasks. Management boards of businesses and nonprofit organizations take collective decisions about what strategies to implement. Public policies in democracies are collective decisions taken by groups of elected representatives, often after consultations with affected stakeholders. In all these contexts, collective decision-making is the process in which stakeholders have to transform their different preferences into a single collective decision that binds all actors within the social system. In doing so, all actors try to influence the decision outcome, including efforts of some of them to prevent decision-making for the preservation of the status quo. Seen from this perspective, not power or influence but interest alignment is the key to understanding collective decision-making: how diverging preferences for collective outcomes nevertheless result in one collective outcome that is binding for all. Such an analysis requires a focus on and specification of fundamental processes by which interest alignment takes place, even when we realize that actors have different capabilities to do so and differ in their perceptions of how much of their interests are at stake. Joint production inevitably involves both shared and conflicting interests in the perceptions of the stakeholders (Stokman and Vieth 2005). Shared interests result from the perceived added value of the joint product; conflicting interests from the perceptions of the division of the added value and the division of the individual contributions to the joint production. We will show that the perceptions of the relative weight of shared and conflicting interests strongly affect the type of process we expect to emerge in different collective decisionmaking settings. This perception also determines the intensity with which people try to influence the collective decision outcome in line with their own position, versus their willingness to compromise in order to arrive at a broadly supported common position. Interest alignment implies coalition building. The dynamics in collective decision-making processes result from the simultaneous efforts of stakeholders with different policy positions to build as large coalitions as possible around their own positions. This implies that stakeholders are willing or forced to support other positions than they started with. Most studies study just one such process, without specifying the conditions under which that process is likely to take place. Here we specify three such processes: persuasion, logrolling, and enforcement. Each of them is associated with a specific type of network as well. We argue that in any decision-making context all three processes and associated networks take place simultaneously, but that only one of them is dominant. We specify the conditions under which each is likely to be dominant and under which conditions the logrolling and enforcement processes are likely to support or undermine the persuasion process. Characteristic of earlier studies on coalition processes is that they study only one and do not specify the conditions under which that process is likely to dominate. So-called contagion models (Friedkin and Johnsen 1990, 1997, 1999;

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Marsden and Friedkin 1993; Leenders 1995, 2002) assume that actors’ opinions and attitudes in a social system depend only partially on individual characteristics, and that these opinions and attitudes are also shaped by social influence. Social influence is represented in the form of an influence network, reflecting the dyadic influence of actors on each other. Technically, spatial autocorrelation algorithms are used to capture such processes. In the social influence part of the model, a person’s opinions or attitudes are modeled as the weighted mean of the opinions or attitudes of the people who have an influence relationship with that person. In the literature, a large variety of weights have been proposed, as Leenders (2002) has shown. Dynamic network models combine influence and selection effects in networks and investigate the relative impacts of the two effects (Stokman and Zeggelink 1996a; Steglich, Snijders, and Pearson 2010). Stokman and Zeggelink (1996b) and Stokman and Berveling (1998) connect these types of models with the fundamental step of aggregating the individual opinions to a collective outcome, a step the other models do not make. Moreover, they do not specify the conditions under which these processes are expected to occur. If we consider other approaches to social exchange in the literature, we find two main alternatives. The first consists of extensions of Coleman’s exchange model that incorporate networks (1972, 1990). Coleman assumed that actors have an interest in some events and control over others. By exchanging control over events in which they are less interested for control over events in which they are more interested, mutually beneficial outcomes can be achieved. The main mechanism in this model is that of a market. The model is able to predict the division of control among the actors in equilibrium. Power (and value of the events) is derived from the model, rather than being introduced in an ad hoc fashion. While the original Coleman model assumed that exchange possibilities are unrestricted, later models introduced the concept of unequal exchange opportunities by connecting Coleman’s exchange model to networks (Marsden and Laumann 1977; Laumann, Knoke, and Kim 1987; Knoke et al. 1996; König 1997; Pappi and Henning 1998). In these models, structural constraints force actors to exchange with particular other actors. Moreover, the models were adapted to predict outcomes on issues on which there are only two policy alternatives (such as yes or no). Coleman’s model thus became extended to outcomes of collective decision-making processes. The second approach to exchange consists of Network Exchange Models (see, for example, Bienenstock and Bonacich 1992; Cook and Yamagishi 1992; Friedkin 1992; Markovsky, Willer, and Patton 1988; Skvoretz and Willer 1993; Willer 1999).Whereas Coleman’s model is based on global equilibria, Network Exchange Models focus on network effects on exchange rates between pairs of actors. Actors’ power derives primarily from the possibilities they have to exclude others from exchange. This power is defined in terms of shifts of exchange rates to an actor’s own advantage. A difference between our work and work in Network Exchange Theory is that the latter deals mainly with exchanges of private goods (for an exception, see Dijkstra and Van Assen 2006, 2008a,b,c). Private goods are also the starting point for Coleman’s models, and generalizations to public goods are not straightforward (Stokman and Van Oosten 1994). We, however, investigate exchanges of voting positions. Changes

156 Stokman,Van der Knoop, and Van Oosten in voting positions affect all stakeholders in collective decision-making and have externalities for other actors (Van Assen, Stokman, and Van Oosten 2003; Dijkstra,Van Assen, and Stokman 2008). Another important difference between our approach and studies informed by Network Exchange Theory is that the latter study given and static networks (see Willer and Willer 2000 for an exception). In contrast, we derive exchange networks from the distribution of positions and saliences of the stakeholders on the issues (see Figure 4.3). As the processes in the bargaining stage and the voting stage are fundamentally different, game-theoretical models of the two stages are expected to be fundamentally different. Models of the bargaining stage formalize different views on the nature of the bargaining process, which results in shifts in actors’ positions. Models of the voting stage formalize different views on the way in which the procedural rules of decision-making affect decision outcomes. There are cooperative and noncooperative models of both the bargaining stage and the voting stage. The most important difference between cooperative and noncooperative models is that agreements between stakeholders are considered to be more or less binding in cooperative models, whereas they are not in noncooperative models. As agreements in noncooperative models are not binding, actors continually evaluate proposals against the status quo and other proposals in terms of the utility they provide them. As a consequence, the status quo plays a much more dominant role in noncooperative models than in cooperative ones as a reference point for evaluating support for different proposals. Table 4.1 summarizes the main classes of models of each of the two stages. Cooperative models of the voting stage were first dominant, starting with onedimensional coalition models (Axelrod 1970; De Swaan 1973). These models were later extended to multidimensional models (Schofield 1976; Laver and Schofield 1990). More recently, noncooperative models for the voting stage have become dominant in the new institutional approach (Baron and Ferejohn 1989; Austen-Smith and Banks 2005). A winset is a set of possible decision outcomes that improve the utility of a required majority of decision-makers relative to the status quo. If winsets are based on a careful analysis of procedural rules, the models are known as procedural models (see Steunenberg and Selck 2006 for an overview). As procedural rules are particularly complex in the European Union, the European Union is an attractive field of application for these models (ibid.; Tsebelis 1994; Moser 1996; Steunenberg 1994; Garret and Tsebelis 1999a,b; Hosli 1993, 1997; Lane and Maeland 1995; Widgrén 1994, 1995; Tsebelis 1996; Tsebelis and Garrett 1996, 1997; Pajala 2002). These models assume that outcomes of decisions are determined by the combination of preferences of the formally empowered decision-makers and the formal institutional rules that determine the voting weights and rules of the decisionmakers and the sequence of moves they can make. ta bl e 4 . 1 Classification of Main Types of Collective Decision-Making Models

Voting stage Bargaining stage

Cooperative models

Noncooperative models

Coalition PersuasionExchange

WinsetsProcedural models Enforcement/Challenge

Modeling Collective Decision-making 157

Scholars have also developed both noncooperative and cooperative models of the bargaining stage. The best known noncooperative model of the bargaining stage is the Expected Utility model of Bueno de Mesquita (Bueno de Mesquita, Newman, and Rabushka 1985; Bueno de Mesquita 1994). Despite having some similarities, cooperative models of the bargaining stage differ in important respects from coalition models that have been developed in the context of the voting stage. In the latter context, coalition models’ primary aim is to predict the composition of coalitions based on voting weights and decision rules. Voting weights and rules are less important at the bargaining stage than at the voting stage. Cooperative models of the bargaining stage, therefore, do not focus primarily on the composition of majority coalitions, but on the prediction of decision outcomes. These predictions depend on which of the bargaining processes dominate. Persuasion models are based on the assumption that the outcome is the one supported by all stakeholders often after being persuaded to do so with convincing arguments, whereas exchange models are based on the assumption that stakeholders try to build larger coalitions through bilateral exchanges between stakeholders or groups of stakeholders. The focus of the present article is on cooperative and noncooperative bargaining models and their empirical applicability. There are three reasons for this limitation. The first and most important reason for concentrating on bargaining models is that models of the voting stage in our view neglect one of the fundamental features of collective decision-making. As mentioned above, one of these fundamental features is that collective decision-making involves interdependencies among actors involved in joint production. Models of the voting stage ignore such interdependencies, and instead assume that decision outcomes are determined by formal decision-making procedures together with actors’ preferences. In many real world decision situations, however, formal rules provide relatively scant indications of how decisions are actually taken. For instance, there are many political systems in which a decision might formally be allowed if only a simple majority of decision-makers agree, but where in practice the support of a broader majority of decision-makers is required for policy change. Such an informal unanimity norm can be observed in many organizations (among them the Council of Ministers of the European Union). In such contexts, formal procedures do not appear to determine behavior or decision outcomes, but do set the boundaries within which action takes place. Institutional rules then work like legal contracts. They provide safeguards to actors in case fundamental problems arise or other actors misbehave. Such safeguards cannot, however, always loom large in consensual decision-making systems. If actors often have to fall back on the safeguards of formal decision rules, the more the norm of consensus building will be put under pressure. The frequent use of formal rules is likely to undermine the perception that shared interests are so salient that the actors will compromise for the sake of consensus. The mere existence of the rules should give sufficient constraint to enforce agreement and compliance. This implies that the voting stage formalizes primarily the result of the bargaining process and ensures that external sanctions can be used to enforce implementation and compliance. The result of the decision outcome, then, is not determined by

158 Stokman,Van der Knoop, and Van Oosten the combination of preferences of the authorities and the formal institutional rules, as the procedural models assume, but by the dominant bargaining process that precedes the voting stage. The second reason to limit the present discussion to bargaining models is that the models of the voting stage are limited to those decision situations in which there are well-developed formal rules. As described in the opening paragraph, collective decision-making also takes place in very informal settings in which there are few formal rules. Moreover, even in situations, such as national politics, in which there are formal rules, stakeholders who are not formally empowered to take decisions have huge influence. Models of the voting stage do not integrate these stakeholders into the analysis. A third and final reason for limiting the present discussion to bargaining models is that procedural models are generally poor at predicting decision outcomes. One of the largest and most comprehensive comparative tests of the performance of bargaining and procedural models was recently conducted on decision-making in the European Union (see particularly Achen 2006b) and confirmed in Thomson’s replication in the extended European Union of the twenty-five to twenty-seven members (Thomson 2011). Both studies found that bargaining models were generally much better at predicting decision outcomes across a large range of issues than were procedural models. In the European Union, the poor performance of procedural models results from the prevailing norm of consensus seeking, despite the formal possibility of supermajority voting.

Summary of Data Collection and an Empirical Example Applying different bargaining models to complex decision-making processes requires that we describe these decision situations in a systematic and stylized way. This section gives details of what these descriptions entail, illustrated with an example. The above overview of different approaches toward collective decision-making has made clear that a full-fledged model of collective decision-making needs to contain the following elements. All models require a specification of the set of issues and the relevant set of stakeholders and authorities with their policy positions on the issues. We must also obtain estimates of concepts that are specific to certain models, such as the position of the status quo, the relative saliences of the issues for the stakeholders, the relative power of the stakeholders, which higher-ordered goals are at stake, and which priorities stakeholders attach to these goals. More details of the bargaining models referred to above are then provided.There we will introduce the three fundamental bargaining processes in collective decision-making and the models that represent them, how they are related to each other, and under which conditions they will dominate. Subsequently we will discuss and illustrate how the models are applied in practice. As an illustration, we take some data from a recent study on the 2009 Copenhagen climate negotiations. An example. The fifteenth Conference of Parties (COP) meeting took place in Copenhagen from December 7 to 15, 2009. The aim of the conference was an agreement on measures to be taken against climate change caused by our fossil-based economy. The climate treaty of Kyoto ended in 2012. Obligations

Modeling Collective Decision-making 159

after 2012 had to be agreed upon either in an extension of the treaty period or in a new treaty, but COP 16 and COP 17 were also unable to do so. Two experts from the Stockholm Environment Institute specified seven issues as the main ones at stake in Copenhagen. Subsequently, they specified which countries and country groups have to be distinguished and their potential influence and salience for an overall consensus. Finally, they provided the data for each stakeholder on each issue: its position, issue salience, and potential influence. The two experts were interviewed on October 27 and 28, 2009. Table 4.2 presents the Party Groups the experts identified and the abbreviations we use in the remainder. Stakeholders are defined as individuals or groups that have both sufficient power resources potentially to exert influence in the decision-making process and sufficient stakes in the issues to exercise their influence, directly or indirectly (for example, by anticipation of others). If a stakeholder is a group, then the members of that group agree on the desired outcome of the decision and on the importance of the issue. Furthermore, the members of that group are seen to act collectively. Developing countries coordinate their positions within the Group of 77 (G77). At the establishment of this group in the 1960s, seventy-seven developing countries participated. The name of the group remained the same over the years, even though many new developing countries emerged and joined. Since the G77 countries are very diverse, the experts identified several subgroups within the G77 and provided data for each of the subgroups rather than for the whole G77. Table 4.2 also presents estimates of the relative influence of Party Groups during the informal negotiation process preceding the final vote. Above, we have seen that there are fundamentally different ways in which power and influence have been measured in the literature. We usually use voting power measures, such as the Shapley-Shubik index (Shapley 1953; Shapley and Shubik 1954; Pajala 2002) or the Banzaf index (Banzaf 1965), when our analysis is confined to formally empowered authorities (as in the studies of decision-making in the European Union by Thomson et al. [2006] and Thomson [2011]). Influence reputation measures are usually applied when other stakeholders are included as well. To reach agreement in Copenhagen, the vote should be unanimous; consequently, voting power is equal for all Parties, but the differences in influence of Parties and Party Groups in the preceding negotiations are very large. We deal with many different resources—such as exclusive information, financial resources, number of persons an organization represents, superior access to authorities or other stakeholders—that are difficult to weigh in a combined measure of overall influence. Expectation status theory (Berger et al. 1977; Berger, Rosenholz, and Zelditch 1980; Berger and Zelditch 1985) has demonstrated, both in experiments and in field studies, that the ascription of status differences makes them real, that ascription is linked with performance differences. This is the strongest argument for the use of reputation-based influence measures in collective decision-making studies. As a consequence, we follow the approach of Bueno de Mesquita, Newman, and Rabushka (1985) and use expert evaluations of relative influence as our measure of influence in collective decision-making processes.

160 Stokman,Van der Knoop, and Van Oosten ta bl e 4 . 2 Party Groups with Their Relative Influence and the Importance They Attach to Reaching an Overall Agreement Party groups

Abbreviation

Relative influence

Importance attached to reaching agreement

United States of America Canada Australia European Union Japan Russia China and India Brazil Least Developed Countries Alliance of Small Island States G77 minus LDC, AOSIS, China, India, and Brazil.

USA Canada Australia EU Japan Russia China India Brazil

100 15 10 60 20 5 95 10

10 40 50 90 60 10 70 60

LDC

30

85

AOSIS

30

90

Other G77

10

65

To reach agreement, the vote should be unanimous, but Party Groups differ in the importance they attach to reach an overall agreement (group salience). The more importance they attach to an overall agreement, the more they are willing to compromise.We asked the experts to score this on a scale from 0 (not important) to 100 (the Party Group will try to reach agreement with all means at its disposal). The expert ratings are given in the rightmost column of Table 4.2. The United States is estimated to have the greatest influence; however, it is also very little inclined to make concessions to come to a unanimous agreement. In contrast, the EU is willing to promote unanimity very strongly. The first step involved in collecting data is the specification of the problem to be analyzed in terms of a limited number of issues. This is often one of the most challenging stages in the data collection procedure. Each of the issues specified must be described in two ways: first, in terms of a specific policy question on which a collective decision must be taken; and, second, in terms of a scale or continuum on which the alternative possible outcomes of this decision can be placed. Each of the issue continua is assumed to be unidimensional, and each actor involved in the decision who has an interest in the issue can be placed on a point on the continuum to represent his policy position on that issue. We assume that actors have single peaked preference functions. Thus each actor evaluates points on the continuum that lie further away from his position more negatively. This means that each actor expects to receive most value from the realization of his own position on the continuum compared with other positions, and less from alternatives located further from his own position.The two extreme positions, or endpoints, on each issue continuum are usually occupied by the most extreme positions favored by any of the actors. Intermediate positions represent more moderate positions and also possible compromise outcomes. The specification of problems in terms of a limited number of issues provides a conceptual structure in which the positions of all actors can be represented. The specification of the issues should be comprehensive, in the

Modeling Collective Decision-making 161

sense that the decisions taken on these issues should determine the main contours of the solution to the collective decision problem. The number of issues that are necessary varies from one decision-making situation to another. Usually, one to five issues are sufficient to represent all combinations of possible outcomes in even highly complex decision-making processes, but up to twenty issues have been used in some applications. The requirement of specifying a limited number of issues is often a useful exercise in itself, because it compels analysts to distinguish the main points from subordinate ones. Ill-defined issue specifications mean that analyses are based on incorrect representations of the political problems. Poor issue specification will result in bad model predictions. In practice, the issues are specified using a combination of content analysis of documentation and interviews with key informants (also referred to as “subject area specialists” or “experts”). The estimation of the policy positions of each of the stakeholders depends on the specification of the issues as described above. If the issue does not represent a quantitative outcome (such as budget or time), the most extreme positions are usually placed at points 0 and 100 of the issue continuum. In the analysis, all issues are rescaled to a 0 to 100 continuum, based on the positions of the most extreme stakeholders. It is vital that the stakeholders are placed on the issue continua to reflect the political distances between the alternative decision outcomes they support. The next variable that informants are asked to estimate for each stakeholder is the level of salience that each stakeholder attaches to an outcome close to its policy position on the issue (the stakeholder’s issue salience). Note that obtaining an outcome close to the policy position on a given issue may be more important for one stakeholder than for another. In addition, any given stakeholder may attach more salience to one issue than to another. The more utility loss a stakeholder experiences resulting from a difference between its policy position and the outcome, the more likely that stakeholder will put into effect its potential power to obtain an outcome close to its policy position. The variable salience can therefore also be interpreted as a measure of the extent to which a stakeholder is willing to put into effect its potential power if the issue is brought up during interaction with other stakeholders. The level of salience each stakeholder attaches to each issue is usually expressed on a scale from 0 to 1. A score of 0 indicates that the issue is of no interest whatsoever to the actor. In fact, if an actor attaches zero salience to an issue, it is not considered to be a stakeholder on that issue. A score of 1 indicates that an actor will devote all of its potential power to this issue if the issue is brought up during the course of interaction with other stakeholders. A score of 0.5 indicates that the issue is neither important nor unimportant. Taken together, the potential influence times the salience of a stakeholder determines its effective influence with regard to a certain issue. In the literature and in practice it is often neglected that the combination of position and salience determines the behavior of stakeholders. These combinations are generated by the incentive structures of stakeholders. If one of the two is overlooked (in practice, often salience), serious miscalculations are inevitable.

Outcome NBS (61) Outcome after concessions to USA and China India (85)

Outcome after exchange (57)

A Collection of Decisions

10

A New Treaty

20

Extension of Kyoto

50

90

100

80 Russia (70)

Canada (80)

EU (40)

USA (90)

Japan (60) AOSIS (90) Australia (40 )

Brazil (50) China India (90) LDC (90) Other G77 (50)

figure 4.1. New Decisions vs. Extension of Kyoto (issue 1)

Outcome after concessions to USA and China India (82)

Outcome NBS (53)

Outcome after exchange (46) Low

High

10

15

China India (100)

30

Russia (10)

Brazil (90) Other G77 (80)

40

50

70

AOSIS (30) LDC (30)

80

90

Australia (60) EU (50) Canada (50) Japan (50)

figure 4.2. MRV CO2 Reduction in Developing Countries (issue 2)

USA (100)

Modeling Collective Decision-making 163

One of the major controversial questions in Copenhagen was whether the Kyoto Treaty had to be extended, or whether the decisions in Copenhagen had to result in a new treaty. This issue is particularly controversial, as the United States had not signed the Kyoto Treaty. The second most controversial issue concerned the measurable and verifiable contributions of China, India, and Brazil. These countries have no obligations under Kyoto, but their economic growth is now so high that they can be expected to contribute to the worldwide CO2 emission reduction. Most of the other five issues are related to mitigation and adaptation. Mitigation concerns the reduction of greenhouse gas emissions, such as CO2; adaptation concerns measures to circumvent or diminish damage caused by climate change. As an illustration, we will concentrate here on the two most controversial ones and report over the others only globally. For the full report, delivered one month before the conference, we refer to Stokman 2009. Figure 4.1 contains the data on the status of the Kyoto Treaty. Is the outcome of the Copenhagen COP an extension of the Kyoto Treaty (position 100 on the scale), a new treaty (position 50), or just a collection of decisions (position 0)? Saliences of Party Groups are given in parentheses after their acronym, ranging from 0 to 100. The salience is also represented by shades of gray. Party Groups in dark gray attach a salience of between 80 and 100 to the issue; in middle gray between 50 and 80; and in light gray below 50. Both ends of the scale are covered with dark gray Party Groups, indicating the highly controversial nature of the issue. Above the scale the outcomes we expect under different assumptions are presented. They will be discussed in more detail later. Figure 4.2 contains the data on the MRV CO2 Emission Reduction in Developing Countries. MRV CO2 emission reduction refers to reductions that are “Measurable, Reportable, and Verifiable” (MRV). These criteria are applied to ensure measurable CO2 emission reductions. Whereas in rich countries MRVs concern reductions in the total amount of emissions by 2020, developing countries are still allowed to increase their total emissions in order to obtain a higher welfare. MRV CO2 emission reductions in developing countries aim to increase the CO2-emission-free proportion in their growth, especially in sectors involving high emissions such as heavy industries, electricity, and transport.The MRV issue concerns, therefore, the commitments of developing countries to create a more sustainable economy.

Bargaining As described above, the dynamics in decision-making processes result from the fact that each of the stakeholders attempts to realize the policy position it favors as the outcome. The complexity of such processes derives from the fact that stakeholders often take quite different positions, have different levels of potential to influence the decision outcome, and differ from each other with respect to the intensity of their preferences. Stakeholders may attempt to build a coalition as large as possible in support of the policy positions they favor. By building such coalitions, stakeholders hope to affect the positions of the final decision-makers, the authorities, which will in turn lead to a collective outcome that reflects their interests as much as possible. Consequently, the dynamics

164 Stokman,Van der Knoop, and Van Oosten tabl e 4.3 Fundamental Processes, Dominant Networks, Approaches, Conditions for Processes to Dominate Fundamental Processes

Dominant Networks

Present Not-integrated Approaches

Persuasion

Information and Trust Networks

1. Contagion Models Reciprocal 2. Exchange Networks

Cooperative Nash Bargaining Solution for all relevant stakeholders

1. Reversion point very unattractive 2. Overall coalition possible/ Subcoalitions difficult to form Risk averse stakeholders

Logrolling

Negotiated Exchange Networks

3. Coleman Exchange Model 4. Network Exchange Theory

Voting Position Exchange Models (Cooperative solutions for subsets of stakeholders with positive and/or negative externalities for others)

Opposite positions and complementary interests

Enforcement

Hierarchical/ Power Networks

5. Noncooperative Models

(Noncooperative) Challenge Model

Opposite positions and noncomplementary interests

Integrated Approach

Conditions for process to dominate

of decision-making processes are based primarily on processes through which other stakeholders are willing or forced to change their positions. Three fundamental processes can result in such shifts in positions: persuasion, logrolling, and enforcement. Udehn (1996) derives these three fundamental processes from the literature in his sociological critique of economic models of politics. Each of these is associated with its own specific interdependencies.Table 4.3 gives an overview of these three processes, the types of networks associated with these processes, which approaches in the literature are associated with which process, and the conditions under which each of the processes is expected to dominate collective decision-making.We then elaborate on each process and the different elements contained in Table 4.3. For the logrolling and enforcement processes, we will also specify the conditions under which they strengthen persuasion processes and under which conditions they undermine persuasion processes. Persuasion Through persuasion, stakeholders aim to change other stakeholders’ initial positions, or preferences, and the levels of salience they attach to the issues that must be decided on (Stokman et al. 2000). When a stakeholder changes its position or alters the level of salience it attaches to an issue as a result of persuasion, this change constitutes a fundamental internal switch on the part of the stakeholder. Persuasion is achieved through the provision of convincing information. Persuasion strategies are particularly likely to dominate when collective decision-making based on unanimity is a strong formal or informal norm (that is, if the group consensus salience is high and includes all stakeholders). The Nash Bargaining Solution (NBS) (Nash 1950) provides an approach with which to model persuasion as a dominant mode of interaction. One of the central conditions conducive to persuasion is that stakeholders perceive shared

Modeling Collective Decision-making 165

interests to greatly outweigh their individual interests. When stakeholders have a strong shared interest in reaching a collective decision, failure to do so is highly undesirable, and far less desirable than any of the decision outcomes advocated by any of the stakeholders involved. This facilitates the feasibility of grand coalitions of all stakeholders, particularly when smaller coalitions are difficult to form. Under these conditions and assuming quadratic loss functions on the issue continua (implying risk-averse stakeholders), Achen (2006a) shows that the compromise model becomes a first-order approximation of the Nash Bargaining Solution. This compromise model prediction is simply the average of the stakeholders’ initial policy positions, weighted by the product of each stakeholder’s influence and salience. Conditions that are conducive to persuasion can exist only when stakeholders are embedded in dense trust networks or are severely punished when they deviate from shared interests. Stakeholders need to be confident that the information they receive is sincere and not strategically manipulated. Pursuing one’s own personal gains is permitted as long as this does not inflict harm on others, and as long as personal gains are compatible with shared interests.Within this context, stakeholders can be confident that the concessions they make to stakeholders who have strong interests in present issues will be compensated in future situations when their own interests are stronger. Reciprocal and generalized exchanges (Molm 1997) are therefore an integral part of decisionmaking by persuasion, and not of decision-making by logrolling as the name might suggest. Stakeholders who provide information will be trusted if they have proven to be reliable in the past and if they would experience future negative consequences from providing distorted or incomplete information. This “shadow of the future” (Axelrod 1984) is more effective if providers of distorted information lose reputation, not only with respect to the recipient stakeholder but also with respect to others (Raub and Weesie 1990; Buskens 1999; Panchanathan and Boyd 2004; Nowak and Sigmund 2005).Trust will also be greater if the information is less related to the provider’s central interests. These conditions for trust emerge more readily among like-minded stakeholders and among stakeholders who also meet each other in other contexts, than among stakeholders with conflicting interests. Stakeholders also tend to assign more weight to the opinion of powerful stakeholders, whereas powerful stakeholders tend to listen more to one another than to less powerful ones (Molm 1997; Stokman and Zeggelink 1996b). Large power differences, however, make it less likely that persuasion strategies will be successful. The same holds for highly polarized issues. In contrast to persuasion, logrolling and enforcement processes typically do not affect stakeholders’ initial positions or the levels of salience they attach to issues. Logrolling is a process of negotiated exchanges. The result is that stakeholders are willing to support another position on an issue that is of relatively less importance to them in exchange for support of another stakeholder on an issue that is relatively more important to them. Similarly, when enforcement is the dominant mode of interaction, stakeholders can feel forced to support another position under pressure from more powerful stakeholders or coalitions. Logrolling and enforcement are most likely if stakeholders’ initial positions fundamentally differ because of the different weights they attach to

166 Stokman,Van der Knoop, and Van Oosten different higher-ordered goals. In such situations, arguments do not help to bring initial positions closer together. Therefore, coalitions can be built only through processes that affect the final or voting positions of stakeholders. We will consider these two processes in the next two sections. Logrolling Whereas information and trust networks define persuasion, negotiated exchange networks define stakeholders’ exchange possibilities under logrolling. When stakeholders shift their policy positions as a result of logrolling, these shifts lead to changes in the expected outcomes on the issues involved in the exchange. Consequently, stakeholders experience gains and losses when the expected outcomes on issues move closer to or further from their initial positions. Stakeholders from two groups with opposing positions can profit from position exchange if the relative salience of the two issues for each of them is different (see Figure 4.3; Stokman and Van Oosten 1994). A position exchange is then profitable for both stakeholders. The model of logrolling bargaining processes assumes that each stakeholder has complete knowledge of the positions, saliences, and capabilities of all other stakeholders. We further assume that all stakeholders share a common view on what the collectively optimal outcome would be on each issue when considered separately. This collectively optimum outcome is assumed to be the Nash Bargaining Solution, approximated by the average of the stakeholders’ initial policy positions, weighted by the product of each stakeholder’s influence and salience (see above in the section on persuasion). Position exchanges link pairs of issues and provide pairs of stakeholders opportunities for bilateral winwin situations above the NBS solutions of the issues in isolation (see Figure 4.3). They can be seen as bilateral active optimizations of the NBS. Each stakeholder potentially has a number of possible exchanges. Each stakeholder has to choose which of these potential exchanges to realize. A potential exchange is realized only if both stakeholders agree to realize it. This will happen only if neither of them has a better alternative exchange. When an exchange is realized, both stakeholders are no longer able to change position on the issue on which they have moved their position. This of course limits future exchange possibilities in the bargaining process. In other words, when stakeholders realize an exchange they enter into a binding commitment, which is what makes the logrolling model a cooperative bargaining model. Modeling position exchanges requires careful consideration of the nature of these exchanges. In particular, a choice has to be made about which exchange rate to use. Utility gains and losses result from outcome shifts on the two issues because of their position shifts and depend on the size and direction of the outcome shifts and the issue saliences of the stakeholders. The exchange rate determines the extent to which each stakeholder shifts its position. Stokman and Van Oosten (1994) use an equal utility gain for both exchange partners. This has the advantage that exchanges have the same utility for both partners, and that the exchanges can be ordered in terms of their relative attractiveness to both exchange partners. The disadvantage of the equal utility gain assumption is that it involves an intersubjective comparison of utility, which is theoretically problematic. Two alternative solutions for the exchange rate have been derived

Modeling Collective Decision-making 167 Issue 1 A

D

B

C O1 (Nash Bargaining Solution as expected outcome)

Issue 2 A

D

C

B O2 (Nash Bargaining Solution as expected outcome)

figure 4.3. Effects of an exchange between stakeholders of type A and type D. The arrows mean that actor D shifts his position on issue 1 in A’s direction, while actor A shifts his position on issue 2 in the direction of actor D.

that are independent of the utility scale: the Nash solution (Achterkamp 1999; Van Assen 2001), and the Raiffa-Kalai-Smorodinsky (RKS) solution (Van Assen 2001).1 With the exception of the equal gain exchange rate, all exchange rates face the same problem of deadlock, whereby no two stakeholders prefer, and therefore realize, the same exchange.2 Bilateral exchanges also have important side effects or externalities with respect to other stakeholders’ utility. Externalities arise when stakeholders who are not involved in an exchange are either positively or negatively affected by it. This can clearly be seen in Figure 4.3. Assume that a stakeholder of type D attaches relatively more salience to issue 2 than to issue 1 if we compare its saliences with those of a stakeholder of type A. Then, issue 2 is D’s demand issue and A’s supply issue. Position exchange between A and D implies that A is willing to shift its position on issue 2 in the direction of D, while D does the same on issue 1. If they do, they both shift away from C in the direction of B on both issues. In that case, C is punished doubly and B rewarded doubly, while neither of the two is directly involved in the exchange (Van Assen, Stokman, and Van Oosten 2003). Positive and negative externalities also emerge within the A and D groups if A and/or D consists of more stakeholders. An exchange of two stakeholders from the A and D groups will have positive externalities for other members in the A and/or D group if the relative saliences within each group are relatively homogeneous. Otherwise, such an exchange may well have negative externalities within the A and D groups. In the most extreme case, one A member may want to use issue 1 as its supply issue whereas another A member may want to use that issue as its demand issue. Here, we return to the Copenhagen example. In Table 4.4, the Party Groups are ordered on the basis of their relative salience for the two most controversial issues—that is, the salience for the issue on the status of the new treaty (issue 1) divided by the salience for the issue on the MRV CO2 reduction in developing countries (issue 2). In the last column of Table 4.4, the Party Groups are allocated to the four cells in Figure 4.3 on the basis of their positions: their placement depends on whether they are located to the left or to the right of

168 Stokman,Van der Knoop, and Van Oosten ta bl e 4 . 4 Relative Saliences of Copenhagen Party Groups for the Two Most Controversial Issues and Their Positions Relative to the Expected Outcomes on the Two Issues Party group

Canada USA Japan China India LDC AOSIS Russia Australia Brazil Other G77 EU

Relative salience for Issue 1/Issue 2

Cell

1.33 1.20 1.00 1.00 1.00 0.95 0.78 0.67 0.67 0.63 0.50

A A A C D D C A C D B

note: Party Groups in cell A have positions left of the expected outcomes on both issues; Party Groups in cell B left on issue 1 and right on issue 2; Party Groups in cell C right on issue 1 and left on issue 2; Party Groups in cell D right on both issues.

the expected outcome (the Nash Bargaining Solution) on each issue. As in Figure 4.3, only Party Groups with opposite positions on both issues can make exchanges—that is, Party Groups in cell A can make exchanges with those in cell D, and Party Groups in cell B with those in cell C. Cell A consists of four Party Groups and cell D of three. Cell C consists of three Party Groups, cell B of one. This results in twelve potential exchanges between the A’s and D’s and three between the B’s and C’s, making a total of fifteen potential exchanges of voting positions. Three members of cell A attach relatively more salience to issue 1 than do all Party Groups in cell D. For these A’s, the first issue is the demand issue (as in Figure 4.3), and all potential exchanges go in the same direction: toward the initial position of the Party Groups in cell B. The fourth Party Group in the A cell (Australia), however, can make an exchange with Party Groups in cell D in both directions. With the Party Group Other G77 again its demand issue is issue 1, but with the Least Developing Countries (LDC) and the Alliance of Small Island States (AOSIS) Groups issue 2 is the demand issue, as the latter have a higher relative salience for issue 1 (1 resp. 0.95) than Australia (0.67). Whereas most potential exchanges between the Party Groups in cells A and D will result in a better outcome for the Party Group in cell B (the EU) and a worse outcome for the three Party Groups in cell C, the EU has potential exchanges with three Party Groups in cell C. If one or more are realized, the positions of the EU and the three Party Groups in cell C (China, India, Russia, Brazil) will all shift in the direction of the Party Groups in cell D, resulting in worse outcomes for the Party Groups in cell A. In other words, all potential bilateral exchanges will have negative externalities for at least some Party Groups, making an overall unanimous outcome less likely. We can now specify the conditions under which logrolling based on

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bilateral exchanges is compatible with cognitive interdependencies that support persuasion and consensus building.The following three conditions should hold simultaneously:3 1. One of the four groups should be empty.Without loss of generality, let us assume that group C is empty. 2. The relative saliences of the two groups that can exchange is such that the exchange shifts the decision outcomes in the direction of the positions of the stakeholders in the nonempty group. 3. The relative saliences of the two groups that can exchange are such that there are no negative externalities within each of these groups. This occurs under the following condition. Without loss of generality, let us assume that a stakeholder in the A group attaches the highest relative salience to issue 1 compared with all other stakeholders in the A-D group. Under the assumption of linear decreasing utility functions around the policy positions of stakeholders, no negative externalities occur if the exchange rate is lower than the relative salience of the A stakeholder with the lowest relative salience for issue 1, and is higher than the relative salience of the D stakeholder with the highest relative salience for issue 1. This implies that negative externalities within an exchange group are unavoidable when stakeholders of one group embed some stakeholders of the other group in the ordering of the relative salience they attach to the issues.4 If these conditions are not met, bilateral exchanges over pairs of issues produce negative externalities for other stakeholders. Such negative externalities will harm consensus building, unless the stakeholders who experience negative externalities are compensated in other respects.5 Certain institutional conditions may discourage stakeholders from realizing exchanges with negative externalities and encourage them to realize exchanges with positive externalities. Some decision-making rules stipulate that outcomes must be supported unanimously. In other contexts, informal norms stipulate that unanimous support should be sought, although outcomes could formally be taken by majority voting. In both these contexts, we expect stakeholders to avoid voting position exchanges with negative externalities and to realize only exchanges with positive externalities. Exchanges with positive externalities facilitate overall consensus, as the interests of the exchanging Parties are in harmony with those of the others. Under the condition that stakeholders avoid exchanges with negative externalities, linking issues can potentially improve the overall Nash Bargaining Solution for all stakeholders. Dijkstra, Van Assen, and Stokman (2008) incorporated this idea in a new version of the exchange model, denoted the Externality Exchange Model (EEM), and tested their model against the original model in the context of the European Union. A nonparametric test for which of the two models more often gives the best prediction shows no significant difference between the two. Relative to the original logrolling model, the predictions of the EEM model show a more substantial improvement, albeit not significant in the nonparametric test.This is a weak indication that stakeholders avoid exchanges with negative externalities in contexts in which an overall consensus is normatively promoted.

170 Stokman,Van der Knoop, and Van Oosten Enforcement When collective decision-making is driven by power processes, enforcement, not persuasion, is the dominant mode of interaction among the stakeholders (see Table 4.3). Stakeholders try to build as large a coalition as possible behind their own policy position by showing that they have sufficient power to enforce a decision and/or to block other alternatives. Solutions to substantive problems are not sought by arguments but by showing that there is sufficient support to enforce the decision on the basis of the formal procedures and/or informal power arguments. When enforcement is the dominant mode of interaction, stakeholders may shift their positions because they feel compelled to do so, not because they are convinced to do so. To the extent that a stakeholder’s issue salience is lower than that of stakeholders who support another position, and the power of those other stakeholders is greater, that stakeholder may be inclined to give up its initial position. Stakeholders may avoid costs by conceding on an issue that is only marginally related to their own interests. When enforcement occurs, decision outcomes can be seen as the result of a noncooperative game in which no binding agreements are made (Bueno de Mesquita, Newman, and Rabushka 1985; Bueno de Mesquita 1994, 2002). In his computer simulation model, a challenge to a stakeholder’s position is more likely to be successful if the stakeholder to whom the challenge is directed attaches less salience to the issue than does the challenger, and if the support for the challenged stakeholder’s position is lower than the support for the challenging stakeholder’s position. In the model, these two aspects dominate the determination of which stakeholders will challenge which other stakeholders. Each stakeholder makes this choice in relation to each of the other stakeholders. Based on the challenges made, each stakeholder has a set of cards in its hands that represent the challenges made and received. If a stakeholder received challenges, that stakeholder has to draw the one that is best. The result is either conflict (if the stakeholder made a challenge to the other as well) or a forced position change. These position changes create a new decision-making setting (iteration in the computer simulation model). In that new setting, the stakeholders repeat the choice process. This continues until none of the stakeholders move (substantially) or until all stakeholders take the same position. If enforcement dominates decision-making about organizational policies, hierarchy dominates over arguments also in the preparatory stage of decisionmaking. In such a situation, the goals of the organization are likely not primarily seen as shared goals, but as the goals of and set by the top of the organization. Such a setting leads to a cognitive interdependence model in which personal relationships are seen primarily in the light of their hierarchical place and ordering. In other words, power networks dominate the outcomes of collective decision-making processes. Again, as bilateral negotiated exchanges may well be compatible with consensus or even enhance consensus building (in the presence of large positive and the absence of negative externalities), it is unlikely that persuasion on the basis of high shared interests will long survive without clear institutional rules and clear responsibilities that are derived from them.6 They connect joint production with external sanction (legal) systems to enforce cooperation,

Modeling Collective Decision-making 171

resulting in sufficient trust that noncooperative individuals can effectively be sanctioned or even fired. Enforcement of cooperation is also important for the timely and correct implementation of collective decision-making. Recent EU studies have investigated such effects on implementation of distances between decision outcomes and policy positions of Member States and the European Commission and of consensus among Member States in the Council (see, among others, Falkner et al. 2005; Zhelyazkova and Torenvlied 2009; König and Luetgert 2009; Steunenberg 2010; Thomson 2009, 2010). If cognitive interdependencies are linked to norms that decisions should be based on consensus, institutional rules work like legal contracts. As mentioned before, they provide safeguards to stakeholders in case fundamental problems arise or other stakeholders misbehave. However, the more often you have to fall back on them, the more the norm of consensus building will be under pressure. Building sufficient support for a specific outcome may lead to a preferable outcome, but it may also lead to disturbed relations. Some stakeholders may not be interested in a specific outcome, but in any outcome as long as it is supported by all stakeholders. Other stakeholders may be interested solely in an outcome close to their policy position, even when it implies a lot of opposition and turmoil. From this perspective, each stakeholder can be perceived to have at least two objectives while intervening in decision-making. The first objective is to minimize the distance between the outcome and the policy position of the stakeholder on the issue. The second objective is to minimize the variance of the positions of all stakeholders or the subgroup of stakeholders with whom the stakeholder is associated. Earlier, we denoted the first issue salience and the second group consensus salience. The two objectives can be modeled by using an aggregate utility function in which both objectives are combined. This can be realized by applying the Cobb-Douglas function with two weights, one being the issue salience and the second the group consensus salience. The three bargaining processes: transitions and testing dominance It is interesting to study and model transitions from one dominant process of decision-making to another. This is the subject of future research in which both Lindenberg’s theory about frame switches (Lindenberg and Frey 1993; Lindenberg 1998, 2000) can be helpful, as well as Esser’s model building on shifts in the definition of situations (Esser 1997, 2000). The dominance of the three types of networks (persuasion, logrolling, enforcement) in the context of the European Union was evaluated on the basis of the accuracy of the three corresponding models. To determine the dominance of the three types of processes (persuasion, logrolling, enforcement) in the context of the European Union, the accuracy of each model is determined by the distance between the model-predicted outcomes and the actual outcomes on the issue scales (for the EU 2001 extension, see Stokman and Thomson 2004: 19; for the EU after the extension, see Thomson 2011). Models based on cooperative solutions that include the positions of all EU decision-makers give the best predictions. Unanimity, wherever possible, is a very strong norm in the EU, even when decision outcomes

172 Stokman,Van der Knoop, and Van Oosten supported by only a qualified majority of actors are possible (see also Mattila and Lane 2001). Decision outcomes in the EU tend to take into account actors’ essential interests, wherever possible, and actors avoid harming the essential interests of others (Schneider, Finke, and Bailer 2010). This implies that persuasion networks dominate in the European context. Negotiated exchange networks do not often support consensus building in the European Union because of the high negative externalities involved. Given the dominant norm of consensus building, this type of network is not dominant in the European context, as shown by its worse predictions than the persuasion model. Dijkstra, Van Assen, and Stokman (2008) show, however, that negotiated exchanges that avoid negative externalities indeed contribute to overall consensus building in the European Union. Power networks do not dominate European Union decision-making either: noncooperative procedural and bargaining models do even worse. We therefore conclude that, also in the European context, procedures do not determine behavior, but set the boundaries within which action takes place. The reader should be aware that the inferences about European Union decision-making can be made only by a comparative analysis of the three processes and corresponding networks.

Strategic Intervention in Decision-making The methodology of data collection and the dynamic analysis of the bargaining processes through computer simulation have not only been validated in scientific research but are also applied in commercial projects as a successful tool for strategic intervention (see Stokman et al. 2000 for two examples). Whereas in scientific applications the main aim is the prediction of outcomes and the determination of the dominant process, applied projects usually aim either to arrive at decisions close to the client’s position with sufficient support to be viable, or to arrive at a common position in stakeholder dialogues and mediation. The approach can be applied fruitfully both in contexts where organizational strategies have to be determined and where organizational strategies have to be implemented. Stokman et al. (ibid.) elaborates strategic moves for all three bargaining processes. Here we will illustrate just one such move in the context of our example of the Copenhagen climate conference in December 2009. The question of whether consensus could be reached in Copenhagen depended on two perceptions of the Party Groups.The first perception concerns the severity of the expected climate changes as a consequence of greenhouse gas emissions owing to currently unsustainable industrial production. The second is evaluating the importance of a worldwide agreement between the Parties in order to realize the transition to a more sustainable production. If both perceptions are strong and can be shared by all Party Groups, failing to reach a unanimous agreement will be seen as highly undesirable, even less desirable than a weak compromise. If this were the case, unanimity was expected to be reached in the end, even when the Party Groups fundamentally disagree on a number of issues. For each issue, the expected outcome will then be close to the mean of the Party positions on the scale, weighted by their influence and

Modeling Collective Decision-making 173

salience, the approximation of the Nash Bargaining Solution, as we have seen earlier.Table 4.2 shows, however, that certain Party Groups do not attach much importance to reaching an agreement. The EU, the least developed countries, and AOSIS want to reach an agreement, but others such as the United States and Russia do not.This implies that the NBS is unlikely to be a good predictor for the outcomes on this issue. The expected outcomes, but also the variation of the positions can change fundamentally if Party Groups exchange voting positions by linking the issues with each other. The degree of agreement after the exchange process increased substantially for five of the seven issues, but remains low for the two most controversial issues—namely, the state of the decisions in Copenhagen as new or as an extension of Kyoto (Issue 1; Figure 4.1), and the size of MRV CO2 reduction in advanced developing countries, such as China, India, and Brazil (Issue 2; Figure 4.2). In other words, the basis for agreement improves fundamentally, but two issues will continue to cause problems. Another reason why it is not expected that this exchange process will result in an overall agreement is that, over all simulated exchanges between Party Groups, the positive externalities are greater than the negative ones only for the EU, Russia, and some developing country groups. All other Party Groups perceive higher negative externalities than positive ones, which is the second reason for the main conclusion that the interests of the Party Groups are not sufficiently aligned to arrive at an overall agreement by simply exchanging positions. Two issues remain controversial and require another solution. There are simply not enough complementarities between interests to reach an overall agreement. The next question is then whether there are instruments to increase the complementarities of interests of the Party Groups in Copenhagen in such a way that an overall agreement can be achieved. A strategy for such an outcome is based on two small changes in the data on the basis of solid reasoning. Issue 1 is a problem mainly for the United States, which never ratified the Kyoto Treaty. If the new decisions are classified as an extension of the Kyoto Treaty, the U.S. House and Senate ratification of the Copenhagen agreement implies a ratification of the Kyoto Treaty. Moreover, after eight years of the Bush administration, the United States cannot easily catch up. Consequently, the U.S. will not likely sign a treaty that implies ratification of the Kyoto Treaty. On the other hand, China and India have high stakes in having a Copenhagen agreement as an extension of the Kyoto Treaty, as rich countries can realize their emission reduction obligations with projects in their countries.The MRV CO2 free reduction in the growth (Issue 2) is especially important to China and India, as they are willing to realize such a component in their growth but are not willing to make binding agreements to do so. A possible solution could be to accept nonobligatory intentions in both cases, but to put the realizations of CO2 reduction of these countries in the Copenhagen Treaty. Such a double arrangement considerably reduces the salience of the United States in Issue 1 and the salience of China and India in Issue 2, which can be investigated by a considerable reduction of the two saliences in the data. The salience of the U.S. on Issue 1 is reduced from 90 to an arbitrarily chosen value of 70 or lower, such as 50. Simultaneously, the salience of 100 of China and India on Issue 2 is also reduced to 50.

174 Stokman,Van der Knoop, and Van Oosten These changes reduce the variances of positions on all seven issues substantially enough to expect overall consensus. The results are stable as long as the salience of the United States is reduced to 70 or lower for Issue 1 and that of China and India to a value of 90 or lower on Issue 2. Doing so provides us with very stable results. Now, after bilateral exchanges, sufficient agreement is realized on all issues to arrive at a complete agreement. This prediction was made in November, one month before the start of the Copenhagen Conference and turned out to be the sole solution for something like an agreement in Copenhagen (see Stokman 2009 for details).

Conclusions Starting from the idea that collective decision-making is a special case of joint production, required in any situation in which individuals are mutually outcome dependent, we hope to have shown that the topic is of much wider importance than in simply the political sphere. Collective decision-making is at the heart of any collaboration, whether that is in small informal groups or in complex organizations or in political systems. Placing collective decisionmaking in this perspective, one’s attention is immediately drawn to the relative salience of the shared versus the conflicting interests that is of such importance in any joint production. We hope also to have shown convincingly that in the domain of collective decision-making this ratio strongly determines the type of dominant process and the likelihood of arriving at common positions, even when formal institutions do not require reaching them. The chosen perspective also shifts the attention from formal rules toward informal rules, without underestimating the importance of the formal rules for the evolution and effectiveness of the informal rules. If, then, outcomes cannot be seen as the result of the interplay of formal institutions and preferences, we almost automatically have to shift our focus toward the informal processes preceding the final vote. Notwithstanding the elegance of neoinstitutional models and the extra insights they have generated, they seem not to be able to predict outcomes of decision-making processes in reality. Models that represent informal bargaining processes seem to do much better in this respect. This does not imply that formal institutions are neglected in such models. On the contrary, formal institutions and the voting rights and rules that are based on them are, first of all, required to make outcomes binding for social systems. In addition, they codetermine power and influence distributions in social systems, codetermining which stakeholders have to be included in the analysis. Finally, they connect collective decision-making processes to external sanction systems, without which informal processes are likely soon to degenerate, as stakeholders will not have formal sanctions to enforce cooperation and norm-conforming behavior. In this article, we have specified three main bargaining processes and the conditions that each of them is likely to dominate in decision-making processes. Moreover, we have specified under which conditions logrolling and enforcement processes are likely to support or undermine persuasion processes. Finally, we have tried to develop an integrative set of models for all processes, enabling both a comparative analysis of the expected outcomes under each

Modeling Collective Decision-making 175

of the processes and a strategic analysis of how to align the different processes in such a way that they support each other. It is this combination that makes the approach valuable both for scientific analysis and strategic intervention in decision processes. The largest project in which this approach is applied is the Decision-Making in the European Union (DEU) project (Thomson et al. 2006; Thomson 2011). In the Forum Section of European Union Politics, Mattila (2012: 459) concluded independently: “In many respects the DEU project has led EU studies to a new level. It was the first project of its scale to analyse the EU’s decision-making system with a systematic rational choice approach.” If we have valid and reliable estimates of the main issues at stake and the positions, saliences, and influence of the relevant stakeholders, rational models are able to provide far-reaching insights and conclusions. This does not imply, however, that the positions and saliences of the stakeholders are based on rational considerations only, focused on an optimal outcome for each stakeholder. A theoretical derivation of these data requires a more complex model of man (see, for example, Lindenberg and Steg 2007). Nevertheless, there is more to do. We are presently particularly working on two lines of further development. First, the models can be improved by incorporating not only the issue salience of the stakeholders but also their group consensus salience. Stakeholders aim not only at outcomes close to their policy position but also at outcomes that receive support from either all stakeholders involved or the stakeholders they want to align with. We have indicated that the Cobb-Douglas function can be used for the simultaneous optimalization of these two goals, taking into account the relative saliences for both goals. Second, a further elaboration of persuasion models requires a further elaboration of the relationships between instrumental (issues) and higher ordered goals. In such an elaboration, both differences in priority of the higher ordered goals and differences in cognitive perceptions of the relationships between issues and goals have to be integrated with the collective decisionmaking models as treated in this article.

Notes The ideas in this article were developed in close collaboration with many persons, of whom we would particularly like to mention Siegwart Lindenberg, Robert Mokken, and Marcel Van Assen. We thank Vincent Buskens, Jacob Dijkstra, Beth Levy, Siegwart Lindenberg, Robert Thomson, Timo Septer, Hanne Van der Iest, David Willer, and Rafael Wittek for their comments on earlier drafts. 1. There is a strong link between our work and Network Exchange Theory because the exchange-resistance solution used in Network Exchange Theory (see, for example, Willer, Markovsky, and Patton 1989; Skvoretz and Willer 1993; Szmatka and Willer 1995) is also derived from the game theoretical RKS solution (Heckathorn 1980). 2. Stokman and Van Oosten’s exchange model has been tested in several contexts, ranging from complex negotiations between employers’ organizations and trade unions (Rojer 1996; Akkerman 2000), urban politics (Berveling 1994), European Union decision-making (Arregui, Stokman, and Thomson 2006), and the international climate conference in Copenhagen (Stokman 2009). We have published the outcomes for the Copenhagen study not only in advance but also at four other occasions at the beginning

176 Stokman,Van der Knoop, and Van Oosten of the negotiations. The first time, in 1996, Rojer and Stokman gave the predictions of outcomes on sixteen issues in a forthcoming negotiation process in the Dutch metal industry to a lawyer. They announced publicly that these predictions would be revealed at a press conference at the end of the negotiation process. Three times, in 2002, 2007, and 2009, predictions were published at the start of coalition negotiations between Dutch political parties. In all three cases, more than 80 percent of the outcomes were correctly predicted within strict, previously specified boundaries. (See http: //www. stokman.org/news-related%20activities.htm.) 3. The proof is given in Dijkstra,Van Assen, and Stokman 2008. 4. If such an exchange is possible, another condition may limit the size of the exchange. For none of the actors, the distance between the expected outcome and their position on the demand issue should be larger after exchange than before (Dijkstra,Van Assen, and Stokman 2008). 5. Van Assen, Stokman, and Van Oosten (2003) define measures with which the positive and negative externalities of bilateral exchanges for other stakeholders can be computed. In their approach, exchange is considered as a cooperative two-person game. That is, in the derivation and the calculation of the measures it is assumed that actors not involved in the exchange do not affect the exchange rate of the exchange under consideration. 6. For the interaction between informal cooperation and sanctioning systems, see, among others, Yamagishi 1986; Ostrom, Walker, and Gardner 1992; Fehr and Gächter 2002; and Rockenbach and Milinski 2006.

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chapter

Social Exchange, Power, and Inequality in Networks

5

karen s. cook and coye cheshire

Introduction There is an interesting tension in the writings about social exchange, especially in the early work of Homans and Blau as well as in many of the subsequent writings about exchange. For some authors, exchange, especially social exchange, entails the transfer of valued resources or the performance of mutually rewarding actions by actors who are relatively equal. Exchange is voluntary and exit is easy. This image also fits the basic model of market exchange in economics if we add the condition that information is fully and freely available. Even our received image of the Kula Ring exchange system (Malinowski 1922), the classic example of generalized exchange, is viewed primarily as an exchange among equals that builds solidarity at the communal level. Levi-Strauss (1969: 266) argues that generalized exchange “presumes equality.” Ekeh (1974: 63) also expresses an egalitarian bias: “[T]he significance of social exchange for social dynamics lies in its integration of society not in its differentiation of society.” But exchange is often not among equals, and it frequently forms the basis for differentiation and inequality. It is no accident that Blau (1964) named his most famous book Exchange and Power in Social Life.1 Power inequality is an inevitable outcome of differentiation in resources and structural position. Over time some actors gain positions of advantage in their exchange relations (or networks of exchange relations) and thus have the capacity to exploit this advantage. However, distinct forms of exchange have different implications for social differentiation, the emergence of power inequalities, and social solidarity. We discuss the emergence of such inequalities in exchange networks and their implications for the analysis of power and solidarity. Differentiation and a kind of benign form of inequality are central to basic processes of social exchange. Without differentiation in preferences and endowments there would be little reason for exchange. As Blau (1964: 170) notes, “[T]he reason two men engage in a voluntary exchange transaction is that both benefit from it. Both can benefit only if they have divergent attitudes

186 Karen S. Cook and Coye Cheshire (preferences or endowments).” Specialization, he argues, provides each “man [sic]” with more of some resources than he can use and fewer of others than he needs. Some differentiation is thus presumed to exist prior to the formation of social exchange relations, but it is differentiation in endowments and/or preferences that are not necessarily imbued with wider social significance in terms of differential social status, power, and influence. These differences in endowments and preferences breed interdependence, not socially significant distinctions. Once inequality emerges, however, those with more resources are often viewed as having higher status and more social influence (Blau 1977). Such distinctions based on rewards may produce beliefs that support the development of differentiated status conceptions (see, for example, Ridgeway, Berger, and Smith 1985), which may eventually attain broader social significance.

Social Exchange, Power Inequalities, and Solidarity For Blau the source of power is the “one-sided dependence” of one actor on another. This notion is also the key to Emerson’s power-dependence formulation (1962, 1964) of power in exchange relations, though Emerson focuses on mutual dependence. As Blau argues (1964: 118–19), the conditions that Emerson defines as “power-balancing mechanisms” can be viewed as conditions that establish power imbalance itself. This schema, he goes on to suggest, can be used to identify the requirements of power, the conditions of social independence, and the bases of power conflicts and their structural implications. Even among those who are initially equal, power differences are produced, Blau (ibid.: 140) contends, by the imbalances in obligations that are incurred in social transactions across time. This is perhaps the most basic form of inequality that emerges in social exchange relations.These imbalances are built up through social exchange in which one party ends up providing services of greater value than another, inducing a kind of social debt that is difficult to discharge fully except in the return of benefit whenever possible. Such imbalances in obligations naturally occur in most social exchanges, eventually generating inequalities in the dependencies of the actors in the exchange relations that in turn produce power differentials. In discussing the “tension” in systems of exchange, Blau (1994: 158) comments: “A paradox of social exchange is that it gives rise to social bonds between peers and differentiation of status.”2 Blau’s influential analysis, however, focused primarily on the emergence of social differentiation. In his classic treatment of the exchange of advice for status in a work group, he provides an example of a common pattern in groups and presents it as a general principle of social differentiation. He subsequently discusses the role of legitimation and organization as they relate to the emergence and sustainability of differentiation.3 Blau (2002) identified his study of consultations in a work group as the original source of his idea of social exchange. For Blau (1955: 108), “A consultation can be considered an exchange of values; both participants gain something and both have to pay a price.” His version of exchange theory was quite different from Homans’s conception of exchange largely as a result of their different microlevel assumptions about the determinants of behavior. Blau’s microlevel theory was based loosely on an extension of principles of microeconomics,

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whereas Homans’s was based on principles of behaviorism influential at the time he wrote his paper on social behavior as exchange (see also Cook and Gerbasi 2006). In this contest of ideas we see both the early rational choice roots of the individual level model behind some versions of exchange theory and the behaviorism or principles of learning and reinforcement that were reflected not only in Homans’s work but also in the early work of Emerson (1969, 1972a) and subsequently Molm (1985). Competition for scarce resources, Blau (1964: 141) argued, leads to power differentiation. “In informal groups the initial competition is for participation time, which is scarce, and which is needed to obtain any social reward from group membership” (ibid.). This insight is also supported by a large literature concerning the emergence of inequality in small groups both in status and influence (see the work of Bales, Berger, and his colleagues). In communities, Blau goes on to argue, the primitive competition is for “scarce means of livelihood.” He concludes that “as status differences emerge in consequence of differential success in the initial competition, the object of competition changes, and exchange relations become differentiated from competitive ones” (ibid.).4 Here we see the separation of cooperative exchange relations from relations of strict competition and conflict.5 Subsequently, this distinction was superseded by Emerson’s classification of exchange relations into more or less cooperative or competitive. Negatively connected exchange relations involve competition for access to resources. Positively connected exchange relations tend toward cooperative modes of interaction since there is no resource competition in relations that are positively connected. Like Blau (1964), Emerson (1972b) viewed the fundamental task of social exchange theory to be the building of a framework in which the primary dependent variables were social structure and structural changes. He argued that structural arrangements among actors who controlled valued resources created differences in potential power. Cook and Emerson (1978) and their colleagues subsequently demonstrated experimentally that power was a function of relative dependence, which was determined by the shape of the network of interconnected exchange relations and the positions each actor occupied in the network. While Cook and Emerson (ibid.) examined other exchange outcomes such as commitment formation between actors in this seminal piece, the connection between the structure of social networks and the use of power became the central focus of research for the next two decades. Return to the study of commitment and other indicators of solidarity, such as trust, did not occur until the 1990s (with a few exceptions). In networks composed of exchange relations, differentials in dependence generate structurally embedded power inequalities. Actors with greater access to valued resources by virtue of their location in a network of exchange opportunities can often enhance their structural advantage, while those with less access to the resources they value as a result of their network location often lose power with the inability to negotiate more favorable rates of exchange and with few alternatives and limited exit options. In this way, structurally embedded power inequalities in exchange networks often increase over time. Operating against this tendency are the power-balancing mechanisms identified by Emerson (1972b).

188 Karen S. Cook and Coye Cheshire Emerson’s original power-dependence formulation conceived of power as determined by the mutual dependence of one actor on another in a social relation (later applied to exchange relations).This formulation was influential in Blau’s development of his theoretical conceptualization of power and exchange as noted above. For Emerson (1962, 1964, 1972a,b) power in a two-party relation is a function of dependence (Pab = Dba),6 such that the power of actor A over actor B (Pab) is a direct function of B’s dependence on A. More formally, in an exchange relation between two actors, A and B, the power of actor A over B in the Ax:By exchange relation (where x and y represent resources of value) increases as a direct function of the value of y to A and decreases proportional to the degree of availability of y to A from alternative sources (other than B). These two factors—resource value and resource availability—determine the level of B’s dependence on A and thus A’s power over B. An exchange relation in which power (and dependence) are unequal is referred to as “imbalanced” in Emerson’s formulation (1972a,b). An exchange relation is balanced if Dab = Dba; that is, if both parties are equally dependent. The concept “balance” is important because it sets the stage for understanding the “balancing operations” Emerson developed to explain change in exchange relations and networks. He identified four possible “balancing” operations, or processes, that alter or mitigate the power differences between actors in exchange relations characterized by power inequality. If A is more powerful than B—that is, Pab > Pba and Dba > Dab in a two-party exchange relation— four generic options exist to alter the balance of power.These options are based on the two variables that determine levels of dependence: value of the resources at stake and the degree of availability of these resources from alternate sources. To alter the balance of power in the Ax:By exchange relation: (1) actor B can reduce the level of motivational investment in goals mediated by A or reduce the perceived value of the resources at stake7 (that is, a form of “withdrawal” from the relationship); (2) B can come up with alternative sources (for example, actor C) for those goals mediated by A or resources of value provided by A (referred to as “network extension”); (3) B can attempt to increase A’s motivational investment in the goals B mediates (for example, through “status-giving” or other efforts to increase the value of the resources provided to A); and/or (4) B can work to eliminate A’s alternative sources for the goals or resources B mediates access to (for example, by engaging in coalition formation with other actors, in particular suppliers of key resources). We discuss some examples of these processes in the section on power dynamics. The key assumptions of exchange theory, summarized by Molm and Cook (1995: 210), include: (1) behavior is motivated by the desire to increase gain and to avoid loss (or to increase outcomes that are positively valued and to decrease outcomes that are negatively valued); (2) exchange relations develop in structures of mutual dependence (both parties have some reason to engage in exchange to obtain resources of value or there would be no need to form an exchange relation); (3) actors engage in recurrent exchanges with specific partners over time (that is, they are not engaged in simple one-shot transactions); and (4) valued outcomes obey the economic law of diminishing marginal utility (or the psychological principle of satiation). Based on these core assumptions various predictions can be made about the

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behavior of actors engaged in exchange and the effects of different factors on the outcomes of exchange. The power-dependence principle, in addition, is the basis for predictions concerning the effects of increasing the value of the resources in the exchange and their availability from alternate sources, referred to by Emerson as “power-balancing” mechanisms, as noted above. Exchange relations, however, are rarely isolated. Actors are typically embedded in networks of social relations, which provide alternative access to the resources they value. Since access to alternatives is one of the main determinants of differentials in power and dependence, it was natural for Emerson to extend his conception of relational power to the analysis of exchange networks representing linked relations of exchange. To make this link Emerson (1972b) defined several types of network connections that have different implications for the development of power differences within networks composed of exchange relations connected in various ways (see also Cook and Emerson 1978; Cook et al. 1983; and Yamagishi, Gillmore, and Cook 1988). The exchange network is the network of connected exchange relations in which the A:B exchange relation between any two parties is embedded. The network is the social structure created by the distribution of exchange opportunities, and power differences in the network are determined by the value of the available resources to each actor in the exchange and by the nature of their connections to others, which provide access to these valued resources (Cook and Whitmeyer 1992). This social structure of exchange opportunities forms the basis for Emerson’s structural theory of power. Power in this context is potential power and the use of this power is a variable to be explained. Networks are composed of exchange relations that are connected to the extent that exchange in one relation affects or is affected by the nature of the exchange in another relation. By this definition exchange relations are connected, and the actors are linked by virtue of their involvement in these exchange relations. The connection can be either positive or negative.8 A negative connection means that exchange in one relation reduces the amount or frequency of exchange in another exchange relation involving one of the same parties (for example, the A-B and B-C exchange relations are negatively connected at B if exchange in the A-B relation reduces the frequency or amount of exchange in the B-C relation).9 An example is a typical dating network. A connection is positive if the amount or frequency of exchange in one relation increases the amount or frequency of exchange in an exchange relation involving at least one of the parties to both exchanges (for example, the A-B relation is positively connected to the B-C relation if exchange in the A-B relation increases the frequency or amount of exchange in the B-C relation). A communication network is typically positively connected. Exchange in more complicated networks, often called mixed networks (Yamagishi, Gillmore, and Cook 1988), involves both positive and negative connections. Subsequently,Willer and his collaborators in developing Network Exchange Theory (NET) made a distinction between types of connections, similar to Emerson’s conceptualization. Positive connections typically result in what Willer and colleagues call “inclusion” (that is, the need to cooperate), and negative connections result in what they call “exclusion” as a result of competition for access to valued resources. The relationship between the specific structure of

190 Karen S. Cook and Coye Cheshire these social exchange networks (sets of connected exchange relations) and the distribution of power and power use in the network became the central focus of empirical research in the social exchange tradition for several decades. To test power-dependence theory experimentally social interaction was defined as the exchange of resources of value that could be manipulated in a laboratory setting. While the theory applies to the exchange of any resources (or services) of value, it was possible to create a setting for exchange by giving actors access to resources for exchange in the laboratory and giving them monetary value (even though the theory applies to anything of value; see Molm 1997). Emerson published his first empirical tests supporting powerdependence theory applied to dyadic relations in 1964. Subsequent research focused on exchange in networks of connected exchange relations, and the structural determinants of power and power use. We have already introduced the concepts of power, dependence, exchange relations, positive and negative connections, networks, and power-balancing mechanisms. Other key concepts include reciprocity and relational cohesion (linked subsequently to issues of social solidarity). For Emerson, reciprocity was central to all social exchange. Without it there would be no mutual social exchange; thus he conceived of reciprocity as part of the definition of exchange. Norms of obligation emerge to reinforce reciprocity, but reciprocity itself cannot be viewed as an explanation of the continuation of exchange. In Emerson’s earliest formulation (1972a), reinforcement principles provided sufficient explanation for the initiation and the continuity or extinction of exchange relations. Molm and her associates’ recent work (2004, 2007b, 2010), however, treats reciprocity as a variable feature of the different types of exchange. Cohesion represents the “strength” of the exchange relation or its propensity to “survive conflict” (Emerson 1972a). Relational cohesion is the average dependence of the two actors in the relation. Subsequently, Molm (1985) and others (for example, Lawler, Ford, and Blegen 1988) referred to this concept as average total power: the higher the mutual dependence, the greater the total power in the relation. It represents how much is actually at stake in the relation (not the relative power of each actor within the exchange relation, another important determinant of commitment, power use, and cohesion). From this perspective high mutual dependence is positively related to relational cohesion.

Network Determinants of Power Cook, Emerson, and their colleagues (see, for example, Cook and Emerson 1978; Cook et al. 1983; and others) published the results of their early tests of the application of power-dependence principles to the analysis of exchange in networks connected in various ways.The focus was the test of basic propositions concerning the structural effects of networks and specific types of exchange connections on power use, as measured by the distribution of exchange profits in the networks over time. This work led to subsequent studies of network exchange including experiments that challenged the power-dependence formulation (see our discussion of alternative theoretical formulations). Based on power-dependence reasoning, actors who have more alternatives for

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obtaining resources they value are less dependent and thus have more power in the network. In a negatively connected network, actors with more partners with whom they can engage in exchange thus have more power. Access to alternatives increases the availability of the resources of value (assuming relatively constant valuation during an experimental session). Building on the initial study of Stolte and Emerson (1977), the first general test of the theory focused on negatively connected exchange networks. Assuming that to have power is to use it (Emerson 1972), this general proposition could be tested by measuring power use in terms of the extent to which one party could negotiate more favorable terms of exchange than others in a network of linked exchange relations. Exchange was operationalized by having participants negotiate the terms of trade for resources of value, converted to monetary payoffs at the end of the experiment. The interaction was computer-mediated to increase experimental control and to reduce experimenter effects. Assuming actors would use their potential power, the more powerful actor in an exchange relation will typically obtain a larger share of the valuable resources to be exchanged—that is, to receive more points— than the actor’s partner. The two experiments reported in Cook and Emerson (1978) involved four-actor, fully linked networks. The networks were either power-balanced or power-imbalanced. In the unbalanced networks, not only did the more powerful actors gain significantly more points than their partners, but they also gained significantly more points than any of the actors in equivalent positions in the balanced network. Other factors investigated in this study were commitment and equity effects. Cook et al. (1983) developed an extension of the theory to apply to larger networks. In this study, variation in network structures was the key variable of interest. The network studied consisted of five actors linked in a chain so each actor had only two potential trading partners. Ignoring the low-profitability relation (which connected F1 and F2 the two end-points of the chain) results in a line (later called “Line 5”) of five actors involving four exchange relations, F1 – E1 – D1 – E2 – F2.10 Previous theory on social networks had supposed that positional centrality in a network confers the most power, and thus that D1 would be most powerful. However, in this study power-dependence theory was used to predict that if this network is negatively connected, actors E1 and E2 will emerge as the most powerful actors, as a result of the increased availability of their alternatives (F1) and (F2). The experimental evidence supported the predictions concerning relative positional power.11 Cook and Yamagishi (1992) developed an algorithm consistent with powerdependence theory that they referred to as the “equi-dependence” formulation. It specifies equilibrium points in the network at which the dependence between exchange partners reaches “balance.”They argue that social exchanges in a network proceed toward an equilibrium point at which partners depend equally on each other for valued resources. This “equi-dependence” principle has implications for partner selection as well as for exchange outcomes. Three different types of relations that can emerge from a network of potential exchange relations (which they refer to as an exchange opportunity structure) were identified. Exchange relations are those in which exchanges routinely

192 Karen S. Cook and Coye Cheshire occur. Nonrelations are potential partnerships within the network that are never used, and that if removed from the network do not affect the predicted distribution of power. Finally, latent relations are potential exchange relations that also remain unused but that if removed affect the subsequent predicted distribution of power across positions in the network. The existence of latent relations is important because they may be activated at any time as an alternative source of valued resources. An example is the reactivation of a relationship with a former partner. When activated they modify the distribution of power in the network. This principle was supported by simulation results and was consistent with some of the empirical investigations of exchange in power-imbalanced networks of exchange, but the algorithm was limited in its applicability to large-scale networks and thus was superseded by the work of Markovsky, Willer, and their collaborators, who developed the GPI index and later, ESL, an “exchange-seek” algorithm for determining power distributions in networks of exchange relations. One of the most consistent findings in the experimental research on social exchange that emerged over time in various research settings is that relative position in a network of exchange relations produces differences in the relative use of power, typically manifested in the unequal distribution of rewards across positions in a social network (Bienenstock and Bonacich 1992; Cook and Emerson 1978; Cook et al. 1983; Friedkin 1992; Markovsky, Willer, and Patton 1988; Markovsky et al. 1993; Molm and Cook 1995; Skvoretz and Willer 1993). While a number of competing microtheories connecting network structure and power-use emerged in the intervening decades, these competing perspectives generally converge on the prediction that power differentials relate directly to actors’ network positions (Skvoretz and Willer 1993: 803). The theories differ to some extent, however, in the causal mechanisms at work in converting these differentials in network position into actual power differences and often in the nature of the experimental paradigms employed to test predictions. Network Exchange Theory (NET) derived from Willer’s “elementary theory” of social relations is the best-developed and most extensively tested alternative formulation (see below). power dynamics Inherent in Emerson’s treatment of power were the seeds of a theory of social change based on principles relating to changes in the distribution of power in the network of connected exchange relations. In his view the important feature of power inequality is that it creates “strains”12 in exchange relations and provides an impetus toward structural changes, creating problems of collective action unique to exchange contexts (Emerson 1972b; Cook and Gillmore 1984; Lawler and Yoon 1998). Power imbalances were viewed as a temporary state, generating strains in exchange relations. The four distinct “balancing” operations would stabilize relationships, he argued. One such mechanism was coalition formation as a power-gaining strategy. The other mechanisms, listed earlier, included network extension, status giving, and exit. The early work on coalition formation in exchange theory (Cook and Gillmore 1984) empirically demonstrated that power imbalances do promote the formation of coalitions.13 In the simplest hierarchical network structure

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in which one power-advantaged actor exchanges with a number of powerdisadvantaged actors, a coalition of all power-disadvantaged actors against the powerful will lead to a balance of power in the network (ibid.). Coalitions that do not include all disadvantaged actors will not result in power-balance because the powerful actor still possesses alternatives to the coalition, which can be used to advantage. Moreover, coalitions including all of the power-disadvantaged actors tend to be more stable over time (Emerson 1972b) than coalitions that do not. However, the formation of large coalitions is problematic in part as a result of simple coordination issues. A different power-balancing mechanism is network extension. Powerdisadvantaged actors, rather than forming coalitions to balance power, may seek out new exchange relations, reducing their dependence on any given actor for valued resources. Leik (1992) proposed a theory of network extension and contraction based on principles derived from the Graph-theoretic Power Index (GPI) and related assumptions developed within Network Exchange Theory tradition (for example,Willer and Anderson 1981; Markovsky,Willer, and Patton 1988; Markovsky et al. 1993; see below for further details). Leik (1992) argued that as long as actors are assumed to be trying to maximize their power vis-àvis their partners, power-advantaged actors would attempt to reduce linkages between partners to consolidate their power, while power-disadvantaged actors would attempt to create new linkages to increase their power. Such a theory requires that actors have information and strategic capacity: “Without sufficient information and the savvy to utilize it, neither the weak nor the strong will be able to perceive the advantage of linkage changes” (ibid.: 316). In addition to laboratory research on network connections, there have been several attempts to apply these concepts outside the laboratory. For example, Anderson, Håkansson, and Johanson (1994) analyzed business networks, defined as two or more connected relations between businesses conceived as collective actors. A key proposition is that each firm will develop a network identity, which has three dimensions: an orientation toward other actors, competence, and power. Power is a function of an actor’s resources and its network context, following Emerson, Cook, and colleagues. Anderson, Håkansson, and Johanson (1994) report contrasting effects of positive and negative exchange connections in two case studies and point out that connections may actually switch between positive and negative through time, or may be simultaneously positive and negative (Whitmeyer 1997b). In addition, Anderson, Håkansson, and Johanson (1994) identify mechanisms, typically involving network identity that result in change over time in relationships and connections in business networks. Power-dependence theory has also been applied in the study of organizations (resource dependence) and in economic sociology with investigations of network embeddedness and its effects on various types of economic relations (for example, in the manufacturing industry and the like) in part because power-balancing operations are difficult to examine in the laboratory.The relatively short duration of a typical experimental session (often between one to two hours) makes it hard to study change over time. Thus field studies are often more appropriate for investigating power dynamics, as indicated by some of the early applications of power-dependence reasoning in the literature on organizations. One of the first applications in the field

194 Karen S. Cook and Coye Cheshire of organizations was the development of resource dependence theory (Pfeffer and Salancik 1978). Resource dependence creates power differences between organizations and subunits within organizations. According to Scott (1992: 115), a major contribution of this perspective is the specification of strategies that organizations use to manage their strategic dependencies—strategies “ranging from buffering to diversification and merger.” For Emerson (1972b; Cook et al. 1983), many of these strategic responses are examples of powerbalancing or power-gaining tactics14 (see also Thompson 1967; Cook 1977; Cook and Emerson 1984). Other strategies that reflect responses to strategic dependencies include vertical integration and specialization strategies designed to reduce competition and collective reactions that alter power relations such as joint ventures, long-term contracting, and consolidation, similar to coalition formation strategies in the research on individual actors within exchange networks characterized by power differences. Factors other than network structure can affect power use, including behavioral constraints created by fairness considerations (for example, Cook and Emerson 1978) or concerns over the ultimate impact of power use, such as the potential for termination of a relationship of value, especially in the face of strong interpersonal commitment. Analysis of the effects of uncertainty and risk on commitment between parties to the exchange and the structure of social exchange in networks (including the work of Molm and Lawler and their separate collaborators) builds directly on the early theoretical work of Emerson. In fact, Cook and Emerson (ibid.) included examination of the emergence of commitment between parties to an exchange relationship over time, arguing that commitment was more likely to occur under uncertainty, especially when risks were involved (see also Cook and Emerson 1984), especially the risk of failing to locate an exchange partner. Research focused on other factors related to the emergence of cohesive exchange partnerships, including exchange frequency. For Lawler the key factors leading to commitment or relational cohesion were frequent positive exchange and the positive emotions they generate (Lawler and Yoon 1996). Facing uncertain environments (including uncertainty about resource quality), actors involved in exchange were more likely to seek to form committed exchange relations (Cook and Emerson 1978; Kollock 1994) or networks of trusted exchange partners (Cook 2005). A significant effect of the emergence of commitment in many networks is that it reduces the extent to which actors seek exchange with alternative partners and thus serves to reduce power inequalities both within the exchange relation and within the network in which the relation is embedded (Rice 2002). Kollock’s work (1994) demonstrates that uncertainty not only results in commitment formation as a means of reducing uncertainty but also tends to be correlated with perceptions of trustworthiness of the actors involved in the exchange relations and thus trust (see also Cook et. al. 2005).15 Yamagishi, Cook, and Watabe (1998) similarly report that trust emerges in exchange relations under conditions of high uncertainty when actors form commitments to exclusive exchange relations, and it helps to avoid the possibility of exploitation by unknown actors who enter the exchange opportunity structure. Given low uncertainty, actors are much more likely to continue to “play the market” and to avoid forming commitments to

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specific partners to maximize access to valued resources. (Uncertainty in these experiments refers to the likelihood of being exploited by a new partner in a network of exchange opportunities that changes over time.) In research on trust, uncertainty and vulnerability to exploitation are often defined as two of the key elements of situations in which trust considerations are paramount (see, for example, Heimer 2001). Cook, Rice, and Gerbasi (2004) identify the types of economic uncertainty that lead to the formation of trust networks for exchange. Under high political and economic uncertainty such as that characteristic of eastern European countries and Russia post-1989, trust networks, if they become closed, retard the transition to more open market economies. Commitment processes are often also reflected in business relations, even in those involving power differentials. For example, Seabright, Levinthal, and Fichman (1992) in a study of the dissolution of auditor-client relationships in which there is a clear power difference found that commitments (or attachments) mitigated the tendency for such relations to end. And Cook, Kramer, et al. (2004) found that in professional relationships between physicians and their patients (characterized by a power difference) the commitment that resulted from a long-term relationship increased trust and often provided the basis for better communication, higher levels of perceived patient compliance, and greater patient and physician satisfaction. Other relational outcomes including fairness also became the focus of subsequent investigation.

Inequality, Fairness, and Normative Constraints on Social Exchange Processes Homan’s distributive justice proposition is often viewed as central to some of the later developments in social exchange theory, since it clearly introduced a normative component, something he had ironically assiduously tried to avoid in his development of a theory of “sub-institutional” behavior. Homans (1961: 144) argues that justice is a “curious mixture of equality within inequality,” reflecting the tension that subsequent theorists wrote about in their treatment of exchange and power. The introduction of norms of fairness in Homans’s work and later Blau’s on social exchange provides a sense of how norms emerge in groups to regulate exchange (see also Ekeh 1974: 148). In addition, as Ekeh argues, distributive justice, in the hands of Homans, “leads to the justification of status inequalities in the distribution of rewards,” and he was quite critical of this fact. Without the conception of distributive justice the normative component would be missing from Homans’s basic theory of exchange. Cook and Emerson (1978) found that concerns over equity appeared to be more pronounced among those who were power-disadvantaged, not surprisingly, and it was the reduction in willingness to accept offers on their part that mitigated the use of power among those in power-advantaged positions, once the inequality in outcomes became common knowledge. Experimental research by Molm, Takahashi, and Peterson (2003) shows that the effects of fairness considerations in exchange situations are nuanced. They depend not only on the power of the actor involved but also on the type of exchange (for example, negotiated, reciprocal). Stolte (1987) identifies the conditions under

196 Karen S. Cook and Coye Cheshire which fairness considerations come into play in systems of productive exchange in which coordinated action is required. Even in Blau’s early work (1964) some consideration was given to the general role of social norms in the analysis of social exchange. Blau was much less oriented to the study of “sub-institutional” forms of behavior and viewed exchange relations as central to the analysis of associations, organizations, and institutions. In fact, he theorized about the role of such relations in institutional change and transformation. According to Blau (ibid.: 255): “Normative standards that restrict the range of permissible conduct are essential for social life. Although social exchange serves as a self-regulating mechanism to a considerable extent, since each party advances his own interests by promoting those of others, it must be protected against antisocial practices that would interfere with this very process.” He goes on to state: “Without social norms prohibiting force and fraud, the trust required for social exchange would be jeopardized, and social exchange could not serve as a self-regulating mechanism within the limits of these norms.” Moreover, superior powers and resources, which often are the result of competitive advantages gained in exchange transactions, make it possible to exploit others. This creates a need for social norms that prohibit at least those forms of exploitation that conflict with fundamental cultural values. In addition, Blau (ibid.: 257) argued that norms were needed to prohibit actions through which individuals could gain advantages at the expense of the “common interests of the collectivity.” Such norms serve to foster collective action and inhibit selfish acts that undermine collective well-being (see also Ostrom and Walker 2005 for a review). But the maintenance of such norms through monitoring and sanctioning is clearly problematic. We discuss some of the research in the exchange tradition that focuses on these issues of collective action as they relate to power dynamics. The specific role of norms as they emerge to regulate exchange in various settings has not been the focus of much empirical investigation (except for fairness considerations).

Alternative Approaches to the Analysis of Power in Exchange Networks A number of alternative models were developed to specify the exact nature of the link between structural features of networks and the distribution or location of power in exchange networks.These most notably included the work of David Willer and his collaborators (see Willer 1999). Willer differentiates his approach from Emerson’s by defining it as being structural rather than behavioral. This particular characterization does not accurately reflect Emerson’s primary purpose in extending his theory of exchange relations (Emerson 1972a) to the study of networks (Emerson 1972b). In fact, Emerson (1972a: 41) states that his purpose is to “address social structure and structural change within the framework of exchange theory,” even though the microlevel model of individual behavior he developed in the late 1960s was derived from behaviorism (as was Molm’s earliest work on exchange). We provide a brief overview of these alternative formulations (see also reviews by Molm 2000; Cook and Rice 2003; Willer and Emanuelson 2006). Subsequently we return to Emerson’s work and the theorists that have extended his program of

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research—in particular, Edward Lawler and his colleagues, and Linda Molm and her colleagues. network exchange⁄resistance theory In the late 1980s David Willer, Barry Markovsky, John Skvoretz, and their collaborators developed a theory of power in networks that deviated from the earlier works of Blau (1964), Homans (1974), Emerson (1976), and Cook and her colleagues (1978, 1983). In response to what the researchers felt were omissions of scope in the earlier theories of power and social exchange, Markovsky, Willer, and Patton (1988) established a method for computing relative power among positions in different social networks and across different exchange conditions. This network exchange resistance approach defines power as a position’s structurally determined potential, which is indirectly measured through power use (manifested in resource distributions). Predictions about relative power differences are then made using graph theory to analyze structurally contingent interactions. Markovsky, Willer, and Patton (ibid.) formulated predictions about power differences using the Graph-theoretic Power Index (GPI) and then tested these hypotheses in a series of laboratory experiments.16 The GPI predicts levels of actors’ resource acquisition based on the probabilities of particular partnerships being formed. As a net result of actor positions and the lack or presence of ties between them, different structures have more of an impetus toward the exclusion of some parties from exchange than do others. Comparable to powerdependence reasoning, positions in a network that have more alternatives for exchange have more power, as long as the alternatives themselves have few or no options. The GPI method calculates power for each position in a network and then predicts which positions will exchange with others based on the resulting index. Paths with even numbers of links are weighed negatively, while those with odd numbers of links are weighed positively.The “power” of a given point i is computed by taking the sum of all weights connected to that point (Markovsky, Willer, and Patton ibid.). In addition to the use of the GPI, a key component of the network exchange resistance approach is what Willer and his colleagues refer to as elementary theory (Willer and Anderson 1981; Willer, Markovsky, and Patton 1989; Willer and Markovsky 1993). Willer and Anderson (1981) describe elementary theory as a fully general theory, designed to account for social aspects of human interaction as well as cognitive and biophysical factors. According to Willer and his colleagues, elementary theory is a response to what they believe is unnecessary reductionism in earlier psychological theories of operant exchange. Elementary theory disregards learned reinforcement in favor of structural contingencies between actors in social networks (Willer and Anderson ibid.) as the primary focus of study and basis for the analysis of power differences in networks. From a methodological standpoint, experiments originally conducted to test elementary theory differed fairly substantially from the earlier experiments of Emerson, Cook, and their collaborators. Researchers in the power-dependence tradition used computer-mediated systems that deliberately regulated the information available to the participants (for example, relative position in a network, total size of resource pool or profit overlap, and so forth). On the

198 Karen S. Cook and Coye Cheshire other hand, experiments derived from elementary theory used face-to-face interaction situations in which individuals were allowed to overhear other offers, the size of the resource pool was known, and locations within a given network structure were fully disclosed (see Willer and Emanuelson 2006 for a full review of the theory and other work in this tradition). forms of power and coalitions from the perspective of network exchange theory The network exchange approach has been extended in a number of ways since Markovsky, Willer, and Patton’s initial experiments (1988). Skvoretz and Willer (1991) examined additional network structures in which they varied the number of exchanges available to each position in the network. In addition, Markovsky et al. (1993) used the network exchange approach to examine networks that differed in what they called “weak” and “strong” power.The main distinction between the two is that strong-power networks include positions that can exclude particular partners without affecting their own relative power or benefit levels. Densely connected systems (that is, friendship networks) exemplify weak-power networks, while strong-power networks appear in sparsely connected systems such as monopolies and hierarchies. Using computer simulations, Markovsky et al. (ibid.) demonstrated that higher connectivity provides additional opportunities for weaker positions to lessen the structural advantages of the stronger positions. Coalition formation and the distribution of resources resulting from coalitions are also major topic areas for Network Exchange Theory researchers. Following the initial work by Cook and Gillmore (1984), Willer (1987) investigated coalitions in coercive structures in which “the coercer has negative sanctions that are costly for coercees to receive. Coercees seek to retain the positive sanctions they hold” (Borch and Willer 2006: 81). Willer’s laboratory experiments (1987) showed that individuals with low structural power could earn more points by forming a complete coalition with others in the same structural position. Following their earlier work, Willer and Skvoretz (1997) began to use strategic analysis to extract the game-theoretic situations embedded in various structures for the purpose of investigating power use and coalition formation across different network forms. As the researchers argue, individuals in lowpower positions engage in prisoner’s dilemma (PD) type interactions.17 More broadly, all strong power structures appear to include PD games, at least for some range of offers (ibid.: 18). Borch and Willer (2006) applied the same strategic analysis method as Willer and Skvoretz (1997) to examine the game structures in bipartite networks (that is, networks where nodes can be separated into two subsets and all nodes in one group connect to all nodes in the other group). Borch and Willer (2006) found that coalitions can transform the social dilemma for low-power actors from a simple PD to a Privileged game (that is, the dominant strategy equilibrium is Pareto optimal; no social dilemma exists), yet coalitions do not change the initial Privileged game for high-power actors. In this case, coalitions among the less powerful allowed them to gain power, as Emerson had originally predicted.

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other directions in network exchange theory A relatively recent development in this line of research is Willer’s application (2003) of Network Exchange Theory to power use beyond a single relation (called “power-at-a-distance”).Willer (ibid.) argues that power can be exercised through many different levels such as generals who pass orders down a chain of command or in horizontal networks that are typified by competitive seller markets. In horizontal power extensions, an organization’s power is observed through competition and market position. In each of these examples, power can operate indirectly—not just as an exact measure of all face-to-face, direct relationships. In Willer’s conception of indirect power, “For A’s favorable outcome to be at B’s expense, it is not necessary that the two be adjacent. . . . [T]his understanding means that local power exercise is to be distinguished from power-at-a-distance” (ibid.: 1298). Willer allows for network exchange systems that can centralize power such that resources flow from distant actors and intermediaries, potentially giving one or more actors power centralization, defined in terms of power concentration and closeness centrality (ibid.: 1323). Using the experimental framework of Network Exchange Theory,Willer (ibid.) finds support for the predicted effects of power centralization and the ability for central actors to exercise power over indirectly connected actors. Unlike similar studies which limit payoff information to one’s own direct relations, in this study actors have access to information on the payoffs not only to self but also between others in the network. In an empirical extension of the Network Exchange framework, Thye, Willer, and Markovsky (2006) link status and power in negotiated exchange systems by integrating Network Exchange Theory with status characteristics theory. Status characteristics theory argues that in collectively oriented groups, culturally valued status characteristics (that is, gender, age) can generate expectations about performance. Thus, those with the highly valued state of a given characteristic are granted higher status and prestige relative to those with a less valued state of the characteristic (Berger, Cohen, and Zelditch 1972).Thye, Willer, and Markovsky (2006) examine the effect of status ascriptions on power through the theoretical models of status value (value derived from possessing a characteristic) and status influence (ability to change one’s beliefs such that it affects one’s behavior). The researchers show that high status individuals earn more points and have higher perceived competence and influence than lower status individuals in the same network location. As the authors note, status characteristics theory is limited “to the circumstances under which individuals initially select exchange partners and sample information” (ibid. 2006: 1487), while structural and relational theories such as Network Exchange Theory encompass the behaviors that occur within exchange. In general, linking theories to better understand the antecedents and consequences of power, exchange, and status deserves continued attention. In sum, Network Exchange Theory has led to a number of theoretical and empirical developments since the 1980s. During its nascent period, much of the early work led to lively discussion of social exchange networks, methods, and processes (for example, Markovsky, Willer, and Patton 1988; Willer, Markovsky, and Patton 1989;Yamagishi and Cook 1990). With more than three decades of research based on NET, power-dependence, and other frameworks, it is evident

200 Karen S. Cook and Coye Cheshire that the cumulative result is a varied yet empirically grounded body of work that unites on the importance of structural determinants of social network outcomes. probability and game-theoretic approaches to power in exchange networks In contrast to the equi-dependence algorithm based on power-dependence reasoning and network exchange theories of power, two very different approaches to power come from applying principles of game theory and probability to social exchange networks. Friedkin’s expected value theory (1992) builds on underlying assumptions about the probability of interactions in the various theories of social exchange. Friedkin (1995: 213) notes that the fundamental notion of power “as a relation that defines opportunities for interpersonal events, such as exchange transactions . . . or interpersonal influences” was already present in the early theoretical formulations of power (that is, French 1956; Emerson 1962). Friedkin (1992, 1993) argues that the outcomes from a given structure can be viewed in terms of the expected value of the possible exchanges weighted by their actual likelihood of occurrence. As with earlier approaches to power, the expected-value model predominantly focuses on dependencies between actors in a given network structure. Formally, the dependency between any two actors i and j is defined in terms of a joint probability that “i is excluded from an exchange and i does not exchange with j” (Skvoretz and Willer 1993: 816). Thus the relative dependence of one actor on another in a system determines the magnitude of offers. This principle is extended to all possible relations, which ultimately predicts total earnings. The expected-value model receives the most empirical support when the actor’s dependencies are created from observed relative frequencies (Skvoretz and Willer 1993). A subsequent extension of the expected-value model explains how social exchange outcomes shape emergent social structures, while simultaneously addressing some prediction anomalies in the original formulation of expected-value theory (Friedkin 1995).18 Bienenstock and Bonacich (1992, 1993, 1997) developed a theory for analyzing network exchange in terms of N-person cooperative game theory with transferable utility. Bienenstock and Bonacich (1993) demonstrated that a pure rational-choice game theoretic model accurately predicts the frequency of interaction and the distribution of valued outcomes in certain exchange networks based on the likelihood of coalition formation. In their formulation, the distribution of valued outcomes is the only real consequence of power. Thus they argue that power becomes an “unnecessary” intervening variable when analyzing network exchange structures (ibid.: 118). Despite their reservations about power as a variable in exchange networks, Bienenstock and Bonacich’s solution predicts relative power differences using the core, or a set of all outcomes such that “no group of players will accept an outcome if by forming a coalition they can do better” (1992: 125). Forming a coalition equates with engaging in exchange in this model. In game-theoretic terms, the core is the set of all outcomes that have individual rationality (individuals will not accept less in a coalition than could be earned alone), coalition rationality (a set of individuals will not accept less than what

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could be earned in a coalition), and group rationality (all actors combined will maximize their overall reward). Many network structures have a core, which leads to a stable exchange environment. However, if there is no solution that an individual (or set of individuals) can improve on, then a core may not exist and the network is strategically undetermined. Such networks are unstable because no single position or set of positions can consistently exercise power over others (Bienenstock and Bonacich 1993).19 One alternative theoretical approach referred to as general equilibrium analysis (a fundamental tool of microeconomics) was adapted in various ways for application to exchange networks by a number of researchers (for example, Marsden 1983; Whitmeyer 1994, 1997b; Yamaguchi 1996), following early discussion of the subject (Blau 1964; Heath 1976; Cook and Emerson 1978). Unlike game theory, which applies to situations involving few actors who can act strategically, assumptions of general equilibrium analysis are appropriate for market situations, involving many actors, all of whom have competitors (Whitmeyer 1997a). For analyzing exchange networks, it has the merit of yielding a single power distribution, which lies within the range of power distributions identified by game theory.20

Other Forms of Social Exchange moving beyond reward power and negotiated exchange Extending the work of Emerson, Molm and her collaborators (Molm 1990, 1994a, 1994b, 1997; Molm, Peterson, and Takahashi 1999) investigated reward-based versus punishment-based power and affective outcomes such as commitment and trust in different types of exchange. In her early work, Molm (1990, 1994b) examined reciprocal exchange rather than negotiated exchange, the focus of most of the research on exchange and exchange networks by other scholars at that time. In reciprocal exchange, actors do not bargain or negotiate the exchange of resources but participate in reciprocal (and contingent) acts of giving and receiving resources of value. The failure of reciprocity in this context results in infrequent exchange or termination of the relationship. Much of Molm’s research focuses on the distinction between negotiated and reciprocal direct exchanges. The primary distinction between these two forms of exchange is the nature of the interaction involved as noted above. Both are instances of mutual dependence. In negotiated exchange two parties typically bargain over the terms of trade through a process of offers and counteroffers before reaching a mutual agreement (if they do). In reciprocal exchange there is no negotiation, only the contingent exchange of beneficial actions (or resources of value) over time. For Molm, and for Blau, this type of exchange was central to social exchange. Examples include neighbors or friends doing favors for one another or even engaging in reciprocal acts of kindness (for example, mowing each other’s lawns, inviting each other over for dinner on separate occasions, or exchanging baby-sitting).21 Such exchange systems are also common in underground and informal economies in which individuals engage in valued activities for one another in place of purchasing such services in the market. An exchange relationship develops as actors calibrate their acts of giving and receiving to maintain the relationship. Actors run the risk in

202 Karen S. Cook and Coye Cheshire such exchanges of not receiving in return. Obligations emerge over time as parties to the developing exchange relation evaluate their benefits and costs and determine the value of the continuation or termination of the relationship. Molm investigated coercion or punishment power in addition to reward power, noting that power is not based only on the legitimate use of authority (that is, authorized reward power). Her work is in direct contrast to the view that power is the use of one’s structural advantage in a network of exchange relations to exclude other actors from exchange to drive up profits. Molm analyzes the use of sanctions or the imposition of negative outcomes on others as a form of exchange power (arguing that actors have control over both rewards and sanctions in the typical exchange relation).22 The threat or practice of exclusion is most effective in networks in which there is a large power difference between the actors. In addition, actors who are most dependent (least powerful) are most likely to be excluded from exchange in certain networks (for example, networks in which there is a monopoly structure). Molm’s work demonstrates that not all power use is structurally motivated (Molm 1990, 1994a, 1997). Punishment power is not used unwittingly in the same way in which exclusion can produce the unconscious use of reward power in negotiated exchange contexts (Molm 1990). Power use can also have strategic motivations. Punishment power may be used much less frequently, but when it is used it is most likely to be employed purposively to influence the future actions of an exchange partner (Molm ibid., 1994a). The less frequent use of punishment power results from the risk that the target of punishment will simply withdraw from the relationship. Molm’s research demonstrates how coercive power is also constrained by structures of dependence. The primary force in exchange relations is the dependence on rewards, which motivates both the use of punishment as well as reward power (Molm 1990). Since those involved in ongoing exchange relations frequently control both rewards and punishments, Molm’s research facilitates the investigation of more complex exchange situations. In addition, Molm specifies the nature of the precise mechanisms that relate structural determinants of power with the actual use of power by those in positions of power. Norms of fairness or justice and attitudes toward risk play a central role in this analysis. Conceptions of fairness constrain the use of power under some conditions, especially the use of coercive power, and risk aversion makes some actors unwilling to use the structural power at their disposal for fear of loss (see also Kahneman and Tversky 2000). Molm, Takahashi, and Peterson (2003) and Molm (2003a) analyze the relationship between different forms of social exchange (for example, negotiated versus reciprocal exchange) as a key factor in predicting exchange outcomes. The relative importance of fairness, risk aversion, and the strategic use of power varies depending on whether the exchange is negotiated directly between the parties involved or is reciprocal, non-negotiated exchange. Molm’s (Molm, Peterson, and Takahashi 1999, 2001; Molm et al. 2000, 2003b, 2004, 2006, 2007) recent work focuses on explaining these differences in the outcomes of exchange based on the nature of the differences in these forms of exchange, rather than on the structure of the network in which the exchange relations are embedded.23 In addition, she focuses on the integrative (for

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example, commitment, positive affect and trust) rather than the differentiating outcomes (for example, conflict and inequality). She analyzes three general forms of exchange: negotiated and reciprocal direct exchange relations, and indirect exchange referred to as generalized exchange. The study of integrative outcomes of exchange became the focus of the work of both Molm and Lawler and their collaborators, following Blau’s insight that exchanges involve acts that integrate the actors engaged in exchange as well as differentiate them, though the balance of these forces is determined in part by the form of the exchange, as Molm’s work has clearly demonstrated empirically. In particular, the differentiating outcomes are central in negotiated exchange, and under certain conditions integrative outcomes are more salient in reciprocal and generalized exchange. Integrative outcomes include those that reflect the emergence of bonds of attachment: trust, commitment, affect, and cohesion or solidarity. For Lawler the focus is the relationship itself rather than the individual actors engaged in exchange as he attempts to explain the development of group attachment (see below). Molm’s theoretical work specifies the key dimensions along which the basic forms of exchange differ, which she argues account for the differential effects of the form of exchange on both differentiating and integrative outcomes. These dimensions of variation include nature of the risk involved in the exchange, the salience of the potential for conflict, and the significance of the “voluntary” acts of reciprocity, which can occur in reciprocal exchange but not negotiated exchange. Findings to date suggest that many integrative outcomes are more positive in reciprocal exchange, stronger positive affect and perceived fairness, commitment and trust, as well as lower levels of perceived conflict. In part the risk involved allows actors to demonstrate their trustworthiness in reciprocal exchange, but not in negotiated exchange, in which agreements are typically binding (Rice 2002; Molm 2003b). More recent findings (Molm, Collett, and Schaefer 2007; Molm, Schaefer, and Collett 2007) extending this work to include generalized exchange that involves indirect reciprocity (not direct reciprocity as in reciprocal exchange) indicate that even stronger positive regard, affect, trust, and solidarity emerge in this type of exchange setting, reflecting some of the early anthropologists’ claims (for example, Mauss 1954; Malinowski 1922) about generalized exchange systems. Molm (2003b; Molm, Collett, and Schaefer 2007) demonstrates that two features of reciprocal exchange—the indirect form of the reciprocity it entails and the unilateral as opposed to the bilateral flow of resources—are key to explaining the different effects of these forms of exchange on integrative outcomes.When established, reciprocal exchange leads to greater positive affect, higher levels of trust and solidarity, than negotiated exchange that involves direct reciprocity and the bilateral flow of resources typically not inducing much trust. The main reasons behind these findings are developed in her updated theory of reciprocity (Molm 2010). They include the increased risk of the failure of reciprocity in reciprocal (rather than negotiated) exchange, the increased expressive value of reciprocating, and the decreased salience of the conflictual aspects of exchange, which are much stronger in negotiated exchange, as noted above. Lawler’s line of research on solidarity and integrative

204 Karen S. Cook and Coye Cheshire outcomes of exchange is similar, but he proposes a different set of theoretical explanations for their emergence in different types of exchange. relational cohesion and solidarity more on integrative outcomes Lawler and his collaborators (for example, Lawler and Yoon 1993) developed a theory of relational cohesion and subsequently relational exchange. This formulation is an extension of some of the principles derived from Emerson’s initial theory of social exchange (1972a,b). This research examines the conditions under which social exchange relationships emerge out of opportunities for exchange and lead to the emergence of positive emotions about the exchange relation itself. Such positive emotions subsequently lead to relational cohesion, commitment, and solidarity. They develop in response to positive evaluations of exchange outcomes and the frequency of exchange. Low frequency and unfavorable (or less favorable) outcomes are less likely to lead to commitment, positive feelings about the exchange, and bonds of cohesiveness or solidarity (that is, what Lawler summarized in the phrase “wefeeling”). This line of research, along with Molm’s work and related work on trust (Cook, Hardin, and Levi 2005; Cook 2005), addresses the nature of the links between exchange and solidarity. It also expands the scope of exchange theory to include the emotional bases of exchange, commitment, and cohesion, undertheorized in Emerson’s work and in the research that followed on power in exchange networks, including NET (Network Exchange Theory). Lawler and Yoon (1998) conducted experiments on equal and unequal power relations in different network structures to test their theory of relational cohesion. Their results generally supported their theoretical predictions. When networks create equal power relations and actors repeatedly engage in positive exchanges, relatively cohesive partnerships develop. Relational cohesion is high partly as a result of successful exchange and the associated positive feelings. Frequent exchanges in unequal power relations, however, do not have this effect, as predicted. In unequal power relations, low-power and high-power actors have quite different emotional responses to successful exchange. High-power actors are more satisfied and positively oriented to continued exchange than are low-power actors who expressed less satisfaction with successful exchange and perceived less cohesion. Group identity reduced the differentiation of exchange frequencies in unequal power networks by evoking egalitarian norms. Making salient an overarching group identity reduced powerful actors’ efforts to exploit their structural advantage. New work on generalized exchange by both Lawler and Molm also explores not only the underlying collective action issues but also solidarity and trust.24 inequality, generalized exchange, and social solidarity Different types of exchange systems yield different levels of inequality and different degrees of solidarity, as Molm’s work has demonstrated. Differences in inequality and solidarity exist between different forms of direct exchange (for example, reciprocal and negotiated), but also between the broader forms of direct and indirect exchange. When individuals exchange valued resources indirectly and without explicit agreement, it can create generalized exchanges, or

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systems in which the rewards that an individual receives from others do not depend on the resources provided by that individual (Ekeh 1974; Emerson 1976;Yamagishi and Cook 1993). Under typical rules of generalized exchange, reciprocity is not mutual; it is “univocal” or one-directional. Anthropologists first observed and described systems of sustained generalized exchange in the Kula ring among the Trobriand Islanders of Papua New Guinea (Mauss 1954; Malinowski 1922). The Kula ring was a stable exchange of decorative items with no real monetary value in the local economies, but substantial symbolic value among the members of the society. Mauss (1954) described this and other similar systems as gift economies to contrast them with more common systems of bartering and negotiation. In his polemical discussion of social exchange, Peter Ekeh (1974) describes several different types of generalized exchange.Although there are many different varieties and subcategories of indirect exchange in Ekeh’s original formulation, Yamagishi and Cook (1993) label the two major classes as network-generalized and group-generalized exchange. Chains or cyclic patterns of exchange, such as A→B→C→A, characterize the former. In addition to the aforementioned Kula ring in Papua New Guinea (Malinowski 1922), Bearman’s observation (1997) of aboriginal tribes that exchange women between families also constitutes a form of network-generalized exchange. Unlike network-generalized systems, group-generalized exchanges do not typically involve any connections between individual actors. Instead, actors contribute to a collective pool, and valued resources are redistributed from this pool. Examples include citizens working together to build a community bridge, or housemates sharing cleaning responsibilities to maintain a communal kitchen (Yamagishi and Cook 1993). Other contemporary examples of groupgeneralized exchange include peer-to-peer file-sharing networks and other forms of information pooling and redistribution on the Internet (Cheshire 2007; Cheshire and Antin 2009). Generalized exchange, like coalition formation, presents a standard collective action problem. Individuals do better by not giving to others, but if all refuse to give, they all do worse since there is no gain for anyone in the network. Thus the typical structure of a generalized exchange system entails the classic incentives of a social dilemma (see Yamagishi 1995). Since a generalized exchange system requires a minimum of three actors, coordination problems are also likely, especially as the size of the network increases. Actors are not trading within dyads, so they must rely on the goodwill of a third party, over whom they have no direct control. The unilateral gift giving makes systems of generalized exchange vulnerable to free riders. Without guarantees of reciprocity or mutually contingent exchanges, actors can shirk reaping rewards by receiving and refusing to reward others to which they are connected. Giving and receiving resources in a unilateral fashion opens the door to exploitation by others (Bearman 1997; Takahashi 2000). Given the temptation to free ride in generalized exchange systems, it may seem surprising that such systems often emerge and persist. However, the social dilemmas inherent in generalized exchange are partially mitigated by group cohesion, solidarity, and normative constraints on behavior. For example, in the Kula ring (Malinowski 1922), tribes living on different islands in Papua New Guinea traded bracelets

206 Karen S. Cook and Coye Cheshire and necklaces in overlapping, counterdirectional cyclic chains. There was no economic value attached to the bracelets and necklaces, and no one enforced the trading practice. Yet the groups involved in the Kula exchange knew that they were part of a larger system that connected the various islands. Mauss (1954) took some issue with Malinowski’s original interpretation of the Kula ring, noting that the exchange was not so much about individual gifts between individual groups or actors, but was instead a series of exchanges that could not be separated from one another; it must be viewed as a whole (compare Ekeh 1974). In other words, to truly understand generalized exchange systems such as the Kula ring, we must look at the larger network (system) level, not just the dyadic level. Importantly, the individuals in a generalized exchange system may not actually perceive a specific fixed, network-generalized structure. Individuals might help one another (such as in the case of the stranded motorist), essentially choosing when or if to give resources to a recipient. Takahashi and Yamagishi (1996) and Takahashi (2000) refer to this as a pure-generalized exchange system. When viewed as a system rather than a series of isolated dyads, aggregate effects become apparent. Such effects include the reinforcement and transmission of norms of fairness or the development of social solidarity. Takahashi (ibid.) demonstrates that generalized exchange can emerge in a simulation environment, so long as individuals employ a fairness-based selectivegiving strategy. That is, he assumes that individuals will give more often to individuals that have higher ratios of giving over receiving. His solution, like many solutions to the problem of the evolution of cooperation in systems of repeated prisoner’s dilemmas, relies on the existence of network structures that provide some sort of localized information and accountability (for example, Axelrod 1984; Macy and Skvoretz 1998). In such a structure, norms regarding contribution can emerge and persist through reputation systems as well as informal monitoring and sanctioning. The power of Takahashi’s analysis (2000) is that it demonstrates how a normative base can create a system of generalized exchange within a community.25 For Blau, generalized exchange is supported at the group level by a social norm of reciprocity—since “doing favors for others is socially expected.” This is in effect a group norm, and the behavior, he argues, can more simply be explained as conformity to this norm: “Conformity with this norm is the reason all group members receive favors in the long run and solidarity is strengthened” (1994: 156). But there is no explanation of the emergence of the norm of reciprocity, which is key to Blau’s explanation of the emergence of generalized exchange systems. Subsequent work on social dilemmas made it clear that these norms that require monitoring and sanctioning represent what has been called the “second-order” social dilemma (and a collective action problem of the same type as the first-order social dilemma). That is, individuals can free ride on others to monitor and sanction the failure to conform to such norms (see Yamagishi 1995). For Durkheim, the “organic” solidarity built through exchange among equals is compromised when inequality exists. Levi-Strauss (1969) similarly viewed inequality as a barrier to building greater social solidarity through generalized exchange among equals. However, Bearman (1997) argues that generalized exchange tends to block tendencies toward subgroup cleavages

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and thus is more stable, and generates greater communal solidarity. This is in contrast to restricted dyadic exchanges (Ekeh 1974;Yamagishi and Cook 1983), in which exploitation within dyads can occur, potentially weakening groups by allowing inequalities to emerge between pairs of exchange partners. In addition, he argues, dyads may isolate themselves from the group, creating their own exchange system. This type of subgroup cleavage has negative consequences for solidarity at the group or communal level. Dyadic isolation is not likely in generalized exchange systems because connections are composed of indirect, univocal reciprocity rather than direct reciprocity. Bearman’s analysis of the kinship data from Groote Eylandt identifies a clear case in which a generalized exchange system emerged to regulate the transfer of women as wives. “This system ensures solidarity by binding all members into a chain of univocal prestations, embedding each block in a network of debt and obligation” (1997: 1406). Bearman (ibid.: 1413) makes an interesting argument (similar to the arguments of Ekeh 1974) concerning the different solidarity implications of distinct forms of social exchange. “All exchange systems yield solidarity as their by-product, as they embed actors in chains of mutual obligation and debt. But different systems provide different levels of solidarity. In direct dyadic exchange, exploitation can occur[,]” increasing the inequality within and potentially between pairs. “Skilled actors build on ambiguity over valuation in exchange and thereby profit from within the exchange relation. Those exploited by reciprocity norms may appeal to the group for redress, but other actors may be indifferent to exchange outcomes among other pairs and therefore fail to sanction the exploiter.” And only embedded dyadic exchange relations could be affected by monitoring and sanctioning. Thus Bearman goes on to argue: “The inherent tendency in restricted exchange systems is toward increased inequality and differentiation between and within exchange pairs.” This insight is supported by the early experimental work on power and inequality in negotiated exchange networks. Furthermore, he emphasizes the point that “the structure of a society bound together by dyadic exchange is at risk of subgroup cleavages.” This work supports Ekeh’s original argument (1974) that restricted dyadic exchange was more brittle and less likely to lead to the type of organic solidarity and integrative bonds now argued to be a by-product of reciprocal exchange (and relations involving indirect reciprocity as is characteristic of generalized exchanges). Generalized exchange may produce a more secure form of solidarity than other forms of exchange. According to Bearman (1997: 1413),“Equals exchange, and only a violation of reciprocity norms allows exchangers to obtain more value.” Such violations may affect all parties equally, thus normative responses are likely to restrict exploitation. Restricted exchange systems change because of endogenous pressures, while generalized exchange systems are more stable and more likely to be changed by exogenous shocks.This is Bearman’s argument for the observed stability of generalized exchange systems—in particular, the system of cyclical exchange in marriage across blocks defined by kin relations. The structure of marriage across blocks is not one of dyadic, direct reciprocal exchange. Rather it is a systematic cycle from one block to another in a circle of generalized exchange—the origin is as sisters in one block or subgroup to their destination as wives in another subgroup or block.

208 Karen S. Cook and Coye Cheshire Beyond the early anthropological work and Bearman’s research, there have been few applications of generalized exchange conceptions outside the laboratory (see current work of Lawler, Thye, and Yoon 2008; Molm et al. 2007). In one such effort, Cook and Donnelly (1996) applied the concept of generalized exchange to intergenerational relations. Relations between generations can be examined as implicit exchange relations in which each generation must determine how to allocate its resources to the next generation and on what basis. Reciprocity, trust, dependence, power, fairness, and asymmetry in exchange benefits all play a significant role in these determinations. These dynamics are important within families and relate to long-term care, childcare, elder abuse, health care, and the transfer of wealth. Many of these issues also arise at the aggregate level for the society at large in terms of the nature of the relations between the generations with implications for property law, taxation, welfare policy, social and health services, and education. Finally, another important area where ongoing generalized exchange exists outside of the laboratory is on the Internet. Many different websites and services allow individuals to engage in generalized exchange of goods and services. For example, on websites such as NetCycler.com and Freecycle.org, individuals give their unwanted or superfluous items to others who have a matching need. In systems such as Freecycle.org, direct negotiation or payment is explicitly discouraged in order to sustain the gift economy. Researchers have begun to examine group identity, cohesion, and solidarity among individuals who use these generalized exchange systems (Willer, Flynn, and Zak 2010; Suhonen et al. 2010). Consistent with earlier anthropological and sociological work on generalized exchange, this line of work shows that online generalized exchange systems can foster solidarity and community among participants over time. However, online social interactions without negotiation, agreements, or sanctions also create high levels of uncertainty that can be difficult to overcome for potential exchange participants (Suhonen et al. 2010). These topics and others require further investigation.

Future Directions Throughout this chapter, we have detailed many theoretical avenues in the sociological study of social exchange. This body of work has laid a stable foundation on which researchers may further build theoretical and empirical work in this tradition. In this section we propose new directions for research based on common themes in existing research, especially on topics that have not been fully explored. As we have shown, previous work in direct-exchange systems (for example, reciprocal and negotiated exchange) has extensively explored the determinants of power and power use in exchange networks. However, little research has explored the role of power in generalized exchange systems. The lack of work in this area is likely because there are few if any alternative sources of resources or exchange partners in both network and group-generalized exchange systems. Often those who analyze these systems simply assume equality of the actors involved. Power in direct-exchange social networks is often accomplished with ties that grant access to additional resources or to alternative exchange opportunities, so generalized exchange

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systems create new and interesting problems for the study of power relationships in indirect-exchange systems. Even when alternatives are available, such as in the pure-generalized exchange systems studied by Takahashi and Yamagishi (1996) and Takahashi (2000), the unilateral nature of exchange may hamper the development of relational power differences. Although relational power within generalized exchanges may initially seem difficult to formulate, the aggregate effects of generalized exchange systems may significantly connect to larger power dynamics within a given community. As Willer and Skvoretz point out, “[C]ollective action countervails power” (1997: 19). Since group-generalized exchange systems are synonymous with collective action efforts, it is reasonable to imagine group-generalized exchange networks acting as power-balancing exchange structures within a larger system of social exchange. For example, weak-power individuals who are able to work together within group-generalized exchange systems can pool resources to counterbalance alternative resource-rich actors. This collective action through group-generalized exchange is like the use of coalition formation to limit the use of power by others (that is, it is a power-balancing mechanism at the network or group level). This example of generalized exchange networks embedded in a broader system of exchange hints at some of the larger implications of overlapping exchange structures within a social system. While the focus of much empirical and theoretical work in social exchange and power has dealt with the separate forms of exchange, one of the key directions for future research is the study of multiplex relations, or overlapping forms of exchange among the same set(s) of actors. In the real world, social relations frequently involve different intersecting modes of exchange. The same group of actors might exchange different goods and services within positively connected, negatively connected, or mixed types of exchange networks. Furthermore, distinct sets of actors may participate in different systems of exchange, leading to power structures that apply in one domain yet not in another. Social exchange theory is moving increasingly close to analyzing the complexity of real-world dynamics, such as when an exchange relationship in one system affects other actors in distant (and seemingly unrelated) exchange networks. Future research needs to articulate the mechanisms behind these effects (for example, extending work on weak or bridging ties, brokerage, reputations, and so forth). Another crucial direction for research on social exchange processes and power dynamics is the use of real-world data. Experimental research is advancing toward analyses of complex exchange systems that approximate real-life social networks, and the future is profoundly contingent on access to data that can bridge the gap between rigid experimental control and ecological validity. One of the most promising new directions for maximizing both concerns is the study of computer-mediated interactions such as those that emerge on the Internet.This includes empirical research on digital information exchange (see, for example, Cheshire 2007; Cheshire and Antin 2009; Shah and Levine 2003) and gift economies of goods, services, and favors managed through websites and online services (for example, Suhonen et al. 2010; Willer, Flynn, and Zak 2010). A second direction is the investigation of pure economic exchange on the

210 Karen S. Cook and Coye Cheshire Internet. For example, nonbinding and binding negotiated exchange systems such as online auctions continue to be significant topics of investigation for both sociologists and economists. In particular, one of the central focal areas in direct-exchange via the Internet involves emergent reputation systems in online auction systems (for example, Kollock 1999; Houser and Wooders 2006; Yamagishi et al. 2009; Resnick et al. 2000). Reputation systems are critical to the perceived legitimacy of computer-mediated forms of social and economic exchange (Cook et al. 2009). Real-world systems of social exchange are often complex and dynamic, taking different forms and structures over time. Furthermore, individuals frequently join and leave systems of exchange, thereby changing the composition of nodes in a relational network. For example, many relationships start out as formal, contractual arrangements. As the individuals, parties, or organizations learn more about one another and build a history of interactions, they may shift into less formal exchange relationships. The converse is also possible, such as relationships that begin with informal or loose reciprocity (that is, small favors such as alternating rides to the airport). Eventually the experiences from the previous exchanges may carry over or evolve to include more formal, direct negotiations over new types of goods or services. While real-world systems provide an abundance of examples of transitions between forms of social exchange, current theoretical and empirical research is only beginning to tackle such complex social exchange arrangements. We believe that a primary direction for the future of social exchange theory involves the specification of the determinants of power and other relational outcomes within intersecting and multifaceted exchange systems that transition between forms over time. If a system of exchange shifts from one mode to another, this change should have attitudinal and behavioral consequences for the actors involved (Cheshire, Gerbasi, and Cook 2010). As current experimental work shows, a shift between two structural arrangements (for example, reciprocal exchange and negotiated exchange) may influence the attributions actors make about one another (Cook, Gerbasi, and Cheshire 2006). Thus shifts in modes of exchange and other temporal transitions may lead to changes in perceived fairness, trustworthiness, and locus of control, levels of commitment, cohesion, and solidarity. Alterations in the mode of exchange may also have consequences for rates of successfully completed exchanges (for example, cooperation) at the group or network level. As we have previously argued, one of the key differences between the social exchange perspective and related microeconomic theories is that the latter deals with efficiency while the former focuses on the emergence and maintenance of structures through processes such as power. In focusing on the structural determinants of power and the effects of power use, social exchange theory and research openly attempt to bridge microlevel interactions with increasingly larger social structures (for example, groups, networks, organizations, institutions). This is not to say that larger macro structures are simply reduced to constituent exchange structures; rather, the social exchange perspective shows how exchange processes link to observed social structures (Cook 1991) and how they emerge. A vital future direction for social exchange theory and the study of power

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is to confront directly the micro-macro link by integrating interpersonal exchange processes with larger network dynamics. This task continues to elude sociologists, yet there is much agreement about the potential of social exchange theory to meet this challenge (see Lind 1986; Stolte 1988; Singelmann 1972; Cook 1991). Exchange processes exist through social interactions, yet other pre-existing macro structures clearly influence and constrain them. One of the key features of the social exchange perspective is the focus on the relational tie between actors rather than on the actors themselves. Thus the same exchange processes that help explain interpersonal power dynamics can be applied to interorganizational systems (Cook 1977). The challenge is connecting the different levels of analysis through the same theoretical tools and procedures, with a focus on shared processes rather than instrumental reductionism.

Notes 1. Homans (1961, 1974), on the other hand, includes almost no reference to the concept, power, in his book on elementary forms of social behavior in which he introduces his conception of social interaction as exchange (see also Cook and Gerbasi 2004). 2. Blau (1964: 328) argues: “Exchange processes, therefore, lead to the emergence of bonds of intrinsic attraction and social integration, on the one hand, and of unilateral services and social differentiation, on the other.” 3. Blau (1964: 333) extrapolated this argument to the group level, stating: “Transactions among organized collectivities, then, may give rise to social ties that unite them, just as social exchange among individuals tends to produce integrative bonds. These transactions also differentiate competing organizations and may result in the elimination or absorption of competitors and the dominance of one or a few organizations . . . just as unilateral transactions and competition among individuals generate hierarchical differentiation and may result in the dominance of one or a few leaders in a group.” 4. Blau comments on this competition stating: “Those successful in the earlier stages of competition tend to compete later for dominant positions and, in communities, for movement into higher social classes, while the unsuccessful ones cannot compete with them for dominance but become their exchange partners, who receive instrumental benefits in exchange for subordination and status support.” 5. Willer also classifies exchange as distinct from relations of conflict and competition. 6. In Emerson’s original words, the dependence of B on A in turn is a positive function of the “motivational investment” of B in “goals mediated by” A and a negative function of the “availability of those goals” to B outside the A-B relation Emerson (1962: 32). 7. An extreme form of devaluation of the resources provided by actor A to B or of the goals important to B mediated by A is complete withdrawal from the relationship— which came to be known as the “exit” option. 8. In Network Exchange Theory (see Willer 1999), a null connection is said to exist in networks for completeness. In Emerson’s theory if there is no connection between two exchange relations they are not linked in a network sense, though clearly the absence of a connection may have implications for network power. 9. An example is the situation in which A and C are alternative dating partners for B. 10. In addition to the empirical results, computer simulation results for four

212 Karen S. Cook and Coye Cheshire networks: the Line 5, and networks with seven, ten, and thirteen actors were also presented to extend the theory. An early algorithm for determining the distribution of power in a negatively connected exchange network directly from the network structure was also developed by Cook et al. (1983). This algorithm was grounded loosely in power-dependence theory, but its application involved only analysis of the network structure and did not use power-dependence theory or models of actor behavior explicitly, as did subsequent models. 11. The experiments reported in the 1978 and 1983 articles were designed to test theory. Thus many features of these experiments are not theoretically crucial. They are operationalizations of theoretical concepts in a laboratory setting. Exchange was operationalized as coming to agreement over the terms of the trade of resources (or profit points), and negative connection was operationalized by allowing each actor only one exchange per round. (Allowing more than one exchange would have resulted in a positive connection in Emerson’s terminology, giving actors the chance to exchange with each of their alternatives, thus eliminating any competition or reason for exclusion.) While some of these aspects of experimental design are not common in natural situations (for example, one exchange per round), they do instantiate the theoretical concepts in ways easy to control and measure and therefore permit clear tests of theory. Thus tested and supported, the theory can then be applied to more complicated naturally occurring situations involving exchange and exchange networks, the focus of much of the subsequent research. 12. In this work Emerson was clearly influenced by Heider’s “balance” theory, though in his case the strains were not cognitive (though they could be in the case of an individual in a power-imbalanced relationship), but they were defined as structural, the result of structural pressures for change. 13. A much larger literature on coalitions based in part on game theory also demonstrates this fact. 14. As Scott (1992: 193) puts it: “Unequal exchange relations can generate power and dependency differences among organizations, causing them to enter into exchange relations cautiously and to pursue strategies that will enhance their own bargaining position.” 15. Outside the laboratory exchange theory was applied to the study of interpersonal relationships. For example, in the study of dating couples, partners, and married people various authors have applied exchange concepts to the analysis of the longevity and quality of such relationships despite the argument that an exchange “logic” does not work in close, personal relations. Michaels, Edwards, and Acock (1984), for example, find that exchange outcomes are a more important predictor of relationship satisfaction than are equity concerns. In addition, Sprecher’s research (1988, 2001) indicates that relationship commitment is affected more by the level of rewards available to partners in alternative relations than by fairness or equity considerations. 16. The GPI is also a central component of Network Exchange Theory, which was developed by Willer and his colleagues as an alternative to other social exchange theories (for example, Willer 1987; Willer and Patton 1987). 17. Coalitions between low-power actors can also produce game situations like the Chicken game, in which the outcome of mutual defection is the worst possible outcome, yet the best possible outcome occurs if one defects and the partner cooperates (Simpson and Macy 2001). 18. Skvoretz and Willer (1993) found that the expected-value model couldn’t account for the observed advantage of the central position in the Kite network structure. Friedkin’s extension of expected-value theory (1995: 214) resolves this problem by considering the probability of an exchange at time t based on the value of an exchange at time t -1.

Social Exchange, Power, and Inequality in Networks 213 19. Bienenstock and Bonacich’s core solution demonstrates how game theory can successfully predict exchange frequency and resource allocation in negatively connected social exchange networks. While the other major sociological and social psychological theories of power are all based on some rational behavior assumptions (that is, individuals maximize gains over losses), core theory is a pure rational-choice model with no additional explanatory factors. As a consequence of this restricted approach, core theory cannot always make specific point predictions for all positions in some networks. As Skvoretz and Willer note, “Because no specific social psychological principle is assumed, rationality considerations alone cannot always single out a particular outcome” (1993: 804). Despite this limitation, the predictions and experimental results of core theory are consistent with other major sociological theories of power (Bienenstock and Bonacich 1993, 1997; Skvoretz and Willer 1993). 20. For application of general equilibrium analysis to the analysis of power in positively and negatively connected networks, see Yamaguchi (1996). Through estimation of a parameter s which changes sign when the connection changes sign, the model can approximate results from experimental networks, both positive and negative. 21. As Molm (1994b) notes, the distinction between negotiated and reciprocal exchange parallels game theorists’ distinction between cooperative and noncooperative games. “In cooperative games and negotiated exchanges, strictly binding agreements are made jointly by players who can communicate; in noncooperative games and reciprocal exchanges, actors make choices independently, without knowledge of others’ choices” (Heckathorn 1985). 22. For Willer, coercion is treated as distinct from exchange. 23. Molm typically controls for network size and number of alternatives to determine the independent effects of type of exchange. 24. Molm’s focus on reciprocal exchange has been a major impetus for this extension of exchange theory, building on the work of Blau (1964), Ekeh (1974), Emerson (1972a,b), and others. 25. As Takahashi (2000) points out, his simulation analysis is restricted to puregeneralized exchange systems where individuals choose their recipients.

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chapter

Social Capital

6

henk flap and beate völker

Social Networks and Network Studies People’s relationships show patterns, so-called social networks. These social networks affect people’s lives considerably. For example, in all Western industrialized countries between one- and two-thirds of the working population found their jobs through informal social ties (Marsden and Gorman 2001). People’s chances of illness and recovery, and even of dying, partly depend on their networks (House, Landis, and Umberson 1988). In this chapter we present a research program on social networks, that of social capital. The emergence of social networks and their consequences for individual behavior and well-being are central in this program. Before embarking on this we will describe the state of the art in network studies.

State of the Art A review of the social-scientific literature teaches that social networks studies have gained great momentum since the 1960s. There are more than ten thousand articles on social networks, and a number of handbooks (for example, Wasserman and Faust 1994), edited volumes (for example, Lin and Erickson 2008). and reviews (such as Portes 1998) have been published; network ideas are applied in many different fields in the social sciences (compare Rivera, Soderstrom, and Uzzi 2010). Thus, on the one hand social network research is flourishing. But on the other hand social network research requires general theories that answer questions on the (a) emergence of social networks and their effects, and on the (b) integration of different and diverse results. In addition, one wants to know (c) whether network effects can be generalized across situations. If this is not the case—since most regularities know exceptions—it becomes important to understand (d) why certain network effects sometimes occur and sometimes not. Answering these questions is a necessity for the progress of network research.

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structuralism An important development that might integrate network studies theoretically is the elaboration of the structuralist view, an expression coined by Mullins (1973). This structuralist stance claims that structure overrides preferences. Social networks are so restrictive that, to explain people’s actions, you need to know only the structure of the social network these actors are part of: “Give me the network and I will tell you what the actors will do.” The selling point of structuralism is that it attempts beating neoclassical economics on its home turf—that is, the analysis of the economic world. All markets—for example, labor markets (Granovetter 1974), but also markets for illegal services such as abortion (Lee 1969)—are socially organized through networks. Structuralism produced valuable theoretical insights that are partly corroborated empirically, and that will be part of more general theories on social networks. In the 1970s, Harrison White developed the idea of structural equivalence and the technique of block model analysis to detect and analyze positions of actors. His major contribution was that not only the “1s,” representing the choices, but also the “0s,” indicating nonchoices, in a sociomatrix are important. The zeros do tell something about someone’s network. When one looks at Figure 6.1, a sociogram of a playgroup of children, where each arrow represents a choice for playing with a child, and Figure 6.2, a sociomatrix of the same group, one sees that children 1, 3, and 5 are similarly placed in the social network, because they do not want to play with each other, and no one picks them to play with. They have a structurally equivalent position, as they are tied to the same persons (Lorrain and White 1971). So, according to the hard-core argument of structuralism, they will also behave similarly. By rearranging the columns and the rows in the sociomatrix in a way that blocks are created with only zeros, as done in Figure 6.3, one can come to this result far more easily. One also sees that there is another group of children

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222 Henk Flap and Beate Völker 1 3 5 2 4

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who are also similarly placed in the network: the children 2 and 4 want to play only with each other and with no one else, whereas all the others would like to play with them. (Note: There is also the notion of being role equivalent, meaning that persons are tied not to the same persons but to similar persons [see Wasserman and Faust 1994].) Aggregating structurally equivalent actors shows that there are two positions in the network—that is, that of an elite person and that of a hanger-on. So the block model can be reduced to a so-called image matrix, as in Figure 6.4, showing only two positions or roles. The basic intuition of zero-blocks must have inspired Granovetter (1973), as White’s student, to come up with his “strength-of-weak-ties” argument: although news is quickly disseminated through strong ties, strong ties will hardly ever bring news that is new, because friends of friends will be friends such that there will be inbreeding. “No strong tie will be a bridge” to other networks, a bridge through which information might flow that is nonredundant, really new, and possibly relevant to one’s goals. Only a weak tie will be a bridge to other new groups. Burt (1992), starting from the same insight that zeros are indicative of someone’s position, argues the importance of structural holes in one’s network: having ties to others, who do not have ties to each other, gives ego nonredundant information and also a control advantage. the problem: structuralist shortcomings However, there is something wrong with the structuralist argument. According to the empirical results no general assumption on effects of network structures holds. An important example is the above-mentioned strength-of-weak-ties argument. Granovetter assumed that weak ties make for quick dissemination of information on job vacancies. His study Getting a Job (1974/1995) indeed showed that weak ties bring better jobs. However, his research evidence is weak: “colleagues” in the sample are equated with weak ties, and contact frequency is used to measure tie strength. Support for the weak-ties argument has not always been found; sometimes it was even refuted (Lin, Vaughn, and Ensel 1981b; Bridges and Villemez 1986; Grieco 1987; Flap and Boxman 1999). Hence, it is not unconditionally true that informal contacts lead to better jobs. On the contrary, placement via social networks only rarely results in higher prestige jobs, and income is often even negatively affected.

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Another example of a structural hypothesis refuted empirically is the “structural holes” argument. According to Burt (1992), structural holes bring advantages—for example, in occupational life: if weak ties feed back into the group—that is, form no bridge—they bring redundant information. The best assets are strong ties that bridge. They not only bring information advantages but also control advantages, since others to whom one is strongly connected are more prepared to help, and even more so if one’s strong ties remain unconnected (compare Grieco 1987). Note that Burt implicitly uses rational choice arguments. His empirical research on the occupational attainment of managers shows that structural holes work only for established men, but not for women or men who are new in an organization. According to his own explanation newcomers and women lack legitimacy, and therefore need the support of a tight personal network, or preferably the support from a higher placed male mentor (Burt 1992). Upon closer reading it turns out that structuralists often use individualistic assumptions to understand networks.Take “the strength of weak ties” argument: the mechanism producing this structural effect is based on individualistic assumptions. The effect is supposedly the outcome of a tendency toward cognitive balance as described by Heider (1958). Structuralists often supplement their core assumption—that network structure explains people’s behavior— with the idea that people infer what is in their own interest by interpreting and imitating the behavior of people who have a network position similar to their own one. More or less implicitly a social comparison or learning theory is used. For example, in his reanalysis of Coleman, Katz, and Menzel’s classic researchmonograph Medical Innovation (1966), Burt (1987) explains the influence of networks of colleagues on the decision of physicians to adopt a new drug by pointing out that physicians resolve their uncertainty about a risky choice by comparing themselves to other physicians who are located similarly within the social network at large, or who are, with a technical term, structurally equivalent. Another example can be taken from the analysis of product markets by Leifer and White (1988). They argue that producers compete for status and profit, and that they decide on prices for their products not by looking at the demand of buyers but by referring to similarly placed other producers. Burt, White, and Leifer actually use a signaling argument: in case of uncertainty, people use signals to decide about their best interests. the theory-gap in network analysis Structuralists acknowledge these points of criticism. In a—surprisingly widely neglected—small essay on “The Theory Gap in Social Network Analysis,” Granovetter (1979) gave a few examples of well-known network ideas that are refuted. He demonstrates that structural balance theories cannot be upheld, since social reality produces many counterexamples of which he explicates two. Situations of conflicting loyalties—“forbidden” by balance theory—often last for years. Furthermore, he mentions patronage networks, in which a patron has strong ties with his clients while the clients remain unconnected with each other. These open triads are “forbidden” by balance theory. Implicitly he also acknowledged that structural sociologists need individualistic theories for

224 Henk Flap and Beate Völker their explanations. In conclusion, Granovetter (ibid.: 501) gave the following diagnosis of the state of the art in network studies at that time: In my reading of the rapidly expanding literature on “social networks,” one nagging question keeps intruding: where is the theoretical underpinning for all these models and analyses? . . . [M]ost network models are constructed in a theoretical vacuum, each on its own terms, and without reference to a broader or common framework. Despite continuing progress, therefore, the point of diminishing returns is approaching, and will rapidly overtake us, unless we pay more attention to what I call the “theory gap” in network studies.

Thus what has kept social network studies together is not a full-blown theory but the orienting notion that the structure of social networks determines the actions of the network members (Watkins 1957). Why do structuralist “laws” on network effects meet with exceptions? One inroad to this question starts with a constraints-driven rational choice perspective on social networks that conceives of networks as social resources. Some social anthropologists (Kapferer 1972; Boissevain 1974) and sociologists (Fischer 1982; Fischer et al. 1977) took this perspective in the 1970s. Later, the argument has been further developed by sociologists who conceived social networks as social capital.They are rational choice sociologists who, inspired by the achievements of human capital theory, apply a utilitarian, rational choice point of view to social networks. Or they are neo-Marxist and neo-Weberian sociologists who apply an interest-driven account of human action to social networks. All emphasize the productive and investment side to social networks (Bourdieu 1973; Loury 1977; Coleman 1988; Flap 1988; Burt 1992). The remainder of this chapter sketches the research program of the theory of social capital, its core, main questions, and tentative answers. Finally, we provide research evidence showing that the program works and discuss a number of new, theoretically interesting but unresolved questions that have emerged from the program.

The Research Program of a Social Capital Theory the common view One way to solve the problem described above is to go back to the assumptions about human nature. What are the goals people strive for? Most efficient is to assume that basic preferences are the same for everybody and do not change remarkably. Human nature is the same for people at different ages and in different places, meaning that people have the same general goals. According to Adam Smith (Lindenberg 1990) these goals are to achieve physical welfare, social approval, and status. This view also holds that those with more resources will better succeed in reaching their goals. Importantly, according to Smith there are specific means in typical situations to reach these goals. For example, under the constraints of capitalism people hardly have a choice but to specialize in economic resources, since these are the means to most other goods. It is not for the love of money, why people strive for high profit and income, but because money

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is instrumental for many things people want. This point is somehow lost in economics. People’s preferences or interests are socially conditioned. Given their social situation, people can only achieve the goal of having a good life by realizing the less general goals. The latter are instrumental goals, so to speak. People produce their subjective well-being by optimizing these instrumental goals (Ormel et al. 1999). Sociology contributed at least two major insights to this common view of man. First, next to economic resources there are also other means that produce general human goals. According to the neo-Weberian synthesis of sociology, there are three main types of resources to achieve a better life: economic resources (financial assets and capital goods, but also occupational knowledge and skills), political resources (voting rights, membership of political bodies such as parties), and symbolic resources (occupational prestige). Having these means enables a person to achieve a better life. Second, sociology describes several institutional conditions next to markets. In traditional societies individual action is influenced mainly by traditions and norms transmitted through the generations, whereas in modern societies individual behavior is more constrained by markets and organizations (Heilbronner 1964). A major sociological task is to specify how institutional constraints influence the returns of the above mentioned resources. the program: hard core and research questions It is plausible to interpret personal networks as yet another type of resource, analogous to the three types of resources in the classic sociological program, and treat them as social capital that is instrumental in reaching general goals. This idea ties in with neo-Weberian arguments on life chances, determined by one’s economic, political, and cultural resources. The idea is not new, though. “To have friends is to have power: for they are strengths united”; see Thomas Hobbes in his famous Leviathan (1663). This assumption, however, is of great heuristic value in social network studies. It is the hard core of a budding research program (Lakatos 1970). It serves as a guide for where to look for explanations of network phenomena. In a nutshell, it presents a research program in which social networks are treated as a specific resource important for most goals people have in life. The core of social capital theory consists of two straightforward propositions. First, the social resources hypothesis: people better equipped with social capital will be better able to attain their goals. Second, the investment hypothesis: people will invest in social capital according to its instrumental value in producing their ends.These propositions are analogous to the common view on economic, political, and symbolic resources described above. Take note: social networks are not merely seen as another constraint, but they are social capital that produces goals that cannot be attained otherwise or only at much higher cost. These thoughts lead to some important new questions, such as: 1. What are the main constituents of social capital and how do the various effects of social capital depend on its main constituents? What makes a social network productive? 2. How can social capital be measured?

226 Henk Flap and Beate Völker 3. How are social resources related to other resources? Does social capital increase the returns to human capital? 4. How do people acquire social resources? How and when do persons invest in others? 5. Why are social resources distributed unevenly? 6. Under what circumstances and in what societies are social resources most important? This series of related questions articulates the contours of a research program that is encompassed by the idea of social networks as social resources (Lakatos 1970). Such a program systematizes the results of social network research, creating a system that was lacking before. Several theoretical and empirical contributions to this budding research program can be discerned, which will be discussed next. tentative answers The first question Scattered through the social science literature there are attempts to answer the research questions of the program. Lin, Vaughn, and Ensel (1981a: 1163) pointed to an answer to the first question. Social resources consist in “the wealth, status, power, as well as the social ties, of those persons who are directly or indirectly linked to the individual.” The resources of someone’s network members are substitutes for their own resources; that is why Boissevain (1974: 158–63) called them “second order resources.” An important aspect of the latter is the diversity of the second-order assets. Greater diversity of these resources is social capital, especially if one realizes that for many goals in life only one or two other helpers are needed, and a third or more potential helpers do not bring additional benefits but are a drain on one’s time and energy (see Snijders 1999). It is usually assumed that the mere presence of another person and his social support are enough to satisfy someone’s needs, but it is often crucial what is at the other end of a tie. A mother, for example, usually wants to help her child with his studies; however, if she did not receive much education herself, this help will be of no great avail. According to Coleman (1988, 1993) American youth currently have a dim future because parents do not help their children as much as in earlier years, although American parents nowadays do have more resources than their predecessors. As a counterpoint Coleman (1990: 491) presents the example of children of Asian immigrant families who always purchased two copies of a textbook. The second copy was bought for the mother to study along with her children, in this way maximizing the help she could give to her child. Social capital consists of at least three elements: the number of others prepared or obliged to help, the extent to which they are willing to help, and “what is at the other end of the tie”—that is, their resources. One can include the structure of the network as a fourth dimension of social capital. Bourdieu (1981) and Coleman (1990) hold that there is social capital in a dense social network. It is critical, for example, to school success: a rather tightly knitted

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community network is an asset as parents will continuously observe each other’s children and correct them if they go astray or notify the parents of these children. So there is social capital in the structure of networks. Dense networks not only lower the costs of information search, they also decrease the costs of norm enforcement. These arguments on the effects of dense networks are also forwarded by transaction cost economics. Coming to an agreement is easier in a closed social network. It spreads reputations for being trustworthy and thereby increases the chances of cooperation because people know that opportunistic behavior will be uncovered, and probably sanctioned by others (Granovetter 1985; Raub and Weesie 1990). Trust is higher in closed networks. People will sooner invest in particular others if they think that these people will honor trust (see below for the answer to question 4); compare Smith 2005). Burt (1992) proposes the opposite view (see, however, Coleman 1990: 313– 19)—that is, that the structural autonomy of a person within a network increases the readiness of others to provide help. If others have no alternatives for you, but you do have alternatives for them, you are autonomous.This does not bring only nonredundant information but also control benefits. You can play those who are tied to you off against each other. Being autonomous, of course, is an instance of having a favorable exchange rate in transactions with others. So being in the middle between other persons who are otherwise disconnected, having “structural holes,” can be seen as social capital. This principle was discovered earlier in studies of patronage-ridden societies: the staying power of patronage derives partly from the particular network structure—that is, an open triangle (Singelman 1975; Flap 1989). With regard to our first question it has to be said that there is too much talk about the concept of social capital and its definitions. Definitions tell nothing about the real world. Sociology is about theories, not about definitions. And Coleman’s proposal to define social capital in a functional mode—social capital is whatever aspect of a social structure that is helping actors to realize their interest (Coleman 1990: 305)—is an immunizing stratagem. The second question As empirical research on social capital is developing, it is annoying that measurements of social capital are often rather ad hoc, pragmatic, and unsystematic. How can social capital be measured, given its multidimensional nature, its goal specificity, and the institutional conditioning? In network research various methods have been used to chart networks, running from direct observation, respondents’ diaries, secondary data—for example, on memberships—to more direct questions such as: “To whom do you feel close?” or the role-relation question: “Who are your three best friends?” Usually the latter two questions are followed by questions on how well the respondent knows these persons, what activities one undertakes with them, what their occupation is, and so forth (see, for example, Laumann 1966: 171). Claude S. Fischer (1982; Fischer and McCallister 1978) improved the measurement of social capital. Instead of starting with the question about friends, and then asking about their jobs and the like, Fischer proposed to first

228 Henk Flap and Beate Völker ask about activities, for example: “With whom do you discuss your personal problems?” and thereafter ask whether this person named is a friend, family, or neighbor, as well as how strong this tie is, how frequent one sees the person, what kind of occupation the person has, and so forth. The first question is called the name generator. The latter ones are name interpreters. This way one gets information on the three major dimensions of social capital: the number of people prepared to help, the extent to which they are prepared to help, and the resources they can use to provide this help. The fourth dimension—that is, the structure of the network—can also be measured by asking whether the persons mentioned know each other. The question about discussing personal problems describes the core-network of confidants and is about the only standard question in network studies. Lin and Dumin (1986) came up with another, even simpler instrument to measure a person’s social capital, called position generator. The respondents are presented a list of job titles, all represented in the labor force and spread across the occupational prestige ladder.The next question is for all these jobs, whether the respondent knows anyone in a particular job, and if so whether this is family, a friend, or an acquaintance.This instrument again gives information on the three major dimensions of social capital—that is, on how many people are prepared to help the respondent, to what extent, and what kind of resources they have to provide this help, while assuming that family is more prepared to help than a friend, and that a friend is more prepared to help than an acquaintance (see Van der Gaag, Snijders, and Flap 2008). Inspired by Putnam’s work (see below) on collective social capital, new measurements are now used. One is a question on general trust: “Generally speaking, would you say that most people can be trusted, or that you cannot be too careful in dealing with people?” The other is a count of the number of memberships in voluntary organizations. But the link of both measures to the network theoretical idea of social capital is questionable. The third question With respect to the third question—how social resources are related to other resources—Bourdieu (1981), Coleman (1988), and Burt (1992) argue that a person’s social capital increases the returns to his other resources. The productivity of social capital is rooted in the opportunities embedded in social relationships that help to benefit from one’s other resources, especially human and financial capital. Social capital adds to their value. An interesting result comes from a study by Boxman, De Graaf, and Flap (1991) on managers of Dutch companies. They found that social capital helps to achieve a higher income at any level of human capital, but human capital makes no difference at the highest levels of social capital. Bourdieu states that the occupational prestige ladder has two dimensions at the upper end: there are jobs with a higher prestige in the financial and economic sphere, and similarly there are jobs with a higher prestige in the cultural sphere. The prestige ladder has the shape of a fork. Hansen (1996) and Flap and Völker (2008) demonstrate how resources are interconnected. Especially at the higher ranks of society children receive an extra benefit if they complete an education and get a job in the same sector as their father; they lose in income if they switch to another work sector.

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The fourth question With regard to the question of how social resources are acquired, the idea of social capital implies that men spend their resources on others, not only for the efficacy of the moment but also with an eye to the future. As early as 1923, Marcel Mauss, in his famous Essai sur le don, forme archaïque de l’échange, expounded on how people acquire social capital—namely, by giving and in that way indebting others to them. Coleman (1990: 306) introduced the image of “credit slips” to indicate the amount to which a receiver was indebted to his or her helper. In their investment decisions people will always discount what they think future benefits will be and consider their value. The importance of a relation is not only determined by past investments but also by the expectation of future help (Boissevain 1974: 250). People will invest in social capital according to the present expected value of future support. There are a number of assumptions implied in the hard core of social capital theory. The importance of social capital in social life strongly relates to nonsimultaneous exchange of help (delayed or generalized reciprocity), which usually is, at the time given, considerably more valuable to the recipient than it is costly to the donor (Coleman 1990: 90–116). This means that some complementarities of the partners’ fortunes are required. If they do not expect that there might be a reversal of fate, generalized reciprocity between two partners will not occur (Litwak 1985; Cosmides and Tooby 1992). Furthermore, through time there will be a discount rate to the value of future help (Taylor 1974: 9). The faster the value of social capital has to be discounted, the smaller the expected value of support will be. Axelrod (1984: 12) catches the idea’s meaning with the image of the shadow of tomorrow.The value of social capital increases by enlarging the shadow of tomorrow. However, the future is less important than the present, for three reasons. First, players tend to value payoffs less as the time of their obtainment recedes. Second, there is always some chance that the actors will not meet again. A relationship may end when one of the other actors moves away, changes jobs, or dies. Third, there is a risk that the other behaves opportunistically and does not repay his debt. Because there is a time lag between investments and returns, one has to trust that the other person will repay the service delivered. Investing in others is similar to what game theory calls playing a trust game (Dasgupta 1988; Diekmann 2007). As to the costs of investments in others and of entertaining a particular tie, these have not been clearly envisioned in social capital research so far. They will be lower if both partners are members of a pre-existing group (Lindenberg 1998) or a community (Glaeser 2001). Sharing a context where one meets the other also decreases the costs of engaging in and maintaining a social tie. Sharing a context implies that the chance of meeting again increases drastically, so that people can trust each other more (Diekmann 2007: 51). There is a way of acquiring social capital without having to mobilize one’s resources—that is, through endowment, or more generally through ascription. The major example is being born into a family. This part of a person’s social capital develops without one’s own intervention. Further, weak ties can grow “at random,” as a by-product of actions toward other goals. The beauty of the program is that it has one key idea, explaining effects of

230 Henk Flap and Beate Völker social networks as well as their emergence and change. Such an investment theory makes it possible to explain why theories that are often used to explain personal relations, such as the exchange theory and cognitive balance theory, meet with refutations. Refutations include, for example, battered wives staying in a strained relationship with their husbands (Rusbult et al. 1991; Rusbult and Martz 1995). People invest in social networks pending their expected value of future support. Together with the direct costs and rewards of maintaining a tie, the past investments in the tie, the shadow of the future, the quality of available alternatives, and the cross-linkage between the personal networks of both partners in a relation are involved in the decision to divest or invest. The “shadow of the past” is important not only because one has learned about the trustworthiness of others but also because investments in others are nearly always relation-specific. These investments are largely gone if one switches partners. If a person’s investments in others are clustered in a dense network, it is more difficult to withdraw one’s investment because this will damage relations with others as well (Kapferer 1972). An illustration is that homeowners have a larger network in the neighborhood than those who rent their house (Glaeser 2001), not only because they have a greater interest in having ties to their neighbors but also because their shadow of the future is larger. Take note, there is not much research on investment in ties to others. Research is usually on the stability of existing ties and not on newly emerging ones. The establishment of ties is hard to observe. Any action of a person may be a repayment of an earlier investment by the other rather than a genuine act of investment in a new relationship. Experimental research might help here (see various reviews by Jackson: see, for example, Jackson 2005). The fifth question The answer to the fifth question, why social capital is unevenly distributed, is rather straight-forward. If people control more economic, symbolic, and political resources they can produce more social capital, and since the former are usually unevenly distributed, the same goes for the latter—that is, social resources. From the perspective of the others, those with more resources are an attractive target for investments. Lin,Vaughn, and Ensel (1981a) stress that the social background of one’s parents influences the social resources of the children. Combining this hypothesis (the more economic, symbolic, and political resources someone has, the more social capital he can produce) and the social resources hypothesis (the more social capital someone has, the better he can achieve his goals) leads one to expect a reproduction or even an accumulation of social inequality. Social inequality will be perpetuated intragenerationally and intergenerationally by differences in access to and use of social capital (Bourdieu 1973; Flap 1991). So there will be a kind of Matthew effect here. According to Bourdieu social closure through selective employment of social capital is a compensatory strategy used by the social elite when their position is threatened (Bourdieu and De Saint Martin 1982). Often such a closure will be an unintended effect of one group employing social ties to transmit advantages to others of their own group while other groups do not act like that. This goes for job vacancies, but it also applies, for example, to housing (Grieco 1987). If

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work is organized in vacancy chains, a differential tendency to use informal channels to find a job may quickly result, unintendedly in one group taking over a whole line of work. Lin, Ao, and Song (2009), using a nationwide survey of urban residents in China, established clear reproduction and accumulation effects of social capital. Being older, well educated, and having work experience led to more social capital. While questions 1 to 5 of the research program received tentative answers, there is not yet an answer to the 6th question, on how institutional arrangements influence the returns on social capital. This question is largely equivalent to the question of why there are no pure structural effects. Below we will deal with conditions, such as level of technology and the kind of legal institutions that confound structural effects by causing differences in returns of networks—that is, in the instrumental value of social capital. Before proceeding to an answer on the 6th question, we discuss necessary preconditions for network effects: numbers and places. Numbers and Places. Without meeting there will be no mating (Verbrugge 1977). This insight sank in only recently. Basic to meeting chances are numbers and places. The circumscriptive effect of numbers on meeting chances was brought forward by Blau and Schwartz (1984) in their study on marriage patterns. Their point is summarized neatly in the one-liner: “You can’t marry an Eskimo, if no Eskimo is around.” They presented strong support for their supply-side argument (see also Blum 1995).This argument does not apply only to marriage ties, but to all kinds of relations—for example, in the United States it is far easier for a black person to have a white person for a friend than the other way round. The most obvious condition influencing contact opportunities, apart from absolute numbers, are places. Feld (1981, 1984) noticed that social interaction is often tied to certain places offering foci for interaction with other people. Obvious examples of foci that can organize social ties are public places and facilities, such as a bar, shops, schools, a disco, a restaurant, a library or public squares, but one can also think of work places, voluntary associations, or other organizations. As a result people’s networks become organized around such foci. Social ties emerging from foci are a quasi by-product of other actions, and the relational demography of such foci strongly determines which ties are actually formed (Flap, Bulder, and Völker 1998: 117–18; Lindenberg 1998; Kalmijn and Flap 2001; Mollenhorst,Völker, and Flap 2008a,b; Rivera, Soderstrom, and Uzzi 2010: 105–7). This is a supply-side argument: the composition of people’s social networks reflects the composition of the pool of people in the places that they visit—that is, the opportunity structure for selection of associates (Marsden 1990: 397). Structuralists question the assumption that ties exist because two members of a dyad want to interact with each other. In practice, many ties are involuntary in that they come as part of a network membership package. They may be ties to persons who must be dealt with at work or in the neighborhood (Wellman, Carrington, and Hall 1988). Meeting places have more effect if people are forced or required to stay in them for longer periods of time, and if it is more difficult to enter and

232 Henk Flap and Beate Völker leave a particular meeting place (Mollenhorst,Völker, and Flap 2008a). Smaller meeting places will lead to more dense networks, but the ties are usually more heterogeneous (compare Fischer 1977; 1982). One may also expect that weaker ties will be more strongly influenced through meeting places people find themselves in than stronger ties. And indeed meeting places are less decisive in finding a friend or a partner than in acquiring other types of ties. Preferences play a larger role in the choice of stronger ties (Mollenhorst,Völker, and Flap 2008a). Our idea is that through time there occurred an unbundling of contexts in the Western world, leading to individualization also of contact patterns. Coleman (1990: 579 passim) hinted that such a process may be unfolding (Pescolido and Rubin 2000; Völker, Flap, and Mollenhorst 2009). Network changes are a result of changes in the structure of meeting places. In modern society, social contexts such as work, neighborhood, family, or voluntary groups have become unbundled. There is a long-term trend of unbundling from “ascribed” (family, neighborhood) to “achieved” social contexts (work, voluntary organizations). Or as Coleman calls them, from “primordial” structures that grow without conscious design to “purposive social structures” that are consciously designed. Activities that were once enmeshed in the home, extended family, or the neighborhood, such as domestic care, child rearing, food consumption, preparation for adult tasks, spending leisure time, and work are taken over by modern state or market institutions and their agents (see Coleman 1990: 585). Organizations take over activities that were once integrated in family and neighborhood communities because they are often more efficient in conducting these activities. If social contexts are falling apart, personal networks are expected to change. The more contexts are bundled, the more an individual meets the same others and the more the networks of actors will overlap. In consequence, personal networks are expected to be denser and probably more multiplex, and will exhibit stronger ties than personal networks in separated, unbundled contexts. Once contexts become unbundled different network structures can emerge, since the supply of potential interaction partners increases. The ultimate result of context unbundling would be a radial network structure, where the focal actor is related to others through ties that are disconnected, weak, and only uniplex (Pescolido and Rubin 2000). Another cause of unbundling has been the functionalistic city planning in the last century. The spatial spread of functions hinders community development. In one place you live, in another you work, going out takes place in yet another, and so forth (see Jacobs 1961). In reaction, modern city planning, in particular the so-called new urbanism, has recently been heading toward consciously bundling contexts by locating work, residence, and recreational facilities within each other’s proximity. A basic argument is given by Lindenberg (1998), who points out that it is efficient if a relationship or a network fulfills various functions at once. In network studies, the costs of investing in new ties and maintaining existing ties are often not accounted for. Having friends in one place is less costly. Verbrugge (1979) and Mollenhorst,Völker, and Flap (2008a) found that people favor having their friends in one place, even if that results in friendships with

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dissimilar others: if a person has a friend in a certain setting, the chances that a second friend will be taken from that same setting are far greater. The sixth question: technology Insecurity probably enlarges the value of social capital. Analyses of African stateless societies at a rather low level of technology (horticulture and herding) show the strong impact of technology on what can and has been done by social networks. In such a situation an extra premium is placed upon the formation and maintenance of social capital, since under subsistence conditions each family is too small to support itself (Gluckman 1965: 13–14). For example, success in hunting today is no guarantee of success tomorrow, so it is wise to share with others. Moreover, since there are “no cops and constables” in stateless societies, one had better have friends for personal protection (Flap 1988, 1997). And as food and other goods are difficult to store or trade, the main investment available to man is in personal relationships. At higher levels of technology insecurities are not banned from social life. Although some types of social capital are goal specific (for example, it takes a strong man to carry an invalid), its major advantage is that, like money or human capital, it is often a means to all ends. Litwak (1985) showed that support from informal networks is far more important in the sheer amount of services delivered and the number of people that are helped than care provided by formal organizations. Informal relations can better master events and tasks with many contingencies that are not easily subdivided, or involve problems for which the time of their occurrence is hard to tell. That is why solutions to many everyday problems cannot be routinized or standardized. Coleman (1990) provided a very apt example. Because small children growing up in a neighborhood need continuous attention, so that they, for example, do not get into traffic incidents or fall into a pool of water, a dense network of good relations among neighbors is very helpful. When solutions can be routinized and standardized through technology or universal laws and rules, the value of social capital usually shrinks. But new highly developed technologies also produce new nonstandard, nonroutine exigencies because of all kinds of unforeseen tight couplings in technological and work processes (Perrow 1986; Vaughn 1990) that can be mastered only by resourceful people and through fine tuning of social relations. The damage potential of accidents is often enormous in terms of money and lives lost. Generally, the value of social capital will increase in periods of economic contraction, even in industrial societies. If there is a labor surplus, stronger ties will be more important for getting a job (Grieco 1987: 48). In the last decades, the discovery and diffusion of new technologies has raised hopes of various people that communities might be saved or rebuilt by using the Internet. The costs of interacting have decreased drastically. Yet research shows that the Internet largely functions just like the telephone (Fischer 1992)—that is, one emails mainly with those whom one also speaks with. Internet traffic is mostly very local. So the hope that one might form new communities in an easy way while using the Internet has to be curtailed. People first have to meet in person, looking each other in the eyes, before they trust each other. In our own survey of the networks of the Dutch, we found

234 Henk Flap and Beate Völker that only 1 percent of all the contacts were first met on the Internet. The opposite is not true either; the Internet does not make people lonely (Franzen 2000). The network of those who use the Internet does not decrease in size, nor does it decrease the time spent with friends. The sixth question: institutions It is a challenge for the field to come to grips with the institutional embeddedness of social ties. Institutions, just like technology, can provide universal solutions to human problems that make particularistic solutions through mobilizing social capital more or less superfluous. The welfare state provides social rights, pre-empting much of the former value of social networks. This idea is sometimes called the “crowding out hypothesis.” But man does not live by bread alone: social prestige and an identity cannot be created through issuing social laws. Particularistic solutions are called for, and there will always be some value in social relations with others. Institutional arrangements affect the productivity of people’s resources, social capital not excluded. According to Coleman (1990: 585–87, 1993) there has been an irrevocable loss of social capital in Western industrial societies, caused by the growth of the welfare state, technological changes, and the rising number of large organizations providing services that were once produced more efficiently in the family and the neighborhood.These developments have destroyed the social capital in the family and local community. Parents, for example, will not take care of other parents’ children. They will not even invest much more in their own children, because their need for them has decreased with the availability of old age pensions. Putnam (2000) has presented quite some empirical evidence that in the United States over the last thirty years there has indeed been a decline in social capital, at least as measured by him. That is social capital measured by memberships in associations and by trust in strangers. The images of “bowling alone” and “checkbook-writing organizations” summarize the discussion (Putnam 1995). We should note, however, that such trends as the decline in membership rates of voluntary associations are to be discerned in some Western countries, but certainly not in all. Given a certain institutional arrangement, social capital may be differently productive across social groups. Van der Meer, Scheepers, and Te Grotenhuis (2008) find in their international comparative research, for example, that enforcement of rights by the state, as well as a greater national welfare, lead to more informal help given especially to and received by the poor. Institutions also influence what type of relationship might be instrumental to a good life. A major example of the last decades is provided by the political turnover in Eastern Europe from a totalitarian one-party to a democratic multiparty political system, and from a centrally controlled economy to a market economy. The institutional changes alter the returns of investments in social capital and thereby affect the (dis)investment of persons in one another, which implies that their social networks will change. See various contributions in Badescu and Uslaner (2004) as well as in Meulemann (2008) on the productiveness of social capital in the so-called transition countries. Our own research in the former German Democratic Republic (GDR)

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suggests that weak ties, quite unlike the situation in Western societies, had perverse effects in communist societies, as they pose a threat (Völker and Flap, 1997, 2001). One never could be sure whether state or party organs were not spying on one’s private life, or whether third persons would not collect information that could prove to be dangerous upon disclosure. Although the regime did succeed in mixing neighborhoods socially (the professor living next door to the plumber or the pimp), people actually living next door to each other kept their dealings with each other to a minimum. The Marxist experiment that was meant to create social cohesion actually resulted in people distrusting their neighbors and having small personal social networks. Although today fear of weak ties is gone and one would expect networks to have grown years after the turnover, people’s networks were still small in the first years after the fall of the wall; in particular, the core networks did not change much. People seem to cling to what they have, probably because they do not yet know what is in their best interest, let alone how specific social relations might serve these interests (Völker 1995;Völker and Flap, 1997, 2001). Networks do not always work in concert with existing institutions. Some situations present an institutional minimum. This puts an extra premium upon the formation and maintenance of social capital. Concentration camps are such an extreme case. As Primo Levi (1979: 94–95) states, in his horrific autobiographical account of his time in Auschwitz: With the adaptable, the strong and the astute individuals even the leaders willingly keep contact, sometimes even friendly contact, because they hope to perhaps derive some benefit. But with the musselmen, the men in decay, it is not even worth speaking, because one knows already that they will complain and will speak about what they used to eat at home. Even less worthwhile is it to make friends with them, because they have no distinguished acquaintances in camp, they do not gain any extra ration, they do not work in profitable Kommandos and they know no secret method of organizing. And in any case, one knows that they are only here on a visit, that in weeks nothing will remain of them but a handful of ashes in some near-by field and a crossed-out number on a register.

Examples can also be found in modern Western societies. For example, stratification research has shown that the rise of democracy during the last century led to more equality between the higher and lower strata. Bourdieu describes how elites in modern times compensate for their loss of power by compensatory mechanisms: one is a keen marriage politics. Elites in democratic societies will close their ranks to potential marriage partners from other social classes, guard their resources, and compensate for egalitarian measures taken by social-democratic or socialist governments. It shows that social capital can be effective notwithstanding moral disapproval and legal prohibitions on the use of social connections, if relations are hidden from the public through ignorance or secrecy—for example, if rich families marry into each other (Bourdieu and De Saint Martin 1982: 42). Organizational conditions also influence the value of social capital.Whenever the quality of services and products is hard to measure or the damage potential

236 Henk Flap and Beate Völker of a job is high, social networks come in and the value of social capital goes up, because people rely more on the opinion of others they trust. For example, for jobs with a high damage potential employers and contact persons want to be certain that they do not hire or recommend the wrong person (compare Smith 2005). They accomplish this by recruitment through informal, stronger channels (Flap, Bulder, and Völker 1998; Flap and Boxman 1999, 2001; Völker and Flap 1999). In addition, strong ties also provide more leverage to ward off opportunistic acts. Networks are also affected by cultural norms. Kalmijn and Uunk (2008) studied the effects of deviance from important shared norms on people’s network. People who break traditional norms are sanctioned by others. For example, in regions where divorce is strongly disapproved of, those that nevertheless divorce from each other suffer a significant loss of social ties.

The Program Works the first round The social capital program works, as can be seen from the empirical insights on the emergence and effects of social networks. It has produced cumulative research especially in the area of occupational attainment. A boost to social networks and social capital studies was the organization of large-scale data collections on social networks and social capital. One of the first large surveys on social networks was the Detroit Area Study of 1966, originated by Laumann. His 1973 book is based on it. He used the role-relation method and collected information on respondents’ three closest friends. In his earlier book (1966) he had used data from a survey in 1963 in Cambridge and Belmont on a few hundred male respondents. Fischer et al.’s study Networks and Places (1977) is based on this data set too. Influential has been The Northern California Study conducted by Fischer (1982), among others, because it was the first time that the name generator methodology was applied. Another milestone has been the American General Social Survey (GSS) of 1984. A representative sample of all Americans were interviewed employing the by now standard question on the persons with whom the respondent discusses personal problems. These data were used in multiple articles. The International Social Survey (ISSP) of 1986 contained a network module. These data are as far as we know the first international comparative data set on social networks. In eight countries it was asked to whom respondents would go for help in case they needed a specific kind of help. Höllinger and Haller (1990) compared social networks of citizens in seven countries involved in the ISSP of 1986 and showed that people in Middle Europe—that is, in West Germany, Austria, and Hungary—have fewer friends than in other Western countries, or no friends. Using the same data set Immerfall (1997) described in detail the differences between the networks of citizens of different Western countries. Next to the size of the networks of people from different countries there are also clear differences in their composition. People from Middle and Southern European countries include more family within their networks than people from the Nordic countries, and people from Australia and the United States include even less family. Moreover, people in Middle Europe turn more often to the same people for different kinds of help.

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How to account for international differences in social networks is the first issue to be discussed here. International differences in social capital might be caused by institutional differences. One hypothesis is Coleman’s idea that welfare states drive out social capital incorporated in people’s personal social networks.The contrasting hypothesis on socioeconomic security is that welfare states and economic prosperity enable individual citizens to engage in voluntary associations without time-pressure and to acquire a sense of belonging. Using Euro-barometer data from 1992 on thirteen European countries, Scheepers, Te Grotenhuis, and Gelissen (2002) corroborate that in a more developed welfare state people have less social capital (“crowding out hypothesis”). However, a more recent publication by Van der Meer, Scheepers, and Te Grotenhuis (2008) on ISSP-data on twenty Western countries from 2001 refutes this crowdingout hypothesis. Social security has no negative impact on social participation. Social capital research seems to have entered a new phase. In particular, it is new that international comparative studies allow for comparison of networks of citizens in different societies. European sociology has a special position, because sociology in Europe is catching on with the research in various areas—among others, network research. Even more important, Europe has an interesting institutional and cultural variation between various countries and regions, inviting research on the contingency of the value of social capital as a resource. The diffusion of multilevel-regression analysis is another stimulant for this kind of research (Snijders and Bosker 1999). By now there are three types of this comparative research depending on how social capital is measured.The first branch uses name generating questions, whereas the second branch uses questions on generalized trust of others, including relative strangers. And lately there has been yet another, a third branch of comparative research in the making, a literature that uses the position generator. Lin, Ao, and Song (2009) and Völker and Flap (2008) are among the first to start this latter line of comparative research. The research literature on social capital in (former) communist societies uses both the name-generator and the interpersonal trust question to measure social capital (see, for example, various contributions to Badescu and Uslaner 2004). Citizens of former communist countries of Central and Eastern Europe have less trust in their fellow citizens than those in the West. Their associational involvement is also far lower than that of their Western counterparts. Too many people have bad memories of party-controlled associations. However, their social networks today do not seem to be that different from those in Western countries. Research on the effects of social networks while applying the resources hypothesis of the social capital theory has been successful in several research areas. A good example is research on the role of networks on the labor market. This research shows quite some progress through the years. It is clear that use of informal social contacts as such does not produce better jobs. The central finding is that, not so much the number of people prepared to lend a helping hand, nor the cohesion within the network, but the resources of the persons within one’s network are critical social capital in achieving a good job. It was furthermore demonstrated (Lin, Vaughn, and Ensel 1981a; De Graaf and Flap 1988) that part of the effect on occupational success originally attributed to human capital has to be attributed in fact to the employment of social resources,

238 Henk Flap and Beate Völker human capital being partly responsible for having better social resources. See also Flap and Völker (2008). It is important to realize that this does not indicate favoritism or clientelism. If someone helped to do a favor, there are hardly any clear benefits. One does get a job, but not a good one. Usually there are all kinds of disadvantages such as too much noise, and dirty and dangerous work circumstances and the like (see Sprengers, Tazelaar, and Flap 1988). Mouw (2003) criticized existing research because reversed causality is not considered: having and achieving a better job leads to having friends who have better jobs themselves. Recently Ruiter and De Graaf (2009) demonstrated that members of voluntary associations are more likely to start a new and better job than nonmembers. Since Ruiter and De Graaf (ibid.) have the precise timepoints when respondents became a member of an association and when they accepted a new job, they can counter the criticism that the association between social capital and a good job may be the product of selection. It is curious that the second hypothesis of the hard core, the investment hypothesis, has not been tested often, although the idea is at the heart of the program. It has been tested by social psychologists for the dissolving of romantic love relationships (Rusbult et al. 1991; Rusbult and Martz 1995). And more generally for the stability of informal relationships of respondents over a period of several years, while experiencing a number of life events (Busschbach 1996; Busschbach, Flap, and Stokman 1999). Both tests support the idea. These tests show that, apart from direct rewards and costs, especially the shadows of the past and of the future determine investment and stability in social relations. Having relational alternatives is also somewhat important. Rusbult’s theory does not include expected future benefits and second-order resources, though. Busschbach showed that the embeddedness of ties contributes to their stability only in the short term. Companionship and emotional ties that are embedded will last even when a person temporarily does not invest in them. But if an embedded instrumental tie has to last over a longer period of time, people do have to make maintenance investments. Take note, existing tests are about the stability of ties, about decay and not about newly emerging or newly chosen ties. Research on the latter is scarce. As mentioned earlier, questions on tie stability are quite similar to questions on change in social networks. McDonald and Mair (2010) apply a life-course perspective to network changes. Using cross-sectional data on Americans, they find that networks tend to grow in size if persons get older, yet the closeness of the ties and the density of the networks decrease by around thirty years of age. Interestingly, resources embedded in occupational networks accumulate across the career even if the size of this network of colleagues shrinks. McPherson, Smith-Lovin, and Brashears (2006) published an article that made an impression also on the general public. As previously said, the General Social Survey of 1985 contained network questions. The same questions were posed again in the GSS of 2004. This makes possible describing the changes in American discussion networks over a period of twenty years. This has led to two main findings. First, the discussion networks were smaller in 2004 than in 1985; the average core-network decreased in size from an average of 2.9 to 2.0 members. Second, the number of people without confidants nearly tripled,

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from 10 percent in 1985 to 25 percent in 2004. Other interesting findings are that the educational heterogeneity of the core-network decreased, whereas the ethnic heterogeneity went up. Furthermore, as the decrease among nonfamily ties is somewhat greater than among kin ties, people have to rely more on their kin, especially their partner to discuss their personal problems. Take note that these are usually ties that are less bridging. These empirical results of course underlined concerns about the loss of community. But see Fischer (2008), who based on various kinds of inconsistencies in the results argues that the data overestimate the number of isolates strongly because missing data and refusals have been miscoded as isolated respondents. The study by McPherson, Smith-Lovin, and Brashears was soon replicated in Germany and in the Netherlands. Wöhler and Hinz (2007) studied samples of the Family Survey of the German Youth Institute from 1988 and 2000. Comparative results are that the size of the average core networks of the Germans grew somewhat between 1988 and 2000, from 1.9 to 2.1. In addition, the percentage of respondents without a confidant decreased quite clearly, from 47 to 37 percent. The percentage of people with nonkin confidants also clearly rose. Thus there is no erosion of the core networks in Germany. Recently we also replicated the American study for the Netherlands.Völker, Mollenhorst, and Flap (2008) found that the average size of the core network of the Dutch is stable—that is, 2.4 other persons at both time points, 1999 and in 2007. Furthermore, the number of persons without a confidant decreased a little from 13 percent in 1999 to 11 percent eight years later, in 2007. Relatives and especially the partner became somewhat more important as a confidant. In our study of changes in the networks of the Dutch we used several name-generating questions. This allows us to determine in more detail what happened to the many ties that are not any longer within the core-network. Only 30 percent of the core ties at the first point of measurement remain in the core network, and 70 percent are not in the core anymore. Yet most of these former core members—that is, 80 percent of all core members—stay within the personal network and to a large part fulfill other functions. Only 17 percent of all former core ties are not mentioned anymore in whatever function. It is amazing that with so much personal change the size and composition of people’s networks are that stable. Contacts that are embedded in a tight network are most stable (ibid.). Most change is explained by relational characteristics, such as age of the tie. People who are liked, live nearby, or have a higher education also have a greater chance of staying within the core network. The program also produced new interpretations of well-known facts in established fields of study, such as stratification research. A finding that can be better understood within a social capital framework is that in larger families children profit less from their parents’ resources, probably because siblings have to compete for these resources (Downey 1995). Social capital research has opened up new research areas. Posing new questions is scientific progress too. Great impact was made by the study of Coleman and Hoffer (1987) on the differential school success of minorities in the United States, which was shown to be greater in Catholic schools. The presumed reason was the greater social capital located in the communities of parents

240 Henk Flap and Beate Völker surrounding these schools. Children achieve better educational results attending schools in which the parents of one child take care, on their own initiative, of the children of other parents. Especially children of parents who do not have many personal resources themselves profit from such schools. Migration tends to destroy this kind of capital, which is detrimental to the educational and occupational chances of children unless the father and the mother do have strong relations with their children (Hagan, MacMillan, and Wheaton 1996). Within the sociology of the family, McLanahan (1984) started research on the detrimental effects of single-parent families, especially of divorce, on the educational and occupational chances of the children. Children of oneparent families have lower educational achievements, a high drop-out rate from school, lower earnings and occupational status, and a greater chance of becoming a welfare recipient. McLanahan interprets these effects as caused by loss of social capital within the family. A divorce seems to be more incisive than the death of a parent, probably because the death of a parent does not end the support delivered by the child’s family of both parents, in contrast to the divorce, which often puts an end to relations with at least part of the extended family. Even more detrimental to a child’s chances in life seems to be a father who is imprisoned (Western and McLanahan 2000). Another new problem opened up by social capital research is the mutual influence of partners on each other’s career. Having a partner with a good education and a good job is promoting the career of the main actor. Someone’s partner is a major form of social capital to ego, always available and strongly prepared to help (see Bernasco, De Graaf, and Ultee 1997 for more on these partner-effects).When spouses support each other, education is not only human capital but also social capital. Bernasco, De Graaf, and Ultee (1997) demonstrate such “cross-effects.” There is an accumulation of advantages within a family, as partners well provided with educational and occupational resources establish coupled careers in which each partner promotes the career and income of the other. A similar argument can be made for the very employment of the spouse. Just being employed, for example, brings with it information, available to a person’s partner, that is not available to others. Research shows that having a partner with a higher education promotes a partner’s chances of being employed, of attaining a job with a higher prestige, and higher hourly wages (Ultee, Dessens, and Jansen 1988). These partner effects go against the wellknown specialization argument made by Gary Becker’s human capital theory: partners in a marriage are a kind of firm and they specialize: those, the men or the women, who are more productive in earning an income work on the labor market, while the others make a home and take care of the children. Social capital theory also has made an impact in the area of minority research. Immigrants are not isolated, as is often thought, but are frequently rather well connected (Fernandez-Kelly 1994). However, often they do not profit from their networks because there are only a few second-order resources at the other end (see, for example,Völker, Pinkster, and Flap 2008). One bone of contention is left—that is, whether networks with holes or dense networks promote performance. It is our contention that Burt’s idea only seemingly contradicts Bourdieu’s and Coleman’s idea on the positive value of integration of a group. The first idea refers to situations in which individuals

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can further their ends better by competing with others, whereas the latter refers to the situation in which individuals generally can better improve their fate by cooperation. So it depends on the situation at hand whether the one or the other type of network structure is productive. Because real life is a changing mixture of both situations, it is hard to optimize one’s personal network. Another manner of reconciling both views was presented by Uzzi and Gillespie (1998). They describe how firms that entertain strong ties to a particular bank, or more precisely, an account manager at a bank, and also have ties at arm’s length to other banks, do get better deals in their transactions with the bank because they use their weak ties to evaluate the deals they make in their strong connections. In fact the bank also turns out to close a better deal, because it is far better informed about the characteristics of its client and the condition of the client’s firm (see Flap, Bulder, and Völker 1998: 134–36). the next round The first surge of studies along the lines of the research program has sharpened the theoretical formulations and produced interesting new theoretical questions. We present a number of new issues of which at least some will or should be on the research agenda for the upcoming years. The first issue promises to become large in several respects. Coleman (1990) notices that there is a collective good aspect to social capital that could lead to an underinvestment in social capital: why should people contribute to keeping their common network in good shape? It is not a pure collective good, though: individuals do not provide information for nothing. There is also an argument to be made for the opposite statement: because people do not know their future and do not know whose help they might need, they do not want to be caught on the wrong side and invest in far more people than they will ever cash in on. Glaeser (2001; Glaeser, Laibson, and Sacerdote 2002) suggests that virtuous and vicious circles will occur: people like to belong to communities that are thriving and to which the members make contributions, whereas vicious circles may also easily arise. Some members seeing other members not contributing anymore or contributing less than earlier on will also stop contributing to the general interest, setting in motion a downward spiral of disinvesting. A recent discussion, especially in the political sciences, revolves around collective social capital. Putnam (1993) examined why everything seems to go wrong economically and politically in the Italian south, and why the north is thriving. This has been a classic theme in social sciences since Carlo Levi’s novel Christ Stopped at Eboli (1945) and Banfield’s anthropological case-study The Moral Basis of a Backward Society (1958). Putnam argues that civic traditions in the north promote the growth of lateral social ties, voluntary organizations, norms, and trust. People well organized in voluntary organizations and having lateral ties to each other pressure or even force politicians and civil servants to practice good government, which strengthens local democracy and regional economic growth. He explicitly locates social capital at the collective level of regions. In the south patronage networks are a brake on any collective action. Together with his book Bowling Alone from 2000, this made such an impression on political and other social scientists and the general public that Putnam’s ideas have been applied to various areas of life rather indiscriminately.

242 Henk Flap and Beate Völker The sheer mass of publications on collective social capital is overwhelming. A quotation from Putnam (2007: 138) illustrates what is meant: My wife and I have the good fortune to live in a neighborhood of Cambridge, Massachusetts, that has a good deal of social capital: barbecues and cocktail parties and so on. I am able to be in Upsala, Sweden, confident that my home is being protected by all that social capital, even though I actually never go to the barbecues and cocktail parties. I benefit from those social networks even though I am not actually in them myself. In the language of economics, social networks often have powerful externalities.

In his lectures Putnam sometimes adds that his wife does join these barbecues and parties. A major field of application is health research. There indeed are some indications that in neighborhoods in which people are on average a member of more voluntary associations, their health is somewhat better, controlling for several individual-level characteristics (Poortinga 2006; Fagg et al. 2008). But what the mechanism could be is not directly clear. It might be the readiness to help relative strangers when they fall ill or daring to ask relative strangers for help, or it may be that citizens pressure local government to invest in regional health care facilities. Even more important, in this application of social capital ideas, the achievements of the network tradition are almost forgotten. An article critical of this development is titled “Lost in Translation” (Moore et al. 2005). The main point is whether there is something to the notion of social capital at the collective level. Is it a real context characteristic, or is it just a composition effect of individual characteristics—that is, of all kinds of individual characteristics of residents living in the region, such as education, or the personal networks of all citizens? Or is it a result of selection? There are still other issues that for reasons of space cannot be extensively dealt with. These are, among others, whether social capital is a kind of castor oil, a means for all purposes, or whether it is nearly always goal-specific. A nice example of goal-specific social capital in the educational career is given by Parcel and Menegahn (1993) and Parcel and Dufur (2001). They discovered that children at primary schools fare better at school if their parents give them emotional support, yet if their children are in higher education they thrive better if the parents help them with their homework. Another issue is whether there is such a thing as sour social capital—that is, enemies that work against someone, and how effective they are. Moerbeek and Need (2003) found, in an analysis of data on occupational careers of a representative sample of Dutch respondents, and applying event-history analysis, that somebody who gets another job through an internal hiring gains twenty points of job prestige on Blau and Duncan’s well-known occupational prestige scale (running from 0 to 100), compared with one who has to change jobs because of having troubles with colleagues. These latter persons lose prestige. The social capital idea suggests that the negative effects of having foes will be larger to the degree that these foes have more resources. Labianca and Brass (2006) argue that negative ties have a bigger effect on performance and promotion than positive ties.

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Social capital evaporates if it is not used. It differs from other kinds of capital, such as cultural capital, in that it grows in use. Because social capital fades away if no action is undertaken, people often consciously try to create institutional carriers for informal networks, foci one might say, such as fraternal or other voluntary organizations with signs communicating who is “one of us.” People stabilize social production functions in which social resources are included by building institutional brickwork around it, often creating settings in which people meet each other (Müller 1986). Baron, Jennings, and Dobbin (1994) suggest that internal labor markets are created by employers to bind employees with valuable human and social capital to the company, for example those with extensive ties to customers.

Conclusions The research program of social capital structures the field of network studies through its research questions and by its hard core. Social capital theory is a research program that can help to close the theory gap in social network analysis. The beauty of the program is that one key idea, social networks being social capital, explains the emergence as well as the effects of social networks: a person’s social capital promotes his goal achievement, and he will invest in it depending on its instrumental value. The program does not only bring unity to a rather disintegrated research area, it also provides new predictions. A major example is the development of a supply side argument on numbers and places. Furthermore, the program helps to explain why there are, contrary to the structuralist claim, no pure structural effects: structural effects meet with exceptions because effects of networks often depend on the resources that are embedded in a network. Moreover, the instrumental value of social capital is contingent upon existing institutions and available technology. For example, we now understand why in totalitarian societies people are afraid of strangers. Weak ties are a liability in such a situation. Both the structuralist view as well as social capital theory take the idea of goal-directed, rational man as a point of departure; the former uses its alleged atomism to define its own position, the latter uses it to create a new research program by adding new auxiliary assumptions on networks. Although the structuralist view and social capital theory defined their position in opposition to each other, actual research conducted within the tradition of structuralism is not that far removed from rational choice sociology and social capital research. Although its popularity is rapidly growing, there is also skepticism on social capital ideas. For example, Baron and Hannan (1994) stated that its “theoretical cutting edge is lost if attention is not called to investments, rates of return, opportunity costs, the future, and the ability to appropriate the returns from the investment.” A major provision for the further development of the research program is to take seriously the analogy with human capital (see Glaeser, Laibson, and Sacerdote 2002; Esser 2008). A next step that most certainly will be made will be the organization of longitudinal or panel data on the development of networks through time. Analyses of own panel data on the networks of the Dutch in the period between 1999

244 Henk Flap and Beate Völker and 2007, the SSND, show, for example, that networks stay rather stable qua size and composition although there is quite some in- and outflow from personal networks.

Discussion Our sketch of the social capital theory did not provide definitive answers to the question on mechanisms that make personal networks productive. A review of the literature teaches that several mechanisms are important. The main mechanism is instrumental help promoting a person’s interest in some sense. Another mechanism is to cognitively frame the social situation of actors and to define what is in their interest. A third mechanism is a normative one: behavior is steered through norms or agreements enforced by dense social networks. Another critical issue is that proper tests of the investment theory are scarce. This major part of the program is actually not very well established. People choose others who can solve or help with their problems. They probably are not looking for specific others but for others who are capable of solving their problem. If they have a problem at work they look for a friend, but for a type of friend who can help with that specific problem. It is likely that this person is a colleague from the workplace. It is a potentially revolutionizing idea that people choose particular contexts instead of particular persons. If a person has a work-related problem, he wants advice from somebody from the work context (Feld 1984). This thought also provides some explanation for the fact (see above) that over time people seem to reconstruct similar networks qua size and composition although the actual network members change. In addition, it becomes less puzzling that tie characteristics have the largest share in explaining stable and new ties (Busschbach, Flap, and Stokman 1999;Völker and Flap 2008). Experimental research would probably help to depict investment processes (see Riedl and Van Winden 2005). It is hard to tell whether providing help is an act of investment or a repayment for a service rendered earlier. To represent what happens if one actor invests in the other, one can first play a dictator game and let people invest in others and next play a trust game and see whether investments pay out in this game in greater cooperation. There is also new and growing experimental research that explicitly focuses on network formation. Conventional models of exchange or dilemma games between a number of players in a pregiven constant social network are altered by assuming that the players can change their network and add or delete social ties. In economic models of dynamic networks, ties have a utility and their formation has a cost. In subsequent rounds players make choices to delete a tie, which can be done unilaterally, or to form a tie for which both partners have to agree. For more information on experimental work on social networks and social capital, see the contribution by Snijders on social network dynamics in this volume (see also Jackson 2005 for a review of dynamic models of network formation). The focus on macrolevel social capital is important and will have lasting consequences. However, the theoretical elaboration of collective social capital is not really progressing. In addition, there is a discontinuity in research problems studied, in theories and measurements between studies based on the microlevel of existing ties and networks on the one hand and the macrolevel

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of the communitarian, collective dimension of social capital on the other. Understanding the interrelationship between these two dimensions of social capital is a future research problem.

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Social Capital 251 Völker, Beate. 1995. Should Auld Acquaintance Be Forgot . . .? Institutions of Communism, the Transition to Capitalism and Personal Networks: The Case of East Germany. Amsterdam: Thesis. ———. 1999. “Getting Ahead in the GDR.” Acta Sociologica 43: 17–34. ———. 2001. “Weak Ties as a Liability: The Case of East Germany.” Rationality and Society 13: 397–428. ———. 2007. “Feinde am Arbeitsplatz.” In Die Analyse von Gesellschaften, Organisationen und Individuen in ihrem Zusammenhang. Theoretisch und methodische Herausforderungen, edited by H. Hummell, 133–55. Bonn: Gesis—IZ Sozialwissenschaften. ———. 2008. “Reproduction of Inequality in the Netherlands through the Creation of and Returns to Social Capital?” Paper presented at the International Social Capital Conference Academia Sinica, Taipei, Taiwán May 29–30. Völker, Beate, and Henk Flap 1997. “The Comrade’s Belief: Intended and Unintended Consequences of Communism for Neighbourhood Relations in the Former GDR.” European Sociological Review 13: 241–65. Völker, Beate, Henk Flap, and Gerald Mollenhorst. 2009. “Changing Places: The Influence of Meeting Places on Recruiting Friends.” In Contexts of Social Capital: Social Networks in Communities, Markets and Organizations, edited by Ray-May Hsung, Nan Lin, and Ronald Breiger, 28–48. Oxford: Routledge. Völker, Beate, Gerald Mollenhorst, and Henk Flap. 2008. “Core Discussion Networks of the Dutch ‘Ten Years After.’” Unpublished paper. Völker, Beate, Fenne Pinkster, and Henk Flap. 2008. “Inequality in Social Capital? Differences in Networks and Social Capital between Ethnic Minorities and the Dutch in the Netherlands.” In Special Issue of Kölner Zeitschrift für Soziologie und Sozialpsychologie, edited by F. Kalter, 325–50. Wasserman, Stanley, and Kathy Faust. 1995. Social Network Analysis: Methods and Applications. Cambridge: Cambridge University Press. Watkins, John W. N. 1957. “Between Analytical and Empirical Statements.” Philosophy 33: 112–31. Wellman, Barry, Peter Carrington, and Alan Hall. 1988. “Networks as Personal Communities.” In Social Structures: A Network Approach, edited by Barry Wellman and Steven Berkowitz, 130–84. Cambridge: Cambridge University Press. Western, Bruce, and Sara McLanahan. 2000. “Fathers behind Bars: The Impact of Incarceration on Family Formation.” In Families, Crime and Criminal Justice: Contemporary Perspectives in Family Research. Vol. 2, edited by Greer Litton Fox and Michael L. Benson, 309–24. New York: Elsevier Science. Wöhler, Thomas, and Thomas Hinz. 2007. “Egozentrierte Diskussionsnetzwerke in den USA und Deutschland.” In Sozialkapital. Grundlagen und Anwendungen, edited by Axel Franzen and Markus Freitag, 91–112. Wiesbaden:Verlag für Sozialwissenschaften.

chapter

Network Dynamics

7

tom a. b. snijders

Introduction The scientific interest in social networks arose in the early twentieth century, and grew in the second half of that century, in the first place because the networks in which individuals are embedded have important effects on their behavior, performance, and general well-being.This history is described vividly by Freeman (2004). In most of these studies, networks were taken as a given. Interest turned in the last two decades of the century toward the explanation of networks using, for example, theories of social capital or social resources.These developments examined the consequence, logical within theories of purposive actors, of the proposition that benefits and harm can accrue to social actors from their network position: social actors will attempt to obtain beneficial network positions. Studies of social capital seek to analyze and explain in detail what is beneficial in network positions (Coleman 1990; Burt 1992; Lin, Cook, and Burt 2001; Flap and Völker, this volume). Studies of network dynamics, reviewed in this chapter, seek to model and explain why networks are as they are, in particular how they change. When this explanation is based in part on the importance to actors of the consequences of their network positions, a natural next step is to endogenize not only networks but also actors’ behavior and outcomes. outline This chapter considers networks as relational structures in a given set of social actors, and provides an overview of models and some empirical results for dynamics of social networks, considered in a setting of social actors optimizing a utility function that is based, among other things, on their network embeddedness (excluding purely rule-based models). Some attention is also paid to network equilibrium, this being relevant for network dynamics as a potential final state. The chapter starts with discussing some general properties of networks, and how a rational actor perspective may be helpful to understanding them. This is a background to the rest of the chapter, focusing on models for representing

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networks. It then turns to a discussion of game-theoretic models for network equilibrium and network dynamics.The game-theoretic approach has difficulties in coming to grips with empirical reality; the latter is the purpose of the statistical models treated next. Network dynamics are important especially in studies in which not only the network but also actor properties are endogenized.Therefore, the second part of the chapter discusses models for the joint dynamics of networks and actor characteristics, both in a game-theoretic and in a statistical framework.

Some Empirical Regularities This section considers some well-known strong empirical regularities of social networks, and sketches explanations for these regularities. number of ties The number of ties per actor is usually limited in some sense: social networks are sparse. What is sparse depends on the type of social actor and the type of relation under study. Core discussion networks of individuals, discussed as the set of close important personal relationships of an individual, are usually limited to two to six people; McPherson, Smith-Lovin, and Brashears (2006) found that from 1987 to 2004, the average size of the core discussion network of Americans decreased from 2.6 to 2.1. The core discussion network defines a highly selective relation. At the other extreme of the spectrum of tie strength, the number of acquaintances of individuals (corresponding to the question “How many people do you know?”) is estimated to be usually in the range from 150 to 1,000 (Marsden 2005). In the network defined by the whole world, this seemingly large number still leads to a sparse network. Zheng, Salganik, and Gelman (2006) estimate that the median acquaintance network size is about 610, with 90 percent of the population having between 250 and 1,710 acquaintances. Explanations of limited network sizes are typically based on the resources needed to maintain network ties, of which for sociologists time is a primary example (examples abound; for example, Hallinan 1979), but not for the evolutionary psychologists Stiller and Dunbar (2007). These authors propose that the major reason for limiting our acquaintance networks is the limitation of cognitive capacities, and find that interindividual differences in the number of close relationships can be predicted by intentionality (that is, the capacity to understand the intentions of others) and memory capacity. There can also be strategic arguments for restricting the number of ties. Gulati, Nohria, and Zaheer (2000) discuss “lock-in” in the formation of strategic alliances between firms, defined as exclusion of other partners because of fidelity to an already existing alliance; as these authors say, “Many alliances are explicitly monogamous.” reciprocity There is a tendency to dyadic reciprocation in most directed networks: the existence of the tie i → j makes it more likely that also the tie j → i exists. This was early proposed as a basic feature of social networks by Moreno (1934) and has been studied and confirmed enormously. Social exchange theory (for

254 Tom A. B. Snijders example, Emerson 1972) provides a basic explanation: actors depend on each other for valued outcomes, and benefits will be received from another actor only if they are also given in return. Axelrod (1984) offered a game-theoretic explanation by showing the good performance of the tit-for-tat strategy in the iterated prisoner’s dilemma. Gould (2002) argued that relations are liable to be terminated more rapidly when they are not reciprocated, because keeping a nonreciprocated relation implies status deference. Reciprocity need not be direct but can be indirect—that is, circulate in larger groups; see, for example, Molm, Collett, and Schaefer (2007). However, although mutual dependence and solidarity in larger groups are pervasive in societies, the number of three-cycles in empirically observed directed networks is relatively low (Davis 1970). homophily Many social networks have a tendency toward homophily—that is, actors have a larger probability of being tied to each other if they have similar characteristics. The importance of homophily was noted by Lazarsfeld and Merton (1954), and it has been found to be a strong determinant of network ties in many cases. A review is given by McPherson, Smith-Lovin, and Cook (2001). These authors mention as major explanations of homophily the spatial-geographical organization of social ties, which is closely related to opportunity arguments; the genesis of social ties within families; the role of organizational foci (compare Feld 1982) in creating and maintaining ties; and influence processes between actors who are tied. Based on theories of social capital (Lin 2001) and given the high value of having access to diverse resources, however, the reverse—heterophily—can also be expected. The importance of complementarity for creation of alliances between firms is well known; see Gulati and Gargiulo (1999). As examples, Chung, Singh, and Lee (2000) found evidence for resource complementarity as an explanation of alliance formation between investment banks; Casciaro and Lobo (2008) found that collaboration between individuals occurs more frequently when similarity on demographic variables goes together with complementary specializations. Riolo, Cohen, and Axelrod (2001) present a game-theoretic model of the iterated prisoner’s dilemma type, in which cooperation is higher when actors are similar on a trait that otherwise is arbitrary. They show that this gives a sufficient structural condition for high levels of cooperation, and reciprocity is not required to achieve this. transitivity The existence of the two ties i→j and j → h often makes it more likely that also the tie i → h exists. This is called the tendency toward transitivity or triadic closure.

figure 7.1. Transitive and Intransitive Triads

transitive (closed) triad

intransitive (open) triad

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When social ties are based on being affiliated to the same group (as discussed by Simmel 1908), transitivity is one of the consequences. Thus transitivity follows from homophily and from arguments based on the opportunity to interact (Feld 1981). However, there are other mechanisms that show directly the advantages of, or tendencies toward, triadic closure, without being necessarily linked to common affiliations. Simmel’s teachings (1917) about the fundamental importance of triads, the constellation of relations between three actors, have been expressed in network analysis early on by the focus on triadic structures. Triads were studied systematically by Davis, Holland, and Leinhardt in the late 1960s and during the 1970s; see Davis (1979) and Holland and Leinhardt (1975). Davis (1970) found empirically, in a study based on a collection of a large number of networks of positive interpersonal affect, that transitivity is the main feature that differentiates these data from a pattern of random ties. Similar findings were obtained later in studies of interorganizational linkages—for example, by Gulati and Gargiulo (1999) in a study of strategic alliances between large production companies. Simmel (1917) brought forward the special consequences of triadic embeddedness on bargaining power of the social actors and on the possibilities of conflicts between them.The manifold consequences of triadic embeddedness, and especially the tensions between openness and closure, are basic threads in the modern literature on network analysis. Coleman (1990) stressed the importance of triadic closure for social control, where the third actor, who has information about the behavior and interrelations of the two other actors, has the potential to sanction them in case they behave opportunistically or otherwise violate norms of good behavior. This was confirmed by Gulati (1998) both theoretically and empirically in his review of studies of strategic alliances between firms, where uncertainty about potential partners and risks of opportunistic behavior can be checked by alliances that are transitively embedded. Gulati and Gargiulo (1999) argued that information from third parties, signaling capacity for cooperation, and reputational effects will favor the creation of transitive ties between firms. On the other hand, arguments for the advantages of being in a brokerage position, where an actor has information from two unrelated others, were formulated early by Granovetter (1973) in his study on the strength of weak ties. This was elaborated in studies of the strategic importance of brokerage positions (“structural holes”), and of the potential to exploit the informational and strategic advantages of the broker, by Burt (1992 and further publications). Krackhardt (1999) elaborated the consequences of triadic embeddedness by defining a Simmelian tie as a strong tie between two partners that is combined with strong dyadic ties of both partners with one or more others. He argued that Simmelian ties are more constraining, and are more difficult to break. The contrast between Burt’s and Krackhardt’s theories is most clear in the bow tie structure (see Figure 7.2). Structural hole ideas will lead to the conclusion that actor A is in an advantageous position, being the only linkage between two strongly tied groups: tertius gaudens. Simmelian tie theory, on the other hand, puts forward the idea that actor A has to satisfy the normative constraints of two distinct

256 Tom A. B. Snijders

A

figure 7.2. Bow Tie

groups: the ties that torture.The differences between situations in which network closure or openness of networks is more advantageous for social actors were elaborated, for example, by Ahuja (2000) and Burt (2000). Another argument that can differentiate between closed and open networks is uncertainty and risk aversion. If closed networks are more helpful for uncertainty reduction (Burt and Knez 1995), while open networks give the potential of new opportunities but at a higher risk, then actors who are more risk averse should have a greater tendency to form open networks and explore the new possibilities associated with ties to more distant others. This was hypothesized by Baum et al. (2005), who proposed that firms whose performance deviates from their aspirations—be it positively or negatively— will have a higher propensity to form nonembedded ties. They found this confirmed for syndication ties between investment banks. As a sideline in a paper on network dynamics, Vega-Redondo (2006) presents an interesting game-theoretic result that gives a potential explanation for transitivity. He postulates a model where actors play prisoner’s dilemma with their network partners, where ties are formed and maintained if and only if they are profitable, and where information about behavior of others is shared between actors who are tied. One of the results is that transitivity of ties enhances the conditions for stability of the network, which can be attributed to the strategic foreshadowing of the information sharing. node centrality and network centralization An important issue in social network analysis is the position of nodes, and a primary characterization of this position is the centrality of nodes in the network— a concept capturing the extent to which nodes are connected to other actors, which can be defined in various ways (Freeman 1979; Bonacich 1972, 1987). Many social networks show a fair extent of centralization—that is, differentiation between social actors with respect to their centrality. Centralization of networks can be the result of feedback processes that favor the creation of links to nodes that are already highly connected. Such a model was proposed by Price (1976) for bibliometric networks. Price called this a cumulative advantage model, in the spirit of Merton’s Matthew effect (1968): “Unto him that hath is given and from him that hath not is taken away, even that which he hath.” His model leads to power law distributions for the degrees; these are distributions with heavy tails—that is, relatively high probabilities of a few nodes with very high degrees (“hubs”). For most types of networks between human individuals this does not seem realistic because, as was discussed above, various constraints will limit the occurrence of very high degrees. This model was independently rediscovered, elaborated, and popularized by Barabási and Albert (1999), who called it a

Network Dynamics 257

preferential attachment model and gave many examples of networks—for example, the Internet, for which the distribution of degrees for large degrees is close to a power distribution. Handcock and Jones (2004) give further references about these models and their recurrent rediscoveries. Centralization of a social network reflects social organization and social opportunities. Differentiation of node centrality represents inequality between nodes; for example, centrally located actors will have more resources and greater power; they may also incur higher costs. In studies of collective action, Marwell, Oliver, and Prahl (1988) found that a strongly centralized network is conducive to the potential for collective action in organizer-centered mobilizations. The reason is that the organizers of collective action can selectively contact central actors who, in turn, will have a larger contribution to the collective action and thereby increase the probability that the collective action will be produced. Even if centralization is important for social networks, it is noteworthy that centralization is much larger in physical networks, which often are designed to have “hubs”—that is, highly central nodes—to facilitate flows through the network. Examples are electronic communication networks, air link networks, and so forth. This is indeed one of the differences noted by Newman and Park (2003) between social networks and other networks. connectedness Most social networks, even if they are large, have the property that a large portion of the nodes are connected: for most pairs of nodes it is possible via a chain of ties to traverse the network and, starting from one node, arrive at the other one. A component is defined as a maximal set of nodes that are mutually connected. If the number of nodes in the network is large and the network is sparse—that is, the largest degree is of limited size—then it is not immediately evident that most of the network would be connected; a network can also “fall apart” in a number of disconnected components. A basic property concerning connectedness can be proved mathematically for random networks—that is, networks in which ties occur independently and with the same probability between all pairs of nodes. A famous result of Erdös and Rényi (1960) is the existence of a so-called giant component. This is a set of nodes that are connected and have no further outside connections, and comprise (in the limit as n grows indefinitely) a positive fraction of the set of all nodes. Denoting the number of nodes by n and the average degree by dn, they proved that if n → ∞ and dn tends to a finite limit greater than 1, there will be a giant component, and no more than one, with probability tending to 1. This can be regarded as a mathematical micro-macro result, because on the basis of a trivial model for tie formation—random links—it proves a nontrivial result at the level of the whole network. The existence of a giant component holds also for many networks that do not have the pure randomness of the Erdös-Rényi construction, both in mathematical models and in the empirical world. A beautiful example is the structure of romantic relations illustrated by Figure 7.2 of Bearman, Moody, and Stovel (2004). This is not a random network at all but it does consist of a giant component together with a large number of very small components and isolates. Kogut, Urso, and Walker (2007: fig. 3) demonstrate empirically the genesis of a giant component in the network of venture capital ties between

258 Tom A. B. Snijders firms, where the links are defined as common investments in the same target company. shortness of path length s Another basic empirical observation for social networks has been that geodesic distances, defined as the shortest path lengths in the graph connecting a given node to another node, tend to be relatively small. This was first studied in the experiment of Milgram (1967) and Travers and Milgram (1969), discussed extensively in the literature collected in Kochen (1989), and it has led to the insight that through acquaintance links almost all people in the world are linked by paths of a length of at most 6. Watts and Strogatz (1998) noted that high transitivity by itself will tend to increase geodesic distances, so that—given the tendencies toward transitivity— it is remarkable that many social networks indeed have short geodesic distances. They defined a small world as a network with many nodes, having degrees that are not too high, without dominating nodes—in other words, with a maximum degree much smaller than the number of nodes, having a high tendency toward transitivity (or clustering, as it is also called), and short average path lengths. They wondered about the possibility of proposing a mathematical model that would combine these properties, and proposed such a model in Watts and Strogatz (ibid.) and Watts (1999). The model is defined by placing the n nodes on a circle, first linking each node to the k nearest neighbors, and then reconsidering each link i ↔ j and with some small probability p replacing it by a link from i to a randomly chosen node. They showed that this model indeed produces a small-world network, if the parameters n, k, and p are chosen appropriately. This in itself is not a plausible social network model (compare Robins, Pattison, and Woolcock 2005), but it does give an existence proof of a probability model for networks that has the small-world properties. Many subsequent publications have investigated properties of this model and of slight modifications intended to make it better mathematically tractable. Robins, Pattison, and Woolcock (ibid.) noted that the exponential random graph model, or p* model (Wasserman and Pattison 1996; Robins et al. 2007), a flexible and quite general distribution on the space of graphs and digraphs, can also be specified so that it yields stochastic network models that have the smallworld properties; other parameter choices can yield well-interpretable but quite different types of networks. This opens up the possibility of combining insights into small-world structures with empirical data analysis based on the exponential random graph model. In situations in which networks represent opportunities for communication, flow of resources, transport, and the like, short path lengths have a direct benefit. Indeed one of the most studied game-theoretic specifications of network formation is a model where direct ties are costs, and short distances are benefits; see the utility function (1) discussed below.

Network Games Networks can define opportunities for interaction that are fruitfully modeled as games. Examples are Raub and Weesie (1990) and the theory of network

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exchange (see below). Reviews are given by Goyal (2007) and Jackson (2004, 2008). In the context of this chapter, especially interesting are situations in which the network evolves endogenously because the network determines the payoffs, and the actors (nodes in the network) respond to this. stability and efficiency When discussing network dynamics, it is important to pay attention also to network statics. Stable networks can be reference points in studies of network dynamics, and in idealized situations they can be the structures obtained as limits of a dynamic process. An essential element in optimization of networks is the dyadic nature of ties: two actors are involved. For nondirected networks, a natural assumption often is that the two actors concerned have to agree for a tie to be created (Myerson 1991; Jackson and Wolinsky 1996).This can be formalized as follows. A strategy for actor i is the vector Yip* = (Yip1,..., Yinp ) of proposals (constraining Yiip to be 0, regarding it as a meaningless variable); the realized network Y is the disjunction of the reciprocally proposed ties, defined by Yij = min {Yijp ,Yjip }. The two actors involved have to enter in some kind of negotiation or cooperation process about the creation of the tie. The general concept of a Nash equilibrium is not quite satisfactory for nondirected networks because it does not account for this type of cooperation. An example is provided by the case where ties are formed if and only if both participating actors decide to establish a tie, while utility functions are non-negative, and zero only for isolated actors. Then all actors prefer to be part of a nonempty network. However, the situation in which all actors propose no ties at all is a Nash equilibrium.This defect of the Nash concept for network games has led to the proposal of various stability concepts. equilibrium concepts for network games Jackson and Wolinsky (1996) defined pairwise stability for nondirected networks. Their basic idea is that both actors involved in a tie have to agree for the tie to exist. A network is stable if, for every existing tie, the utility of the network would become smaller or remain equal for both actors when the tie is deleted; and for every nonexisting tie the utility would either remain constant, or become smaller for at least one actor, by creating the tie. The definition of pairwise stability is distinct from the definition of a Nash equilibrium because it involves simultaneous choices by two actors, which are not considered in Nash equilibrium; and the latter also considers changes by a given actor in more than one tie, which is not considered in pairwise stability. The combination is made by Goyal and Joshi (2006) and Gilles et al. (2006). A network is defined to be pairwise Nash (the concept was mentioned by Jackson and Wolinsky 1996, section 5, and Gilles et al. call it strongly pairwise stable) if it is a network corresponding to a Nash equilibrium and also pairwise stable as defined above. Thus, no pair of actors would both prefer to have an additional tie between them, and no single actor would prefer to dissolve a subset of his ties. Buskens and van de Rijt (2008) propose a further strengthening of this equilibrium concept.They define a network to be unilaterally stable if no actor i would strictly gain by changing his ties in such a way that this would entail no utility loss to any of the other actors with whom i establishes a new tie. Bloch

260 Tom A. B. Snijders and Jackson (2006) discussed diverse definitions of equilibrium for networks, focusing on equilibrium concepts where transfers between the players are allowed, and on the relations between these with the preceding concepts. some theoretical results The literature on network formation games is rapidly growing, and here we can give only an outline of a few results. Jackson and Wolinsky (1996) considered utility functions where each tie i ↔ j has a cost cij while the benefit of the existence of a path from i to j is positive but decreases exponentially with the geodesic distance.Thus the utility function for actor i is ui (Y ) = ∑ wij b j ≠i

(

d ij (Y )

− cijYij

)

(1)

where dij(Y) is the geodesic distance (length of the shortest path) between i and j, the wij and cij are positive constants, and b is a constant between 0 and 1. They proved that for such utility functions, the only possible pairwise stable networks are the empty network, the stars (where one actor is connected to all the others, but the others are mutually disconnected), and the complete network; which of these is stable depends on the parameters of the utility function. Since the star is also the most centralized network (see above), this can be related to the empirical occurrence of highly centralized networks. Jackson and Wolinsky went on to study the relation between stability and efficiency for general utility functions, and found essential tensions between these two network properties. A network is efficient if the total payoff to all actors is maximal. For intermediate tie costs, the uniquely efficient structure is the star, where the central actor links all other actors. However, this network is not pairwise stable because the central actor contributes disproportionately to the collective good represented by the efficiency of this network structure. The only pairwise stable network here is the empty network, which, however, is Pareto dominated by other networks. This tension between stability and efficiency, which must be expected to have consequences for network dynamics, as actors may be assumed to be attracted to stability but also to efficiency, was further investigated by, among others, Jackson (2003) and Jackson and van de Nouweland (2005). To give a flavor of their results, let us mention one theorem from the latter paper. The main assumptions are that the payoff function is such that within connected components, every actor gets the same (“componentwise egalitarian allocation”), and the payoff of actors in a connected component is not affected by the ties within other components (“component balance”).The first is a very specific condition (ruling out differential payoffs caused by power differences, for example); the second is reasonable in many situations. Jackson and van de Nouweland proved that under these conditions, the set of efficient networks is the same as the set of pairwise stable networks if and only if the efficient networks also maximize the payoff per individual actor. Note that the latter is not the case if a subset of actors can exclude some of the others and thereby gain a payoff per actor that is, within this subset, higher than the payoff per actor in the efficient network. A loose interpretation of these results is that

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if conflict of interests is high (as in social dilemma situations), efficiency and stability in networks can be contradictory; in situations with less possibility for opportunistic action and with egalitarian payoffs, the combination of efficiency and stability is less problematic. Bala and Goyal (2000) consider directed networks. They study utility functions for actor i that depend only on the number of actors reachable from i (via directed paths in the “one-way flow” case, and via paths where tie direction does not count in the “two-way flow” case), and on the number of outgoing ties of i (the out-degree), in which the number of reachable actors is a benefit and the out-degree is a cost. They find that for the one-way flow, Nash equilibria must be the empty network or a wheel (all nodes circularly connected in one direction without any other ties). For the two-way flow, Nash equilibria are either the empty network or a star. For utilities also depending on geodesic distances the Nash equilibria can also be more complicated networks, called flowers, defined by a central actor who is part of a number of further disconnected wheels. Buskens and van de Rijt (2008) studied nondirected networks with the utility function being defined as the negative of Burt’s constraint measure (1992). This reflects the postulated wish of all the actors in the network to be involved in structural holes. They found that pairwise stable networks must be connected and have all geodesic distances smaller than or equal to 2. A number of further stability results were obtained for multipartite networks (where the actors are divided into several nonempty subsets and there are no ties within subsets) and bipartite networks (where there are two such subsets). empirical results for network formation games There have been a variety of experimental studies in which the utility function is determined by the researcher and supplied to the actors, and the question is investigated to what extent the players empirically converge on equilibria of some kind. Kosfeld (2004) gives a survey. It turns out that for many network games the players do succeed rather well in converging to equilibria, as long as the equilibria do not contradict fairness conditions. Details of the experimental design can have important consequences. Berninghaus, Ehrhart, and Keser (1999) propose to use a continuous-time design instead of the more usual design where games are played in discrete rounds. In the continuous-time implementation, players have opportunities to change their ties at any moment while time is flowing on. This is more realistic and adds fluidity for reaching equilibrium states. In their game, a modification of the game of Bala and Goyal (2000), a periphery-sponsored star is the unique strict Nash equilibrium. Berninghaus, Ehrhart, and Ott (2006), as well as Berninghaus, Ehrhart, Ott, and Vogt (2007), find that in such a game, where the central position is most advantageous, which contradicts an even distribution of payoffs, many groups tried to combine fairness with the Nash equilibrium—for example, by occasionally rotating the central position between the players. Another way to deal with the problems resulting from fairness considerations is to introduce heterogeneity between the actors. Goeree, Riedl, and Ule (2009) conducted experiments in which again the game was a variation of Bala and Goyal (2000), now with actors who differed in their benefit to others or in their costs of tie

262 Tom A. B. Snijders formation. It turned out that introducing one actor with high benefit to others led to star networks, with this actor in the center; that was not the case when introducing one actor with lower tie costs. By estimating actor-dependent parameters for envy and guilt according to the utility function proposed by Fehr and Schmidt (1999), representing inequality aversion (not part of the payoff function supplied to the actors, but implicit in their decisions), Goeree, Riedl, and Ule explained this result from the fact that the envy parameters tended to be sufficiently high that the actors operated (“subjectively”) with a utility function in which the star network was a strict Nash equilibrium. Burger and Buskens (2009) studied network formation in small groups while differentiating between a competitive and a cooperative context. They found that in the cooperative context networks tended to be created with a high extent of transitivity, whereas in the competitive context, where it is advantageous to be in the center, the players did not permit each other to occupy the central position.

Statistical Models To empirically test theories of network dynamics it is important to have tractable models for statistical inference for network data, but the interdependence of network ties has long been an obstacle to their development. This section presents such models that have been constructed explicitly on the basis of rational action models. An interesting statistical model for network dynamics was used by Gulati and Gargiulo (1999) in their study of strategic alliances in three production industries over a twenty-year period. Their data was collected on a yearly basis, and for the creation of an alliance Yijt between organizations i and j in year t they used a random effects probit model, P{Yijt = 1} = Φ(α′ xij + β′ zij(t – 1) + uij)

(2)

where xij is a vector of time-constant characteristics of organizations i and j, zij(t – 1) is a vector of changing characteristics of these organizations as measured for the preceding year, uij is a random effect capturing unexplained nonchanging characteristics of the pair (i, j), and Φ is the cumulative distribution function of the standard normal distribution. The changing characteristics of the pair (i, j) included measures of network embeddedness, such as past alliance history, centrality, and transitivity-related measures. This model is quite flexible. Limitations of this approach, as discussed by Gulati and Gargiulo (ibid.: 1483), are the lack of representing the dependence between decisions by any given actor (except by the included covariates), and the lag of one year in taking account of the changing covariates zij. actor-based statistical models An approach to network dynamics that is based on modeling the choices made by the actors in the network was proposed by Snijders (1996, 2001). It was noted in Snijders (1996) that the usual approach to theory testing in the social sciences is to deduce implications from the theory with the boundary conditions, and then test these empirically using statistical models that have no

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particular connection to the theory being tested; and that it can be preferable to use a statistical model that is itself a direct formulation of the theoretical model. This aligns well with studying revealed preferences, because such models allow estimating parameters in preference or utility functions. A traditional example of such an approach is McFadden’s model (1973) of choice among a set of discrete alternatives. Integrating theoretical and statistical models is fruitful especially for studying network dynamics, because traditional statistical models have difficulties representing theoretically plausible dependencies by suitable stochastic dependence conditions.This leads to actor-oriented statistical models for network dynamics, in which the ties are controlled in some way by the nodes representing the social actors. This model (Snijders 1996, 2001) is composed of a stochastic process model for the evolution of a network on a given set of nodes, where ties can be created and terminated, and defined with a continuous time parameter. It can be used for the case that the network data consists of a sequence (“panel”) of two or more successively observed networks, but also if a continuous record of changes in network ties are available. The following ingredients are used to specify the model. • The control of actors over part of the network. The control is specified in line with the game-theoretic models discussed above. For directed networks, a natural assumption is that actors control their outgoing ties. For nondirected networks, a natural assumption is that ties are formed only if both corresponding actors agree with the existence of the tie, and some kind of negotiation process has to take place to decide upon creation of ties. • The actions that the actors can choose, and the time schedule for doing so. In the case of sequential network experiments, the actions permitted and their timing are defined by the experimental design. When the game is played in rounds where each player can select new a collection of ties at each round (for example, Callander and Plott 2005), it is natural to use a discrete time parameter t and allow the actors in the mathematical model to make the same changes as the actors in the experiment. When the game is played in quasi-continuous time (for example, Berninghaus, Ehrhart, and Keser 1999), it is natural to use a model with a continuous time parameter and to allow only one change in a tie at any given (“infinitesimal”) moment. Holland and Leinhardt (1977) proposed using a continuous time parameter also for networks observed repeatedly outside the laboratory according to a panel design.The arguments are the theoretical plausibility of allowing network changes in continuous time (compare Berninghaus, Ehrhart, and Keser 1999; and Berninghaus, Ehrhart, and Ott 2006) and the greater simplicity that is possible when using continuous-time models (already argued by Coleman 1964). Such a continuous-time model for observations in a panel design implies that there will be a sequence of unobserved changes between each pair of consecutive observations. In a model with a continuous time parameter, and in models with fixed rounds where only one or some pairs of actors meet in any round, it has to be

264 Tom A. B. Snijders specified which actors, or pairs of actors, change their ties at given moments. For example, in Watts (2001), at each round one pair of actors is randomly chosen to redefine their tie. When the salience of the network is different for different actors, it may be plausible that actors for whom the network has a higher salience will also have, or take, more frequent opportunities for changing their ties. Next to differential salience, there may be differential meeting opportunities; compare Verbrugge (1977); Feld (1981); and Pattison and Robins (2002). Holland and Leinhardt (1977) further proposed to allow no more than one tie change at any time point. This decomposes the change model into its smallest constituents and excludes coordination between actors. • The utility or preference functions of actors, ui(Y). To have a flexible specification of models, allowing to estimate the weights of several mechanisms or influences simultaneously, a linear combination of several components can be employed, ui(Y) = ∑k βk sik(Y)

(3)

The utility function (1) mentioned above combines a cost (negative β1) for si1 defined as the number of links of actor i and a benefit (positive β2) from si2 defined as a function of short geodesic distances to other nodes. More generally, any functions sik(Y) representing the network position and network neighborhood of actor i can be chosen to express the theories investigated, along with alternative mechanisms and known dependencies between ties (reciprocity, homophily, transitivity, and so forth), while their weights βk can be treated as statistical parameters whose values are estimated from the data. • The information available to each actor. A simple first-order approximation is to assume that each actor has full information about the entire network. In large networks this may not be a reasonable assumption. Actors will not know about all the ties, and they may even have a limited knowledge about the composition of the network. The perception of network ties is known to be more precise for the part of the network that is close to the focal actor (Kumbasar, Romney, and Batchelder 1994). Here the concept of a social setting (Pattison and Robins 2002) can be useful to circumscribe the knowledge available to actors, depending on their social, institutional, and geographical environment. • The type of optimization performed by the actors. Full strategic rationality does not seem to be a very realistic option, as it may be too hard even for the modeler. Myopic optimization is an alternative, where actors, when they have the opportunity to change a tie, use a myopic best response strategy: they choose a best change given the rest of the network existing at the current moment. Such models were proposed for network dynamics, for example, by Snijders (1996); Bala and Goyal (2000); and Watts (2001). • The role of probability, or randomness.

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As in other statistical models, randomness has to be included to account for deviations between what is actually observed and the best choices that actors would have had, according to the model. A tradition in game theory is to model deviations by “trembles” (for example, Jackson and Watts 2002; Goyal and VegaRedondo 2005), where actors choose either a best action or, with some small probability, a random other action. The econometric modeling tradition is to model these deviations by random utility components (McFadden 1973), where actors optimize their utility function to which independent random components are added. This yields models where the probability of choices is an increasing function of their utility, which seems more reasonable for statistical modeling than the use of trembles. • Lack of antisymmetry between creation and termination of ties. For nondirected networks, Jackson and Wolinsky (1996) already made clear the difference that creation of a tie will require consent of both involved actors, whereas for breaking the tie it will be sufficient for one of the actors to discontinue the tie. Another deviation from antisymmetry is that breaking an existing tie may yield a difference in the utility function that is not equal to the negative of the difference obtained from creating that tie, even if the remainder of the network is exactly the same. As an example, the cost of terminating a reciprocal friendship tie might be greater than the gain in creating such a tie— one could say that the existence of a reciprocated tie gives a reward without cost; this is argued by van de Bunt, van Duijn, and Snijders (1999). This is similar to the endowment effect in microeconomics (Thaler 1980), defined as the difference between selling prices and buying prices, and related to loss aversion and framing as discussed, for example, by Kahneman, Knetsch, and Thaler (1991) and Lindenberg (1993). Using these ingredients, actor-based models for network dynamics were proposed by Snijders (1996) for networks defined by rankings and Snijders (2001) for networks defined by digraphs. These methods were applied, for example, in studies of friendship formation (van de Bunt, van Duijn, and Snijders 1999; van Duijn et al. 2003; Schaefer, Kornienko, and Fox 2011), dynamics of work-related trust (van de Bunt, Wittek, and de Klepper 2005), and job mobility of managers in venture capital firms (Checkley and Steglich 2007). An overview is in Snijders, van de Bunt, and Steglich (2010).

Network Structures and Utility Arguments After this review of utility-based models for networks, let us briefly consider the type of utilities that have been postulated. First we consider theoretical work, subsequently some empirical work. Much work in game theory models for network formation is based on the connections model (Jackson and Wolinsky 1996), which assumes that there is a cost to ties and a benefit to indirect connections, leading to a weighted sum of the number of indirect connections (as the benefit) and the degree (as the cost) as the utility function for an actor, as in (1). This utility function can be compounded by spatial considerations (for example, Johnson and Gilles 2000; Jackson 2008). Experimental studies of these games have mostly used the same

266 Tom A. B. Snijders utility functions as the theoretically proposed ones. An interesting exception is Goeree, Riedl, and Ule (2009), who in their empirical analysis added to the utility function components for envy and guilt as proposed by Fehr and Schmidt (1999). In the coauthorship model of Jackson and Wolinsky (1996), ties are nondirected, and each tie is interpreted as a collaboration project between the two actors. Actors have a given amount of time that they distribute over their projects, so that actor i devotes 1/yi+ to each collaborative project, where yi+ is the degree of this actor. The utility function for actor i is 1 + ∑ yij j

( y1

j+

+ y1y i+ j+

)

figure 7.3. Utility Function

where the interpretation is that the term 1 is the result of the efforts of the actor on her own projects, and each collaborating actor j provides the fruit of her activities 1/yj+ to which is added a synergy reward 1/(yi+yj+). Thus, if i and j collaborate, then the collaboration of j with third parties is a negative externality for i as it diminishes the time that j spends on the collaboration with i. Jackson and Wolinsky examined stability and efficiency for this game. The implication of the value of structural holes (Burt 1992) for network formation was elaborated by Goyal and Vega-Redondo (2007), Kleinberg et al. (2008), and Buskens and van de Rijt (2008). The first of these papers used a utility function for actor i that depends on the number of times that i is necessary for linking any pair of two other actors, and the number of others with whom i shares this strategic position. The second does something similar, considering only shortest paths of length two. The third uses Burt’s constraint measure (1992) as a utility function, which, however, leads to a study of brokering without considering the parties who are to be brokered. Belleflamme and Bloch (2004) and Goyal and Joshi (2006) consider a model for free trade agreements in which the utility for actor i is a function that increases in its own degree and decreases in the degrees of those to whom i has a tie. The models of Price (1976) and Barabási and Albert (1999), although only implicitly utility-based, come close to using utility functions that depend increasingly on the degrees of those to whom the focal actor is tied. Such models are also analyzed in Jackson and Rogers (2007, section V). Now let us turn to empirical work. For studies of interfirm alliances, rationality arguments are quite natural (Gulati, Nohria, and Zaheer 2000). Evidently, for commercial firms the final utility function is profit, or expected future profits. In practice, cognitive limitations imply that network formation is driven by more proximate goals. Gulati, Nohria, and Zaheer mention endogenous constraints such as the costs implied by ties, which limit the number of ties that actors can sustain; and alliance loyalty, which leads to the exclusion of ties to competitors of one’s allies.They also argue that competition can move from the firm level to the level of multiparty alliances (clusters) of firms, while internally these multiparty alliances are characterized by a combination of aligned and opposed interests. Stuart and Sorensen (2007) discuss the fact that the utility functions used

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in the economic game-theoretic literature do not correspond well to the mechanisms in the entrepreneurship literature. They suggest mechanisms leading as components in utility function to resource complimentarity; access to diverse information; homophily (explainable, for example, as compatibility of procedures and culture, both conducive to collaboration); and transitive embeddedness (conducive to trust, sanctioning potential, and reputation). For friendship networks, utility-based approaches were proposed, for example, by Zeggelink (1995), Stokman and Zeggelink (1996), van de Bunt, van Duijn, and Snijders (1999), van Duijn et al. (2003), and Jackson and Rogers (2007).Van de Bunt, van Duijn, and Snijders proposed an explicit list of utility arguments, including the need to have friends; the desire to affiliate with popular others, where popularity is measured by indegree and regarded as a reflection of status (formally similar to the consideration of the Matthew effect by Price 1976); the preference for proximate and similar others; balance (friends who make the same friendship choices as oneself; Heider 1958; this is quite close to transitivity); reciprocity; and aversion to loss of the investments accumulated in a reciprocal friendship.Van Duijn et al. (2003) differentiated between similarity on visible and invisible characteristics, and hypothesized that the former would be more important in early stages of the friendship formation process, and the latter in later stages. Stokman and Zeggelink (1996) distinguished between attributes leading to homophily (where a similar value is preferred), aspiration (where an ideal value is preferred), and complementarity (heterophily). Mayer and Puller (2008), elaborating a model proposed by Jackson and Rogers (2007), use a very restricted utility function determined by homophily only.

Coevolution of Networks and Behavior If individual outcomes are influenced by individual behavior as well as by network position, actors will attempt to choose their behavior as well as their ties so as to improve their outcomes. This leads to dynamic models in which individual behavior as well as networks are endogenous. If we regard the individual behavior as a representation of the microlevel, and the network as the social context defining the macrolevel, then such models are integrated micro-macro models (Wippler and Lindenberg 1987)—although one might also call them micro-meso. empirical research Questions about the interdependent dynamics of networks and individual outcomes are studied in a variety of fields. In the broad domain of adolescent development, for example, Ennett and Bauman (1994) studied influence of friends on smoking behavior, Haynie (2001) effects of friends on delinquency, and Dijkstra et al. (2010) influence of friends on weapon carrying. The general observation here is that friends tend to be similar; and that this might be due to mutual influence between friends, to preferential selection of friends who are similar on salient characteristics, or to friends being subject to similar contextual influences. A central question then is which of these three types of processes is the major determinant of the observed similarity between friends. It may be noted that the term “homophily” sometimes is used for the

268 Tom A. B. Snijders descriptive phenomenon of similarity between tied actors, and sometimes more specifically for the preferential choice of similar network partners. When discussing simultaneous evolution of networks and individual outcomes, usually the more restrictive definition is used, so that homophilous selection is contrasted with influence between network partners. The descriptive phenomenon is referred to as network autocorrelation (Doreian 1989)—that is, the correlation of outcomes between those who are tied in the network. In alliances between firms, the explicit purpose of creating ties is to improve the firm’s competitiveness, and therefore in this domain the dynamic interdependence between network ties and firm success is a natural point of view, and argued for by Gulati, Nohria and Zaheer (2000). They mention the example (Gomes-Casseres 1997) of alliances between minicomputer industries in the 1980s, where each cluster of alliances developed its own standards, and where the competitive dynamics became a competition at the level of alliances and between the standards. Alliance formation here was intimately linked to the commercial success of the standard, and thereby, of the firms. Stuart and Sorensen (2008) argue that the expected effects of network positions on firm success, and the strategic behavior of entrepreneurs, imply that network formation is endogenous, and discuss the resulting difficulties for the empirical identification of network effects. In the next three sections, a variety of models will be discussed that have been put forward for the coevolution of a network and an actor-level variable. This literature is rapidly expanding, and we can only indicate the issues being studied without attempting to be even close to complete.

Homophily Coevolution Models Several coevolution models have recently been proposed where actors prefer to be tied to similar others, and can change their ties as well as their behavior. Macy, Kitts, Flache, and Benard (2003) consider a model with actors situated in a nondirected valued network and having a binary behavior variable. The tie values as well as the behavior are updated in a way favoring homophily: behavior is influenced toward the weighted average of the behavior of the network neighbors, and tie values tend to become stronger between similar actors and weaker (or stronger negative) between dissimilar actors. This can be regarded as a balance model (Heider 1958). Simulations show that the dynamics are most likely to lead to polarization between two antagonistic camps, but under some parameter combinations it is possible to converge to pluralistic alignments. Holme and Newman (2006) study a model of a nondirected network where behavior of actors is a categorical attribute. At each discrete time step a random nonisolated actor is selected, and with some probability an edge of this actor is moved to connect to another actor with the same behavior, and else (with the complementary probability) the actor’s behavior is changed to the behavior of a randomly selected tied actor. This model leads to a situation of isolated groups of actors having homogenous behavior, and Holme and Newman study by simulation how this limiting situation is approached depending on various parameters.

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Ehrhardt, Marsili, and Vega-Redondo (2007) study the coevolution of a nondirected network and similarity between actors in continuous time. The similarity between actors i and j is denoted by dij. For nontied pairs of actors at a distance dij ≤ d0, new ties are randomly formed at a rate of 1 per unit of time; for actors at a larger distance, new ties are randomly formed at a rate % much lower than 1; existing ties are dissolved randomly at a rate λ. Three different specifications of the distance are considered. In the first, it is the geodesic distance—thus the model represents a tendency to cohesion and transitive closure. In the second specification the actors have one categorical attribute, and they form ties only to those having the same value for the attribute. In the third model the actors have a real-valued attribute that changes in a diffusion model with a preferred direction toward their network partners. Each actor changes his attribute at a rate ν where values held by a larger number of neighbors have higher probabilities. It is assumed that ν is very large, such that the conditional distribution of attributes, given the network, may be assumed to be in stochastic equilibrium. These three types of distance-dependent coevolution all represent that ties are formed preferentially with similar actors (as defined by the distance), and also that distance tends to be, or to become, small between tied actors. In all three models there is a stable state consisting of networks with cohesive subgroups of actors with high similarity that can be regarded as networks with coordination. In addition, contrasting with the model of Holme and Newman (2006), there is a stable state consisting of a sparse network with low similarity between network partners.

Game-Theoretic Coevolution Models An interesting class of coevolution models is those in which behavior includes the strategy played in games between the actors. Most published models are about models of nondirected networks where, in each round, actors may play social dilemma (cooperation—defection) games with all their network neighbors, and where in any round of the game each actor follows the same strategy in all games played; or where the actors play coordination games, following the same setup. cooperation Skyrms and Pemantle (2000: 9340) give the following sketch to describe the simultaneous evolution of strategy and social network they are studying. “Individual agents begin to interact at random. The interactions are modeled as games. The game payoffs determine which interactions are reinforced, and the social network structure emerges as a consequence of the dynamics of the agents’ learning behavior.” Specifically, they study schemes for network dynamics where there is a propensity matrix with elements wij, and repeated realizations of stochastic networks, regarded as encounters. Time progresses in discrete rounds and at every round the probability of an encounter i→j depends on wij compared with wik for k ≠ j. When an encounter takes place the two partners play a game that yields a payoff to each of them, and the propensities wij are updated as a result of the payoffs. Individuals follow the same strategies

270 Tom A. B. Snijders in all their encounters in a given round; they may change strategies between rounds, subject to inertia. The individual variables are the strategies followed and the accumulated payoffs; the network variables are the propensity matrix and the realized encounters. Updating rules for the propensity matrix either depend only on who encounters whom (that is, with trivially defined payoffs), or are defined by the result of a coordination game played in each encounter; with varying rules of reciprocity, noise, and discounting of the past. Bonacich and Liggett (2003) study a similar model for the case of updating based on encounters only. Skyrms and Pemantle (2000) show that the propensity matrix tends to a structure where interaction is concentrated in small groups following a coordinated strategy. In the case of the coordination game, the probability to reach the payoff dominant (that is, socially efficient) strategy depends on the degree of inertia in updating strategies—less inertia leads to more easily achieving the efficient strategy. Eguìluz, Zimmerman, Cela-Conde, and San Miguel (2005) study the coevolution of ties and individual strategies in a network of actors playing cooperation games. Time proceeds in discrete steps, and at each step each actor plays prisoner’s dilemma games with all his network partners; as in Skyrms and Pemantle (2000), each actor follows one behavior (cooperation, C, or defection, D) toward all partners, but this behavior may change freely from step to step. The strategies are assumed to be chosen according to “replicator dynamics,” where the actor adopts the behavior of that actor in his personal network (including himself) who obtained the highest payoff in the preceding step. If the actor adopts the behavior of a defecting partner, with some probability she replaces this partner by a randomly chosen other actor. This process determining interaction partners is simpler than that of Skyrms and Pemantle (2000) in the sense of assuming less information and less calculation by the actors. Stable states of the network turn out to be states in which actors can be distinguished in three classes: leaders, who are cooperators and have the highest payoff in their personal network; conformists, who are cooperators not having the highest payoff in their personal network but who imitate another cooperator; and exploiters, who are defectors who have a higher payoff than the cooperators in their personal network. The stable networks are necessarily trees. It is clear that a model in which strategies are prescribed yields less insight than one in which strategies emerge from the analysis. Vega-Redondo (2006) studies a population of actors connected by a network, where connected actors play prisoner’s dilemma games.The payoff structures in the PD games differ across dyads, and change randomly with some frequency (“payoff volatility”). The network specifies who plays with whom and also determines transmission of information about behavior. Specifically, at each step in the sequential process, all linked pairs of actors share the information they have acquired concerning the behavior of any other; evidently, they have direct information about those who played with them in a dyad. This information sharing has an impact on the set of pairwise stable networks, enlarging this set compared with the situation where there would be no sharing of information. The network changes by a random choice of one player i who may change one tie. The player either carries out a search for the best change within her own component; or is confronted with a randomly chosen other player from the

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whole population. Whether the tie change is made depends on the collection of dyadic payoff structures, in which player i chooses the partner with the most advantageous payoffs. Links that do not give a profit to both partners are removed. The main result is that when payoff volatility increases, the network becomes less dense (links become nonprofitable more frequently) but also more “cohesive”; one could say that the transitivity becomes stronger, although the measure used for cohesiveness is not precisely a transitivity measure. Also the size of the giant component decreases. Santos, Pacheco, and Lenaerts (2006) study a model in which actors can play social dilemma games with their network neighbors, being a cooperator or a defector in all their games played in a given round. Actors try to be connected to cooperators rather than to defectors. A random actor i is selected and a random network neighbor j of this actor. They play the social dilemma game with all their neighbors and compare their total payoffs from the games in the current round. The round can lead to a network change with probability p and to a behavior change with probability 1 – p. In case of a network change, if actor j is a defector, then actor i will attempt to switch the tie i ↔ j to a tie linking i with one of the other neighbors of j. In case of a behavior change, j will attempt to influence i to adopt the same behavior as j. In both cases, the probability that the attempt is successful depends on the difference between i’s and j’s total payoff in the games they played in this round. They find that if the probability p is high enough, cooperation will eventually dominate. Takács, Janky, and Flache (2008) study the joint equilibrium states of partner choices in a network and contributions to a collective good. They obtained results where, because of the network structure and the assumption of behavioral confirmation by network partners who have the same contribution behavior, it is possible to obtain stable situations in which a fraction between 0 and 1 of the population contributes, and where contributors and noncontributors are linked to each other. coordination Goyal and Vega-Redondo (2005) study a model where actors can unilaterally establish ties to others; ties are costly; and actors play 2×2 coordination games with their network partners, where at any moment their behavior is the same toward all their interaction partners. The game is symmetric and is defined such that one option is efficient and the other is risk-dominant. All payoffs are positive, so that there is no reason to refuse any offered ties. At each time step actors have a certain probability of being allowed to revise their ties and their behavior; when this happens, they choose myopic best-response strategies. In addition, there is a small probability that the actor chooses a random strategy; stable strategies are studied that are obtained as this probability tends to 0. The Nash equilibria are either the empty network where nobody plays; or the complete network (that is, all pairs of actors play with each other) where everybody has the same behavior; or two disconnected internally complete subnetworks, each of which has a homogeneous behavior different from that of the other subnetwork. It turns out that if costs of ties are high, actors will eventually coordinate on the efficient behavior option; if costs of links are low, they will coordinate on the risk-dominant behavior.

272 Tom A. B. Snijders Buskens, Corten, and Weesie (2008) study the conditions under which a group of actors, playing coordination games with those to whom they are tied, and having the possibility of changing their ties, polarize into opposite “camps.” They also study what influences the extent to which the socially efficient solution is reached. These conditions are described in terms of the initial network structure. They find that initially denser networks lead to more homogeneous behavior, while initially less dense and more segregated networks lead to more heterogeneous behavior. The final proportion of choices for the efficient solution depends on the initial proportion; this lock-in effect is much stronger in initially dense than in initially sparse networks.

Statistical Coevolution Models Statistical actor-oriented models for the coevolution of networks and behavior were proposed by Snijders, Steglich, and Schweinberger (2007) and Steglich, Snijders, and Pearson (2010), extending the actor-oriented models for network dynamics discussed above. The actors control their outgoing ties as well as their behavior, and in a continuous-time model network and behavior change in mutual dependence.To decompose the model in the smallest possible steps, it is assumed that at any moment where a change occurs, this can be a change by only one actor in either one outgoing tie or in one behavior variable. As in the stochastic actor-oriented models for network dynamics only, the actions result from myopic optimization of a stochastically perturbed utility function.What is called a utility function here must be regarded as a resultant of costs, benefits, and constraints, and these will depend on a mixture of distant and more nearby goals as well as practical considerations. Since statistical modeling requires the flexibility to adapt the model to fit well to the data, this leads to the desirability of employing potentially different utility functions for network choices and behavior choices. One way of arguing this is by regarding network choice and behavior choice as being determined by different decision frames (Lindenberg 2001, this volume).The fact that network change is codetermined by behavior is called behavior-dependent selection (or selection briefly), represented by letting the utility function for the network depend also on the behavior of the focal actor and the interaction partners. Similarly, the change probabilities for behavior, defined by the utility function for the behavior, can depend also on the current state of the network as well as the behavior—for example, the behavior of the interaction partners—and this will be called influence. This terminology was also used, for example, by Ennett and Bauman (1994). This yields models in which the preference for being tied to similar others can be expressed in the utility function for the network as well as the utility function for behavior. Given longitudinal data, the model can be used for testing whether observed similarity between network neighbors can be attributed to influence (the behavior dynamics), selection (the network dynamics), or both. Some examples are given in Steglich, Snijders, and Pearson (2010) and Dijkstra et al. (2010) to friendship networks between adolescents and behaviors such as smoking, drinking, and delinquency; by Agneessens and Wittek (2008) to interemployee relations and well-being; by Berardo and Scholz (2010) to

Network Dynamics 273

collective action dilemmas in policy networks; and by Lewis, Gonzalez, and Kaufman (2012) to cultural tastes and online friendships.

Outlook Social networks have long been studied because of their effects on behavior, well-being, and performance of social actors. Research on the endogenous formation of social networks has come up more recently, with a number of important papers in the 1990s and a flurry of activity since the turn of the millenium. In addition to models of optimizing actors as treated in this chapter, there have been closely related and very interesting developments in agentbased models and models inspired by statistical mechanics, of which reviews may be found in Gross and Blasius (2008), Jackson (2008), Newman (2003), and Vriend (2006). In all these models one can distinguish between agent-based or computational models, game-theoretic models, and statistical models. The boundary lines are blurry, as the myopic best-response models in game theory as well as the actor-based statistical models are fundamentally of the same type as agent-based models. The differences often are in the details, and in the tradition and focus of research. Game-theoretic models mostly have the aim of studying stability and efficiency.To keep the analysis tractable and make possible obtaining explicit analytical results, such models are restricted to including only a small number of cost and benefit terms in the utility function. Agent-based models usually have the purpose of studying how global properties emerge from local rules of behavior, often with a special interest in phase transitions— that is, discontinuities in global properties as a function of the parameters of the model. Statistical models have the purpose of being used in data analysis, which requires flexibility in incorporating a large number of utility components, together with principled methods of parameter estimation and hypothesis testing. These diverse strands in the literature are not well integrated and are mostly oriented toward different disciplinary or subdisciplinary audiences. Much still is to be gained from more linkages between these literatures. The empirical study of network dynamics, and of the dynamic interdependence of networks and individual behavior, is only just beginning, as is argued, for example, by Stuart and Sorensen (2008). Especially for the more detailed investigation of the mutual dependence between networks and individual outcomes, theoretical arguments as well as data analysis methods have to be further elaborated. The collection of longitudinal network data is a painstaking process, and for generalizing across networks it is necessary to collect such data for multiple networks (Snijders and Baerveldt 2003), posing even stronger requirements.The insights into micro-macro processes that will be generated by such developments are ample reasons for making these efforts.

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Rational Choice Research in Criminology: A Multi-Level Framework

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ross l. matsueda

Introduction A challenging puzzle for rational choice theory concerns the causes and control of criminal behavior. Crime is a difficult case for rational choice. Compared with market behavior, financial decisions, and corporate crime, in which institutionalized norms frame decision-making in the terms of rationality, street crimes are often characterized as irrational and suboptimal. Street criminals are commonly portrayed by the media and a few social scientists as impulsive, unthinking, and uneducated, and their behaviors as beyond the reach of formal sanctions (for example, Gottfredson and Hirschi 1990). Consequently, support of rational choice principles for criminal behavior would provide strong evidence for the perspective (Matsueda, Kreager, and Huizinga 2006). Crime is an important arena for investigating rational choice for another reason: utilitarian principles, and their accompanying psychological assumptions, undergird our legal institution (for example, Maestro 1973). This connection is rooted in writings of members of the classical school, particularly Jeremy Bentham and Caesare Beccaria. Bentham (1948 [1789]) argued that happiness is a composite of maximum pleasure and minimum pain, and that the utilitarian principle—the greatest happiness for the greatest number—underlies morals and legislation. Punishment by the state constitutes one of four sanctions—political, moral, physical, and religious—that shape pleasures and pains. Influenced by the moral philosophers of the Enlightenment, Beccaria (1963 [1764]) assumed that criminal laws reflect the terms of a social contract between members of society and the state. Individuals receive protection of their rights to personal welfare and private property in exchange for relinquishing the freedom to violate the rights of others. The rights of individuals are protected by the state through deterrence, threatening potential transgressors with just enough punishment to outweigh the pleasures of crime. With his writings, Beccaria attempted to reform the unjust and brutal legal system of eighteenth-century Europe by developing a rational system in which laws are specified clearly and a priori (so individuals have full information about the consequences of their acts), judicial

284 Ross L. Matsueda discretion is eliminated (so all citizens are equal in the eyes of the law), and punishments are made certain, swift, and no more severe than needed to deter the public from crime (Matsueda, Kreager, and Huizinga 2006). Because of the obvious implications for public policy, theory and research on rational choice and crime have focused primarily on the question of deterrence: Does the threat of punishment by the state deter citizens from crime (see Zimring and Hawkins 1973)? Recent research concludes that the threat of formal sanction does deter, but that the effects are modest in size and perhaps conditioned by social context (for example, ibid.; Nagin 1998). Less research has moved beyond deterrence to examine incentives outside the scope of formal punishment, such as psychic rewards and costs, within a rational choice theory of crime. This modest but growing literature has underscored the importance of rational choice theory for understanding and explaining criminal behavior (for example, Clarke and Cornish 1985; Cornish and Clarke 1986). At this time, rational choice remains an important but still minority position in criminology. This is partly because of the historical dominance of sociologists in criminology, many of whom continue to take a jaundiced view of rational choice theory. Such views are holdovers of old sociological debates that persist today, such as free will versus determinism, macro- versus microexplanations, and liberal political views versus conservative individualist ideologies. Skepticism over rational choice theories of crime has diminished recently as neoclassically trained economists and rational choice sociologists have increasingly turned their attention to the problem of crime. But, with a few notable exceptions, particularly in the policy realm, economic research has not been well integrated into the mainstream of criminological thought. At the same time, during the last decade, criminologists have made substantial theoretical and empirical advances in uncovering important causes of crime. Most of this research is rooted in sociological perspectives. For example, research has underscored the importance of life course transitions—such as developing a committed marriage, serving in the military, becoming a mother, and successfully entering the labor force—in altering trajectories of criminal offending (for example, Sampson and Laub 1993; Giordano, Cernkovich, and Rudolph 2002). Research has found that incarceration of residents undermines the strength of local communities, and that re-entry of felons into communities may also have negative consequences for both the former offender and the community (for example, Western 2007; Pager 2007; Clear 2007). Sociologists have identified important dimensions of community social capital upon which residents can draw to solve local neighborhood problems, such as crime and disorder, and which help to explain the effects of urban structure on community rates of crime (see Sampson, Morenoff, and Gannon-Rowley 2002). Research has also provided detailed ethnographic descriptions of innercity gangs (for example,Venkatesh 2000), street violence (Anderson 1999), and organized crime (Gambetta 1993).With a few notable exceptions (for example, Gambetta 1993), most of this research is not explicitly rooted in rational choice perspectives. This chapter uses a multilevel framework to discuss advances in rational choice research on crime. Rather than providing an exhaustive review of

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pertinent research, I instead organize the discussion around one important theoretical issue, the integration of micro- and macrolevels of explanation.Thus the underlying assumption that gives structure to the chapter is that rational choice principles offer a parsimonious microfoundation for macrosociological concepts and causal mechanisms. The task, then, is to identify how macrolevel social contexts condition microlevel processes (individual decisions), and how microprocesses, in turn, produce macrolevel outcomes (social organization) (for example, Coleman 1990). I begin by discussing an individual-level model of rational choice, deterrence, and criminal behavior. A rich and voluminous literature has developed around the question of general deterrence—do threats of formal sanction by the legal system deter the general public from crime? I review the models and different research designs used in empirical studies, and then discuss the individual-level rational addiction model of drug use (Becker and Murphy 1988; Becker 1996). To link individual-level models to macrosociological models, I review the micro-macro problem in sociology, and the potential utility of using a rational choice model as a microfoundation for macrolevel causal relationships. Here, I summarize Coleman’s position (1990), which emphasizes the crucial task of identifying micro-to-macro transitions. I then use this multilevel framework to analyze two productive lines of research in criminology: (1) social capital, collective efficacy, and neighborhood controls (Sampson, Raudenbush, and Earls 1997); and (2) the protection racket of organized crime (Gambetta 1993). Theoretically, I treat these processes as examples of what Edwin Sutherland (1947) termed “organization against crime” and “organization in favor of crime” as the defining features of his theory of differential social organization (see Matsueda 2006). In each instance, I stress the utility of rational choice at the individual level, the broader context that conditions individual purposive action, and the micro-to-macro transitions that lead to social organization either against or in favor of crime. The extent to which these lines of research capitalize on a rational choice microfoundation varies considerably. For example, collective efficacy theory has been treated as a purely macrolevel process linking social disorganization, social capital, and informal social control into a macrostructural theory of crime. Therefore, I show how rational choice can provide a microfoundation for social capital and collective efficacy that opens new theoretical puzzles and empirical research questions. In contrast, Gambetta’s analysis (1993) of the Sicilian Mafia’s protection racket draws explicitly on a rational choice perspective to explain the origins and functioning of privatized protections. Therefore, I explicate the individual-level rational choice argument and show how it links to a macrolevel system of illicit action. In the final section, I discuss avenues for future research within a multilevel framework.

Individual-Level Model of Criminal Behavior rational choice, deterrence, and criminal acts Rational choice theories of crime are rooted in the seminal writings of Gary Becker (1968), who argues that the same principles explaining decisions

286 Ross L. Matsueda by firms and members of households should also explain criminal behavior. Drawing on the expected utility theory of risky decisions under uncertainty by von Neumann and Morgenstern (1944), Becker (1968: 177) specifies a simple utility function for committing crimes: E(UC) = (1 – pc) U(R) + pc U(R – C)

(1)

where E(UC) is the expected utility of crime, pc is the probability of getting arrested and punished, (1 – pc) is the probability of getting away with crime, R is the return (both monetary and psychic) from crime, and C is the cost of punishment (for example, a fine or prison sentence), and U is a utility function translating punishments and rewards to a common metric. The expected utility model assumes that individuals have complete and transitive preference orderings for all possible decision outcomes. As von Neumann and Morgenstern (1944) famously pointed out, expected utilities can differ from expected values. For example, the expected income from crime will not differ when an increase in the probability of punishment p is compensated by an equal percentage decrease in severity of punishment, C (Becker 1968). E(R) = (1 – pc) (R) + pc (R – C) = R – pc C

(2)

Such a change in pc and C, however, can change expected utility because it will alter risk. The change in expected utility depends on the individual’s attitude (or taste) toward risk. If a person has a preference for risk, the utility function is convex, and an increase in pc will reduce expected utility more than an equal increase in C (ibid.). Conversely, if a person is risk-averse, the utility function is concave, and C will have a greater effect than pc. Finally, if a person is riskneutral, the utility function is linear, and pc and C will have identical effects. If we ignore the role of legitimate opportunities, that is, assume the expected utility from noncrime is zero, E(UN) = 0, we can specify that a crime will occur when E(UC) > E(UN) = 0, so that from equation (1), a crime will occur when the following holds: U(R) > pc U(C)

(3)

That is, when the returns to crime exceed the punishment, weighted by the probability of detection, an individual will commit a crime. The policy implication here is that by increasing the certainty and severity of punishment, the probability of crime will be reduced. Crime can also be reduced by lowering the rewards to crime—by defending public spaces through increasing surveillance, employing security guards, and using technological advances in metal detection, alarms, locks, fences, and the like. Historically, following Becker’s work (ibid.), most microeconomic research on crime has focused on the policy implications of increasing the certainty and severity of punishment. Of course, legitimate opportunities are important for criminal decisions, as most members of society obtain some utility from noncriminal activities.1 Bueno de Mesquita and Cohen (1995) present a simple model that considers legitimate opportunities by specifying a utility function for noncriminal activity:

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E(UN) = pi U(I ) + (1 – pi) U(W )

287

(4)

where I is income (returns to conventional activity), pi is the probability of obtaining I (through having high social status, resources, or talent), and W is welfare or the social safety net for those who cannot obtain I (that is, pi = 0). Then, the utility function for criminal behavior becomes: E(UC) = (1 – pc) [U(R) + pi U(I ) + (1 – pi) U(W )] (5) + pc U(R +W – C ) In other words, the utility from crime is a function of the returns to crime plus income from conventional activity (each weighted by the probability of getting away with crime), plus the returns to crime and conventional activity minus the punishment for crime (each weighted by the probability of getting caught and punished). This assumes that the criminal’s booty from crime is not confiscated upon arrest (Becker 1968). Note that when the probability of getting caught is zero (pc = 0), the utility from crime is equal to the returns to crime plus the returns to noncrime. When the probability of getting caught is 1.0 (pc = 0), the utility from crime is the returns to crime, plus welfare, minus the penalty. A crime will be committed when E(UC) > E(UN); therefore, from (4) and (5), a crime will occur when the following holds: (1 – pc) [U(R) + pi U(I ) + (1 – pi) U(W )] + pc U(R +W – C ) (6) > pi U(I ) + (1 – pi) U(W ) Or, equivalently, stated in terms of the risk of punishment, crime will occur when pc < U(R) / U(C ) + pi U(I –W )

(7)

That is, crime occurs when the probability of detection is less than the ratio of the reward to the sum of the punishment plus the returns to noncriminal activity weighted by the probability of realizing those returns. From a policy point of view, the probability of crime can be altered not only through criminal justice policies that increase the certainty and severity of punishments or that change defensible space (and thereby reduce opportunities for crime), but also through policies that increase conventional alternatives to crime. For example, job training, higher education, and other programs to enhance human and social capital may reduce the attractiveness of crime by increasing pi, the probability of obtaining a desired income from legitimate activities. Returns to conventional activity include not only income but also social status and prestige, self-esteem, and happiness; policies that increase these quantities by inculcating strong commitments to conventional institutions may help to reduce crime. empirical research on rational choice and deterrence Early empirical tests of Becker’s model used statistical models of aggregate crime rates, focusing on the deterrent effects of objective risk of punishment, using, for example, risk of imprisonment (measured by imprisonment per capita) or risk of arrest (measured by arrests per crimes reported to police). Ehrlich (1973) found deterrent effects of risk of imprisonment, but scholars criticized his simultaneous equation models for using implausible solutions

288 Ross L. Matsueda to the identification problem—the problem of finding good instrumental variables to identify reciprocal effects between rates of imprisonment and rates of crime—such as assuming population age, socioeconomic status, and region have zero direct effects on crime (Nagin 1978). Recent work using aggregate data includes more plausible instrumental variables to address the problem of reverse causality, and found deterrent effects. Sampson and Cohen (1988) follow the work of Wilson and Boland (1978) and use aggressive policing as an instrument for risk of arrest, finding a deterrent effect. Levitt (1997) employs the timing of mayoral elections as an instrument of number of police per capita—such elections should have a direct effect on investment in the police force (as newly elected mayors seek to crack down on crime), but only an indirect effect on crime (but see McCrary 2002). For a review of aggregate deterrence research, see Nagin (1998) and Durlauf and Nagin (2011). These tests of the deterrence hypothesis assume that actors know the objective certainty of arrest and imprisonment (Nagin 1998). By contrast, subjective expected utility models relax this assumption, replacing the single known objective probability with a distribution of subjective probabilities. Subjective utility models are still rational models because the statistical mean of the subjective probability distribution is assumed to fall on the value of the objective probability (ibid.). Empirical research from a subjective expected utility framework uses survey methods to measure perceived risk of punishment directly from respondents, rather than inferring it from behavior through the method of revealed preferences (for example, Kahneman, Wakker, and Sarin 1997). Early empirical research by sociologists used cross-sectional data and found small deterrent effects for certainty of punishment but not for severity (for example, Williams and Hawkins 1986). Respondents who perceive a high probability of arrest for minor offenses (such as marijuana use and petty theft) report fewer acts of delinquency. Such research has been criticized for using cross-sectional data in which past delinquency is regressed on present perceived risk, resulting in the causal ordering of the variables contradicting their temporal order of measurement. To address this criticism, sociologists have turned to two-wave panel models and found, for minor offenses, little evidence for deterrence (perceived risk had little effect on future crime) and strong evidence for an experiential effect (prior delinquency reduced future perceived risk) (see ibid.; Paternoster 1987). Piliavin et al. (1986) specify a full rational choice model of crime, including rewards to crime as well as risks, and find, for serious offenders, that rewards exert strong effects on crime, but perceived risks do not. Recent longitudinal survey research has used more sophisticated measures of risk, better-specified models, and better statistical methods. Matsueda, Kreager, and Huizinga (2006) specify two models based on rational choice. First is a Bayesian learning model of perceived risk, in which individuals begin with a baseline estimate of risk, then update the estimate based on new information, such as personal experiences with crime and punishment or experiences of friends. Second is a rational choice model of crime in which crime is determined by prior risk of arrest, perceived opportunity, and perceived rewards to crime, such as excitement, kicks, and being seen as cool by peers (see also McCarthy 1995; Hagan and McCarthy 1998). Using longitudinal data from

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the Denver Youth Survey, Matsueda, Kreager, and Huizinga (2006) find support for both hypotheses: perceived risk conforms to a Bayesian updating process (see also Pogarsky, Piquero, and Paternoster 2004; Anwar and Loughran 2011), and delinquency is determined by perceived risk of arrest, rewards to crime, perceived opportunities, and opportunity costs (see also Pogarsky and Piquero 2003). Similarly, Lochner (2007) uses two national longitudinal datasets and finds support for an updating model of “beliefs about the criminal justice system” and a deterrent effect of perceived risk. Sherman (1990) has observed that the deterrent effect of interventions, such as police crackdowns or passage of more punitive legislation, often has an initial deterrent effect that diminishes with time. A simple explanation of this decay in deterrent effect is that criminals initially overestimate the effect of the policy change on certainty of getting caught, and consequently through Bayesian updating, adjust their risk perceptions downward (Nagin 1998). A second explanation of initial decay in deterrence derives from decision theorists’ concept of “ambiguity aversion.” In contrast to risk aversion, which refers to an event in which a probability can be assigned to every outcome, ambiguity aversion refers to an event in which the probabilities of outcome are unknown (Epstein 1999). A new intervention may increase the uncertainty of the risk perceptions of potential offenders, which will create a deterrent effect if offenders find uncertainty or ambiguity aversive. Over time, this ambiguity over risk may diminish, as offenders adapt to the new policy and sharpen their estimates of true risk. The important point here is that, even if the policy did not change the true certainty of punishment or the mean values of offenders’ subjective perceptions of risk, it may change the variance of risk perceptions, which will deter crime if offenders are risk averse (Nagin 1998). Sherman suggested that a policy of varying police crackdowns over time and space may increase ambiguity in risk perceptions, and thereby more effectively deter crime. Loughran et al. (2011) found support for the deterrent effect of ambiguity aversion for crimes that did not involve contact between victims and offenders: at low levels of certainty of sanction, ambiguity reduced offending, whereas at high levels of offending, ambiguity increased offending. Another way of addressing the causal order problem is with scenario or vignette methods. Here a specific crime scene is depicted in a written scenario and the respondent is asked to assess the probability of getting caught or getting rewards from the crime depicted. Then the respondent is queried for his intentions to engage in the crime. The method has the strength of embedding reported risk perceptions in the situation in which they should apply (Nagin 1998). Moreover, intentions data may be reasonable proxies for actual behavior (see Manski 1990; Dominitz and Manski 1997). The vignette method has the additional strength of random assignment of scenario characteristics—such as presence of witnesses, time of day, potential monetary returns—to vignettes in a factorial design, creating orthogonal regressors that allow one to obtain precise estimates of characteristics on outcomes (for example, Rossi and Nock 1982). A weakness is the potential for a response effect: respondents who report high risk of arrest may be unlikely to admit to an intention to commit the crime because of social desirability effects.Vignette studies of deterrence and rational choice generally find robust effects of deterrence: certainty has a substantial

290 Ross L. Matsueda effect on criminal intentions, while severity has modest effects. This holds for tax evasion (Klepper and Nagin 1989), drunk driving (Nagin and Paternoster 1994), sexual assault (Bachman, Paternoster, and Ward 1992), and corporate crime (Paternoster and Simpson 1996). In sum, empirical research on an individual model of rational choice, deterrence, and crime finds consistent support for the model. As deterrence theory suggests, certainty of sanctions exerts a consistent deterrent effect on crime, although the severity of punishment exerts a small and inconsistent effect. Consistent with rational choice, returns to crime—particularly psychic returns, such as excitement and high status among peers—and opportunity costs are both important predictors of future criminality. Note that models of deterrence and crime are essentially depicting a two-person game between the criminal and the criminal justice system. Most research on deterrence, however, treats individual criminal behavior as endogenous with respect to the actions of the criminal justice system, which are assumed exogenous (that is, the endogeneity of legal actors is treated as a nuisance to be overcome). Nagin (1998) and Swaray, Bowles, and Pradiptyo (2005) review economic research on the effects of interventions on the criminal justice system—in which the intervention is truly exogenous. A more complete treatment would model the legal system and the criminal as interdependent actors, using game theory—the use of mathematical models to tease out interdependent decision-making. McCarthy (2002) reviews applications of game theory, particularly two-person games, to the relationship between criminals and the legal system (see also Bueno De Mesquita and Cohen 1995). McAdams (2009) reviews the relevance of game theory beyond the prisoner’s dilemma for law and legal analysis. By extending the equations used earlier, I can give an illustrative example, based on research by Bueno de Mesquita and Cohen (1995), of the utility of game theory in theorizing about criminal behavior, and drawing links between macrostructures and social interactions. Bueno de Mesquita and Cohen (1995) show how an unjust social structure— containing selective barriers to human and social capital that undermine job attainment and wages—can change the incentive structure for criminal decisions. For individuals, there is uncertainty about fairness or justice in the social system.Therefore, we can define pj as a measure of individual perceptions of the probability of justice or fairness in social institutions, and (1 – pj) as a measure of perceived probability that society is unfair. The likelihood that an individual will be treated fairly by social institutions will affect the probability of returns to conventional activity. A fair society will allow individuals to gain income from conventional sources (I ) based on pi, the probability of getting a good job, which is based on ability, human capital, and social capital. An unfair society will prevent some qualified individuals from getting good jobs, which implies that those individuals will receive zero income from conventional jobs (I = 0), making total benefits equal to welfare, W. Therefore, if we incorporate fairness into our earlier equation (4), the utility from noncrime becomes: E(UN) = pj [ pi U(I ) + (1 – pi) U(W )] + (1 – pj) U(W )

(8)

In a completely fair society, in which all members perceive fairness, pj = 1, utility from noncrime is pi U(I ) + (1 – pi) U(W ), as above. But in a completely

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unfair society, in which all members perceive unfairness, pj = 0, utility from noncrime is reduced to welfare, U(W ). Then, modifying equation (5), the utility from crime, allowing fairness to vary, is: E(UC) = (1 – pc) {U(R) + pj [ pi U(I ) + (1 – pi) U(W )] (9) + (1 – pj) U(W )} + pc U(R +W – C ) A crime will be committed when E(UC) > E(UN); therefore, from (8) and (9), a crime will occur when the following holds: (1 – pc) {U(R) + pj [ pi U(I ) + (1 – pi) U(W )] + (1 – pj) U(W )} + pc U(R +W – C) > pj [ p i U(I ) + (1 – pi) U(W )] + (1 – pj) U(W )

(10)

Stated in terms of perceived probability of injustice, crime will occur when pj < U(R) – pc U(C) / pc pi U(I –W )

(11)

and it follows that pj pc pi U(I –W ) < U(R) – pc U(C)

(12)

This shows that as perceived justice increases, crime becomes less likely because the returns to conventional activity increase. Using these equations, Bueno de Mesquita and Cohen (1995) provide a game-theoretic analysis of changes in society’s fairness, certainty and severity of punishment, probability that an individual will gain conventional income, and welfare policies. Their simulations reveal three important patterns. First, by increasing social justice, crime is reduced substantially. Second, the effect that poverty reduction policies have on crime depends on the policy: reducing poverty by welfare programs increases crime in the short run; conversely, reducing poverty by increasing the human capital skills of individuals reduces crime sharply. Third, crime is reduced substantially when policies of increasing human capital skills are combined with policies of increasing the probability of punishment. theory of rational addiction to illicit drugs The rational choice model can also be applied to the consumption of illicit drugs. In their path-breaking article, Becker and Murphy (1988) note that addiction or habit formation is pervasive throughout society. People often become addicted not only to drugs, alcohol, and cigarettes but also to work, eating, music, and many other activities. Therefore, Becker and Murphy (ibid.) suggest that the explanatory power of rational choice theories would be seriously compromised if addictions required separate theories. They show how addiction, including drug addiction, can be explained within a rational choice framework in which individuals maximize expected utility subject to constraints and incorporate both past and future behavior in decision-making. In this way, addictive behavior is consistent with the usual assumption of optimization with stable preferences. This explanation consists of two parts. First is a backward-looking model, or “learning by doing,” in which increases in past drug use (consumption) increase current drug use by raising the marginal utility of current drug use. Second is a forward looking model, in which current consumption is a function of anticipated future utility: an individual

292 Ross L. Matsueda expecting to consume drugs in the next period will consider the utility from that future drug use when maximizing utility of current drug consumption. Individuals recognize that consumption of beneficial goods (for example, sex) increases future utility, whereas consumption of harmful goods (for example, illicit drugs) reduces future utility. Thus, in making current decisions, rational actors trade off the present utility of drug consumption with the future utility of drug addiction. The model implies strong intertemporal complementarity for drug consumption: consuming drugs at time one will be highly correlated with drug consumption at time two. A myopic (or backward looking) model is a special case in which individuals fail to consider utility of future behavior on current choices. Empirical research on rational addiction models of drug use models the relationship between drug prices and drug use over time (for example, Becker, Grossman, and Murphy 1994; Grossman and Chaloupka 1998). Drug use at time t is specified as a function of price at time t, drug use at time t – 1 (backward-looking), and drug use at time t + 1 (forward-looking). Ct = θCt – 1 + βθCt – 1 + θ1Pt + θ2 εt + θ3 εt + 1 where Ct is present consumption, Ct – 1 is past consumption, Ct + 1 is future consumption, θ is a parameter reflecting addiction, β is a time discount factor (1/[1 + r]) assumed to be less than one, θ1 is a coefficient for price Pt, and Ct – 1 = θCt – 2 + βθCt + θ1Pt – 1 + θ2 εt – 1 + θ3 εt Ct + 1 = θCt + βθCt + 2 + θ1Pt + 1 + θ2 εt + θ3 εt + 2 To address the obvious endogeneity problem, price at time t – 1 is used as an instrument for drug use at time t – 1, price at time t is used as an instrument for drug use at time t, and price at time t + 1 is used as an instrument for drug use at t + 1. Identification is achieved by the perhaps plausible assumption that price at t – 1 and price at t + 1 have no effects on drug use at time t, net of price and time t. Such models have the weakness of assuming perfect foresight, although partial foresight models are tractable here. Using data from the national Monitoring the Future dataset as well as data on marijuana prices (from Drug Enforcement agents’ attempts to purchase marijuana in nineteen cities for 1982–1992), Pacula et al. (2000) estimate price elasticity of demand, estimating that a 1 percent increase in price reduces demand by about 30 percent.They find, however, that peer effects and attitudes are the strongest predictors of marijuana use. Using the same data, Chaloupka et al. (1999) find that youth living in decriminalized states were more likely to use marijuana than in other states, and that youths’ consumption patterns were responsive to median fines for possession of marijuana. In contrast, Farrelly et al. (1999), using fixed-effects models on the National Household Survey on Drug Abuse, find no relationship between fines and marijuana use. This line of research assumes that youth are aware of the objective costs of marijuana use, and use those costs in their decision-making. It has been criticized for assuming that youth are able to anticipate future prices of marijuana accurately. On this point, with respect to cigarettes, Gruber and Köszegi (2001) argue that a more reasonable assumption is that individuals are able to anticipate future changes in excise taxes because they tend to be publicized, whereas increases in cigarette

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prices are rarely announced in advance. Using data on excise taxes, Gruber and Köszegi (ibid.) find support for a forward-looking model of rational addiction for cigarette smoking. The theory of rational addiction is an audacious attempt to explain addictive behavior—an act that is almost always deemed irrational—within a conventional rational choice framework. It has received remarkably substantial empirical support on a wide variety of addictive behaviors. With respect to illicit drug use, such as marijuana and cocaine, future research is needed to explore whether youth are able to anticipate future prices accurately, how they acquire that information, and whether effects of future prices persist when controlling for other time-varying covariates, such as changes in the certainty of arrest, peer effects, and local supply of the drug.2 Nevertheless, these results allow us to apply forward-looking rational choice principles for addiction, crime, and conventional behaviors as a microfoundation for macrosociological theories.

The Micro-Macro Problem in Sociology Sociologists have long attempted to overcome the bifurcation of the discipline into separate subdisciplines of social psychology and social organization by identifying specific linkages between micro- and macrolevels of explanation (for example, Hechter 1983; Alexander, Giesen, Münch, and Smelser 1987; Huber 1991). Such linkages would presumably help overcome criticisms lodged at myopic theorizing and research operating at single levels. For example, structural theories—and the macrolevel research they stimulate— typically explain system outcomes based on causal mechanisms operating at the macrolevel, thus ignoring the role of individual actors. Such theories have been criticized for being crudely functionalist (a system outcome is explained by a system characteristic defined by its function), obviously teleological (a system outcome is explained by a system-level purpose), and unlikely to identify effective interventions to bring about positive social change (for example, Coleman 1990). Individual-level theories of purposive action—and the microlevel research they stimulate—explain individual outcomes based on causal mechanisms operating at the individual level, with macro outcomes assumed to be mere aggregations of such processes. These theories have been criticized for trivializing the role of social organization and oversimplifying the micro-macro problem.3 Macro-Level Context

Macro-Level Outcome

4

1

3 Micro-Level Predictor

2

Micro-Level Outcome

figure 8.1. Links between micro- and macro-level mechanisms. Source: Coleman 1990.

294 Ross L. Matsueda Among the many proffered solutions to the micro-macro problem (for example, Sawyer 2001), perhaps the most distinctive approach, outlined in a series of papers and chapters by Coleman (1983, 1986, 1990), specifies that macrolevel relationships are brought about by microlevel processes, and vice versa, through a series of micro-macro transitions. Figure 8.1 illustrates these relationships. Macrosocial theories focus on link 4 between a macrolevel context (for example, social structure) and a macrolevel outcome (for example, rates of crime). Microindividual theories focus on link 2 between a microlevel predictor (for example, human capital investment) and a microlevel outcome (for example, earnings). These two levels are connected by two cross-level linkages. Link 1, commonly investigated in sociological studies of individual behavior, shows how macrocontext (for example, social class) conditions individual attributes (such as human capital investments), which in turn produce microlevel outcomes (for example, earnings) through a microlevel theory (such as microeconomic theory). The other cross-level relationship, link 3, is less studied and more complicated. Here, individual outcomes combine to produce macrolevel outcomes (for example, social organization). Stated differently, the question becomes, “How are interdependencies formed among individual actors to organize action?” Here, Coleman uses the concept of emergence to show how “collective phenomena are collaboratively created by individuals yet are not reducible to individual action” (Sawyer 2001). For Coleman (1990: 5), emergence is tied to purpose in interaction: “The interaction among individuals is seen to result in emergent phenomena at the system level, that is, phenomena that were neither intended nor predicted by the individuals.” This allows for more complexity than the simple assumption, made by reductionists and some economists, that collective phenomena are merely the aggregations of individual actions. The ways in which individual purposive actions combine to create macrolevel outcomes vary by the complexity of the social organization being constituted and reconstituted. In the simplest case of bilateral exchange between two actors, an agreement or contract governing the exchange is the macrolevel outcome. In this case, the macro outcome is intended by the individuals. Bilateral exchange between two parties can also result in externalities, which are costs or benefits to third-party stakeholders—usually in the form of a public good—for which compensation is neither collected nor paid. Thus parties to the exchange do not necessarily reap all the costs or benefits of the transaction. This can be seen as an application of Merton’s concept (1936) of unanticipated consequences of action to exchange relationships.4 Externalities, which can be positive or negative, constitute the most elementary form of moving from individual action to system-level properties. Nevertheless, externalities may be the most prevalent micro-macro link in any society, and exemplify the notion of emergence. I will use this elementary form of building social organization to link individual rational choice to neighborhood social capital. Bilateral exchange can be generalized to multilateral exchange, such as a market, in which the system-level outcome is a set of prices. This is perhaps the prototypical micro-to-macro transition, because it demonstrates that certain outcomes (such as the exchange price of goods) cannot be reduced to an aggregation of individual behaviors, but rather entail a broader social

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organization—in this case the organization of the market. Prices are an emergent explained by equilibrium theory, in which individual capital and preferences combine to produce equilibrium prices through competitive exchange. Another micro-macro link concerns authority and control. Individuals that trust others may give up rights of control of certain actions to those others. Such vesting of authority in others provides the basis for the emergence of social norms, an emergent property of social systems based on common interests of the individuals. Authority relations and norms governing those relations, of course, are key elements of hierarchical organizations, authority structures, and formal organizations. I will illustrate the micro-to-macro transition with examples drawn from recent criminological research. To frame these examples theoretically, I use Sutherland’s classical criminological concept of differential social organization.

Differential Social Organization and Crime Edwin Sutherland, perhaps the most important criminologist of the twentieth century, is best known for coining the term “white collar crime” and developing his individual-level learning theory of crime, differential association. Sutherland (1947) also developed the concept of differential social organization—a macrolevel counterpart to his individual-level theory—to explain the distribution of aggregate rates of crime: the crime rate of a group or society is determined by the extent to which that group or society is organized against crime versus organized in favor of crime. Sutherland, however, failed to expound on the macro portion of the theory, leaving the conception of organization empty of content, except by illustration. For example, organization against crime includes strong conventional institutions that inculcate conventional commitments in individuals, such as having a job, investing in education, owning a home; organization in favor of crime includes nefarious organizations such as delinquent gangs, professional theft rings, and criminal organizations like the Mafia. Clearly, the theory would be more powerful if the concrete content and causal mechanisms of such organization were specified explicitly.5 In the following sections I will attempt to specify such concrete causal mechanisms, drawing on rational choice theory as a microfoundation, and showing how social organization is built up by identifying micro-to-macro transitions.The next section specifies mechanisms of organization against crime using recent research on social capital and collective efficacy.This is followed by a discussion of organization in favor of crime using the protection racket of the Sicilian Mafia.

Social Capital, Collective Efficacy, and Organization against Crime social capital theory One of the most important recent theoretical innovations in the social sciences has been the development of the concept of social capital. The concept has been popularized by Putnam (1995, 2001), who defines social capital as elements of social organization, such as “networks, norms, and trust, that facilitate coordination and cooperation for mutual benefit,” and laments

296 Ross L. Matsueda the decline of civic participation and social capital in contemporary society. Similarly, Bourdieu (1986) defines social capital as the “aggregate of the actual or potential resources that are linked to possession of a durable network of more or less institutionalized relationships of mutual acquaintance and recognition— or in other words, to membership in a group—which provides each of its members with the backing of the collectively-owned capital, a ‘credential’ that entitles them to credit in the various senses of the word,” and shows how unequal access to social capital helps to reproduce social inequality. Perhaps the most rigorous and developed conceptualization of social capital is due to James Coleman (1988, 1990). A distinctive feature of Coleman’s version, which separates it from others, such as Putnam (2001) and Bourdieu (1986), is its explicit value in making the micro-to-macro transition. Indeed, in his early writings about the micro-macro problem, Coleman (1986, 1988) discusses the role of exchange relationships, authority relations, social norms, and information flows—all of which he later captures under the umbrella of social capital—as examples of the micro-to-macro transition. Coleman’s version of social capital builds on Granovetter’s argument (1985: 487) that purposive action of individuals is “embedded in concrete, ongoing, systems of social relations,” which generate interpersonal trust. Social capital is defined by two characteristics: it inheres in the structure of social relationships, and not within an individual, and it facilitates certain forms of purposive action (Coleman 1990: 302). From the standpoint of individuals, social capital is a resource that can be used by members of social systems to realize their interests. In this way, it is a capital asset, as is physical capital and human capital, although one that is much less tangible and not “owned” by individuals. From the vantage point of the social system, social capital is the stuff that binds individuals, the fundamental elements of social organization, the medium through which social structure facilitates purposive actions of individuals, and, as important, the medium through which those actions constitute and reconstitute that structure. In this way, social capital accounts for interdependencies among otherwise atomized individuals. More specifically, for Coleman (1990), social capital consists of four dimensions: (1) obligations and expectations, (2) informational potential, (3) norms and effective sanctions, and (4) authority relations. Obligations and expectations, or reciprocated exchange, constitute the most elemental form of social relationships. Actors seek to realize their interests by engaging in bilateral exchange with others—doing favors for each other, which is made possible by the norm of reciprocity and the existence of trust in the social system. When one actor does a favor for a second, the second actor is now indebted to the first who can call in the favor at a future date when it is needed to attain an important objective. Favors are unpaid obligations to be fulfilled at the time of one’s choosing. Social systems with dense social networks of outstanding obligations are said to be rich in social capital (ibid.). A second form of social capital is the information potential that inheres in social relationships and is principally transmitted interpersonally. Information can be used by individuals to facilitate purposive action. As Granovetter (1973) has argued, the form and utility of information may vary by the strength of social

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relationships. Strong ties within a homogenous group lead to the circulation and recirculation of similar ideas and information. Weak ties between members of heterogeneous groups—so-called bridging ties—may expose members of each group to novel information and new ideas because the information is coming from dissimilar individuals occupying disparate roles. Such information can have more utility for certain purposive actions, such as finding a job. Other information derives from the media, a social institution. A third form of social capital consists of norms, which specify proper or improper conduct, and are enforced by sanctions (for an excellent overview, see Hechter and Opp 2001). Norms are needed when an externality affects a collection of individuals (third parties) similarly, and can be resolved by neither bilateral exchange between the perpetrator and the third parties, nor a market solution in which third parties purchase the right of control from the perpetrator (Coleman 1990). Like other forms of social capital, norms are properties of social structure and are more effective when structures are closed because enforcers of the norm can then coordinate their monitoring and sanctioning. A norm entails a transfer of control over behavior from an individual to a collective—thus, it is a form of multilateral control. Norms facilitate purposive action by coordinating otherwise atomized individual actions. The final form of social capital is authority relations, in which individuals transfer control of certain behavior to another individual, the authority, who now exercises power over the others. Weber’s notion (1978 [1921/22]: 241) of charismatic authority is a special case of an authority relation in which a single leader, endowed with “exceptional powers or qualities” is given control over the behaviors of many. Authority relations are the most elaborate form of social capital, and appear in large hierarchical structures and other complex forms of social organization. A number of empirical studies have examined the relationship between social capital and criminal and deviant behavior. For example, Rosenfeld, Messner, and Baumer (2001) use individual-level data from the General Social Survey to measure social capital with attitudes about trust, fairness, and being helpful, as well as voting behavior and membership in Elks clubs. They then aggregate the responses to the 99 GSS primary sampling units and, using a simultaneous equation model, find social capital to predict homicide rates. Using a different survey dataset of individuals within forty geographic areas, Messner, Baumer, and Rosenfeld (2004) find that aggregate measures of trust are negatively associated with homicide rates. Using survey data on Berlin youth, Hagan, Merkens, and Boehnke (1995) find that family and school social capital are negatively associated with right-wing extremism and school delinquency. Finally, Lederman, Loayza, and Menéndez (2002) use data from the World Values Survey (2002) and find (using instrumental variables to address simultaneity) that trust within the community is consistently negatively associated with rates of homicide across thirty-nine countries. These studies suggest that social capital may be important for the etiology of homicide and delinquent behavior.

298 Ross L. Matsueda neighborhood social capital, collective efficacy, and informal social control Perhaps the best application of social capital to crime has been carried out by Sampson and colleagues (for example, Sampson, Raudenbush, and Earls 1997; Sampson, Morenoff, and Earls 1999; Sampson and Raudenbush 1999). They merge the dimensions of social capital of Coleman (1990) with Bandura’s notion (1986, 1997) of “collective efficacy.” Bandura (1986: 391) is well known for his concept of self-efficacy, which he defines as “people’s judgments of their capabilities to organize and execute courses of action required to attain designated types of performances.” For Bandura, if the level of skill and opportunity are held constant, individuals who perceive a high degree of personal efficacy will outperform those with little self-efficacy because they can act with persistence, overcome obstacles, and capitalize on narrow opportunities. Self-efficacy is learned through self-observations of performance, vicarious observations of others, making social comparisons, and the like. The perceived efficacy of a group, a shared belief in acting collectively to achieve an objective, is not the mere sum of the individual personal efficacies of members. Instead, collective efficacy—members’ perceptions of the efficacy of the collectivity— will “influence what people do as a group, how much effort they put into it, and their staying power when group efforts fail to produce results” (ibid.: 449). Again, for Bandura, individuals’ perceptions of the group’s ability to “solve their problems and improve their lives through concerted effort” are more important than the objective ability of the group (ibid.). The insight made by Sampson and colleagues is to apply the concept of collective efficacy to neighborhood action, tie it to Coleman’s concept (1990) of social capital, and obtain operational indicators of it taken from previous neighborhood surveys (for example, Taylor 1996). Sampson, Raudenbush, and Earls (1997: 918) treat collective efficacy as a task-specific property of neighborhoods—namely, “the capacity of residents to control group level processes and visible signs of disorder,” which helps reduce “opportunities for interpersonal crime in a neighborhood.” This definition echoes the flip side of Shaw and McKay’s concept (1969 [1942]) of social disorganization, defined succinctly as “the ability of local communities to realize the common values of their residents or solve commonly experienced problems” (Bursik 1988: 521; Kornhauser 1978: 63). For Shaw and McKay, social disorganization is tied directly to the absence of local community institutions, organizations, and social ties. For Sampson et al., collective efficacy is tied directly to the presence of neighborhood social capital: “[It] is the linkage of mutual trust and the willingness to intervene for the common good that defines the neighborhood context of collective efficacy” (Sampson, Raudenbush, and Earls 1997: 919). Thus, collective efficacy translates the resource potential of neighborhood social networks—that is, social capital—into “active support and control of children” and thereby reduces the rate of youth crime (Sampson, Morenoff, and Earls 1999: 635). This formal definition of collective efficacy emphasizes the objective capacity of a neighborhood to intervene for the common good, rather than members’ perceptions of that capacity, as emphasized by Bandura (1986). Ironically, in operationalizing collective efficacy, Sampson et al. (1997; 1999) use measures of residents’ perceptions of collective efficacy.

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In their empirical research, Sampson, Raudenbush, and Earls (1997: 919) treat collective efficacy as an objective characteristic of neighborhoods, emphasizing that “it is the linkage of mutual trust and the willingness to intervene for the common good that defines the neighborhood context of collective efficacy,” which results in informal social control. They identify two neighborhood-level concepts, “social cohesion and trust” and “informal social control,” that constitute collective efficacy, and collect measures of each using residents of 343 neighborhood clusters in Chicago—from the community survey of the Project on Human Development in Chicago Neighborhoods (PHDCN). For each construct, they use respondents as informants on the neighborhood characteristic, asking them, for example, “[A]re people in the neighborhood willing to help neighbors?” and “[Do] neighbors trust each other?” (cohesion and trust), and “[W]ould you agree that your neighbors could be counted on to intervene if children were skipping school and hanging out on street corners?” (informal social control). After combining the two constructs into a single collective efficacy variable, Sampson, Raudenbush, and Earls (1997) find that disadvantage, immigration, and residential mobility are associated with collective efficacy in the expected negative direction. They also find that collective efficacy is negatively associated with homicide and violent victimization, and to some extent mediates the effects on violence of neighborhood structural covariates. Sampson, Morenoff, and Earls (1999) use the PHDCN, but operationalize collective efficacy slightly differently, and examine spatial processes—spillover effects from one locale to another—across neighborhoods. They retain the concept of informal control, renaming it child-centered control, drop social cohesion and trust, and add two new neighborhood-level constructs: intergenerational closure (relationships among parents and children in the neighborhood) and reciprocated exchange (exchange of favors between neighbors). After combining the new constructs into a single index of adultchild exchange, they find the index to be positively associated with concentrated affluence and residential stability, and negatively associated with population density. Sampson, Morenoff, and Earls (ibid.) find child-centered social control to be positively associated with affluence and negatively associated with disadvantage, immigration, and population density. Finally, they find positive spatial effects: net of other covariates, a given neighborhood’s collective efficacy is positively associated with that of contiguous neighborhoods. Moreover, this effect is racially patterned: white neighborhoods disproportionately enjoy the advantage of spillover effects from surrounding high efficacy neighborhoods, while black neighborhoods are doubly disadvantaged, suffering from low average efficacy and the absence of surrounding efficacious neighborhoods. Using the PHDCN data, research has also found that collective efficacy is related to rates of violence. Morenoff, Sampson, and Raudenbush (2001) find that spatial proximity to neighborhoods with high homicide rates is strongly related to increased homicide rates. Concentrated disadvantage and low collective efficacy are also positively associated with homicide. Finally, Sampson and Raudenbush (1999) use the PHDCN dataset and find that collective efficacy is strongly related to homicide, burglary, and robbery. Moreover, they test the “broken windows” hypothesis of Kelling and Coles (1997), which argues

300 Ross L. Matsueda that physical disorder, or incivilities, such as graffiti, broken windows, and litter, directly induces crime by signaling to criminals that residents are indifferent to crime. Using a simultaneous equation model to control for reciprocal effects of disorder on collective efficacy, they find that the correlation between disorder and crime is spurious because of the confounding variable, collective efficacy. Therefore, they conclude that collective efficacy theory is supported over the broken windows hypothesis. Research on neighborhood collective efficacy is one of the best applications of social capital theory to a specific social problem. As a theory of neighborhood social organization, however, it operates exclusively at the macrosociological level, implicitly treating the neighborhood as a corporate actor, and ignoring— or at least remaining agnostic about—microlevel processes and potential links between individual actors and neighborhoods. An important theoretical task would specify a microlevel model of purposive action compatible with the macrolevel concept of collective efficacy. an individual-level model of investment in social capital Empirical studies of collective efficacy specify macrolevel neighborhood models that estimate macrorelationships, labeled link (4) in Figure 8.1 above (see Figure 8.2). This specification is appropriate and consistent with the conceptualization by Sampson, Raudenbush, and Earls (1997) of collective efficacy as a macrolevel (neighborhood) concept produced by macrostructures (community structural characteristics)—a position, of course, known as methodological holism, in which an internal analysis of social systems is eschewed in favor of identifying causal mechanisms at the system level. Adopting a position of methodological individualism, however, may provide a window for examining the collective action dynamics by which social capital is translated into collective efficacy. Moreover, as Coleman (1990) argues, there are distinct advantages to adopting a position of methodological individualism, in which macrolevel processes are linked to an internal analysis of the social system. From a theoretical standpoint, specifying an individual-level model of purposive action helps address the teleological problem in macrolevel theories, in which outcomes are explained by future states or purposes. In our case, collective efficacy theory may be vulnerable to the accusation that it is a functionalist explanation: the theory assumes consensus among residents in a desire for a safe neighborhood and argues that neighborhood collective efficacy functions to ensure a safe neighborhood. By treating consensus not as an assumption but as a goal that must be achieved by residents, by specifying purpose at the individual level, by allowing for unintended consequences of purposive action, and by explaining outcomes in terms of efficiency rather than final states, we Neighborhood Structure

Collective Efficacy 4

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Child-Centered Social Control Intergenerational Closure Reciprocated Exchange

figure 8.2. Links between micro- and macro-level mechanisms. Source: Coleman 1990.

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1

3 2

Individual Resources

Reciprocal Obligations

figure 8.3. Links between micro- and macro-level mechanisms. Source: Coleman 1990.

can move away from teleological explanation and vulnerability to functionalist critique. An individual-level model of purposive action eventuating in collective efficacy begins with a utility maximization model of neighborhood social interaction (see Figure 8.3). A number of economists, focusing on memberships in civic associations, have found that investments in social capital follow a standard economic investment model: individuals invest in social capital when there are private incentives to do so—such as home ownership, close spatial proximity, fewer opportunity costs for time, and complementarities (peers with more social capital). They theorize that aggregation is complex because of externalities, which can be positive (networks) or negative (status) (for example, Glaeser, Laibson, and Sacerdote 2002). Durlauf and Fafchamps (2005), in particular, have reviewed the economics of social capital literature and identified conditions under which social capital will increase Pareto optimality. I focus on the most elementary and fundamental form of social capital, social exchange—the practice of exchanging obligations and favors—and draw from the classic writings of Peter Blau (1964). Blau (ibid.: 91) defines social exchange as “voluntary actions of individuals that are motivated by the returns they are expected to bring and typically do in fact bring from others.” In contrast to economic exchange, in which a formal contract stipulates the precise nature and quantity to be exchanged, social exchange entails only a general expectation of future reciprocation, whose nature and quantity is left unspecified and open-ended.Whereas economic exchange is depersonalized by institutional rules and expectations, social exchange is personal, and “engenders feelings of personal obligation, gratitude, and trust” (ibid.: 94). Most favors contain an implicit promise to be repaid at some future date. Of course, as in all promises, there is extreme asymmetry of information over the promissory property of favors: the party receiving the favor knows much more about the likelihood of honoring it than the party giving it. We assume that individuals seek to maximize utility under constraints in asking for favors and doing favors for neighbors. Thus residents ask neighbors to borrow tools to facilitate achieving a goal of fixing a car, repairing a home, or shoveling snow. But other potential benefits may accrue, such as deriving pleasure from an enjoyable interaction, gaining social approval or a degree of respect, and

302 Ross L. Matsueda building solidarity with the neighborhood. Residents may ask their neighbors to watch their home or monitor their children when they are away. Here, residents are seeking assistance in protecting their property, a necessary goal in a context in which trust of others—particularly new acquaintances—is imperfect. Failure to reciprocate will produce distrust and eventually end the relationship; repeated reciprocation builds trust, commitment, and strengthens relationships.6 Repeated reciprocation within organized groups often produces norms of reciprocity, which include sanctions for failure to reciprocate.7 Finally, repeated reciprocal exchanges are subject to diminishing marginal utility: continual social exchange between the same pair of actors reduces the benefits each receives (Blau 1964). Why do rational actors do favors for neighbors when there is a risk of nonreciprocation, and even if reciprocated, the return favor will likely have the same or less utility as the initial favor? One rational reason pertains to the timing of the return favor. The initial favor creates an unspecified debt whose settlement is postponed. A rational actor can specify when the debt should be paid—for example, at a time when the actor is in dire straits, and the utility of the return favor is amplified (Coleman 1990). Thus, reciprocated exchange can be explained using a simple utility maximization model. But how does social exchange translate into social capital and collective efficacy? from reciprocated exchange to collective efficacy There are two intersecting neighborhood social systems relevant to the generation of social capital and collective efficacy. The first is a system that generates reciprocated exchange among neighbors, creating social capital; the second is a system translating social capital into collective efficacy, the capacity to solve local problems collectively. Each system entails links between micro- and macroprocesses, and illustrates how communication and consensus building can produce more efficient (collective) forms of purposive action. By describing the two systems, and their interrelations, I provide a picture of the obstacles facing neighborhoods in developing high levels of social capital, collective efficacy, and ultimately, personal safety. Creation of Social Ties. Let us begin with the creation and maintenance of social ties among residents. This is the most elementary form of social capital, described by Coleman (ibid.) as obligations and expectations among individuals, and Sampson, Raudenbush, and Earls (1997) as neighborhood reciprocated exchange. Start with a set of residents who engage in reciprocated exchange with their neighbors for their private instrumental purposes— borrowing tools to fix the plumbing, helping to pull out a tree, lending a hand to fix a car. Coleman (1990) points out that the resulting social ties among neighbors can have a positive externality for the neighborhood as a whole—the creation of neighborhood social capital. Once created, social capital becomes a resource available for individuals to facilitate purposive action, such as maintaining a safe neighborhood through informal social control. Neighborhoods rich in social capital (in the form of dense social ties) will have a large capacity to solve local problems—in other words, they will have collective efficacy (Sampson, Raudenbush, and Earls (1997). But how are those social ties increased and maintained over time? How are they

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translated into the neighborhood’s capacity to accomplish shared goals, such as maintaining a safe neighborhood? Neighborhoods with residents who, individually, have a high propensity for interacting and doing favors for each other will enjoy a high degree of social capital in the form of reciprocal obligations and expectations. These social ties translate into social capital as a positive externality, which generally facilitates residents’ purposive actions, including individual instrumental behavior and collective behavior in behalf of the neighborhood as a whole. Some neighborhoods—and specifically within those neighborhoods, some key residents—may become aware of the relationship between dense social ties and the ability of neighborhoods to solve shared problems collectively.8 They may recognize that some residents are relatively isolated, and realize that if they were more involved, the neighborhood would be better off. Consequently, they have an incentive to encourage those isolated residents to become involved, and urge their neighborhood friends to encourage involvement as well. Over time, they may convert some neighbors with persuasion and rewards in the form of informal approval such as smiles, pats on the back, and kudos, while at the same time questioning, gossiping about, or even demeaning neighbors who remain isolated. In this way, social capital is increased in the neighborhood over and above the sum of effects of high individual propensities to interact. But in a neighborhood in which residents become aware of the link between neighborhood ties and neighborhood solidarity, some residents will realize that they can enjoy the fruits of neighborhood social capital—because it has a public goods aspect—and not contribute to such ties. In the parlance of rational choice theory, they have an incentive to free ride on the actions of others. To reduce the number of free riders, residents might provide selective incentives, such as informal approval or disdain, and even coordinate sanctioning in pairs, which would be facilitated by social ties between pair members (Olson 1971). A more efficient way of eliciting compliance than the use of selective incentives by relatively unorganized individuals would be to create a norm—a general rule backed by collective sanctions—prescribing being “neighborly.” Such a norm necessitates building a working consensus over the value of being neighborly, the transfer of control from individual residents to the neighborhood as a whole, and the appropriate sanctions for violators.9 This consensus, in turn, requires communication and social ties.Thus, neighborhoods in which a critical mass of residents have developed social ties for personal instrumental reasons would have the social capital necessary to facilitate creation of more social capital through creating norms of being neighborly. This may follow a threshold model, in which a critical mass of social ties is needed to communicate and create consensus over a norm of neighborhood participation. Social capital, then, builds upon itself: social ties created for one purpose provide positive externalities facilitating the creation of new forms of social capital, which create more social ties. The norm requires group members to enforce the norm by sanctioning, which can entail a cost, particularly if the sanction is negative. Here, rational actors will again have an incentive to free ride, relying on neighbors to sanction norm-violators, without contributing to sanctioning themselves. To overcome this problem—the second-order public

304 Ross L. Matsueda goods problem—residents might use only positive, relatively costless sanctions, such as informal approval.10 Creation of Collective Efficacy. The existence of neighborhood social ties is a prerequisite for residents to act collectively to combat youth crime and incivilities. Youth crime, which violates essential conjoint norms, may be rational from the standpoint of youth, but also provides negative externalities for local residents.11 For example, vandalism may upset the victimized home owner, but also reduce the attractiveness and consequently property values of the neighborhood as a whole. Residents can respond by attempting to intervene in isolation, confronting the youth, scaring the youth off, or threatening to call the police. Such monitoring and sanctioning entails a cost—youth could fight back, retaliate, or threaten, and even calls to the police take time and energy. Isolated acts of intervention require the individual to shoulder the entire cost of intervening, including investing time and energy, absorbing opportunity costs, and facing potential retaliation or unpleasant interactions with the offender. Regardless of the self-efficacy of the individual, the probability of intervention is probably low because of its high cost. When the negative externalities affect multiple residents similarly—for example, costs such as creating an unsafe environment for children, reducing property values, or inducing fear and anxiety—the potential for a collective response exists. When neighborhoods are disorganized and residents disconnected, collective action is difficult and unlikely. When social ties are dense, residents can coordinate their monitoring and sanctioning through communication, reaching a consensus on the problem, identifying a strategy for addressing the problem, and encouraging all members to agree to contribute (for example, Hechter 1987). Efficient strategies might include reducing the costs of sanctioning by jointly sanctioning in pairs, rotating the monitoring among neighbors, watching over children within the neighborhood, and relying on stay-at-home moms and busybodies to monitor the neighborhood and exchange gossip about problem children. Each of these strategies is facilitated by social capital. For example, developing rotating monitoring, in which neighbors take turns overseeing and sanctioning, may require that all committed residents contribute their share of monitoring, and therefore, take the form of an assurance game.12 Here, in a two-person, nonrepeated game, the key is developing trust of others because if players are trustworthy, each knows the other will contribute, and they will attain the optimal equilibrium of mutual cooperation (Kollock 1998). Thus, neighborhoods rich in reciprocated exchange will have built up the requisite trust to optimize assurance games, such as rotated monitoring. Another example is monitoring and sanctioning of neighborhood children, which is facilitated by intergenerational closure of social networks. If parents know the parents of their children’s friends, they can coordinate their monitoring and sanctioning with other parents, presenting a united front, and sanctioning consistently (Coleman 1990). Some parents may get to know the parents of their children’s friends as a by-product of social activities; the resulting social capital can be used strategically for monitoring their children. Other parents may become aware of such effects and intentionally seek out the parents of their children’s friends. Monitoring and sanctioning are facilitated by the dissemination of information—another form of social capital—relevant to controlling youth,

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including negative gossip about local youth who get in trouble and may be labeled “bad seeds.” A strong gossip network can be crucial for neighborhood informal social control by providing information and reducing the costs of monitoring and sanctioning (Merry 1984). Reducing the costs of sanctioning youth is important because punitive sanctioning of youth is potentially very costly as a result of the possibility of conflict between youth and adults. Such costs can be reduced by sanctioning jointly, which in turn is dependent on social ties among rule enforcers. Thus social ties, consisting of obligations and expectations, allow individual enforcers to coordinate and call in favors to diffuse the cost of sanctions (Coleman 1990: 270). When other residents are willing to stick their necks out and sanction youth transgressors, it is in the interest of any one resident to free ride—enjoying the resulting safety while avoiding the cost of personally intervening in youth trouble.As we saw with reciprocated exchange, free riders can be more efficiently suppressed by creating a norm than by merely using individual uncoordinated selective incentives.The norm, a conjoint and essential norm, would encourage all residents to engage in monitoring and sanctioning of youth indiscretions to maintain a safe neighborhood. It would require building consensus, allowing some control over individuals to be ceded to the collectivity. Thus, the mere existence and legitimacy of the norm will induce some to act in behalf of the neighborhood. But to be more effective, the norm must be backed by effective sanctions to overcome the benefits from free riding. The use of informal social approval would be less costly than the use of punishment such as expressions of disapproval. Such informal sanctions will be more effective in neighborhoods with greater social networks—particularly closed network structures (see ibid.: 318)—making possible joint sanctioning and providing enforcers with leverage (such as outstanding obligations) to use in sanctioning. When interactions are repeated, residents care about their local reputations, and simple sanctions, such as kudos, have value for recipients (Kollock 1998). Moreover, informal social approval has the potential of transforming monitoring and sanctioning into zealous behavior: here, enforcers would have a twofold gain in benefits—the intrinsic reward of helping to reform and deter youth and the secondary reward of receiving social approval from other residents (Coleman 1990). Because of this multiplier effect, neighbors will respond by sanctioning each other with zeal, increasing the likelihood that a given resident will contribute to the public good by intervening when problems in the neighborhood arise. Such processes, however, cannot increase indefinitely, but have a natural upper bound. The use of kudos, social approval, and conferring social status have limits as rewards in finite groups because, as Kitts (2006) has shown, when such incentives are rival—that is, rewarding one neighbor will reduce the value of the reward to remaining neighbors—perverse outcomes can result, such as development of an antisocial norm in which neighbors try to stop other neighbors from rewarding others. In neighborhoods characterized by social structures conducive to zealous monitoring and sanctioning, very high levels of collective efficacy are expected. Such zealous activity is likely to lead individuals to internalize the norms of monitoring and sanctioning. Here, external sanctions are no longer necessary to elicit conformity because residents sanction themselves by inducing guilt.

306 Ross L. Matsueda Residents who have internalized the norms come to identify with the neighborhood as a collectivity: the neighborhood, along with the norms shared by residents, becomes a component of their selves. In the words of Mead (1934), the neighborhood becomes a part of their generalized other. In such a case, intervention—that is, monitoring and sanctioning—becomes an automatic response to neighborhood youth incivilities. Moreover, when automatic responses fail, residents are able to identify alternative courses of action from the standpoint of the neighborhood as a collectivity (because residents have participated in exchange with multiple other residents), which includes the goals, complex roles, and expectations attached to those roles of the neighborhood. A final dimension of neighborhood collective efficacy that, in principle, could result in more efficient interventions in local problems, is the development of an intentional semiformal organization, such as a neighborhood watch or vigilante group. Here, in contrast to social capital produced through positive externalities from reciprocated exchange, social capital in the form of an organization is created intentionally for facilitating purposive collective action.The organization produces a public good, which is available to a “wider range of actors than those who initiated it” (Coleman 1990: 313). For those neighborhoods with strong neighborhood associations, voluntary groups, or homeowners associations, when serious problems of local problems of crime and safety arise, the existing organization can be used to address the new problems. Such associations already have social ties and obligations among members, mechanisms for attaining a working consensus, rudimentary role specialization (for example, a precinct captain, treasurer, information specialist, and membership director), and rudimentary authority structure. Neighborhoods lacking such associations must create neighborhood watches—associations intended to reduce local crime— from scratch when confronted with problems of safety. Neighborhood watches tend to mimic other neighborhood watches, many of which are sponsored by local law enforcement, through the well-known process of institutional isomorphism (DiMaggio and Powell 1983). Successful neighborhood watches are those that move beyond mimicking stereotypical models and respond flexibly to the problem at hand, given constraints on resources available. Here, weak ties beyond the local neighborhood may provide new ideas, strategies, and ways of translating exigent resources into workable solutions to local problems. The mere existence of a neighborhood watch does not necessarily reflect high social capital or a high degree of collective efficacy. Typically, residents create such associations as a response to extreme spikes in the crime rate or a series of heinous criminal acts in the neighborhood. Such associations may function more to provide a cathartic outlet for frustrated residents, induce a feeling that something is being done, and create a symbol of success and less to reduce the source of neighborhood problems. The key to success is the strength of other forms of social capital in the neighborhood—obligations and expectations, closure of social structures, norms of monitoring and sanctioning—which constitute the bedrock of any collective neighborhood action. In the absence of such foundational structures, a neighborhood watch will face an uphill battle to organize new forms of social capital from scratch. In sum, by beginning with a rational choice model of individual action, we

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can specify microfoundations for collective efficacy. Doing so helps bring the actor—and by implication, human agency, back into models of informal social control. It also potentially provides points of public policy intervention. For example, it may be more efficient to increase collective efficacy by targeting concrete interactions by concrete individuals, rather than trying to influence a neighborhood or collectivity as a whole. Finally, it opens new directions for research, such as the identification of social processes leading to micro-to-macro transitions. We have not discussed the role that formal social control agencies play in neighborhood collective efficacy. It is likely that informal neighborhood control operates in the shadow of the legal system, that the threat of calling the police is used to strengthen informal interventions, and that neighborhoods vary substantially in the degree to which they are able to mobilize police. More work is needed to tease out these effects (for example, Silver and Miller 2004).

Organization in Favor of Crime:The Protection Racket As a feature of social structure, social capital has the property of being available as a resource for achieving disparate objectives of a social group or collectivity. It follows that social organization created for one purpose can be “appropriated” and used for another purpose. To illustrate this property, Coleman (1990) uses the example of radical South Korean students who used study circles, based on existing social relationships from common membership in a church or hometown, to facilitate opposition to political authority without actually meeting in person. The study circles constitute a form of social capital “appropriated” for subversive activity. This property has two important implications. First, social capital, social organization, and social structure lack an inherent normative or moral imperative. Social capital is simply a resource that facilitates achieving a variety of goals. Social capital is neither inherently positive nor negative, and the term “negative social capital” (for example, Portes 1998) is misleading; it is more accurate to say that social capital at times can facilitate action that is judged negative from the standpoint of a specific group or collectivity. What is important to examine empirically is the historically specific ways in which social capital is used by groups and individuals to realize their interests. Second, social capital can facilitate criminal or deviant behavior. In the words of Portes (ibid.: 18), “Mafia families, prostitution and gambling rings, and youth gangs offer so many examples of how embeddedness in social structures can be turned to less than socially desirable ends.” I argue that social capital is an important feature of organization in favor of crime, which is actualized by motivated individuals seeking to realize their self-interest. I will examine a classic example of such social organization—the protection industry of the Sicilian Mafia (Gambetta 1993)—and show how self-interested individuals create social organization through a micro-to-macro transition. I will show how rational choice can provide a microfoundation for the genesis and operation of the code. Gambetta’s analysis (ibid.) of the protection racket is rooted in a rational choice microfoundation, and I show how he links rational choice to broader social organization.13

308 Ross L. Matsueda supply and demand for protection in southern italy Unlike most classical studies of organized crime, which examine the structure and function of the Mafia (for example, Cressey 1969), the internal relations within a crime family (for example, Ianni and Ianni 1972), or the day-to-day operations of specific rackets (for example, Reuter 1983), Gambetta (1993) analyzes the illegal market for protection, which he argues is the defining characteristic of the Sicilian Mafia. Stated from a macrohistorical perspective, the demand for protection arose in Southern Italy as a result of the demise of feudalism, the transformation of property into a market commodity, and the inability of the state to define, protect, and enforce property rights. The result was a lack of trust in the state and a demand for private protection. At the same time, the breakup of the patrimonial system—in which noble landlords maintained private guards and semiprivate police—created the supply of an unemployed class of skilled protectors who were being replaced by state-employed police. This confluence of demand and supply produced the protection racket (ibid.).Thus, in contrast to conventional cultural explanations of the rise of the Mafia, which argue that the subculture of organized crime that led inexorably to organized rackets is unique to Sicily, Gambetta’s rational choice explanation eschews the central role of a unique and nebulous culture. Any test of his proposition requires comparative research in which similar conditions of supply and demand arise within different historical junctures. In his study of corruption and organized crime in Russia during the transition from communism to a market economy, Varese (1994, 2001) applies Gambetta’s model to the rise of the Russian Mafia. Varese finds that, under communism during the Soviet period, the means of production were monopolized by the state, which precluded any demand for, or supply of, private protection. During the pre-Gorbachev era, there was rampant organized corruption among officials, but not structures like the Mafia. The economic reforms of 1986, however, produced an explosion of property owners and private transactions that outstripped the development of effective legislation to define and protect private property rights. The resulting vulnerability of property owners to theft and fraud created a demand for private protection. As in the Sicilian case, in Russia, a supply of potential protectors coincided with this demand, as a pool of dismissed KGB, soldiers from the army, and police began to grow (Varese 1994: 194). Members of this pool were skilled at the use of force, the necessary resource for participating in private protection. Varese concludes that the transition to a market economy in Russia created supply and demand for private protection and explained the rise of the Russian Mafia in a way that parallels the Sicilian case. But what are the specific causal mechanisms linking this macrohistorical explanation to individual action? Gambetta (1993) assumes rational actors, and shows how information asymmetries are overcome to produce a stable market for Mafia protection. His explanation draws heavily on economists’ work on the market for lemons. the market for lemons I begin with a brief description of the negative effects of asymmetric information on markets and potential responses to those effects. In a landmark

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paper in economics, George Akerlof (1970) describes the role of asymmetric information (over uncertainty about quality of goods) in the market for “lemons.” Employing the example of the used car market, Akerlof begins with the assumption that there are good cars and lemons. Buyers in this market, lacking information on specific cars, cannot distinguish good cars from lemons. Owners of cars, however, after a period of time, gain information about the quality of their cars, and update their subjective probability that a car is a lemon through Bayesian learning. At this point, there is an asymmetry of information: the owner (potential seller) has more relevant information than the buyer. Because buyers cannot distinguish good cars from bad, they will rationally make the “best guess” that the car is of average quality and make a corresponding average offer.Therefore, an owner of a good car cannot get the true value of his car, and, being a rational actor, takes the car off the market. Buyers revise their estimates of average quality downward and make lower offers, which drives out sellers of moderate cars, until the market collapses. Akerlof (ibid.: 490–92) derives supply and demand based on utility theory and shows that, under these conditions of asymmetric information, no cars will be sold. Akerlof (1970) identifies several “counteracting institutions” that can reduce quality uncertainty, including the use of seller guarantees, in which the seller shares the burden of risk, and the use of brand names, which signal the quality of the good to buyers. The latter point is further developed by Spence (1973) in his theory of job market signaling as a solution to information asymmetries in the labor market. Here the problem is that employers are willing to pay higher wages for good workers, but cannot distinguish good workers from bad. This is not a problem for bad workers, who can free ride on the productivity of good workers. But good workers want to be paid for their higher productivity. They therefore invest in educational credentials to signal to employees that they are good workers. For this signal to succeed, credentialing must be positively correlated with productivity, which is precisely the case: the costs of obtaining a credential are lower for high-ability individuals because their skills will make them more productive workers, as well as allow them to succeed scholastically with less time and effort. Employers, then, use education credentials as a signal of future productivity over and above the role of education in increasing human capital. asymmetric information and signaling in protection rackets Gambetta (1993) shows that both asymmetric information and signaling are crucial mechanisms in markets for Mafia protection. Broadly speaking, the key contextual element is trust. In free markets, the state protects individual rights, including rights of property and market exchange. The protection of those rights is public and universal, which, in conjunction with the institutional arrangements of markets, creates an environment of trust among actors. In perfectly competitive markets, equilibrium price, a macrolevel outcome, exists when prices have been adjusted so that demand equals supply of goods. In an environment of distrust, this model breaks down. Distrust inevitably arises when the state outlaws a certain commodity or exchange of goods, forcing exchange to occur outside the purview of a conventional market and its

310 Ross L. Matsueda institutionalized arrangements of trust. The result is a demand for privatized protection by third parties. Buyers pay the Mafia to protect themselves against being cheated or sold lemons; sellers pay for protection against buyers failing to pay on time or at all. Sellers may also be purchasing protection against themselves—to ensure that they not yield to the temptation of cheating the buyer and thereby soiling their own reputations. Thus, the seller’s payment to the Mafia “would reflect the price he is prepared to pay to be trusted by the customer” (ibid.: 21). Members of the Mafia are frequently observed doing favors for local residents—helping to solve local disputes, returning stolen goods, redressing a wrong—without compensation. Such activity is a way of creating social capital, inducing an unpaid obligation to be fulfilled at a later time, and disseminating information about the Mafia’s ability to deliver (a form of free advertising). In this way, the Mafiosi help create demand for their services (Gambetta 1993). This is also found in housing projects among drug dealers seeking to corporatize: they do residents uncompensated favors, showing that they can deliver services that housing authorities cannot, which helps create a demand for their services and protect their illicit activities, as residents gain an incentive to look the other way (Venkatesh 2000). Transactions involving protection have both positive and negative externalities, which each tend to increase the rate of protection in the system. Protection has a public goods aspect produced through a positive externality. Mafia protection of one business on a street will protect other businesses on that street, which each has an incentive to free ride. Similarly, Mafia protection of a few sellers in a market will deter buyers from cheating because, lacking perfect information, they cannot fully distinguish the protected from the unprotected. In each case, the Mafia has an incentive to tax free riders using the threat of violence to collect (Gambetta 1993), and perhaps an incentive to provide signals of invulnerability for the protected. Protection transactions also create negative externalities for those who lack protection, as predators will target the unprotected, increasing demand for protection, until everyone is protected. But not everyone is protected. The Mafia has strong disincentives to protect all sellers, because, while it would maximize their cut from sellers, it would simultaneously transform protection into a public good, creating a conventional market in which buyers purchase goods based on price, quality, and taste. Gambetta (ibid.) identifies two problems facing the Mafia that would arise from universal protection. The first is the problem of scale. If protection were a public good, sellers would have an incentive to evade taxes. If all sellers were protected, the sheer size of the protected business would prevent the Mafia from enforcing collection of their cut (allowing tax evasion). The problem of scale would also make it difficult to monitor and sanction all transactions against lemons, and each undetected lemon sold would degrade the Mafia’s reputation. The second is the problem of information. If the Mafia guaranteed all transactions, a given instance of protection would not be linked to a specific transaction, and a buyer might think he got a good deal not because of the Mafia’s protection but rather because of “the independent honesty of the seller, which might foster the development of trust directly between the buyer and

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seller and put the mafioso out of business” (ibid.: 23). Therefore, despite the unlimited demand for protection, the Mafia will only selectively protect a finite number of sellers. mafia resources: information, violence, and reputation In providing protection, the Mafia rely on three key resources—information, violence, and reputation. Information, a basic form of social capital, is a key resource for the Mafia. To make protection work, the Mafia must know how reliable a seller is, know whether other Mafia are involved, and have information useful for blackmailing sellers in case they renege. Moreover, Mafia reputations are built largely on their ability to gather pertinent information on a client and other parties to guarantee that they can keep all parties in line. For example, by knowing their clients’ location and the location of their clients’ property, the Mafia is able to inflict punishment for defaulting—and deliver protection (ibid.: 36). Obtaining such information, in turn, relies on bridging and bonding social ties. Information is easily secured over a relatively small familiar territory—for example, where one grew up—where existing network ties, outstanding obligations, and local knowledge can be relied upon. At times, however, as Granovetter (1973) has famously argued, weak ties between disparate groups may produce information otherwise not known in local groups (see Matsueda 2006). Instrumental manipulation of information can also facilitate the protection racket. For example, the Mafia has an incentive to maintain secrecy over information that increases the vulnerability of Mafia members to retaliation. When a client defaults, the Mafia has an incentive to make public strategic information on clients that is punitive in itself. The use of violence or the threat of violence is so ubiquitous that some scholars have included violence in its definition of organized crime (for example, Cressey 1969). Violence is used to enforce sanctions, and therefore, the physical and psychological strength necessary to inflict violence is a critical resource for the Mafia. Why is violence so pervasive in organized crime? Gambetta (1993) is able to answer this question without making it true by definition. There are two parts to this explanation. First, when a state outlaws a good or service, it necessarily threatens violators with the deliberate imposition of state-legitimated pain and suffering. Therefore, the market for the good selects for ruthless, tough, and malevolent dealers who are unafraid of violence. To succeed in the protection racket, organized crime figures must be willing to resort to greater violence and ruthlessness than the dealers they will be policing. If unwilling, they will be inefficient in delivering protection, will lose market share, and will eventually be selected out of the market in favor of more efficient (violent) firms. Second, from the standpoint of an evolutionary model of the protection market, regardless of initial conditions, the market will select for increasingly violent protectors. Violence is a zero-sum game in which victory not only delivers the goods but also provides free advertising to nonprotected agents. To succeed, any new competitor entering the market must be at least as violent and ruthless as established competitors, since new competitors not only have to resort to established levels of violence to sanction defaulters, but must also be willing to use greater violence against competitors to secure a market niche. As more violent and ruthless protectors enter the

312 Ross L. Matsueda market, surviving protectors must ramp up their violence to remain competitive regardless of their personal views toward violence (ibid.). Thus, there is a longterm structural tendency for violence to increase. Violence is essential for providing protection services; it is also a key component of a Mafia’s reputation. Generally speaking, reputation or honor is earned by delivering promised protection, which implies keeping promises, using information effectively, and resorting to violence when necessary. According to Gambetta (ibid.), reputation for the Mafia, as in all businesses, is an asset that exempts the firm from having to prove quality and reliability in every transaction, and also helps shelter them from competition from new firms. Unlike other businesses, for the Mafia, reputation also reduces costs of production: the stronger the reputation, the less likely the Mafia will have to use up resources, such as violence, to guarantee protection and maintain the reputation. Periodic demonstrations of violence reinforce the Mafia’s reputation, but even in the absence of such demonstrations, reputations persist because customers are unlikely to challenge them on account of the high costs of violence. This creates opportunities and incentives for fraud by outsiders—posing as a Mafia member and reaping the rewards of feigned protection. Consequently, Mafia members and their clients develop complex signals of authenticity that are difficult to pirate, and posers respond by trying to decipher and mimic the signals (ibid.: 45). To explore this point, Smith and Varese (2001) develop a game theoretic model of repeated interactions between Mafia and clients or entrepreneurs. They find that entrepreneurs try to filter out fakers by periodically withholding payment, but that means at times the real Mafia occasionally go unpaid, causing the Mafia to inflict punishment to protect their reputation, punish nonpayers, and drive out the fakers. Once Mafia reputations are restored, fakers again have an incentive to pose as Mafia. The result is a turbulent world in which filtering and violence persist. Interestingly, when police increase their presence, sporadic violence may rise in the short term—under police scrutiny, the Mafia must reduce demands and increase punishment if they are expected to be paid. In the long term, however, high levels of police presence allow entrepreneurs to refuse payment for protection, ultimately putting the Mafia out of business. In sum, demand for a market of protection by organized crime is created in an environment of distrust between buyers and sellers, such as when illegal goods and services are being exchanged. Thus, a simple three-party exchange between buyers, sellers, and protectors, involving the strategic use of resources, such as information, reputation, and the capacity for violence, produces Mafia protection, which overcomes the context of distrust and facilitates the exchange of illicit goods. Moreover, these microlevel exchanges produce macrolevel outcomes, such as a market for protection with an equilibrium rate of protective transactions, a high level of turbulence, a high level of violence by the Mafia, and stable levels of lemons sold. Finally, a remarkable feature of the protection market is that the demand for protection—resulting from the production of distrust—is created endogenously as a by-product of the market. In other words, the total number of lemons will increase as the Mafia’s effective protection increases. In conventional markets,

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sellers seek to attract repeat customers by behaving honestly and maintaining a good reputation. But when protected by the Mafia, the seller’s disincentive to sell a lemon to an unprotected outside buyer is diminished: (1) the seller, protected by the Mafia, is immune from punishment by the buyer; and (2) if the seller loses the unprotected customer (and perhaps others who hear about the lemon), he still retains his protected customers. The greater the number of protected buyers, the lower the cost of selling lemons to outsiders and consequently, the more lemons sold to outsiders.The result is more lemons sold and, therefore, an increased demand for protection. This implies that, in this context, “norms of good behavior will not evolve from an economic interest in keeping promises and acquiring an honest reputation” as Hume (1874: 290) suggested, because the incentives for maintaining an honest reputation have been weakened by protection (Gambetta 1993: 28). Indeed, according to Gambetta (ibid.), an oppositional norm may develop that praises and encourages the ability to cheat.

Conclusions In this chapter, I have tried to show the utility of rational choice theory, not only as a theory of individual criminal behavior consistent with the behavioral assumptions underlying Anglo-Saxon legal systems, but also as a microfoundation for macrostructural theories of crime rates. I began by reviewing empirical research on the deterrence question using statistical models, which generally shows consistent but modest effects of deterrence as well as rewards to crime. I then argued that rational choice can provide a microfoundation for macrolevel theories of organization against crime and organization in favor of crime. I showed that explanations of macrolevel phenomena, such as neighborhood collective efficacy and organized crimes of the Mafia, which are often explained by purely structural or cultural theories, can be enriched by recognizing that they are rooted in individual purposive action. Grounding macroprocesses in rational action overcomes the teleological problem of purely macrolevel theories, provides an explanation compatible with the utilitarian underpinnings of the legal system, and may furnish efficient points of intervention by targeting individuals’ agency, their embeddedness in social context, and the complex ways they produce social structure. The examples used to illustrate these points are rooted in empirical research using both qualitative and quantitative methods. Each is essential for future research on multilevel research on crime. Qualitative research is necessary to identify the perceived opportunities and costs and returns to crime, which may be local to communication groups and subcultures. Quantitative research is necessary to identifying structural patterns across individuals, identify network structure, and, after identifying pertinent perceived incentives, subject rational choice models to empirical test. Another useful tool for analyzing rational decisions—mentioned above with reference to organized crime—is game theory, the application of mathematical models to strategic situations in which individual decision-making is dependent on the decisions of others. In framing examples of social organization implicated in criminal processes, I used the concept of differential social organization as a framework that treats

314 Ross L. Matsueda organization in favor of crime and organization against crime as analytically separate phenomena. But clearly the process is more complicated, as anticriminal organization and criminal organization are typically interwoven into a single fabric of social structure that evolves slowly over time (Matsueda 2006). For example, Anderson (1999) shows how the code of the street—a system of informal norms and sanctions concerning violence operating on inner-city streets—is known and used instrumentally to maintain one’s reputation on the street among street youth and decent youth alike. Moreover, as noted earlier, forms of social structure used for strictly legal purposes can be co-opted and used for illegal objectives, and vice versa. Research is needed to identify the dynamic interrelationships between conventional and illicit organization, how they mutually unfold over time, how they conflict and compete for resources, and how one may be co-opted by the other. For example, above I noted that the Mafia and some corporatist gangs use their social networks, threats of violence, and other resources to control predatory victimization of local residents, when such victimizations impede the gang’s illicit pecuniary activity. Criminal organizations frequently attempt to nullify the legal system by buying off public officials, a rational response to their illicit businesses, and at times a rational response from the standpoint of the public officials. More subtly, residents will often tolerate illegal activity, such as drug dealing, when it is in their rational interest to do so, because they gain stability and social control against indiscriminate violence by drug-dealing gangs (see Patillo-McCoy 1999; Venkatesh 2000). Research into such relationships will likely show that criminal and anticriminal organizations often evolve according to a dialectical logic. Identifying the interdependencies that drive such a dialectical relationship is consistent with the thesis of this paper. That is, the interdependencies will be rooted in rational action that creates and re-creates social organization and social structure in which that action is embedded.

Notes The research upon which this chapter is based was supported by grants from the National Science Foundation (SES-0004324, SES-0004323), the National Institute on Drug Abuse (DA019148–01A1), and the National Consortium on Violence Research (SBR-9513040). I thank Maria Grigoryeva for research assistance, editorial advice, and suggestions, and Michael Hechter and Edgar Kiser for comments on an earlier draft. 1. With his control theory, Hirschi (1969) specified that people who are committed to noncriminal activities are less likely to deviate for fear of jeopardizing their investment. 2. For a critique of Becker and Murphy’s theory of rational addiction, see Elster (1997). 3. Economists have attempted to model “social interaction effects,” such as peer effects, using standard economic approaches, including using the method of revealed preference to capture utility maximization processes, and instrumental variables to identify social interaction effects, which are unmeasured peer effects disentangled from contextual effects, selection effects, and correlated individual effects (see Manski 1995; Brock and Durlauf 2001). 4. Although Merton (1957: 51) emphasized the latent functions of unanticipated consequences for the social system, he also noted that unanticipated consequences can also be latently dysfunctional or irrelevant to the functioning of the social system.

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5. For an extended discussion of these issues and an initial attempt to specify concrete causal mechanisms of organization against crime and organization in favor of crime, see Matsueda (2006). 6. This proposition is actually more complicated. Individuals seeking power over another may offer services or gifts that are too extravagant to be reciprocated, creating a burden of obligation to the individual seeking power. The result may be a relation of superiority-inferiority, rather than the egalitarian relation created with reciprocated exchange (Blau 1964). 7. Institutions and norms often provide opportunities for gaining trust. For example, favors that are repaid immediately are ineffective at building trust. Most favors, such as cooking dinner, helping to fix a car, or throwing a party, entail an implicit structured delay in the expected reciprocation, increasing the likelihood of building trusting relationships (Blau 1964). 8. The process of becoming aware of the production of externalities entails overcoming obstacles of information and corresponds precisely to Merton’s discussion (1936) of becoming aware of unanticipated consequences of purposive action. 9. The consensus underlying a social norm directly reduces the cost of sanctioning: control is at least partially transferred from the transgressor to the collection of residents as a whole, and therefore, some individuals will conform—that is, not free ride—because of the mere threat of sanction (see Coleman 1990). My use of the concept of social norms draws from the pioneering treatment by Coleman (1990); for a critique of this treatment, see Elster 2003). 10. Another mechanism for inducing greater social ties is excluding isolates from access to social capital, thus transforming social capital from a public good to a “club good” (Buchanon 1965). In the present case, the costs of exclusion are likely too steep for this to be a practical solution (see Sandler and Tschirhart 1994). 11. Conjoint norms are those for which the beneficiary and target are simultaneously the same person, such as laws intended to avoid a Hobbesian war of all against all: all citizens are simultaneously potential targets if they succumb to temptation, and beneficiaries when the norms are enforced (Voss 2001). Juvenile status offenses apply solely to juveniles and thus are disjoint norms; crimes that violate adult statutes apply to all citizens, making them conjoint norms. Such a distinction is more complex for community-specific norms, since they may be applied to outsiders, who are not beneficiaries. 12. For this to be an assurance game, we must assume that the good—creating a safe neighborhood—can be produced only if all the players (neighbors) contribute. 13. A recent study by Hagan and Rymond-Richmond (2008, 2009) offers a fascinating analysis of how genocidal state systems arise from purposive action of individuals (Coleman’s link 3). Using the concepts of collective action frames and social efficacy (Matsueda 2006), they show how individual racial epithets coalesce into a “collectivized racial intent” that mobilizes groups as well as the state into genocidal victimization (Hagan and Rymond-Richmond 2009). Such collective action is an example of organization in favor of crime (see Matsueda 2009).

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318 Ross L. Matsueda ———, ed. 1983. The Microfoundations of Macrosociology. Philadelphia:Temple University Press. Hechter, Michael, and Satoshi Kanazawa. 1997. “Sociological Rational Choice Theory.” Annual Review of Sociology 23: 191–214. Hechter, Michael, and Karl-Dieter Opp, eds. 2001. Social Norms. New York: Russell Sage. Heckathorn, Douglas D. 1988. “Collective Sanctions and the Creation of Prisoner’s Dilemma Norms.” American Journal of Sociology 94, no. 3: 535–62. Hirschi, Travis. 1969. Causes of Delinquency. Berkeley: University of California Press. Huber, Joan, ed. 1991. Macro-micro Linkages in Sociology. Newbury Park, CA: Sage. Hume, David. 1874 [1739]. Treatise on Human Nature.Vol. 2, edited by T. H. Green and T. H. Grose. London: Longmans, Green, and Co. Ianni, Francis A. J., and Elizabeth Reuss Ianni. 1972. A Family Business: Kinship and Social Control in Organized Crime. New York: Russell Sage. Kahneman, Daniel, Peter P. Wakker, and Rakesh Sarin. 1997. “Back to Bentham? Explorations of Experienced Utility.” Quarterly Journal of Economics 112: 375–405. Kelling, George L., and Catherine M. Coles. 1997. Fixing Broken Windows: Restoring Order and Reducing Crime in Our Communities. New York: Simon and Schuster. Kitts, James A. 2006. “Collective Action, Rival Incentives, and the Emergence of Antisocial Norms.” American Sociological Review 71: 235–59. Klepper, Steven, and Daniel S. Nagin. 1989. “The Deterrent Effect of Perceived Certainty and Severity of Punishment Revisited.” Criminology 27: 721–46. Kollock, Peter. 1998. “Social Dilemmas: The Anatomy of Cooperation.” Annual Review of Sociology 24: 183–214. Kornhauser, Ruth Rosner. 1978. Social Sources of Delinquency: An Appraisal of Analytic Models. Chicago: University of Chicago Press. Lederman, Daniel, Norman Loayza, and Ana María Menéndez. 2002. “Violent Crime: Does Social Capital Matter?” Economic Development and Cultural Change 50: 509–39. Levitt, Steven. 1997. “Using Electoral Cycles in Police Hiring to Estimate the Effect of Police on Crime.” American Economic Review 87: 270–90. Lochner, Lance. 2007. “Individual Perceptions of the Criminal Justice System.” American Economic Review 97: 444–60. Loughran,Thomas A., Raymond Paternoster, Alex R. Piquero, and Greg Pogarsky. 2011. “On Ambiguity in Perceptions of Risk: Implications for Criminal Decision-Making and Deterrence.” Criminology 4: 1029–62. Maestro, Marcello T. 1973. Cesare Beccaria and the Origins of Penal Reform. Philadelphia: Temple University. Manski, Charles F. 1990. “The Use of Intentions Data to Predict Behavior: A Best Case Analysis.” Journal of the American Statistical Association 85: 934–40. ———. 1995. Identification Problems in the Social Sciences. Cambridge, MA: Harvard University Press. Massey, Douglas S., and Nancy A. Denton. 1993. American Apartheid: Segregation and the Making of the Underclass. Cambridge: Harvard University Press. Matsueda, Ross L. 2006. “Differential Social Organization, Collective Action, and Crime.” Crime, Law and Social Change 46: 3–33. ———. 2009. “Toward a Criminology of Genocide: Theory, Method, and Politics.” Theoretical Criminology 13: 495–502. Matsueda, Ross L., Derek A. Kreager, and David Huizinga. 2006. “Deterring Delinquents: A Rational Choice Model of Theft and Violence.” American Sociological Review 71: 95–122. McAdams, Richard H. 2009. “Beyond the Prisoners’ Dilemma: Coordination, Game Theory, and Law.” Southern California Law Review 82: 209–58.

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320 Ross L. Matsueda Portes, Alejandro. 1998. “Social Capital: Its Origins and Applications in Modern Sociology.” Annual Reviews in Sociology 24: 1–24. Putnam, Robert D. 1995. “Tuning In,Tuning Out:The Strange Disappearance of Social Capital in America.” Political Science and Politics 28: 664–83. ———. 2001. Bowling Alone:The Collapse and Revival of American Community. New York: Simon and Schuster. Quillian, Lincoln. 1999. “Migration Patterns and the Growth of High-Poverty Neighborhoods, 1997–1990.” American Journal of Sociology 105: 1–37. Reuter, Peter. 1983. Disorganized Crime: The Economics of the Visible Hand. Cambridge, MA: MIT Press. Rosenfeld, Richard, Steven F. Messner, and Eric P. Baumer. 2001. “Social Capital and Homicide.” Social Forces 80: 283–309. Rossi, Peter H., and Steven L. Nock. 1982. Measuring Social Judgments: The Factorial Survey Approach. Beverly Hills, CA: Sage. Sampson, Robert J., and Jacqueline Cohen. 1988. “Deterrent Effects of Police on Crime: A Replication and Theoretical Extension.” Law and Society Review 22: 163–89. Sampson, Robert J., and John H. Laub. 1993. Crime in the Making: Pathways and Turning Points through Life. Cambridge: Harvard University Press. Sampson, Robert J., Jeffrey D. Morenoff, and Felton Earls. 1999. “Beyond Social Capital: Spatial Dynamics of Collective Efficacy for Children.” American Sociological Review 64: 633–60. Sampson, Robert J., Jeffrey D. Morenoff, and Thomas Gannon-Rowley. 2002. “Assessing ‘Neighborhood Effects’: Social Processes and New Directions in Research.” Annual Review of Sociology 28: 443–78. Sampson, Robert J., and Stephen W. Raudenbush. 1999. “Systematic Social Observation of Public Spaces: A New Look at Disorder in Urban Neighborhoods.” American Journal of Sociology 105: 603–51. Sampson, Robert J., Stephen W. Raudenbush, and Felton Earls. 1997. “Neighborhoods and Violent Crime: A Multilevel Study of Collective Efficacy.” Science 277: 918–24. Sampson, Robert J., and William J. Wilson. 1995. “Race, Crime and Urban Inequality.” In Crime and Inequality, edited by J. Hagan and R. Peterson, 37–56. Stanford: Stanford University Press. Sandler, Todd, and John Tschirhart. 1994. “Club Theory: Thirty Years Later.” Public Choice 93: 335–55. Sawyer, R. Keith. 2001. “Emergence in Sociology: Contemporary Philosophy of Mind and Some Implications for Sociological Theory.” American Journal of Sociology 107: 551–85. Shaw, Clifford R., and Henry D. McKay. 1969 [1942]. Juvenile Delinquency in Urban Areas. Rev. ed. Chicago: University of Chicago Press. Sherman, Lawrence W. 1990. “Police Crackdowns: Initial and Residual Deterrence.” In Crime and Justice: An Annual Review of Research, Vol. 12, edited by M. Tonry and N. Morris, 1–48. Chicago: University of Chicago Press. Silver, Eric, and Lisa L. Miller. 2004. “Sources of Informal Social Control in Chicago Neighborhoods.” Criminology 42: 551–83. Smith, Alastair, and Federico Varese. 2001. “Payment, Protection, and Punishment: The Role of Information and Reputation in the Mafia.” Rationality and Society 13: 349– 93. Spence, Michael. 1973. “Job Market Signaling.” Quarterly Journal of Economics 87: 355– 74. Sutherland, Edwin.1947. Principles of Criminology. 4th ed. Philadelphia: Lippincott. Swaray, Raymond B., Roger Bowles, and Rimawan Pradiptyo. 2005. “The Application of Economic Analysis to Criminal Justice Interventions: A Review.” Criminal Justice Policy Review 16: 141–63.

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Taylor, Ralph B. 1996. “Neighborhood Responses to Disorder and Local Attachments: The Systemic Model of Attachment, Social Disorganization, and Neighborhood Use Value.” Sociological Forum 11: 41–74. Thrasher, Frederic M. 1927. The Gang. Chicago: University of Chicago Press. Toch, Hans. 1969. Violent Men. Chicago: Aldine. Varese, Federico. 1994. “Is Sicily the Future of Russia? Private Protection and the Rise of the Russian Mafia.” European Journal of Sociology 35: 224–58. ———. 2001. The Russian Mafia: Private Protection in a New Market Economy. Oxford: Oxford University Press. Venkatesh, Sudhir. 2000. American Project: The Rise and Fall of a Modern Ghetto. Cambridge: Harvard University Press. Von Neumann, John, and Oskar Morgenstern. 1944. Theory of Games and Economic Behavior. Princeton: Princeton University Press. Voss, Thomas. 2001. “Game-Theoretic Perspectives on the Emergence of Social Norms.” In Social Norms, edited by M. Hechter and K.-D. Opp, 105–36. New York: Russell Sage. Weber, Max. 1978 (1921/22). Economy and Society. Edited by G. Roth and C. Wittich. Berkeley: University of California Press. Western, Bruce. 2007. Punishment and Inequality in America. Cambridge: Harvard University Press. Williams, Kirk R., and Richard Hawkins. 1986. “Perceptual Research on General Deterrence: A Critical Review.” Law and Society Review 20: 545–72. Wilson, James Q., and Barbara Boland. 1978. “The Effect of the Police on Crime.” Law and Society Review 12: 367–90. Wilson, William Julius. 1987. The Truly Disadvantaged: The Inner City, the Underclass, and Public Policy. Chicago: University of Chicago Press. Zimring, Franklin E., and Gordon J. Hawkins. 1973. Deterrence. Chicago: University of Chicago.

chapter

Secularization:Theoretical Controversies Generating Empirical Research

9

nan dirk de graaf

In the past four decades we have seen a revival of world religion on the societal stage. A wide variety of examples include the Islamic revolution in Iran; Islamic political activism in various countries; Protestant movements in the United States and South America; ethical revival in the Roman Catholic Church; political activism among Theravada Buddhism in South Asia; and Hindu activism in India (Wolters and De Graaf 2009). These developments have attracted the attention not only of journalists but of social scientists as well. In the two decades following World War II, the general view was that secularization was inevitable and irreversible in industrial societies, and that developing countries would eventually show a similar trend. According to the secularization thesis,1 scholars expect religion and modernization in general (and the development of science in particular) to be at odds with each other—a conflict nicely illustrated by the widely accepted evolutionary model for explaining the origin of species. The latter is difficult to match with a literal reading of a holy book such as the Old Testament. Although this description of the secularization thesis is—as I will show later— too simplistic, the religious revival in the past four decades and especially the relatively high levels of religious participation in the United States cast doubt on the secularization thesis. What followed was a “renaissance of theorizing” in the sociology of religion (Stark 1997: 3). Bainbridge, Finke, Iannaccone, and Stark introduced Rational Choice Theory in the field of religion in the 1980s. A landmark is the book A Theory of Religion by Stark and Bainbridge, which was published in 1987 and remained relatively unknown in the first years after publication.2 The theoretical work of Stark and Bainbridge became known as “the supply side approach,” as it stresses the importance of the supply of attractive religious options and assumes a stable demand. Some social scientists assume that the supply side theory was the paramount and probably only contribution of Rational Choice Theory to the field of religion, since the labels “Rational Choice Theory” and “supply side approach” were used interchangeably, and the supply side predictions for religious markets dominated the discussion until recently. Of course, there are other theories based on the Rational Choice

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axioms in the field of religion. Inspired by Gary Becker, there is a Rational Choice tradition with respect to religious household production, religious human capital, and religious groups and institutions as well (Iannaccone 1998). The work of the economist Iannaccone has been very influential in some of these fields.3 In this chapter, I will focus mainly on the supply side approach, since it triggered an enormous amount of empirical research and a stream of books and journal articles.4 I will argue that this approach can and should be improved using the Rational Choice perspective.5 One of the questions of interest for this book is whether, in the field of religion, the general criticisms associated with Rational Choice Theory apply—that is, that Rational Choice scholars excel in formal modeling but fail to provide empirical evidence, or when they use data, it is typically to show that their models indeed apply post hoc. As Goldthorpe (2000) noted, a substantial number of proponents of the Rational Choice approach tend to care less about the empirical evidence and are driven mainly by the intellectual challenge of providing a theoretical model for a theoretical puzzle. Goldthorpe agrees with Hechter (1998) when he argues that “the main difficulty here is not so much basic intellectual conflicts as differences in ‘comparative advantage’ arising out of tendencies towards specialization in either empirical research or theory that are, unfortunately, increasingly marked in sociology today” (2000: 20). What I would like to make clear in this chapter is that this criticism does not apply to the study of religion. The Rational Choice approach has not only inspired the theoretical discussions in the field but has also encouraged the gathering of unique data sources. An impressive interplay between theory and empirical research can be noted, and various strategies of data gathering have been used—for example, local, nationwide, and worldwide survey data; the various historical data sources; ethnographies of cults, and so forth. In their review on developments in the sociology of religion, Sherkat and Ellison (1999) noted a substantial organizational and intellectual growth. As a result, many contributions have been published in leading journals. All of this is positive news for the sociology of religion and the field’s scientific progress. Although the influential book by Stark and Bainbridge (1987) does not contain formal models,6 it does contain 344 propositions that are accompanied by clear definitions of most terms used. Later, in an edited volume,Young (1997) summarized what Stark and others had achieved.This was followed by revisions of their Rational Choice Theory of religion. For example, Stark wrote a paper on the revision of the microfoundations of religion (1999a). The propositions derived from the Rational Choice Theory inspired scholars to discuss old and new issues in this field. Many questions have been asked, including:What affects the chance that religious switching occurs; and if one switches, what kind of switch is that likely to be? How can religious organizations affect the number of members? How does a religious market affect the number of church members in a society? Besides asking new questions inspired by the supply side theory, one wonders whether there is indeed an excellent marriage between theory and empirical research in this field. As is the case with every marriage, there are also some downsides, as I will show later in this chapter. Despite the increase of available data to test the hypotheses, the literature has been plagued by an un-Popperian

324 Nan Dirk De Graaf habit of ignoring empirical findings that do not fit the theory. Furthermore, the empirical designs being used to test propositions based on Rational Choice Theory are sometimes problematic, to say the least. This seriously challenges the theoretical progress in this field. Problematic theoretical issues are (1) the strong focus on the supply side—that is, the level of competition; (2) the implicit assumption that the religious market is like any other market; and (3) the strong assumption of a stable demand of religion over time and place. The latter assumption indeed simplifies the theory, but, as I will discuss later, has been seriously criticized for being too simplistic. The organization of this chapter is as follows. It consists of three parts. In the first part, I will introduce this most discussed version of the Rational Choice approach of religion, which is the supply side approach.7 I will discuss the microfoundations and the important propositions at the macrolevel for predicting religious participation. For these macropropositions, religious pluralism is important for understanding religious competition. In order to get more insight in the uniqueness of the religious market, I will also compare the competition within the religious market with the competition of a totally different market. In addition, I will discuss the consequences of religious socialization for the religious market and the various goods being produced. Although the supply side approach is the central focus of this chapter, I will furthermore briefly discuss other contributions of the Rational Choice approach in the field of religion. These contributions, like the household production function of religious goods, attracted far less attention in the literature. I will also pay attention to the Secularization Theory (paradigm), since much of the controversy associated with the supply side approach has triggered a rich empirical tradition, and, as I will argue, this secularization paradigm also fits in the Rational Choice framework. In the second part, I will discuss research that tested the main hypotheses of the supply side approach. Special attention will be given to testing the assumption that religious demand is stable over time and place. In the third part, I will offer some reflections and discuss possible ways progress can be made using the Rational Choice framework for religious participation.

Religious Market Theory from a Supply Side Perspective The supply side approach to religion implies cost-benefit analysis. The starting point is that religion can be perceived as an economic exchange between people and imagined supernatural agents for goods that are scarce or impossible to obtain in the real world. Such otherworldly rewards are more or less comparable to the Heilsgüter in the work of Weber (1972 [1922]: 330).8 The theory has been designed to capture all primary aspects of religion, such as belief, emotion, ritual, prayer, sacrifice, mysticism, and miracle. In his article subtitled “Adam Smith and the Economics of Religion,” Iannaccone (1991) illustrated that The Wealth of Nations (Smith 1965 [1776]: 740–41) already contains an economic theory of religious institutions discussing the disadvantages of a monopoly and the advantages of competition. Adam Smith compared teachers of religion to other teachers, who are also dependent on the contributions of their audience. The clergy of established churches

ta bl e 9.1 Stark’s Rational Choice Theory of Religion and Its Implications (the 20 definitions that accompany this list are left out) 1. Within the limits of their information and understanding, restricted by available options, guided by their preferences and tastes, humans attempt to make rational choices. 2. Humans are conscious beings having memory and intelligence, who are able to formulate explanations about how rewards can be gained and costs avoided. 3. Humans will attempt to evaluate explanations on the basis of results, retaining those that seem to work most efficiently. 4. Rewards are always limited in supply, including some that simply do not exist in the observable world. 5. To the degree that rewards are scarce, or are not directly available at all, humans will tend to formulate and accept explanations for obtaining the reward in the distant future or in some other nonverifiable context. 6. In pursuit of rewards, humans will seek to utilize and manipulate the supernatural. 7. Humans will not have recourse to the supernatural when a cheaper or more efficient alternative is known and available. 8. In pursuit of rewards, humans will seek to exchange with a god or gods. 9. The greater number of gods worshipped by a group, the lower the price of exchanging with each. 10. In exchanging with the gods, humans will pay higher prices to the extent that the gods are believed to be more dependable. 11. In exchanging with the gods, humans will pay higher prices to the extent that the gods are believed to be more responsive. 12. In exchanging with the gods, humans will pay higher prices to the extent that the gods are believed to be of greater scope. 13. The greater their scope (and the more responsive they are) the more plausible it will be that gods can provide otherworldly rewards. Conversely, exchanges with gods of smaller scope will tend to be limited to worldly rewards. 14. In pursuit of otherworldly rewards, humans will accept an extended exchange relationship. 15. In pursuit of otherworldly rewards, humans will accept an exclusive exchange relationship. 16. People will seek to delay their payment of religious costs. 17. People will seek to minimize their religious costs. 18. A religious organization will be able to require extended and exclusive commitments to the extent that it offers otherworldly rewards. 19. Magic cannot generate extended or exclusive patterns of exchange. 20. Magicians will serve individual clients, not lead an organization. 21. Otherworldly rewards entail risk. 22. An individual’s confidence in religious explanations concerning otherworldly rewards is strengthened to the extent that others express their confidence in them. 23. Confidence in religious explanations concerning otherworldly rewards is strengthened to the extent that people participate in religious rituals. 24. Prayer builds bonds of affection and confidence between humans and a god or gods. 25. Confidence in explanations offered by religion concerning otherworldly rewards will increase to the degree that miracles are credited to the religion. 26. Confidence in explanations offered by religion concerning otherworldly rewards will increase to the degree that people have mystical experiences. 27. Vigorous efforts by religious organizations are required to motivate and sustain high levels of religious commitment. source: Stark, 1999a.

326 Nan Dirk De Graaf might become lazy, and this is an advantage for new religious enthusiasts looking for followers. It is therefore clear, as Iannaccone argued (1991), that the Rational Choice approach to religion has its foundation in the work of Adam Smith. Interestingly, what Adam Smith wrote was about the only theoretical contribution that economists have made in the field of religion for about two hundred years (Iannaccone 1998: 1478; Boulding 1970: 170). Contemporary social scientists provided a Rational Choice Theory on religion,9 containing a long list of consistent propositions. Stark’s (1999a) revision of the theory allows me to present the theory in twenty-seven propositions on the microfoundation in a single table (Table 9.1). I will discuss some criticism of the microfoundations of the Rational Choice Theory of religion as shown in Table 9.1. Subsequently I will discuss some of the macrohypotheses. Although these macrohypotheses are arguably more interesting, I will first reflect on the first and most important propositions of Table 9.1.10 microfoundation Stark and Bainbridge define religious goods as supernatural and nonverifiable compensators, and “compensators are treated by humans as if they were rewards” (1996 [1987]: 36). Proposition four in Table 9.1 states that “rewards are always limited in supply, including some that simply do not exist in the observable world.” In Stark’s more recent work (1999a) the label “compensator” is replaced by “otherworldly rewards” and, as mentioned earlier, according to Stolz (2006: 15), the focus on such final goals of religion is similar to the “salvation goals” of Weber. Wilson (2002: 49) argues that propositions one, two, and three are not adaptive in the case of religion. Indeed, one might argue that the “evaluations of explanations” (see proposition three in Table 9.1) on the basis of results are somewhat problematic with respect to religion. How is it possible that one can evaluate which explanation regarding “how rewards can be gained and costs avoided” is most sufficient if results are not transparent and objective? Wilson emphasizes that the microfoundations of Stark’s theory provide us with goods we cannot have (as implied by proposition seven in Table 9.1). If goods cannot be produced by human action, supernatural agents are invented to provide, or promise to provide, these goods in the afterlife, and people pray for such goods. According to Wilson this conception misses the kind of goods that can be produced by coordinated human action and the role of religion in achieving this. It ignores the problem of social life. Indeed, within religious networks people can support each other and may receive positive support,11 and in a society with many poor people, churches may supply food. This brings us to the important question of what kind of religious goods are being produced. I will discuss a variety of religious goods that are not considered as final religious goods when I compare the religious market with the market for cars. Although various religious goods may be produced, it is important that there is no alternative to providing final goods such as eternal life.The problem with eternal life is, of course, that you cannot be sure premortem whether your investment has any effect, whereas on the stock market you know in the end whether your investment is good or bad within a certain time interval.12 In this respect proposition five is relevant, since “humans will tend to formulate

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and accept explanations for obtaining the reward in the distant future or in some other nonverifiable context.” In relation to this, proposition six suggests that humans will seek to exchange with a supernatural, but the question is what size of the population does so, and if people do it, how frequently will they do it? Furthermore, one could easily challenge the proposition. This proposition suggests that people do not have recourse to the supernatural when a less expensive or more efficient alternative is known and available. It is remarkable that the option that some people think the supernatural is implausible is not even considered. macropropositions What has inspired most research is the theoretical model of religious economies explicating what stimulates religious participation. The following propositions are relevant (Stark and Finke 2000: 198–201): Proposition 71: “To the degree that a religious economy is unregulated, it will tend to be very pluralistic.” An unregulated market in this context implies that the state does not subsidize a specific church and does not restrict competition between churches. Here pluralism is related to the number of firms active in the economy. More firms will lead to more pluralism. Proposition 72: “The capacity of a single religious firm to monopolize a religious economy depends upon the degree to which the state uses coercive force to regulate the religious economy.” Proposition 75: “To the degree that religious economies are unregulated and competitive, overall levels of religious participation will be high. Conversely, lacking competition, the dominant firm[s] will be too inefficient to sustain vigorous marketing effort, and the result will be an overall level of religious participation, with the average person minimizing and delaying payment of religious costs.” According to the religious market theory, countries with strong religious competition and a low level of religious regulation will have more religious suppliers producing attractive religious commodities. In these countries, church attendance will be higher than in nations with low competition and strong religious regulations. This, however, is not a linear relationship since, as in every market, there is a ceiling effect. Beyond a certain point, diminishing marginal utility applies, and this has been confirmed by research of Finke, Guest, and Stark (1996), and Pettersson and Hamberg (1997). With each extra step competition led to a smaller increase of church attendance. competition In the above propositions, it is difficult to unravel the relationship between competition and pluralism. It seems that both a lack of regulation and a high level of pluralism positively affect competition. According to Olson (2002) the basic problem with the theories of religious economies is the lack of definition of “religious competition.” The theory is being introduced with many definitions, but not for the key variable “religious competition.” This makes it difficult to measure competition, with the result that authors, for example, agree on the increase of religious pluralism in a society but disagree

328 Nan Dirk De Graaf on whether this should be interpreted as an increase or decrease of competition (ibid.: 134). Olson suggests two definitions of religious competition. One, which seems to fit with the claims of Stark and colleagues, holds that competition is indicated by the number of physically proximate substitutes to one’s own religious group. The other definition takes into consideration substitutability, suggesting submarkets. If we compare it to the market for cars, we can say that there is a submarket for fast sports cars and a submarket for family cars. Olson uses the example of the Lutheran congregation, which is unlikely to compete with the nearby mosque, while both try to meet religious needs (ibid.: 142). The idea of submarkets is also implied by the following hypotheses of Stark and Finke (2000: 121): “In making religious choices, people will attempt to conserve their religious capital” (religious capital is the knowledge and skills related to a specific religion), and “The greater their religious capital, the less likely people are either to reaffiliate or to convert.” Because of this religious capital, people would be unlikely to switch to a totally different denomination. The idea of submarkets, however, when applying the theory of Stark and colleagues, is not supported by empirical findings. One would expect that people are more committed when their denomination has many nearby congregations from the same denomination. However, research clearly indicates that Catholics have higher levels of commitment in non-Catholic regions (Olson 2002). Sometimes the absence of a clear definition of religious competition is problematic. For example, in their response to Lechner, Stark and Iannaccone (1996: 266) argue that because of the lack of direct measures of competition they often used pluralism as a proxy for competitiveness. It seems puzzling that pluralism is used as a proxy for competition while at the same time pluralism is occasionally not related to competition. The separate mentioning of “competition” and “pluralism” in the hypothesis “To the degree that a religious economy is competitive and pluralistic, overall levels of religious participation will tend to be high” (Stark and Iannaccone 1994: 233) suggests that these aspects need not be related perfectly. Causally, one expects that pluralism is required in order to make competition possible. In other words, pluralism is indeed a necessary condition but it is not a sufficient one. In 2000, Stark and Finke state, “It must be noted that in some circumstances, pluralism does not result in competition and thus will not be associated with higher levels of religious commitment” (218).13 An example of a situation with a high level of participation and a low level of religious competition is a situation of conflict. Stark and Finke hypothesize that “even where competition is limited, religious firms can generate high levels of participation to the extent that the firms serve as the primary organizational vehicles for social conflict. Conversely, if religious firms become significantly less important as vehicles for social conflict, they will be correspondingly less able to generate commitment” (ibid.: 202). A popular example is the conflict between Catholic and Protestant groups in Ireland. High levels of Catholic commitment cannot be separated from group loyalty with those that oppose the English ruling elites. In such societies the lack of competition among religious groups is irrelevant.

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religious opposition: religious competition and religious conflict The fact that competition as a mechanism does not work in case of conflict, inspired Olson (2002) to suggest that it is not competition but religious opposition that is the central driving force. Olson suggests that religious competition and religious conflict are combined in religious opposition (ibid.: 135). He defines religious opposition “as behavior (or threatened behavior) that obstructs (or is believed to obstruct) a religious group’s attainment of its goals” (ibid.: 139). According to Olson, both religious competition and religious conflict have the potential to increase religious commitment, but these two types of opposition have different causal mechanisms as a basis. Religious conflict and religious competition are different with respect to the level of consciousness. Almost without exception, religious conflict involves conscious opposition, whereas religious competition can be unconscious. The implications are, according to Olson, fourfold. The “two types of opposition 1) operate via different causal mechanisms, 2) have effects that differ in their potential geographic scale, 3) are best measured using different variables, and 4) draw on different types of explanations taken from quite different theoretical traditions” (ibid.: 145). With respect to consciousness Olson argues that both religious adherents and religious leaders are important. According to Olson: “Perceiving themselves to be the target of a religious conflict, adherents may, without appeals from religious leaders, turn to the religious group as a source of organizational strength and as a means to protect and further their interests, many of which may be linked to the religious or associated identity group” (ibid.). Olson uses Poland under communist rule as an example. High levels of church attendance were most likely the result of the threat of the religious identity of the Polish Catholics, and this is therefore more a demand side issue, although it goes without saying that church leaders experienced the same threats. “Even when religious leaders consciously manipulate the perception of threat in order to motivate higher levels of commitment from their adherents, they increase religious involvement by increasing the demand for religion, not by first making religion more available” (ibid.). However, I doubt whether it is a change in the demand for religion. One could also argue that it is a demand for being associated with a group that fights against possible threats of one’s identity, irrespective of whether this is a religious group. Another issue is whether indeed competition is predominantly unconscious. Also, Hamberg and Pettersson stress the issue that producers in a religious competitive market may not consciously compete with each other (2002: 97). Since competition is definitely conscious in various other markets, it is important to investigate whether and to what extent the religious market is special. For this purpose I will compare the religious market with the market for cars. comparing markets The market for cars and the market for religion14 Is it indeed the case that the same market mechanisms apply for different markets? Assume that you have a driving license and consider buying a car.

330 Nan Dirk De Graaf Advertisements and people within your network may provide you with information that it is attractive to buy car X for a certain price.The cars you can choose from are those for which the car dealers are at a reasonable distance—that is, a distance still attractive for bringing back your car in case of possible defects. The number of car dealers within that particular area is likely to be the basis of the competition. A large number of car dealers implies more competition. If we apply the same conditional frame for the religious market, we can replace the number of car dealers by the number of churches. Interestingly, Stark and Finke, because of lack of other indicators, often replace competition by how pluralistic the market is. Furthermore, similar to our “reasonable distance” for the car dealers, the “degree of pluralism must be assessed from the point-ofview of the individual and thus is a local phenomenon, limited to an easily traveled area” (Stark and Finke 2002: 37). It seems that the two apparently different markets resemble each other in this respect. An important mechanism is that competition becomes lower among car dealers if they make secret price arrangements. Such an oligopoly can be very attractive for firms, and therefore most states have special economic institutions to watch the market, so as to avoid such activities. An oligopoly can also exist on the religious market. For example, it existed in the Netherlands during the pillarization until the 1960s (Lechner 1996a). The main churches divided society into pillars of institutions with religious identities. Every kind of activity, from schools to newspapers, was organized along denominational lines (Lijphart 1975), and each pillar respected the other pillar without stimulating competition. Apparently, there also exist incentives for churches to make such arrangements. The state, like a commercial market, can play an important role in regulating the religious market. Interestingly, Stark and Finke hypothesize, “The capacity of a single religious firm to monopolize a religious economy depends upon the degree to which the state uses coercive force to regulate the religious economy” (2002: 37). In modern societies there is a tendency not to intervene with the religious economy, with the exception of Russia, where the political leaders heavily support the Orthodox Church. In general, the state in a modern society has an incentive to use coercive force to regulate the market for commercial commodities in order to maximize competition, but states in modern societies are increasingly reluctant to intervene with the religious market, which maximizes the competition among religions. According to Hechter, the supply side scholars “only begin to tap Rational Choice Theory’s potential for analyzing religious phenomena” (1997: 150), since religious groups are in various respects different from other firms. One such difference is that religion is concerned with a market for inscrutable goods. In inscrutable markets such as the market for religion, both buyers and sellers have no reliable information on the quality of the product, in this case, salvation. Cars are by contrast an “experience good” (Nelson 1975), which one comes to know by using it. With the market for cars, the production of high-quality cars over a certain period will build up the reputation. The puzzle is that in principle Rational Choice scholars would predict the failure of a market where buyers do not know the quality of the provided goods, and sellers cannot give the acquired information (Gambetta 1994). In other words, one of Rational Choice Theory’s basic assumptions, namely that choice is not only rational but

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based on well-founded beliefs, seems to be violated (compare Elster 1986: 17; see also Bruce 2002: 180). Building up a reputation for a firm is very important, since it saves the burden of continually proofing the quality of products. In the case of inscrutable commodities, one has to rely completely on the reputation, and if firms could find a way to develop one this could solve the puzzle of why it is possible to have a market with inscrutable goods. Firms have to provide signs that the quality of their products is good, and churches provide such symbols (of which a whole variety exist). “The more a commodity approaches inscrutability, the greater the incentive to invest in symbolic resources, and the fiercer the competition selecting successful symbols” (Gambetta 1994: 359). Churches indeed pursue strategies that rely on symbols; a “cross” is a good example, since it is an excellent symbol. It is simple, easy to make, and easy to carry. Church leaders use a variety of symbols, and some of them indirectly give a signal that their products are of good quality.15 If religious leaders are engaged in activities that are only indirectly related to the commodity that they offer, but in which they can show to others their trustworthiness, it might be considered as an indirect sign or a symbol of the quality of the product. Furthermore, in order to protect their property rights, churches will seek for what Gambetta (1994) calls “imitation-resistant symbols” that preferably concern a string of symbols and practices that are costly to mimic. If we take seriously the idea that reputation is of crucial importance for religious leaders and that they can only indirectly build up a reputation of being reliable, one could come up with new predictions. It would imply that in times when religious leaders are involved in scandals, people should either leave that particular church and move to another one, in case of sufficient supply. For example, the relatively large number of scandals among American televangelists as well as with Catholic priests in the past decade should have a negative effect on the reputation and the quality of the religious product, reflected in declining rates of religious participation and/or increasing rates of religious switching. This might open new fields for empirical research; Smith (1992) has already published on this issue. Another important distinct aspect of the religious market with respect to reputation is the judgments of miracles saints are assumed to be responsible for. In this case churches have an advantage over the market for cars. For example, one will often notice in Catholic churches the large number of pictures and related letters on walls, thanking one of the saints. For example, in the Basilica of Saint Anthony of Padua in Italy there are a large number of such pictures and letters on the grave of Saint Anthony because the son, daughter, uncle, aunt, husband, or wife of the writer survived an illness or a horrible car accident. Curiously, nobody questions the role of this saint in the thousands of cases in which people do not survive a car accident. Hence, religious people might not judge religious goods as inscrutable, simply because of the fact that they are looking for verifications only (that is, only positive signals are considered). The implication is that reputation of belief becomes more or less a function of belief. The market for cars is quite different, since people tend to discuss the quality of the car in all accidents.Therefore, car sellers should be jealous of such one-sidedness where negative empirical facts are simply ignored. However, in

332 Nan Dirk De Graaf some cases the force of a car brand name might also lead to a reputation that defies reality. An example is that in the last decades of the twentieth century the Mercedes company had a reputation for building the most reliable cars, whereas objective tests revealed that Toyota’s were not only less expensive but also more reliable. However, the quality of cars can be objectively determined. With respect to the religious market we are objectively faced with inscrutable goods, but, as argued, quite often religious people are looking for verifications; this has as an implication that they might not view the religious market as consisting of inscrutable goods. Besides goods being produced on the religious market, religious goods can also be viewed as household commodities. I will therefore next discuss religious goods produced by individuals themselves. A variety of religious goods: individual and collective goods We have noted that the final goods being produced on a religious market are quite different from goods being produced on the car market. As showed earlier, Stark and Bainbridge define religious goods as otherworldly rewards. However, Iannaccone argued in various publications that religious goods can also be considered household commodities. According to Iannaccone (1998), modern research on the economics of religion started with the household production model of church attendance and contributions by Azzi and Ehrenberg (1975): “Within this . . . model individuals allocate their time and goods among religious and secular commodities so as to maximize lifetime and afterlife utility” (Iannaccone 1998: 1479). In other words, there is also utility that is not just restricted to the afterlife.16 Coming back to the comparison with ordinary markets, Iannaccone argues that religious commodities are not physical goods like cars that can be manufactured and sold (1992: 124). Households cannot produce cars, but they can produce religious satisfaction, by using their “religious human capital” (Iannaccone 1990). Praying is an example, and this brings us to the idea of religious human capital. The capacity of persons to produce or appreciate religious goods depends on their religious knowledge. In other words, the production function depends on time, goods, and what one could label as religious human capital (Iannaccone 1998: 1481). This has various consequences. For example, religious human capital makes it more likely that one marries someone with a similar religious background and that one is less likely to switch between denominations that are very dissimilar. Obviously, similarities with cars can be made, although they might seem farfetched. If a person likes a specific car and if that person is very knowledgeable about the car, it is likely that the person will appreciate a similar taste in others and therefore also of a potential partner. Furthermore, this person is less likely to switch interests to another brand of car if that brand is extremely dissimilar. A logical step is the choice of whether one decides to believe or not. Durkin and Greeley (1991) came up with a standard insurance model, assuming two states of the world—that is, one in which nothing happens and one in which damage happens—to investigate the faith decisions. It is a Rational Choice model under uncertainty based on Pascal’s famous wager: if one chooses not to believe, the costs may be very high in the case that claims of religion are actually real. If one chooses religion and one appears to have made the right choice, it could be said that one has been wise. However, one could also argue

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that the decision matrix of Pascal’s wager is mis-specified, since it is not simply any religion versus atheism, but rather various doctrines versus atheism. The problem with some of these doctrines is that believing in the wrong one might even be worse than being an atheist. Another weakness of the model is that it takes no account of the considerable variation in the estimation of people of how plausible the supernatural is. If one thinks the supernatural is outright implausible, the choice might not even be considered. This reasoning of course assumes that the demand is possibly not stable. Besides religion as an individual good, some religious goods can be characterized as collective goods. According to Iannaccone (1994), during religious meetings, such as testimonial meetings or sacramental acts, religion as a commodity is produced collectively. Since there is the danger that participants can benefit from such collectively produced goods without contributing, the free-rider problem emerges. How churches can solve this problem is answered in Iannaccone’s classic paper “Why Strict Churches Are Strong” (1994). The paradox he solves is why it is often beneficial for a church to create rules and, in particular, why specific rules should have costly consequences for members. Examples of such rules are dress codes, haircuts, dietary restrictions, and the like. More rules help to reduce free-riding. As with all large social groups, churches also face the problem of free-riding. Building on the work of Kelley (1972), Iannaccone (1994) explains this and also answers the question of why people accept those rules. Obviously, church members also tend to free-ride when it is possible to obtain the benefits of the group without paying. By being strict and by having various rules, churches are able to check more frequently whether members are shirking, and those that do not follow the rules will be no longer accepted as members. For an individual, the costs of losing one’s membership are considered to be high. This explanation is probably one of the least controversial contributions of Rational Choice scholars in the field of religion, although there are some critical notions (Bruce 1999: 138–44).17 Recently Olson and Perl (2005) tested the claim of the causal mechanism in the strictness-commitment argument. Strict rules should increase money contributions and mean time invested in the church. If indeed free-riders are expelled in strict churches, only nonfree-riders should be members of those strict churches. To test this, Olson and Perl used an innovative measurement of free-riding. They used the extent to which only a few members give much more than the mean amount of a congregation’s money contributions as an indirect measure of free or, even better, “cheap” riding. As predicted, stricter churches have less skewed contribution distributions than less strict. More recently, Thomas and Olson (2010) found support for the strictness thesis as well, although Hill and Olson (2009) could not find support for the idea that small congregations do more to recruit new members as a result of greater religious competition. However, one could doubt whether Iannaccone was raising the accurate question, since strict churches are rarely strong with respect to the number of members, although they may indeed avoid the free-rider problem. In the words of Bruce: “The more sectarian of the new religious movements of the 1970s attracted most public attention, but it was the less demanding ones that attracted and retained most members” (1999: 139).

334 Nan Dirk De Graaf Choice and socialization Another unique aspect of the religious market is that most people with a denomination are socialized within that denomination. If we translate that to the market for cars we would say that it is as if you are born with a certain brand of car. Of course the parents may have a car, but the car children do not possess and the likelihood that parents’ choice of cars in the past is significantly likely to affect the choice of their children’s choice later in life is doubtful. Strong criticism with respect to the supply side approach comes from Bruce (ibid.: 157), who states that people believe mostly because they are socialized into a culture of belief,18 and that this has little to do with a reward. Whatever one’s theoretical preference, empirically Bruce has a point. The religion of the parents is by far the most important predictor for the religion of their children, also when these children are old. Stark and Finke (2000: 208–9) admit that socialization effects are very strong, but not determinative. However, how much of the variance is left to be explained if something is “not determinative”? People are, for example, Catholic because they are raised as a Catholic and the costs may be high to become unchurched in a strong Catholic environment. Also Stark and Finke (ibid.: 119) notice that most people remain within the religious organization in which they were raised. However, people generally do have the choice when the motives and opportunities come together or interact. Research by De Graaf, Need, and Ultee (2004), using the Rational Choice perspective and employing life history data, revealed that when people have a motive to leave a church, they are more likely do so when they have the opportunity, for example when they leave home. Another option is to switch to another religion. However, especially in some European countries, religious switching is not very common and happens less often than in the United States (Hadaway 1980; Hadaway and Marler 1993; Kosmin and Keysar 2006).19 What we notice in Europe is that typically the only options about what a Catholic decides is whether to stay a Catholic or to become nonreligious. Similar findings exist among Orthodox members in Eastern Europe (Need and Evans 2004). It is very unlikely that people switch to another religion, and if they do so it is rational that it concerns a new church that is very similar, since it is costly not to conserve one’s religious capital (Stark and Finke 2000). Indeed, switching close to home happens more frequently, and people rarely switch denominations (ibid.: 119).This also fits Bruce’s view that belief systems of similar but other groups that contradict one’s own belief system might cause doubt, whereas contact with totally dissimilar groups would make one a more firm believer (2001). To what extent is competition important for these switches? Hadaway and Marler (1993) report for the United States that socialization and marriage within a single denomination restrict denominational mobility more than any other factor. Research for the Netherlands revealed that the main motive for switching was the different denomination of the spouse, suggesting that the religious market is not a very important factor for switching (Need and De Graaf 2005). In that case the openness of the religious marriage market might be an even more important explanatory factor for religious choices. Of course, Rational Choice might still apply, since if one evaluates costs and benefits it may be a wise choice to adapt to the denomination of the spouse.

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Given previous arguments, the following critical question can be raised. How important is religious competition, which is at the heart of the supply side approach, when (a) religious switching is hardly happening in most societies, (b) when it happens marriage is most likely to be the cause, (c) socialization is more or less determining whether one has a certain religion, and (d) competition is irrelevant in case of a conflict? In this respect we have to do with a rather limited market, especially if we compare it to the market for cars. As Hamberg and Pettersson argue, “[R]ational choice theory can explain part of the variations in religious involvement, no more and no less” (2002: 93). The questions whether a substantial amount of variance can be explained, and whether it explains the high rates of religiosity in the United Sates, have to be answered empirically. supply side and secularization as opponents Discussing the Rational Choice Theory of religion is almost unthinkable without discussing Secularization Theory, which is often assumed to be its opponent. With regard to Secularization Theory, Berger (1967) is one of the important and most influential scholars.20 I introduce the Secularization Theory and the supply side approach as opponents, since that is how they predominantly have been discussed in the literature, and their assumed opposite predictions triggered an enormous amount of empirical research. Although the Secularization Theory, in contrast to the supply side approach, focuses primarily on the demand side, the label “opponent” does not necessarily apply, since both theories might hold water simultaneously and both use a Rational Choice perspective, as I will argue. The disadvantage of Secularization Theory,21 or rather paradigm, is the lack of structured hypotheses illustrated in Bruce’s attempt to explain what the secularization paradigm is about (Bruce 2002). Most generally, Secularization Theory assumes that religion and modernization are incompatible. The straightforward hypothesis states that, with the advance of modernization, there is a trend away from religion.22 However, it should be stressed that religion does not simply decline because of developments in science and technology. In the words of Bruce (ibid.: 28–29): “The clash of ideas between science and religion is less significant than the more subtle impact of naturalistic ways of thinking about the world. Science and technology have not made us atheists. Rather, the fundamental assumptions that underlie them, which we summarily describe as ‘rationality’—material world as an amoral series of invariant relationships of cause and effect, the componentiality of objects, the reproducibility of actions, the expectation of constant change in our exploitation of the material world, the insistence on innovation—make us less likely than our forebears to entertain the notion of the divine.” Rational Choice scholars in the field of religion are, according to Bruce, misled by two things (ibid.: 149–50): “First, diffuse beliefs of the sort we see in Liberal Christianity and New Age spirituality . . . cannot sustain the forms of social organization that can act as a bulwark against secularization. Secondly, the ethos of the modern society (individual autonomy, social and cultural diversity, practical relativism) is a uniquely hostile environment for any minority beliefsystem.” Interestingly, this fits with a Rational Choice framework as well, but

336 Nan Dirk De Graaf Bruce’s criticism is focusing only on those Rational Choice scholars in the field of religion. One of the most important critical comments on Secularization Theory is that it predicts a seemingly inevitable downward trend in religious participation in all countries. Since this general downward trend is apparently not happening in all countries, we need a theory that is capable of explaining variation over time. In this regard, Stark and Finke (2000) compared Secularization Theory with a useless hotel elevator that only goes down. Is this conclusion correct? Some authors (compare Norris and Inglehart 2004; Ruiter and Van Tubergen 2009) argue, as we will discuss later, that this conclusion is not correct. One important problem is that there exist not one but several versions of Secularization Theory, and the disadvantage of Secularization Theory is that it is a paradigm that consists of a summation of mostly related hypotheses, schematically described by Bruce (2002). Gorski (2000) argued that the secularization paradigm consists of several theories, whereas in his analysis Casanova (2001) argues that the theories are multiple rather than unified. However, the central feature is that modernization and religiosity are at odds with each other (incompatible). The most straightforward hypothesis being tested in this regard is that modernization, typically measured by Gross Domestic Product per capita, negatively affects religiosity. There are, however, three other versions. The first one, which is very much related, is based on Weber (1972 [1922]) and argues that scientific rationalism undermines the cognitive basis of religious worldviews (Bruce 2002; Need and De Graaf 1996). A popular indicator for the scientific worldview is education, although this of course simplifies the secularization paradigm considerably (Bruce 2002). The assumption is that the higher one’s educational level, the more likely one has a scientific worldview and the more one notices inconsistencies and the more one doubts the plausibility structure of religion. A person is also influenced by the scientific worldview of others and the educational context is therefore also assumed to have an impact. The hypothesis states that both the level of education of one’s context and one’s own educational level negatively affect religiosity (De Graaf and Te Grotenhuis 2008). However, in some nations the relation between education and religiosity is not negative. Voas and McAndrew (2012) solved this puzzle by claiming that education indeed tends to depress belief, but it also promotes social participation and hence church attendance. The second is Secularization Theory of Norris and Inglehart (2004). Their contribution is important, since it could predict a different outcome than inevitable religious decline. It is based on a security axiom: “The first basic building block of our theory is the assumption that rich and poor nations around the globe differ sharply in their levels of sustainable human development and socioeconomic inequality, and thus also in the basic living conditions of human security and vulnerability to risks” (ibid.: 13–14). They also assume that religious reassurance is required less under conditions of greater security. In line with the earlier work of Inglehart (1977, 1990), they expect the security conditions of the formative years to be important: “The experiences of growing up in less secure societies will heighten the importance of religious values, while conversely, experience of more secure conditions will lessen it” (Norris

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and Inglehart 2004: 18). The analyses of the data of the World Values Survey support the claims of Norris and Inglehart. It is important to note that the prediction of Norris and Inglehart does not necessarily imply a continuing decline of religiosity. They assume that in wealthy societies with high levels of income inequality, more people feel insecure than in societies with low levels of income inequality. Existential insecurity gives people an incentive to become a church member. Although modernization tends to be associated with less inequality, there is variation among societies, and in some societies people encounter increasing inequality and therefore a rise of religiosity. The important implication to be made is that Secularization Theory therefore not only assumes a decline of religiosity. Stark (1999b) compared the secularization paradigm with a useless hotel elevator that only goes down. However, the above shows that this hotel elevator might go up occasionally. Recently Ruiter and Van Tubergen (2009) introduced a third version, emphasizing the modernization of social ties, that can be regarded as subsumed under the secularization paradigm and is based on the work of Kelley and De Graaf (1997). Kelley and De Graaf hypothesized and tested the idea that social integration in a religious community positively affects the religiosity of an individual: “[T]his contextual effect comes about in part through people’s exposure to religious culture (and perhaps pro-religious government policies), and in part because pools of potential friends, teachers, colleagues, and marriage partners are predominantly devout” (ibid.: 640). One cannot choose such a context, but one is born into it. The hypothesis is that “[p]eople born into religious nations will, in proportion to the orthodoxy of their fellow-citizens, acquire more orthodox beliefs than otherwise similar people born in secular nations” (ibid.: 641). Ruiter and Van Tubergen also predicted that in rural areas social ties between people are stronger in close networks (families) and people are socialized more religiously. More generally, in their view modernization leads to a weakening of the strength and multiplexity of social ties and the decreasing importance of third parties; therefore it leads to individualization, and church attendance will go down. They found strong evidence for their claims. We have argued that Secularization Theory does not necessarily predict a mere downward trend in religiosity. Still, the secularization approach is assumed to clash with the Rational Choice approach. Indeed, at first glance, the claim that religious supply will positively affect religiosity or church attendance seems to contradict the classical plausibility hypothesis of Berger (1967). Berger claims that “if the religious plausibility structure is massive and durable, the religious world maintained thereby will be massive and durably real in consciousness. In the optimal case, the religious world will then be simply taken for granted. However, as the plausibility structure is weakened, so will the subjective reality of the religious world in question. Uncertainty makes its appearance” (ibid.: 150). Pluralization drives secularization. “The pluralistic situation, in demonopolizing religion, makes it ever more difficult to maintain or to construct a new viable plausibility structures for religion. The plausibility structures lose massivity because they can no longer enlist the society as a whole to serve for the purpose of social confirmation. . . . [It] becomes

338 Nan Dirk De Graaf increasingly difficult for the ‘inhabitants’ of any particular religious world to remain entre nous in contemporary society. Furthermore, the plausibility structures lose the appearance of durability as a result of the aforementioned dynamics of consumer culture” (ibid.: 151). In other words, religious pluralism will undermine the religious plausibility structure, and religious participation will decline consequently. At first glance this seems contrary to the supply side hypothesis proposed by Stark and others. However, according to Pettersson and Hamberg, the plausibility hypothesis seems to suggest the supply of a multitude of religious doctrines (2002: 100). A totally different view of religion might cause doubt on the plausibility structure of one’s own religion. An example is the choice between Christianity, Islam, and Buddhism. However, the supply side hypothesis of Stark and others, as we have argued, can be interpreted as a hypothesis about submarkets in case it is more about the supply of a number of churches or denominations within the same religious doctrine such as Christianity.This will clearly affect the plausibility structure less severely. As mentioned previously, Stark and others also recognize that it is very unlikely that people switch to a totally different religion, and if they do so, it concerns a new church that is very similar, since the religious costs are lower. The implication is that Peter Berger’s plausibility hypothesis and the supply side hypothesis of Stark and others are not necessarily, as often assumed, incompatible. Both can apply and are not theoretically opposed. Recent research of Aarts et al. (2010) suggests that both approaches seem to be empirically compatible. Evidence from twentysix countries revealed that deregulation fosters church attendance, but that duration of deregulation does not increase church attendance. At the same time they find that modernization corrodes church attendance to a larger degree than deregulation stimulates church attendance. Interestingly, this fits with what Smith (2008) calls a “critical realist” approach regarding the conflict between supply-siders and secularization supporters. He states that there might exist counteracting causal mechanisms that outweigh the effects of simultaneously occurring phenomena—that is, modernization and pluralism occur together.

Empirical and Theoretical Controversies: Supply and Religiosity the theoretical controversy sparked a mountain of empirical studies The prediction of Finke and Stark in their 1988 paper, that church attendance will be high in nations with both strong competition and a low level of regulation, inspired many scholars to test this prediction with mostly secondary data. The large number of papers that were published testing this hypothesis motivated Chaves and Gorski (2001) to write an overview of almost two hundred tests in twenty-six published articles. This overview illustrates that the Rational Choice approach of religion inspired an enormous amount of research, although, according to Chaves and Gorski, the empirical evidence does not support the claim that religious pluralism is positively associated with religious participation. However, more recently McCleary and Barro (2006) find, in addition to support for the secularization approach, support also for the supply side approach. Fox and Tabory (2008) make a strong case in favor

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of the supply side argument. They find constantly negative effects of state regulation on church attendance but not on beliefs. Unfortunately, Rational Choice scholars within the field of sociology of religion occasionally ignore empirical findings that do not fit their theory. There has been a controversy for several decades between Rational Choice scholars studying religion and those who are convinced that either secularization applies and those who are not convinced that Rational Choice Theory applies. This controversy stimulated the British sociologist Steve Bruce to dedicate a whole book to criticizing Rational Choice Theory—or rather, the “supply side” version (Bruce 1999). One well-known “empirical” debate is between Stark and Iannaccone (1994, 1996) on the one hand, and Bruce (1995) and Lechner (1996a, 1996b) on the other. Stark and Iannaccone (1994) claim that there does not exist a general process of secularization, since even in the medieval centuries the population was not as religious as generally assumed. Based on historical accounts, they claim that the “medieval masses were . . . . remarkably irreligious” (ibid.: 241), and this finding supports their view that religiosity simply fluctuates and does not decrease structurally. Bruce defended the conventional wisdom by showing evidence that medieval Britain was a Christian society, and despite an increase of religious competition there was a decline in religiosity in the last two centuries. Crockett (2004) wrote an impressive study on the 1851 Census of Religious Worship of Great Britain, which is one of the most detailed historical sources available. He investigated how rural-urban differences affected church attendance. In the early nineteenth century church attendance increased in Britain but declined thereafter. Of importance was the fact that a distance of more than a mile from a church made church attendance unlikely, resulting in low rates in rural areas. Increasing pluralism increased the availability of reachable options by reducing the distance between home and church. The result was an increase in church attendance in rural areas. For urban areas, however, the data reveal a secularization pattern, and low levels of religious participation coincide with high levels of urbanization and industrialization. That urban areas are religiously pluralistic and also experience low levels of religious participation suggests that the supply side approach does not apply. Although the analysis of Crockett is impressive, one could argue that more detailed tests with an elaboration on whether pluralism is a good indicator for competition in these cases may be required. It is therefore likely that there will be an ongoing debate regarding how to interpret the historical evidence for Britain and other countries. Another important controversy lies in discussions between Stark and Iannaccone (1994, 1996) on the one hand and Lechner (1996a, 1996b) on the other. They disagreed strongly on the interpretation of the Dutch data. I will discuss this in some detail because it makes clear under which conditions competition or pluralism do not apply. In the view of Stark and Iannaccone, the Netherlands forms a regulated religious economy, since the state provides financial support for specific church functions, although one cannot ignore that there has been religious diversity. They furthermore argue that subjective faith was still high in the Netherlands in the early 1990s, but that church participation was low. Lechner, however, argues that the puzzle is how it is possible that church participation was very high during the period when

340 Nan Dirk De Graaf Dutch society was heavily pillarized and state regulation very strong. In their reply, Stark and Iannaccone state that pluralism is indeed at the heart of their theory, but “a society whose religious economy consists of a dozen rigid castes, each served by its own, independent, distinctive religious firm would be highly ‘pluralistic’ in the sense of containing numerous different religious firms, but utterly lacking in religious competition” (1996: 266). This situation applied to Dutch society. Furthermore, if there were high levels of conflict among castes and the organizational basis of the conflict is formed by the religious firms, religious organizations are important and will cause high religious participation. The latter is a rejoining to the old paradigm in the sociology of religion, according to Lechner (1996b: 274). However, whatever one might think of this discussion, there is no harm in specifying the conditions under which an assumed mechanism works. A more serious problem is that Stark and Iannaccone predicted that religious participation in the Netherlands in the early 1990s was consistent with the Dutch religious economy. The implication is that “this means that if Dutch religiousness declines further in coming decades, without significant changes in the structure of the Dutch religious economy, its future level will be inconsistent with the character of this economy, and they will then concede more forthrightly than they have thus far that their interpretation of the role of this economy in the Netherlands was incorrect” (ibid.). Substantial changes in the religious economy have been lacking, but recent findings indicate that during the 1979–2005 period both traditional Christian faith and belief in the supernatural declined, although the latter at a somewhat slower rate (De Graaf and Te Grotenhuis 2008). According to De Graaf and Te Grotenhuis (ibid.), the most important explanation for both declines is the slow but continuous replacement of older religious-affiliated cohorts with younger nonaffiliated cohorts. The latter finding is consistent with event history analyses on leaving church (Need and De Graaf 1996; De Graaf, Need, and Ultee 2004). These findings are not in line with the predictions of the supply side approach. For the Netherlands, besides cohort effects, little if any life-cycle effect could be detected. However, research of Stolzenberg, Blair-Loy, and Waite (1995) suggests that life-cycle effects do exist in the United States, but their findings mainly concern an increase in religious participation for those who are already religious. An important issue in the empirical testing is how to measure pluralism as an indicator for competition. A lot of publications have been involved in testing the competition hypothesis, and in most cases pluralism has been chosen as a proxy measure of competition. Pluralism is considered as the number of independent religious organizations having a significant market share. For this purpose most research used the Herfindahl index of religious concentration (Iannaccone 1991). A low score on the index indicates strong competition in the religious market, whereas a high score indicates a low level of competition.The pluralism index, therefore, is calculated as one minus the Herfindahl index. To calculate the Herfindahl index, we first take the market share of denominations Sij. This is the number of people in country j affiliated with denomination i, divided by the total number of people in country j affiliated with any religious denomination. The Herfindahl index Hj is the summation of all squared Sij’s.

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The disadvantage of the Herfindahl index is that it does not distinguish between religions. Some religions do a better job in attracting potential members than other religions. Furthermore, in this measure there is no difference between a country with 1 percent Catholics, 1 percent Protestants, and 98 percent without a denomination, and a country with 50 percent Catholics, 50 percent Protestants, and 0 percent without a denomination. These are rather strong assumptions (compare Bruce 1999). Interestingly, in recent work Stark and Finke (2002: 37) state that “the more firms have a significant market-share, the greater the degree of Pluralism.” If “significant” means compared with the whole population, the Herfindahl index is useless anyway, since nonbelievers are not included. Actually, proposition twenty-two in Table 9.1 already implies that if there are many nonbelievers, this will affect the individual’s confidence in religious explanations. In other words, given Stark’s own theory, the Herfindahl index is already inaccurate. Research based on this index has not given any convincing test of the theory, because this index is not only theoretically mis-specified but also mathematically incorrect, as Voas, Olson, and Crockett showed in their article “Religious Pluralism and Participation” (2002). It appears that there is a mathematically compulsory correlation between the index and the number of people who attend church that is not causal.23 The empirical discussion is therefore inadequate, and there is no sense in going through the long list of papers using this index, since they do not test the supply side hypothesis appropriately.24 Recent work of Koçak and Carroll (2008), however, takes the criticism of Voas et al. into account and presents an analysis of panel data of U.S. communities from 1890 to 1926 to test several hypotheses. Their research resulted in less than supportive findings for the supply side theory, since they concluded “that religious diversity leads to a decrease in church participation in urban communities, where exposure to others is most frequent” (ibid.: 1310). An earlier empirical test that casts doubt on the supply side explanation of American exceptionalism is Kelley and De Graaf ’s paper (1997) on the basis of a fifteen-nation study. The supply side hypothesis implies that there will be fewer people who do not attend church in a highly competitive religious market. The reasoning is, assuming a constant demand, that people living in religious monopolies will have large unmet religious needs, whereas churches in religiously competitive nations, such as the United Sates, will more successfully meet the population’s diverse religious needs. The implication is that in monopolistic societies, those who do not attend church will be more devout. Worrying for the supply side approach is that the results are exactly the opposite: Americans who never attend church are substantially more devout than Europeans who never go to church. This puzzle of an opposite relationship between supply and devoutness of those not attending has not yet been adequately been solved. An explanation could possibly be found in proposition twenty-two of Table 9.1, stating, “An individual’s confidence in religious explanations concerning otherworldly rewards is strengthened to the extent that others express their confidence in them.” This network hypothesis could imply that those who do not attend are also influenced by the abundant number of those who do attend. In a competitive market there will be many church members expressing their confidence, including to those who do not

342 Nan Dirk De Graaf attend church. However, this interpretation applies only if competitive religious markets do indeed result in more church members and higher rates of church attendance, and that is clearly not yet an uncontroversial empirical fact. Socialization, as mentioned earlier, is an important predictor of religiosity. The supply side theory also predicts the strength of religious socialization, depending on the level of religious participation. Proposition seventy-seven of Stark and Finke (2000: 202) states that “societies with low levels of religious participation will be lacking in effective religious socialization.” However, research by Kelley and De Graaf (1997) shows that a nation’s religious environment shapes the way in which religious beliefs are passed on from parent to child. In countries with lower levels of religious participation (that is, secular countries), devout families on average are usually able to insulate their children from secular pressure. In relatively secular nations, the effect of family religiosity on children’s religiosity is strong, and the effect of national religious context is small. Apparently, there is not necessarily a lack of effective religious socialization at the individual level in societies with a relatively low level of religious participation. religious demand stable over time and place? The crucial assumption of Rational Choice Theory in religion—that people would have a constant demand with respect to religious products—has been frequently debated. Hypothesis 8 of Stark (see Table 9.1) holds, “In pursuit of rewards, humans will seek to exchange with a god or gods” (1999a: 270). He furthermore states, “Regardless of power, persons, and groups will tend to accept religious compensators for rewards that do not exist in this life. Here I noted that in some regards everyone is deprived and everyone has a motive for being religious—that since everyone faces death, doctrines of an afterlife appeal to all. We could call this the universal form of religious commitment” (Stark 1997: 8).25 Stark and Finke (2002) state that the advantage of postulating stable preferences is that one is not tempted to explain every shift in religious life by a corresponding shift in public preferences. They therefore assume that “religious preferences are quite stable and form distinctive and durable niches” (ibid.: 33). All people want it “because religion is the only plausible source of certain rewards for which there is general and inexhaustible demand” (ibid.: 85). Finke and Iannaccone phrased it less strictly: “[I]mportant religious developments derive from change in the incentives and opportunities facing religious producers, not some sudden shift in the material or psychological state of the populace. Of course, religious markets respond to the equilibrating forces of both supply and demand, but, as a matter of historical fact, religious demand proves much more stable than religious supply” (1993: 28). Finke and Iannaccone (1993) refer to the work of Greeley (1989), who concluded that the data on religion in America shows in general that the beliefs of the American population hardly change over time.26 With respect to a stable demand, one could find support for this claim in the work of the evolutionary anthropologist Robin Dunbar (2004). According to Dunbar (ibid.: 168), religion in all forms has four important functions: “(1) providing coherence for the world in which we live (a metaphysical scheme that explains why the world is as it is, and thus makes sense of it for us); (2)

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allowing us to feel we have greater control (through prayer and other rituals) over the vagaries of life than we would otherwise do; (3) enforcing rules about how we should behave in society (ethics and moral systems); and (4) allowing a minority to exert political control over the community.” This would imply that if something else could replace these functions, or we do not need these functions anymore, the demand for religion could decline. Dunbar regards even today the contribution of religion to human well-being as so important that the human race cannot do without it. “The problem for the contemporary rationalist is how to create this sense of community without resorting to the mechanism of religion, because religion works its will effectively when we abandon rational thought and surrender ourselves to the mysterious and the ineffable” (ibid.: 200). Consequently, according to Dunbar the best prediction for the future is a stable demand. However, one should realize that scientists have a problem explaining religion from an evolutionary perspective, since all societies bear the huge costs of all kinds of commitments to factually impossible worlds. Evolutionary scientists solve this problem by either interpreting religion as a by-product of other traits that are adaptive (compare Atran 2002), or by assuming that religion is in itself an adaptive characteristic (compare Wilson 2002), If we consider demand and supply simultaneously in a classical market situation (that is, a perfect free market), they should be in equilibrium. Hamberg and Pettersson assume that the importance of religious supply depends on the religious demand structure in a society (2002: 99). In their view the religious demand structure will ultimately be affected by the religious supply structure. The assumption of Stark and others is that the demand for religious goods is to a large extent constant over time and place. If this is indeed the case, one could argue that with a decline in the number of church members there will be an increase of nonmembers who still believe (Davie 1994; compare Stark and Finke 2002: 41). Secularization Theory, however, predicts that both believing and belonging should follow the same path (Aarts et al. 2008). Furthermore, the linear trend hypothesis of one version of the Secularization Theory also implies a replacement of older cohorts who believe and belong to a church by younger cohorts who do not belong to a church and do not believe. Crockett and Voas (2006) tested whether there are such cohort effects in Britain, by looking at cohort differences. Their claim is that believing and belonging have declined in equal measure because of cohort replacement. Also Hout and Fischer (2002) discovered a decline of religious preference in the United States, which is partly due to a small cohort effect—that is, an increase of those who were raised with no religion. Tests using a more substantive design show strong cohort effects for the Netherlands (Need and De Graaf 1996; Te Grotenhuis 1988),27 which are similar to results of Crockett and Voas in Britain. An event history analysis, in which the causality issue can also be tackled more appropriately than with cross-sectional designs, revealed that young people in the Netherlands between the age of sixteen and twenty-one are particularly more likely to leave the church and remain unchurched for the rest of their lives (Need and De Graaf 1996), and that the current level of secularization increases the risk of becoming unchurched. De Graaf and Te Grotenhuis (2008) showed that during the 1979–2005 period both traditional Christian faith and

344 Nan Dirk De Graaf belief in the supernatural declined in the Netherlands as well, although the latter at a somewhat slower rate. In this respect, belonging and believing still go hand in hand in Britain and the Netherlands.28 These results clearly challenge the assumption of a stable demand for religious goods over time and place. Another test as to whether the demand is stable is provided by the postcommunist societies in Eastern Europe. The communist regimes tried hard, although not always very successfully, to abolish religion. After the fall of communism the coercive force of the state to destroy religion disappeared. If demand is indeed stable, one would expect an increase in the number of church members. However, using data gathered in 1993 on religious practice of both parents and offspring in ten East European countries over the past fifty years, Need and Evans concluded that “while the communist regimes were indeed rather unsuccessful in destroying private religion, the forces of modernization have continued this process regardless” (2004: 206). However, Greeley (1994) sees a religious revival in Russia, and what he calls the revivalists are very young. An overview of Voas and Doebler (2011) reveals rather mixed results, although Froese and Pfaff (2001, 2004) claim that anomalies still can be interpreted on the basis of supply side theory. When compared to a sample from 1993, data gathered in thirteen postcommunist Central and Eastern European countries in 2007 show that religiosity has increased in Orthodox countries,29 but not in Catholic countries. These findings suggest that the demand might be stable; they are also in line with predictions of the religious regulation hypothesis. However, the results for the Catholic societies do not support the stability claim.

Conclusions The competition between the secularization approach and the supply side approach has not only stimulated theoretical discussions but has also increased efforts to gather data. Indeed, Rational Choice scholars have gathered an impressive amount of data, using various research methods to test their claims. The prejudice that Rational Choice scholars apply only post hoc explanations definitely does not hold in this field of study. The work of Stark, Bainbridge, Finke, Iannaccone, and others is an important and impressive effort in the sociology of religion. Unfortunately, the tests of the theory are sometimes chosen selectively.30 Illustrative of how prominent supply side scholars are sometimes capable of ignoring facts and even ignoring a crucial mistake is the discussion in the American Sociological Review between Olson, on the one hand, and Finke and Stark on the other (Olson 1998; Finke and Stark 1988, 1989). Finke and Stark tested the hypotheses that religious pluralism (competition) stimulates religious participation using the Herfindahl concentration index. Olson (1998) showed that Finke and Stark made an error in calculating this index, because they calculated religious concentration instead of religious pluralism. One would expect Finke and Stark (1998) to react by showing Olson that their findings were the opposite of what they thought they would imply. Unfortunately, they simply ignored Olson’s critique and went on repeating their hypotheses and statements that other research supports their claims. Such an attitude does not stimulate a proper confrontation of theory

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with data, and blocks theoretical progress and reinforces black and white views that Rational Choice proponents simply ignore data when the outcome does not suit them. The theoretical contribution of Stark and coauthors, however, is important and deserves appropriate open empirical testing, where high-quality empirical findings are taken seriously and errors are admitted and left out of future work. I have tried to show that the supply side approach is sometimes not incompatible with some important hypotheses of the secularization paradigm. Both fit into a Rational Choice framework. For example, the plausibility structure hypothesis of Berger can apply, as well as the hypothesis on the competition of religious groups. However, the comparison of the market for cars and the market for religion revealed that the religious market is quite a specific market that definitely needs more theoretical work. We have to do with a market of inscrutable goods, implying that the building of reputations is of crucial importance. Church leaders can indirectly build up a reputation by being reliable. If this indeed applies, it would mean, for example, that the relatively large number of scandals involving American televangelists and Catholic priests in the past decade should have a negative effect on the reputation and the quality of the religious product, with consequences for the rate of participation. This might open new fields for empirical research. Data on religious participation for various churches over time should be matched with data on scandals for each church over time.With a model including a time lag-function it should be possible to test whether an increase in the number of scandals within a church eventually leads to a decline in religious participation within that church. Accordingly, churches without scandals should show a higher level of religious participation. However, critics might argue that no one would oppose such a prediction, irrespective of one’s theoretical preference. Furthermore, as argued before, the fact that religious people quite often focus only on verifications and ignore falsifications makes it unlikely that religious people themselves regard religious goods as inscrutable. A key criticism of the supply side approach is that it pays little attention to nonbelievers. This is understandable if we take into account the assumption that the demand for religion is stable with regard to time and place. However, nonbelievers may also affect believers, especially if there are increasing numbers in the majority of Western societies these days. Proposition twenty-two of Table 9.1 states that “an individual’s confidence in religious explanations concerning otherworldly rewards is strengthened to the extent that others express their confidence in them.” If this applies, one might expect that in communities or societies where fewer people express their confidence in religious explanations the confidence of believers will become weaker. In an environment in which the pools of potential friends, marriage partners, teachers, and colleagues are predominantly nonreligious, the exposure to nonreligious culture might negatively affect one’s religiosity—that is, if proposition twenty-two applies. However, research by Kelley and De Graaf (1997) shows that in the case of a secular macro context it seems to be compensated by an increase in religious socialization at the individual level. In secular nations devout families usually insulate their children from secular pressure. The neglect of the nonreligious population in the Rational Choice approach

346 Nan Dirk De Graaf on religion is illustrated by the use of the Herfindahl index. Applications of this index completely ignore the size of the population without a denomination and without a religious belief.31 This implicitly assumes that the relative number of nonreligious people will have no effect whatsoever on the chances of religious switching. However, theoretically, the level of competition is likely to be low in a society in which only 1 percent of the population is religious. A critical question that still has to be answered is how important religious competition really is. Religious competition is at the heart of the supply side approach, but the question remains as to what the relative importance of religious competition is when (a) religious switching is hardly happening in most societies; (b) marriage is likely to be the cause of religious switching; (c) socialization is more or less determining whether one has a certain religion; and (d) competition is irrelevant in case of a conflict. Future research should answer this question. Future research should also include non-Christian religions. Norris and Inglehart (2004) tried to test Secularization Theory, analyzing seventy-six nations from the World Values Survey. However, non-Christian religions can also be studied in modern societies, and the advantage is that many data sets at the individual level are available and we have to rely on mainly macrolevel indicators (compare Chaves, Schraeder, and Sprindys 1994). It is a challenge to see whether predictions derived from the Rational Choice approach also apply to Muslims in Western societies (compare Voas and Fleischmann 2012). However, whatever new directions will develop, the discussed empirical studies in this chapter clearly show that the general criticism—that is, that Rational Choice scholars excel in formal modeling but fail to provide empirical evidence or, when they use data, it is only post hoc—clearly does not apply. Another conclusion is that the comparison of the religious market with other markets exemplifies that theoretical progress can and has to be made using a Rational Choice framework. If at the same time more data of various sorts are collected in order to test the (new) theoretical claims, and if the various scholars take all empirical findings from rigorous research more seriously, then I expect that the study of religion will have a promising and less rhetorical future.

Notes I would like to thank Matthew Bennett, Julie Brines, Diego Gambetta, John Goldthorpe, Tim Mueller, Ariana Need, Daniel Olson, Stijn Ruiter, and David Voas for discussions and their comments. 1. Bruce prefers to use the label “secularization paradigm” because that implies the complexity of what is involved, which is illustrated in his chapter “Explaining Secularization” (2011: 24–56). 2. Actually, they had already formulated their axioms in Stark and Bainbridge (1980). 3. Also the institution-building by Iannaccone, of which the Association for the Study of Religion, Economics and Culture (ASREC) is a nice example, having been very important for the field. 4. I do not discuss the work of Warner (1993, 1997, 2002), since he does not apply a Rational Choice model of religion, restricting his attention mainly to the United States, and uses an inductive rather than a deductive way of developing his theory. His “paradigm” article (Warner 1993) has been very influential, however.

Secularization 347 5. Furthermore, there have also been recent attempts at developing a new theory within the framework of Rational Choice to explain variations of religiosity over time. Recently Stolz (2006) integrated Rational Choice with Weberian perspective and presented a new typology of individual religious goods (consumer, membership, and personal goods) and social religious goods (communal, conflict, and positional goods). He argues that markets form only one type of a social system for the production and allocation of religious goods (see also Stoltz 2009). 6. There are various examples of formal modeling in this field. An example is the formal model by Iannaccone on church and sect (1988). 7. Finke and Iannaccone (1993) introduced the label “supply-side” in order to make a distinction with the traditional approach, which interpreted religious developments mainly as a change in the demand for religion. 8. According to Stolz (2006: 18) this has gone unnoticed, since English translators did not know how to translate the term Heilsgüter into English. 9. Although I am using the label Rational Choice, it is of interest to note that Stark and Finke in their later work clearly object to being identified as Rational Choice theorists (2000: 41) because, as they judge it, it bears the danger of being identified as “crypto economists unable to deal with the subtleties of religious realities.” A bit further on, Stark and Finke (ibid.: 84) say, “Our aim is to construct a theory in which both phenomenologists and rational choice theorists can take comfort.” It seems that they want to anticipate criticism of scholars who do not consider themselves as Rational Choice scholars. Discussions on what kind of label applies are not very relevant, since what should count is the quality of the theory. 10. Although I will not discuss all the propositions, I decided to include all of them in Table 1, because it might be helpful for readers to have an overview of all the propositions. 11. Bruce (1999: 122) also criticizes Stark on this issue, by claiming that people also do things because they want to have followers and because they have pride. These are examples of other “objective” rewards obtained from a religious organization, and what is missed in the supply side approach. Iannaccone clearly recognizes these aspects (1994: 1184), and I will discuss the religious goods he distinguishes later. 12. Hechter raises the question, “How can markets ever arise for inscrutable goods—those whose quality it is impossible for consumers, and even producers, to discern?” (1997: 150; see also Gambetta 1994). 13. However, it becomes puzzling when Stark and Finke claim that competition and diversity are aspects of pluralism (2000: 219). 14. Interestingly, the economic approach is also used as a perspective on the functioning of religious suppliers under the condition of monopoly. Ekelund et al. (1996) document the doctrinal changes made by the Catholic Church in order to gain a complete market share in the Holy Roman Empire and gain as much monetary returns as possible. 15. Signaling Theory, although less common in sociology, could provide insight into such processes (Gambetta 2009). For example, Sosis (2003) proposes a Costly Signalling Theory for religion that provides an explanation of why people invest in costly rituals in order to achieve lasting fitness benefits that religious groups offer. Sosis and Bressler (2003) show empirically with data on communes in the United States that communes that imposed costly requirements survived longer than less demanding communes. 16. As in Becker’s classic work (1976), households can be regarded both as consumers and as producers. 17. Bruce claims, for example, that “most religious belief systems have built-in protection against excessive free-riding in that benefits of belief are held to be available only to those who sincerely believe. The cynical pension-fund member who unfairly

348 Nan Dirk De Graaf deflates his contributions will still get his pension. The cynical ‘Pentecostalist’ who only pretends to have been born-again and to have received the second blessing of being filled with the Holy Spirit will not go to heaven” (1999: 141). 18. Dawkins (2007) even relates this to genetic predisposition in children to unquestionably believe their parents. 19. For example, Need and De Graaf (2005) showed on the basis of twenty-one representative Dutch surveys held between 1966 and 2003 that becoming a convert or religious switching is a rare phenomenon. Only 4.5 percent of the population switched between denominations distinguished, and 2.6 percent of the population converted to another religion. Using the powerful 2001 American Religious Identification Survey on the United States, Kosmin and Keysar (2006) concluded that about 16 percent of the U.S. population changed their religious preference. However, that 16 percent also contains a large number who dropped out of religion. Loveland (2003) reports a higher percentage, but that is based on a much smaller sample. 20. Interestingly, in his later work Berger no longer supports his earlier work on secularization. Woodhead, Heelas, and Martin (2001) published an edited book on Peter Berger and the Study of Religion. Bruce (2001) wrote a chapter in that book arguing that Peter Berger’s earlier work is to be preferred, since it is backed by data. The changes from 1960 onward “have been those Berger predicted: increased individual autonomy; increased compartmentalization, decline of authority, and declining indices of involvement” (ibid.: 100). 21. One may doubt whether secularization “theory” is an accurate label, since it is labeled after what is to be explained, without mentioning how it is explained.Therefore, another perhaps more accurate label is “secularization thesis.” 22. An important issue here is the time-span of the data that one accepts for a proper test. Just investigating trends in religious participation is theoretically poor. More information could be gained if one tests the relation between an independent variable (that is, an indicator for modernization) and religiosity over time. 23. See also Olson (2008) for an extensive discussion on the advantages and disadvantages of using the Herfindahl index. 24. Miscalculations are not helpful, either. The miscalculation in the paper on religious mobilization in American cities by Finke and Stark (1988, 1989), as spelled out by Olson (1998), has been ignored by Finke and Stark. The latter is perhaps exemplary of the turbulent and not always transparent empirical debate. 25. One could doubt whether the doctrine of an afterlife indeed appeals to everybody. Some people might consider it not very plausible. 26. Sherkat is known for engaging the demand side of Rational Choice Theory in the field of religion (Sherkat 2001; Sherkat and Wilson 1995), and he used data mainly from the United States to test the claims of this theory. 27. Since cohort, period, and life-cycle effects are linearly dependent on each other (cohort = period-age; see Glenn 1977), it remains difficult to judge how important these cohort-effects are as long as one does not know how strong, for example, lifecycle effects are. In order to make theoretical progress, one should actually test whether theoretically relevant variables for which age, period, and generation effects are indirect indicators have an impact on religiosity and church membership. The advantage is twofold. First, the identification problem is less of a problem, and second, the predictions become more informative, since the characteristics that should have an impact on the development of membership or religiosity have to be clearly specified (De Graaf 1999: 263). 28. It is of interest to note that even in a secularized Dutch society a difference in supply matters. Bernts and De Graaf (2004) tested the hypothesis that activities from the side of the denominations (good marketing of the religious product) result in higher

Secularization 349 participation rates. Participation was operationalized as the number of people attending a divine service during Christmas in a parish in 2000. The supply side was measured by the number of divine services during Christmas. Even after taking into account the general demand (number of parishioners and church attendance during weekends) and the church attendance during Christmas five years earlier, an increase of the number of services still showed a substantial increase in the number of persons visiting the church. 29. For this purpose I analyzed the 2007 data from the project “Social Inequality and Why It Matters for the Economic and Democratic Development of Europe and Its Citizens: Post-Communist Central and Eastern Europe in Comparative Perspective” (EUREQUAL), funded by the European Commission under the contract No. 028920 (CIT5), Framework 6. 30. Greeley (1994), for example, showed that in Russia there was a revival of belief. In his analysis he left out the other fifteen countries of the same international dataset that revealed a secularization trend (De Graaf and Need 2000). 31. Because of the criticism of Voas, Olson, and Crockett (2002) on the Herfindahl index, Montgomery (2003), building on the product-differentiation framework from industrial-organization economics, suggests a new measure for pluralism taking into account subsets of denominations that are more pluralistic than other subsets. However, the disadvantage remains that the subgroup of those without a denomination are still left out.

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chapter

Assimilation as Rational Action in Contexts Defined by Institutions and Boundaries

10

victor nee and richard alba

Introduction Assimilation has evolved endogenously as the dominant pattern of incorporation into the mainstream of American life. The process has been well documented, and there is a broad consensus that assimilation constitutes a core cultural belief and predictable, large-scale outcome of mass immigration to the United States. Despite episodes of pressure for Americanization from political actors, assimilation has been a bottom-up process of cultural and social change for immigrants and their descendants. The changes to immigrant groups are frequently accompanied by shifts in the mainstream to which they are assimilating: emblematic of the latter is the post–World War II attainment by Catholics and Jews of the status of charter religions, as opposed to incorporation by conversion to the previous mainstream religion, Protestantism in its various forms (Alba 2009; Foner and Alba 2008; Hollinger 1995). After a long hiatus in mass immigration to the U.S., the passage of the Immigration Act of 1965 opened legal immigration to all nationalities.The result was a swift and dramatic change in the composition of immigration to the United States. The overwhelming predominance of nonwhite immigrants from Latin America, the Caribbean, and Asia sparked a debate in the social sciences over whether assimilation might be unattainable for immigrant minorities (Glazer 1997; Huntington 2004). In light of the spatial concentration of new immigrant minorities in central cities, Portes and Zhou (1993) have argued that assimilation is being transformed into a deeply segmented process of incorporation wherein the children of poor nonwhite immigrants are at risk of “downward assimilation” into the racialized underclass of the inner city. In segmented assimilation theory, the children of immigrant minorities may be better served by relying on their own ethnic and cultural resources within immigrant enclaves (Zhou and Bankston 1998). Some have argued that the cultural beliefs of the new immigrants from South America and Asia threaten to undermine American identity (Huntington 2004). With the demographic composition of the American population swiftly moving in the direction of

356 Victor Nee and Richard Alba unprecedented ethnic and racial diversity, the question posed by Huntington— “Who are we?”—can be expected to motivate public debate on mass immigration. Post–Civil Rights era immigration from South America and Asia has now reached the scale of the late-nineteenth- and early-twentieth-century immigration of Europeans. The new immigrants have settled in burgeoning immigrant metropolises, rapidly increasing the ethnic and racial diversity of America’s cities. In Los Angeles, Hispanics are the new majority group, while Asians have grown to 14 percent of the population, with non-Hispanic whites now dipping below 36 percent, no longer constituting a demographic majority. In New York City, the children of immigrants make up a growing percent of the population. “About 45 percent of the city’s black population are immigrants or the children of immigrants, as are 40 percent of the white population.The same is true of 59 percent of the Hispanic population and 95 percent of the Asian population” (Kasinitz, Mollenkopf, Waters, and Holdaway 2008: 3). Similar trends of demographic transformation and growing racial and ethnic diversity are in progress in other major metropolitan centers in North America. Such dramatic demographic shifts toward unprecedented racial and ethnic diversity, concentrated in particular regions, have profound effects on neighborhoods, public schools, and workplaces. The growing racial and ethnic diversity of contemporary immigration and the debate over the place of immigrants and their children in American society have called attention to the need to rethink assimilation (Alba and Nee 2003; Lind 1995; Waldinger and Bozorgmehr 1996; Borjas 1999; Bobo et al. 2000; Portes and Rumbaut 2001; Bean and Stevens 2003; Brubaker 2004). The swiftness of the demographic transformation of American cities has motivated and guided social scientists in their work of extending, revising, and updating the concept of assimilation for a new era of global immigration. In this essay, our aim is to lay out some general propositions of neoassimilation theory, first formulated by Alba and Nee (2003), to explain why racial and ethnic minorities are assimilating into the American mainstream. The propositions are falsifiable and applicable to comparative social research on the incorporation of immigrants and their children in all industrial societies. The propositions emerge from the conceptualization of immigrant-origin individuals as rational actors operating in contexts defined by institutional contours and boundary barriers and opportunities. The form of the theory is new institutionalist in that the theory assumes context-bound rationality defined as social action enabled, motivated, and guided by the institutional and social-structural matrix within which actors conduct workaday transactions (Nee and Ingram 1998; Greif 2006).

A Conceptual Foundation for Assimilation Theory The industrializing city of Chicago in the early twentieth century provided a natural laboratory of intergroup relations for the newly established Chicago School of Sociology. Sustained mass immigration and domestic migration offered an unprecedented opportunity to sociologists at the University of Chicago to observe the emerging patterns of intergroup contact, competition, conflict, and accommodation. In responding to the transformative changes

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and social problems associated with the turn-of-the-century migrations, the founders of the Chicago School elaborated the assimilation paradigm to guide social research on immigrant incorporation. This framework has influenced all subsequent sociological research on the incorporation of immigrants and their descendants (Gordon 1964; Shibutani and Kwan 1965; Massey et al. 1987; Portes and Rumbaut 2001; Alba and Nee 2003; Kasinitz et al. 2008). Influenced by advances in human ecology and evolutionary biology, Robert E. Park (1950) proposed a “race relations cycle” as a recurrent general pattern of social transformation resulting from immigration, which he claimed was progressive and irreversible. Following a natural history sequence of development, Park posited four stages of race relations stemming from immigration—initial contact between two or more ethnoracial groups, followed by group-based competition for scarce resources, with the outcome of competition and conflict leading to a modus vivendi giving rise to a stable accommodation between groups. As members of minority groups acquire the culture of the dominant group, and over the course of intergenerational assimilation, the descendants of immigrants eventually become absorbed through intermarriage and amalgamation into the general population. Park’s race relations cycle identified a pattern of development observed not only in the United States but also in other immigrant societies such as Australia and Canada (Shibutani and Kwan 1965). Park never himself specified causal mechanisms to explain assimilation, but instead adopted a teleological view of the inevitability of assimilation. Assimilation as a paradigm for social scientific study of immigration was closely linked to the project of nation building in the writings of Chicago School sociologists. In this view, immigrants were the main source for peopling settler societies like the United States. Although immigrants come with their own native languages and cultural traits, assimilation, conceived as an intergenerational process of endogenous cultural and social change, gives rise to a new type of nation-state based not on common ethnicity but constructed on the institutional elements of common cultural beliefs, norms, rules, and organizations. Park (1930) posited a conception of a composite culture evolving out of the interpenetration of diverse social practices and cultural beliefs of immigrants and their children. The more flexible and open-ended specification of assimilation of the Chicago School largely receded into the background in the “straight-line” assimilation models of Warner and Srole (1945) and Gordon (1964). This post–Chicago School assimilation canon was heavily influenced by structuralfunctionalism, the paradigm that displaced the dominance of the Chicago School in post–World War II American sociology (Parsons 1968; Parsons and Smelser 1956; Merton 1968). The postwar assimilation model conceived of society as a largely homogenous social system integrated around core values and norms, in which the structures and functions of component subsystems sustained social order in equilibrium. Consistent with structural-functionalism, the postwar assimilation model posited an abstract view of Anglo-American middle-class culture and society as the endpoint of assimilation (Gordon 1964). In their effort to revitalize the Chicago School approach, Tomatsu Shibutani and Kian Kwan wrote Ethnic Stratification (1965), which refocused analytic

358 Victor Nee and Richard Alba attention to the earlier emphasis on cumulative causation driving assimilation as a social process. In their theoretical reformulation of the Chicago School approach, Shibutani and Kwan integrated the social behavioralism of George Herbert Mead into the assimilation paradigm. Their approach emphasized the cognitive dimensions of intergroup relations and the causal significance of beliefs shaping perceptions of social distance between majority and minority groups. In their approach, it is the reduction of social distance stemming from institutional change that cumulatively enables the way for assimilation of racial minorities. In the absence of institutional change, ethnic stratification orders, they argued, persist in stable equilibrium of domination of the majority group over the minority groups. In explaining changes that disrupt stable ethnic stratification orders, Shibutani and Kwan (ibid.) emphasized self-reinforcing exogenous changes that cause reduction of social distance between members of majority and minority groups. In Remaking the American Mainstream, Alba and Nee (2003) revised the definition of assimilation to revitalize the Chicago School’s view of the American mainstream as a composite culture. Their rethinking of assimilation sought to adapt assimilation as a social science concept to the context of a multiracial society characterized by unprecedented racial and ethnic diversity. Alba and Nee redefined assimilation “as the decline of an ethnic distinction and its corollary cultural and social difference” (ibid.: 11). Their definition focused measurement on decline of ethnicity for individuals in determining life’s chances and daily experiences as a condition for assimilation. Defined in this manner, assimilation does not require the loss of ethnic identity, nor the vanishing of ethnic boundaries. Compared with the canonical conception of assimilation promulgated by Gordon (1964), the Alba and Nee definition does not equate ultimate assimilation with joining the majority group, something that today appears virtually impossible for racial minorities when that group is defined in racial terms (that is, as white). According to the new definition, members of an ethnic group can assimilate in large numbers even when the ethnic group maintains its distinctive neighborhoods and ethnic institutions. Moreover, ethnic identities may experience periodic resurgence as blending processes yield to segregating processes (Hannan 1979; Bonacich and Modell 1981; Nee, Sanders, and Sernau 1994). Alba and Nee argued that the new definition allows assimilation theory to jettison the tacit ethnocentrism of the past (Warner and Srole 1945; Gordon 1964). In an ethnoracially stratified society like the United States, the mainstream to which the immigrants and their descendants assimilate can be conceptualized as encompassing the social and cultural settings in which the members of the majority group are “at home”—that is, their presence (given the appropriate age, sex, self-presentation, and so forth) is unproblematic (Alba 2009). (We will continue to use the term “mainstream” in the singular, but we recognize that the plural can be seen as more appropriate because of the heterogeneity of the vast U.S. mainstream.) Although the mainstream may be defined by the settings in which whites are found, it is not limited to them, and mainstream settings (even the White House!) increasingly contain ethnoracial diversity. According to Alba and Nee, the mainstream also encompasses a core set of interrelated institutional structures and organizations regulated by rules and practices that

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weaken, even undermine, the influence of ethnic origins. For example, the modern research university is an interrelated set of institutional elements composed of cultural beliefs, social norms, and formal rules governing faculty and student conduct. The same formal rules of competition and cooperation apply to all faculty and students regardless of their ethnicity. A social boundary is a distinction that individuals make in their everyday lives that shapes their actions and mental orientations toward others (Lamont and Molnár 2002); it is typically embedded in a variety of social and cultural differences between groups that give an ethnic boundary concrete significance (so that members of one group think, “They are not like us because . . .”). The social-boundary concept is exceptionally useful for addressing the ethnoracial stratification and changes arising from immigration (Wimmer 2008; Zolberg and Long 1999). One facet of this usefulness is the light it shines on the role of the majority group. In research on assimilation, the focus typically is almost entirely on the immigrant minority and the changes it undergoes; the majority group, when included, appears as a relatively passive player, even though we know that, in many situations, it actively defends its privileges, greeting minorities with prejudice and discrimination. Attention to social boundaries allows us to specify some circumstances under which the vigor of this defense may relent.

Explaining Assimilation in Terms of the Actions of Individuals and Networks This paper aims to specify some general propositions of new assimilation theory (Alba and Nee 2003). In contrast to the “thin” accounts of rationality used by Becker (1976) and extended to sociology by Coleman (1990), the context-bound rationality employed here assumes a “thick” view of rationality embedded in ongoing relationships and institutional structures. Further, the propositions assume bounded rationality, wherein actors are “intendedly rational, but only limitedly so” (Simon 1957: xxiv). As Homans (1974) argued in his criticism of the maximizing assumption in economics, people are more apt to meliorize in their social behavior. By taking into account the context-bound nature of rationality, understanding purposive action involves interpreting choices made by actors within concrete institutional matrices. In other words, rational choice theory is self-limiting when it overlooks advances in understanding how beliefs, norms, rules, and organizations shape social behavior. Although the propositions specify general mechanisms, the theory’s scope condition focuses on assimilation within the institutional and social-structural context of immigrant societies. Obviously, between-country differences in cultural beliefs and legal systems render a mechanical extension of the theory outside of the North American context not automatic. To extend the theory to Western European societies, what is needed is context-specific analysis that takes into account beliefs, rules, norms, and organization embedded in the institutional and social-structural matrix of a country (Greif 2006). Nevertheless, the theory is motivating research in some European countries, such as France (Tribalat 1995, 1996) and Germany (Diehl and Schnell 2006). Moreover, Hartmut Esser (2008) has recently used a rational-choice approach

360 Victor Nee and Richard Alba to propose solutions to key questions about contingent pathways:Why in some contexts does rational action give rise to self-enforcing social dynamics that strengthen racial and ethnic boundaries? Why, in other contexts, does selfinterest seeking at the individual level give rise to self-reinforcing endogenous cultural and behavioral change leading to assimilation? Our aim is to explain assimilation as a process of cumulative causation driven by a repertoire of mechanisms operating at the individual, network, boundary, and institutional levels. We assume that no single causal mechanism explains the mode of immigrants’ accommodation to their host society; instead a repertoire of mechanisms operating at different analytical levels is involved. In combination, and cumulatively, they shape the trajectories of adaptation of immigrants and their children. The mechanisms proposed are general to social behavior and fall broadly within two groups: the proximate causes that operate at the individual and social network levels, shaped by the specific forms of capital immigrants possess, and the distal, often deeper, causes that are embedded in large structures such as the institutional arrangements of the state, firm, and labor market. In contrast to the canonical assimilation literature, our theory does not assume that assimilation is an inevitable outcome of intergroup contact, competition, and accommodation. One problem with an assumption of inevitability is that it assumes away what needs to be explained. As the historical cases of extermination of indigenous people document, assimilation need not be the outcome of interethnic contact (Shibutani and Kwan 1965). Intergroup contact and competition can lead to collective action by the majority group aimed at segregation and exclusion of despised minorities (Bonacich 1973; Nee and Nee 1973). Furthermore, the cases of the Amish of Pennsylvania and Hasidic Jews of New York City show that small ethnoreligious minorities can retain separate identities and communities even while participating to some degree in civil society. Not only does assimilation occur at different rates within different ethnic and racial groups, but within the same ethnic group there is considerable variation in the extent of assimilation—as for example is clear in the sharp contrast between intermarried Jews and the residents of socially encapsulated Hasidic communities. A common feature of human migration is that it is enabled, motivated, and guided by the purposive action of individuals embedded in social networks (Massey and Espana 1987). What we learn from the long record of human migration is the enormous capacity of migrants and their descendants to adapt to new social environments (Massey 1999, 2002). Notwithstanding, irrespective of differences in institutional contexts of receiving societies, interethnic contact invariably sparks competition and conflict. Incrementally over time, amalgamation or assimilation has neither always nor inevitably, but often, evolved as the dominant outcome. In immigrant societies like the United States, Canada, and Australia, assimilation evolved endogenously as cultural belief and social norm. In these societies, contemporary immigrants and their children often settle in mixed ethnic neighborhoods and not only establish ongoing social relationships with members of their own ethnic group but also engage in frequent social and economic transactions with individuals outside their ethnic group. Such

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transactions are a routine feature of living in urban regions characterized by a high degree of ethnic heterogeneity. The higher the level of ethnic heterogeneity, the more likely individuals will transact with others outside of their ethnic group, and the more common are cross-cutting ties connecting different ethnic groups (Nee, Sanders, and Sernau 1994; Lee and Bean 2010). Accordingly, to the extent assimilation occurs, it proceeds incrementally, usually as an intergenerational process, stemming both from individuals’ purposive action and from the unintended consequences of their workaday decisions to optimize on past investments in human, cultural, and social capital (Nee and Sanders 2001a). In the case of immigrants and their children who may not intentionally seek to assimilate, the cumulative effect of pragmatic social action aimed at successful adaptation can give rise to changes in behavior that lead to assimilation. Moreover, the relative mix of mechanisms observed at the community level varies across ethnic and racial groups, sometimes involving more collectivist modes of accommodation in the case of labor migration (Massey et al. 1987; Massey, Goldring, and Durand 1994; Massey et al. 2003) and sometimes more individualist modes of adaptation as in human-capital-driven migration of professionals and skilled workers (Nee and Sanders 2001a; Alba and Nee 2003). For most ethnic groups, a mix of collectivist and individualist mechanisms contribute to shaping the trajectory of incorporation. Even while the modal experience is defined by the purposive activity of individuals, this does not rule out the importance of collectivist efforts at the group level, which help to secure opportunities for gain at the individual level, as documented in Saxenian’s study (2006) of immigrant entrepreneurs in Silicon Valley. purposive action At the individual level, a rational choice theory of assimilation must conceptually incorporate agency stemming from purposive action and selfinterest and provide an account of the incentives and motivation for assimilation. Like all of us, immigrants and their descendants act in accordance with mental models shaped by cultural beliefs and norms that mold perceptions of selfinterest (Greif 2006).They follow rule-of-thumb heuristics in solving problems, and make decisions in the face of uncertainty stemming from incomplete information. Their choices are inevitably context-bound, shaped not only by cultural beliefs but also by institutional and social-structural constraints (Nee 1998, 2005). Lastly, the theory of assimilation assumes aversion to inequity as a universal human trait embedded in cultural beliefs in fairness and distributive justice (Homans 1974; Fehr and Schmidt 1999). In their adaptation to life in the United States, many immigrants face choices in which the degrees of risk and of benefit are similarly hard to gauge; it is also usually the case that these choices involve long-term consequences that are unforeseeable. In contemplating the strategies best suited to improve their lives and those of their children, immigrants and the second generation weigh the risks and potential benefits of “ethnic” strategies, dependent upon opportunities available through ethnic networks (Portes and Sensenbrenner 1993), versus “mainstream” ones, which involve an open-access higher educational system and labor markets (Nee, Sanders, and Sernau 1994; Sanders, Nee, and Sernau

362 Victor Nee and Richard Alba 2002; Sanders 2002; Massey Charles, Lundy, and Fischer 2003). Often enough, there may be little choice in these matters—when immigrants have little human and financial capital and/or they are undocumented, they will usually be limited to jobs located through ethnic networks and constrained to residence in ethnic areas (Light 1972). But others, where possible, may try mixed strategies, built from ethnic and mainstream institutional elements, as when second-generation young adults obtain jobs through family and ethnic networks while continuing their education, thus leaving multiple options open. Individuals striving for success in American society often do not see themselves as assimilating. Yet unintended consequences of practical strategies and actions undertaken in pursuit of the familiar goals—a good education, a good job, a nice place to live, interesting friends and acquaintances, economic security—often result in specific forms of assimilation (Nee, Sanders, and Sernau 1994; Sanders, Nee, and Sernau 2002; Massey et al. 2003). For example, it is not uncommon for first- and second-generation parents to raise their children speaking only English, or at least to avoid placing their children in bilingual educational settings, in the belief that their chances for success in school will be improved by their more complete mastery of the host language (Alba and Nee 2003; Kasinitz et al. 2008).This is often true of families that instill aspirations for professional careers in their children. Surprising numbers of second-generation Asian children speak only English at home, which suggests that their families have adopted this strategy. For another example, the search for a more desirable place to live—with good schools, safe streets, and opportunities for children to grow up away from the seductions of deviant models of behavior—leads immigrant professionals and entrepreneurs to move to upper-middle-class suburbs (if and when socioeconomic success permits this), since residential amenities tend to be concentrated there. One consequence, whether intended or not, is much greater interaction with families of other backgrounds; such increased contact tends to encourage acculturation, especially for the children. Immigrant professionals in particular are likely to optimize on investments in human capital through individualist strategies that increase their children’s chances of entering into the mainstream society (Nee and Sanders 2001a). Associated with acculturation are culturally codified notions of appropriate behavior, which, when learned, serve as cues to others of an individual’s level of cultural and social competence (Spence 1974). Such competence contributes to reducing social distance through the signaling of behavioral attributes that appear familiar and trustworthy. Physical differences may persist, but their effect on perceived social distance attenuates as cultural competence modulates social behavior in ways that highlight shared understandings and cultural attributes. For employers such cues are a “market signal” providing a ready rule-of-thumb measure of the individual’s cultural capital, especially with respect to the linguistic and social competence needed to perform effectively in the workplace (Nee and Sanders 2001a). It is not surprising, given the emphasis on successful adaptation common to immigrant families, that the second generation strives to acculturate. Institutionalized incentives are such that it is rational for individuals regardless of ethnicity to signal that they have the cultural and social competence to compete and perform in schools, the workplace, and other institutional contexts, especially when they believe they

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have predictable chances of success in mainstream institutions.The exploitation of opportunities often carries some ramifications for further assimilation, even if unforeseen ones. Purposive Action Proposition: If perceived opportunities are more extensive and plentiful in the mainstream than in ethnic enclaves, then purposive action of immigrants and their children will be aimed at optimizing returns to investment in human and cultural capital in the mainstream society, even in the face of opposition to their assimilation by individual members of the majority and minority groups. network mechanisms Network mechanisms are the social processes that monitor and enforce norms within close-knit groups (Ellickson 1991; Nee and Ingram 1998). Strictly speaking, social networks and norms do not constitute causal mechanisms insofar as they are elements of institutional structure—the relationship connecting two or more actors and the informal rules governing the relationship—rather than social processes that give rise to and sustain cooperation. A more analytically tractable approach to understanding the causal properties of networks and norms is to focus on the social mechanisms that enable actors to engage in joint action as a means to achieve collective goals (Homans 1950). In close-knit groups, the mechanisms are the social rewards and punishments. Monitoring and enforcement of norms occur spontaneously in the course of social interaction among members of the group through the exchange of social approval for behavior conforming to the group’s norms, and disapproval and ostracism for violating them (Homans 1974). Norms are the informal rules that provide guidelines according to which joint action in close-knit groups or social networks is sustained.They arise from the problem-solving activity of individuals in their strivings to improve their chances for success through cooperation. Members of a close-knit group or social network will informally encourage each other to engage in cooperative behavior by jointly enforcing its norms. Individuals cooperate because not only their interests but also their identities are linked to the success of the group. In collectivities involving large numbers, the “free-rider” problem arises from the availability of a public good to all regardless of whether they contribute to its production; this problem is minimized in close-knit groups where compliance to norms can be effectively secured as a routine by-product of ongoing social exchange among members. No claim is made that the norms of close-knit groups operate to benefit society as a whole. Indeed, the norms that benefit members may impoverish those outside a group—for example, the norm of solidarity among a band of thieves and the norms of racial segregation in the Jim Crow era of the South. Network mechanisms in close-knit groups sustain norms that maximize the welfare of members of the group (Ellickson 1991; Nee and Ingram 1998). Ethnic minorities often exhibit many of the same qualities as close-knit groups in their capacity to monitor and enforce norms of cooperation, especially evident during periods of extreme societal hostility and social isolation (Bonacich and Modell 1981; Portes and Sensenbrenner 1993). Welfare-maximization is seen

364 Victor Nee and Richard Alba in the central role of migrant networks in initiating, sustaining, and expanding streams of labor migration linking small communities in Mexico to destination points in California (Massey Alarcon, Durand, and Gonzalez 1987). It is seen in the norms of close-knit groups within the immigrant community. Newly arrived immigrants turn to relatives, acquaintances, and friends for direct assistance in meeting practical needs from the first weeks following their arrival to establishing the sequence of jobs and residences that form the basis of their long-term accommodation (Nee and Sanders 2001b; Nee, Sanders, and Sernau 1994). The welfare-maximizing feature of norms in close-knit groups is assumed in studies of ethnic economies showing extensive cooperation to secure competitive advantages in markets (Light 1972; Bonacich and Modell 1980). Studies of immigration show that social networks lower the risks of international migration and increase the chances of success in making the transition to settled lives in America (Massey et al. 1987). They support the view that network ties are a fungible form of social capital, providing an array of tangible forms of assistance, especially timely and accurate information about the availability of start-up jobs and of places to live (Massey, Goldring, and Durand 1994). The welfare-maximizing feature of a close-knit group renders network ties a form of capital, a fungible asset that, like human or financial capital, can be converted into social and material gain (Portes 1995). Such social capital is generally accumulated as a by-product of ongoing social relationships, manifested in the buildup of goodwill and trust between members of a group and between acquaintances who have cooperated in the past (Homans 1974; Coleman 1990). For immigrants, it is composed of the webs of network ties that they have accumulated over the course of the migration experience, starting with the strong ties of family, kinship, and friendship and extending to the weak ties of acquaintanceship. Network Proposition: In general, when discriminatory barriers block an individualistic pattern of social mobility, assimilation, when it occurs, depends on ethnic collective action. As with the general pattern of social mobility in industrial societies, intergenerational mobility is likely to be most constrained in the move from the bottom to the middle, and from the middle to the top of the stratification order (Grusky and Hauser 1994). It is reasonable to assume that a similar pattern of divergent outcomes will obtain for the descendants of contemporary immigration as for native groups in industrial societies (Alba and Nee 2003). Hence, many in the second generation are likely to experience upward social mobility into the American socioeconomic mainstream, while the children of immigrant professionals and entrepreneurs may start there and, in fact, enjoy better life chances than white Americans from less advantaged social origins. But other members of the second generation may experience instead lateral or, at best, short-distance mobility, thus remaining close in their socioeconomic position to their immigrant parents (Kasinitz et al. 2008). Portes and Zhou (1993) predict that children of low-wage labor migration are likelier to experience downward mobility into the urban minority underclass than the children of human-capital migration from the same ethnic group.

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Explaining Assimilation in Terms of Institutions and Social Boundaries institutional mechanisms The theory of assimilation turns in part on the structure of relative rewards and the rules of the game embedded in the institutional environment. Institutional mechanisms constitute some of the deeper causes insofar as they determine whether the proximate causes—purposive action and network mechanisms—advance blending or segregating processes (Nee, Sanders, and Sernau 1994; Nee and Ingram 1998).The monitoring and enforcement activity by the state accounts for the effectiveness of coercive isomorphism (DiMaggio and Powell 1983). The vastly expanded reach of centralized authority in modern societies highlights the importance of the institutional mechanisms at the command of the state (Barzel 2002). The state is the sovereign actor in specifying the framework that sets the underlying rules of the game for competition and cooperation in a society. It is the ultimate source of coercion in its geographical area. It has the powers of taxation to mobilize resources to achieve its objectives, to redistribute wealth and income by enacting laws and regulations, and to create wealth by devising and enforcing property rights. It has the capacity to enact and enforce laws and carry out institutional changes in order to secure public goods (for example, defense, environmental protection, civil rights) and to respond to changing relative prices (that is, through interest rates, minimum wage, or money supply). Thus the institutional mechanisms of monitoring and enforcement of formal rules of the state organizations constitute a potent causal force. The state specifies the fundamental rules regarding property rights, citizenship, competition, and cooperation, and hence the structure of incentives of society (North 1981). The striking feature of the institutional environment of advanced industrial societies such as the United States is not so much the variability of localities and regions but the extent to which there is homogeneity in the enforcement of laws and regulations of the federal government (DiMaggio and Powell 1983). For instance, the rules governing civil rights are largely invariant despite state and regional differences in economic conditions (Tomaskovic-Devey and Stainback 2007). Federal laws and regulations extend the power of the central state uniformly despite variability in local and regional customary practices. Variation in local institutional contexts may limit the effectiveness of monitoring and enforcement, but they do not occasion different federal rules. In the post–Civil Rights era, the institutional mechanisms monitoring and enforcing federal and state rules outlawing racism have increased the cost of discrimination in nontrivial ways (Becker 1971; Burstein 1985; Skrentny 2002). For instance, Title VII of the Civil Rights Act of 1964 allows the Equal Employment Opportunity Commission (EOCC) the right to intervene in private bias lawsuits when it deems that the case is of “general public importance.” A follow-up law, the Civil Rights Act of 1991, allows victims of bias to collect compensatory and punitive damages. Although enforcement of Title VII has been inconsistent, firms have become more attentive in observing its guidelines, with increasing numbers offering diversity and multicultural

366 Victor Nee and Richard Alba training workshops for managers and employees and instituting company rules against racial and gender discrimination (Edelman 1990; Dobbin et al. 1993). This attentiveness stems in part from technical improvements in the monitoring of firm behavior by agencies of the federal government (Sutton et al. 1994). Moreover, political actors in Washington, DC, have sought to demonstrate a credible commitment to enforcement of Title VII under perceived pressure to enhance the legitimacy of the U.S. as leader of the free world during the Cold War and a worldwide human rights revolution (Skrentny 2002). Landmark settlements of federal discrimination lawsuits have rendered the cost of discrimination more transparent for corporations and nonprofit organizations (Edelman 1990; Walsh 2000). They also provided the federal government useful case histories and lessons in dealing with discrimination lawsuits. Media attention focused on federal cases also contributes to increased attentiveness to Title VII guidelines in corporate America. Laws, like norms, are statements of expected behavior, ideas framed with moral and ethical authority backed by state power (Posner 2000). Whether as ideology or as cultural belief, they define the parameters of legitimate behavior to which organizations and individuals adapt through the effect of coercive isomorphism (DiMaggio and Powell 1983). Whether the price of noncompliance is perceived as costs imposed by fines and penalties or as a loss of legitimacy is moot, since both are costly to the firm (Nee 2005). The institutional mechanisms of monitoring and enforcement operate exogenously on firms and nonprofit organizations through the costs of penalties and withholding of federal grants and contracts. But there are also endogenous sources of compliance to the rules of the game. The Civil Rights movement and the legislative changes enacted by Congress created a normative environment in which legitimacy is conditioned on fair governance through formal protections of the principle of equality of rights (Edelman 1990; Dobbin et al. 1993; Sutton et al. 1994). Equal employment opportunity law (EEO) defined broad parameters and guidelines of legitimate organizational practices with respect to minorities and women. Because the civil rights laws have weak enforcement features and are ambiguously stated, organizations construct the meaning of compliance “in a manner that is minimally disruptive of the status quo” (Edelman 1992: 1535). This enables organizations to gain legitimacy and hence resources through the appearance of abiding by civil rights legislation. However, once in place affirmative action programs tend to foster constituencies that help to institutionalize EEO/AA goals in the organization. The civil rights–era legislation in this view has its largest impact indirectly through professionals who generate “ideologies of rationality” or cultural beliefs about how organizations should respond to the law (Edelman 1990; Dobbin et al. 1993; Sutton et al. 1994). In other words, as Greif (2006) argues, institutional change is self-reinforcing when it is motivated, enabled, and guided by cultural beliefs and mutual expectations of a widening circle of actors engaged in ongoing transactions. It is more difficult to prove discrimination at the point of hiring than after minorities are already inside the firm. An unintended consequence of Title VII may be to reinforce employer preference to employ immigrant workers, believed by employers to be more acquiescent and less likely to cause trouble (Nee, Sanders, and Sernau 1994;

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Waters 2001; Waldinger and Lichter 2003). Title VII also contributes to the fierce partisanship in national elections as political parties vie for control over the monitoring and enforcement of federal rules. Firms enforce rules against discrimination not only as a result of more effective external monitoring, but also because an increasingly diverse labor force creates positive incentives for management to evolve norms in the workplace that promote a climate of racial tolerance to avoid costly ethnic conflict and tensions. But the more important institutional changes are those that have not only increased the cost of discrimination but also have led to self-reinforcing changes in cultural beliefs and values (Shibutani and Kwan 1965). Alexander (2006) analyzes the robust action of Martin Luther King and civil rights activists in the 1960s. By embodying the ideals of civil society and by strategically using binary oppositions between justice and injustice in leading the struggle for integration, Civil Rights movement activists assumed the moral high ground in the struggle for inclusion in the American mainstream. Alexander shows that the strategy of nonviolent civil disobedience crafted by King succeeded in defining the Civil Rights movement as one that embodied the core values and norms of civil society, while defining those who opposed the movement as embodying the binary-opposite qualities. This symbolic action opened the way for a change in cultural beliefs and norms about diversity and inclusion of racial and ethnic minorities. While the ideological shift has not ended racial prejudice and racist practices, it has changed their character. They are more covert and subterranean; and racism as belief has lost its public legitimacy and can no longer be advocated in public without sanction (Alba and Nee 2003). Today, many white Americans are anxious to demonstrate that they are not racists (Schuman et al. 1997). Institutional Mechanism Proposition: (1) If society’s constitutional rules and their enforcement by the state extend formal equality of rights to all citizens, and (2) if political actors signal credible commitment to reinforcing cultural beliefs and formal rules of equality of rights, then immigrants and their children entitled to full citizenship are likely to choose a course of social action that increases their likelihood of assimilation. Cumulatively, formal equality of rights monitored and enforced by the state and action by political actors reinforcing cultural beliefs and norms of civil rights motivate, enable, and guide self-interest seeking by immigrants and their children oriented to assimilation. boundary mechanisms Because social boundaries are by their nature two-sided, the great utility of the boundary conception within assimilation theory is that it brings attention to the powerful role of the majority population in affecting the life chances of minority individuals and thus influencing the intuitive calculations that immigrant-origin individuals make in assessing the possible risks and benefits of an assimilation strategy. A starting point in an assessment of the role of boundaries with respect to assimilation is that all social boundaries are not the same. As a rough cut, we can distinguish between bright and blurred boundaries (Alba 2005; Bauböck 1994; Zolberg and Long 1999). Bright boundaries involve

368 Victor Nee and Richard Alba a distinction that is unambiguous, so that individuals know at all times which side of the boundary they are on. Blurred boundaries allow for modes of selfpresentation and social representation that place individuals in ambiguous zones with respect to the boundary. In the case of a bright boundary, assimilation takes the form of individualistic boundary crossing. This process is likely to be experienced by the individual as something akin to a conversion—that is, a departure from one group and a discarding of signs of membership in it, linked to an attempt to enter into another, with all of the social and psychic burdens a conversion process entails—growing distance from peers, feelings of disloyalty, and anxieties about acceptance. The paradigm of this process is racial “passing” (but boundary crossing is not limited to racially defined groups; see Child 1943). The nature of boundary crossing suggests that it is a selective process, which not everyone will be willing to undertake. A blurred boundary, by contrast, means that individuals are seen as simultaneously members of the groups on both sides of the boundary or that sometimes they appear to be members of one and at other times members of the other. Under these circumstances, assimilation may be eased insofar as the individuals undergoing it do not sense a rupture between participation in mainstream institutions and familiar social and cultural practices and identities; and they do not feel forced to choose between the mainstream and their group of origin. Assimilation of this type involves intermediate, or hyphenated, stages, that allow individuals to feel simultaneously as members of an ethnic minority and of the mainstream. It is less individualistic and open to assimilation by cohorts of a minority group who then recognize similarities in their experiences. Boundary Proposition #1: The nature and extent of assimilation depend on the nature of the boundary separating an immigrant-origin minority from the majority group. A bright boundary favors individualistic, abrupt assimilation undertaken by a selective subgroup; a blurred boundary, a gradual assimilation by larger numbers who perceive themselves in terms of hyphenated identities and experiences. The nature of a boundary is not necessarily constant, and a focus of investigation for assimilation theory must be the circumstances under which a boundary changes, in particular, going from bright (or, more accurately, more bright) to blurred (or less bright), for a blurred boundary implies easier access to assimilation for a larger number of minority individuals. Another way to think about this change is in terms of the resistance of the majority population to assimilation.The majority population is often invested in preserving a bright boundary in that state because the boundary helps to defend the systemic advantages that majority individuals enjoy (Tilly 1998). At the extreme, some of them may use violence to rebuff challenges to a boundary, as happened in the American South during the Civil Rights movement. Recent American history offers some persuasive cases of boundary change, such as that involving Asian Americans, which is still in the process of evolution, in transit from racial outcast groups to, it appears, ethnic minorities whose members increasingly have mixed ancestry or intermarry with white Americans

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(Lee and Bean 2010). We focus here, however, on the massive post–World War II assimilation of the so-called white ethnics: Jews, Roman Catholics, and Orthodox Christians of Irish or Southern and Eastern European ancestry (Alba 2009). We do so because these groups offer a better analogy to contemporary immigrant groups, given their much larger size compared with the number of Asian Americans and the more gradual intergenerational progress that the large Catholic groups in particular made through U.S. educational institutions (as compared with the unusual educational mobility of second-generation Asians, both in the past and today [Hirschman and Wong 1986]). During the first half of the twentieth century, the white ethnics were distinguished from the American majority group not only in racial position, as is emphasized today in the so-called whiteness literature (Jacobson 1998), but also in ethnoreligious terms. The latter factor has been largely overlooked in the recent literature, but was at the time unquestionably the basis for a bright boundary that in the Catholic case spurred the development of a separate school system and organizational infrastructure.The separation among religious groups was analyzed up through the midcentury in terms of the “Triple Melting Pot,” a pattern of segregated social intimacy that was represented in intermarriage patterns (Kennedy 1943). Yet within two decades following the end of World War II, this separation was dissolving, allowing the ethnicities of these groups to evolve into a voluntary identity, compatible with high rates of intermarriage and other forms of social intermixing (Alba 1990; Waters 1990). The sociological puzzle in this shift involves the stance of the white Protestant majority in relation to what had been a bright boundary: Why did the ethnics become acceptable to white Protestants, who during the first half of the century feared growing Catholic political power as well as the social and economic challenges posed by rapid Jewish mobility? Quite plausibly, this shift was associated with a reduction in the apparent threats that the white ethnics seemed to pose to the Protestant majority. The period in which this mass assimilation took place was one of great economic growth that, thanks to a transformation of the American occupational structure and a rapid expansion of higher education, was to train the cadre of professionals and technical workers needed by advanced capitalism. This economic growth was associated also with the development of new economic sectors and new occupations, such as the computer industry. In concert, these conditions produced what Alba (2009) has described as “non-zero-sum” mobility, a situation in which minorities can advance economically without appearing to threaten the life chances that whites take for granted for themselves and their children. Such a situation then is conducive to greater acceptance of mobile members of minority groups by members of the majority and to greater emphasis on their similarities as opposed to their differences. Although the economic growth of the post–World War II period was responsible for the non-zero-sum mobility, such mobility in principle can also occur in periods characterized by much less robust economic expansion. In the near future, non-zero-sum mobility could also play a role in enhancing minority mobility because of foreseeable demographic changes in the workforce. In particular, the exodus of the baby boomers from the labor market, a massive demographic shake-up, could provide the opening. This group of Americans, born between

370 Victor Nee and Richard Alba 1946 and 1964, is disproportionately white and highly educated and occupies a huge patch of the most rewarding terrain in the labor market (They make up, for example, about 70 percent of engineering managers and two-thirds of registered nurses.) As the baby boomers leave the workforce between now and the early 2030s, when the youngest of them turn seventy, there will be fewer members of the majority entering the workforce than are leaving it. In other words, the young Americans entering the labor market will be much more diverse in ethnoracial terms than the old Americans exiting it. Boundary proposition #2: A boundary becomes less bright (or more blurred) during a period of non-zero-sum mobility, when the threat to the majority posed by minority advance is lessened.

Social Research on the Second Generation We now turn to a case study of the second-generation experience in New York City for a test of our rational-choice theory of assimilation. In Inheriting the City, Philip Kasinitz, John Mollenkopf, Mary Waters, and Jennifer Holdaway report results from a ten-year study of the children of immigrants involving 3,415 young adults, eighteen to thirty-two years old, with at least one immigrant parent, living in the ten counties region of metropolitan New York. The sample was drawn from groups that make up 81 percent of the 12 million people who live in this metropolitan area: Dominicans, Puerto Ricans, Columbians, Ecuadorans, Peruvians, Chinese, Russian Jews, and, for purposes of comparison, native-born blacks, whites, and Puerto Ricans. Of the telephone respondents, the research team interviewed face-to-face 333 respondents for in-depth accounts of their experiences growing up, going to school, finding jobs, and starting up their own families. In assessing secondgeneration assimilation, the reference groups used for comparison were native groups from similar ethnoracial categories. Kasinitz et al. (2008) provide a careful and nuanced review of the debate over assimilation briefly outlined in this chapter. They review the earlier social research on assimilation, from its origins in the Chicago School to the canonical studies of Warner and Srole (1945) and Gordon (1964) and the new assimilation theory proffered in Alba and Nee (2003). It is beyond the scope of this chapter to give a detailed account of the rich veins of empirical findings reported in Inheriting the City. Suffice to say, Kasinitz et al. (2008) provide an authoritative comparative analysis of the family and neighborhood, educational, labor market, and intergenerational mobility of the second generation in their sample. We instead quote summary statements of their findings: On educational attainment: “First, all the second generation groups fared better than native born minority young people in high school and college graduation rates. . . . Even more strikingly, two second generation groups—Chinese and Russians—substantially outpaced native born whites in college graduation rates” (137). On jobs and economic assimilation: “No group works in places where coethnics form a majority. . . . Why does the ethnic economy play such a small role for the second generation? Many second generation New Yorkers avoided

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ethnic economy jobs for the simple reason that they do not pay well. Figure 6.6 [in ibid.] compares the weekly earnings of people working where they are surrounded by co-ethnics with those who are not; the latter situation yielded higher pay for every group except native whites” (198). “In sum, ethnic enclave jobs were much more like safety nets than springboards. . . . While ethnic enclaves have clearly been useful for the immigrant first generation, we find little support for the idea that they will be a significant source of upward mobility for the second generation. Even for the children of Chinatown, ‘moving up’ generally means ‘moving out’” (202). “The work lives of the second generation also provide little evidence of second generation decline into an underclass marked by persistent poverty and unemployment. . . . Indeed, all of the children of immigrants are more likely than those of native minority respondents to be either in the labor force or in school, and the earnings in most groups are closer to those of the native whites than to those of native minority respondents. The children of immigrants also earn more when they work in the mainstream economy, not in ethnic niches or enclaves” (203). On culture:“Overall, the young adults we spoke with look far more ‘American’ than some debates about immigration would lead one to expect. They almost universally speak English well, they do not sustain strong transnational ties, and they pick and choose their religious identities and attend churches that are diverse. . . . [T]hey are far more likely to believe in and practice gender equality than their parents’ generation” (273). On race and discrimination: Kasinitz et al. (2008) report that many of their respondents have personal experiences of discrimination. “On balance, however, the majority of our second generation respondents did not perceive either America or being American as something racial. Even those who had experienced a great deal of discrimination tended to see themselves as American and to see America as a place that accepted their culture and their identity” (339). Overall assessment of social research on second generation: “Our research was initially motivated by worries about second generation decline. Like many other social scientists, we were concerned that the children of recent immigrants might be at risk of downward assimilation as they become Americans. . . . Many scholars have speculated that the larger patterns of racial inequality and discrimination in America will force those children of immigrants who are not classified as white into the ranks of persistently poor native minorities . . . . [Portes and Zhou’s] segmented assimilation model stands the standard assimilation model on its head. For at least some immigrants, the argument goes, coming quickly and easily to share American (or at least lower class American) ways is bad for the second generation. Holding on to immigrant distinctiveness can be an advantage. . . . Few of our respondents followed either of the two most theoretically innovative predictions of the model. Few experienced downward assimilation resulting from overly rapid Americanization, and few also experienced upward mobility by maintaining their place in an ethnic enclave. When downward mobility does occur, it is not correlated with rapid differential loss of parents’ ethnic language or culture. . . . To the contrary, upward mobility is associated with the use of English,

372 Victor Nee and Richard Alba employment outside of an ethnic enclave, and learning American ways faster than one’s parents. Indeed, joining the mainstream is the most common route to success in this study” (Alba and Nee 2003, 347).

Conclusion The theory of assimilation proffered in this essay specifies a repertoire of proximate and distal mechanisms. In combination with the forms of capital immigrants bring with them, the theory explains why assimilation is likely to remain a central social process in the adaptation of immigrants and their descendants and why it will encompass divergent outcomes in American society. It indicates that institutional mechanisms enforcing equal rights rules open the way for assimilation of ethnic minorities by providing predictability in the chances for success for those who try. Prior to World War II the formal rules buttressed racial separatism, especially in the American South under Jim Crow, and reinforced by informal norms of the color line between whites and nonwhites (Shibutani and Kwan 1965). American soldiers fought in segregated units during the war. Far-reaching institutional changes have opened the way for predictable chances of social mobility for ethnic and racial minorities into the American mainstream, not possible before changes in the formal rules and public ideology (Skrentny 2002). Consequently, the scope and extent of assimilation has opened up to provide pathways for intergenerational educational, occupational, residential, and social mobility for many descendants of the post-1965 immigration. Indeed, a case can be made that the pace of assimilation has never before been faster for the second generation, especially evident in the case of children of human capital immigrants (Kasinitz et al. 2008). Children of immigrant minorities are well represented in America’s most selective universities and professional schools (Massey et al. 2003). The theory outlined in this essay addresses the need to explain why immigrants and their descendants seek to assimilate and/or so frequently end up assimilating, as an unintended consequence of their pursuit of other goals. Unlike the earlier literature on assimilation, the theory of assimilation does not assume that assimilation is inevitable, nor for that matter do we assume that it is even irreversible. Instead, assimilation must be explained as a contingent outcome stemming from the cumulative effect of individual choices and collective action in close-knit groups, occurring at different rates both within and across ethnic groups. Assimilation is caused by a repertoire of mechanisms, the precise mix of proximate ones varying considerably across groups. For some groups, especially human capital immigrants, assimilation is shaped mainly by individualistic adaptation conforming to a “straight-line” or perhaps “bumpyline” intergenerational pattern. Others—traditional labor migrants with low stocks of human and financial capital in particular—follow a collectivist pattern in which network mechanisms shape the trajectory of adaptation. Such groups also include middlemen minorities that adapt through reliance on ethnic solidarity to achieve economic security and success, and then employ their resources through collective action to fight barriers to entry and gain acceptance in mainstream institutions. Various combinations of individualistic

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and collectivist adaptation emerge through the mix of purposive action of individuals and reliance on network mechanisms of close-knit groups. This essay draws on and extends the assimilation literature spawned by the early Chicago School of Sociology to construct a rational-choice approach to understanding assimilation as a social process. We focus on the American experience of assimilation, the institutional context of which is broadly similar to other settler societies such as Australia and Canada.The theoretical framework can be extended to global cities elsewhere by taking into account the differing institutional contexts, especially with respect to cultural beliefs and the informal and formal rules governing citizenship. The theory of assimilation turns on distal causes stemming from the institutional mechanisms of monitoring and enforcement that structure incentives in the institutional environment.The state and political actors who monitor and enforce the rules of the game determine the nature and effectiveness of institutional mechanisms. They are the deeper causes insofar as they determine whether purposive action of individuals and network mechanisms result in blending or segregating behavior on the part of both majority and minority groups.

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chapter

Terrorism and the State

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ignacio sánchez-cuenca

Introduction Terrorist activity, particularly in its most extreme manifestations, such as suicide missions, is seen by many as the epitome of pathological, irrational behavior. Even more traditional forms of terrorism are received by the media, the political establishment, and public opinion with such strong feelings of repulsion that any attempt to explain terrorist violence is often misunderstood as an attempt to justify evil. These feelings have been exacerbated by Al Qaeda’s 9/11 attack, the most lethal and spectacular deed in the long history of terrorism. Terrorist violence, however, is not different from other forms of political violence. There is a well-established literature that shows that violence is generally amenable to rational choice analysis. Terrorism is not an exception. Rational choice theory, moreover, can generate an analytically driven taxonomy of different forms of political violence. Drawing on Thomas Schelling’s distinction between military power and the power to hurt, it is shown that terrorism represents an extreme form of political violence in which military power is almost nonexistent. Terrorism, it is argued, constitutes a form of coercive violence carried out mainly by organizations that do not control a territorial base (unlike guerrillas and states). Given their material constraints, terrorist organizations cannot but resort to the kind of tactics that we tend to associate with terrorism. Terrorist conflict is characterized by the extreme asymmetry between the challenger and the state. Once the actor that produces the violence has been properly described, a rational choice approach is adopted that consists basically of analyzing how the actor maximizes utility subject to certain constraints. Although the analysis in this chapter is carried out at the level of the terrorist organization, the issue of individual motivations cannot be completely overlooked, especially if we take into account that some organizations place exacting demands on their recruits, asking for sacrifices that may, in the extreme, entail death (suicide missions). A brief discussion of motivations is also included. As in many other analogous

382 Ignacio Sánchez-Cuenca collective action dilemmas, rational choice theory has not provided satisfactory explanations.The theory seems to work much better at the organizational level, once the previous, collective action problem is somehow solved. The aims and behavior of terrorist organizations are next explored in the strategic context of interaction with the state and with society. Game theoretical models play an important role here. Terrorist violence is carried out either to mobilize followers or to extract concessions from the state. Although these two aims are not mutually exclusive, one of them is usually dominant in the terrorist organization. One exception is Al Qaeda and its imitators, where mobilization and coercion seem inextricably linked.Yet it is interesting to analyze each aim (mobilization and coercion) separately. Mobilization is typically associated with revolutionary groups, coercion with territorial or secessionist ones. Revolutionary terrorist organizations kill with the expectation that killing will ignite a mass uprising. They do not aspire to negotiate with the state the demise of capitalism, the dictatorship of the proletariat, or the world caliphate. How violence is supposed to mobilize people is an intriguing question for rational choice theory. Two different mechanisms are explored. First, violence may affect the thresholds of participation of the masses. Second, violence may provoke a harsh response from the state that, under certain circumstances, induces people to join the violent movement. Nationalist terrorist organizations understand violence as an instrument of attrition. They kill to break the resistance of the state. The point is to produce such pain that the state will consider that it is better off withdrawing from the territory under dispute. Here, violence as a signal about the resources of the organization (and the threat of future pain in the case that the state does not yield) is a crucial element. Terrorist organizations very seldom produce as much pain as they could. Massive, indiscriminate Al Qaeda attacks, such as those of 9/11 in New York or 3/11 in Madrid, are rare in comparative terms. Many terrorist groups show a considerable degree of self-restraint, both in their lethality and in the kind of targets they select. The next issue addressed is whether policy should be based on negative or positive incentives. Negative incentives make violence more costly. Positive ones make violence less attractive vis-à-vis peaceful means. Most governments rely heavily on negative incentives. When the terrorist organization targets many countries, dilemmas of collective action rise for those countries. While each has incentives to protect itself at the cost of other countries that remain exposed to the terrorist threat, all would be better off if they refrained from partial protection and acted collectively against the terrorist enemy. A general assessment concludes this paper. Although there is no doubt that rational choice theory has made important contributions to the study of terrorism, dealing with such essential topics as the strategic interaction between terrorist organizations (TOs), states, and social groups, the consequences of state repression, the mobilizing effects of violence, the choice of targets and tactics (for example, suicide missions), or the relationship between terrorists and their supporters, the fact is that many, if not most, of the formal models are disconnected from empirical research and study only partial aspects of the complex phenomenon of terrorist violence. In other words, we still need

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some middle-range theory, based on rational choice assumptions, with power to integrate the various dimensions of the problem and to formulate testable hypotheses in a systematic way.

The Nature of Terrorism The field of terrorism studies has been dominated by endless discussion about definitional issues. Schmid and Jongman (1988) collected more than a hundred definitions of terrorism, and their search ended in the mid-eighties. Whereas in the case of civil wars the problem has been solved through operational rules (an intrastate conflict with at least a thousand fatalities; see Sambanis 2004), in the case of terrorism the problem seems intractable.1 The issue at stake is not merely terminological. Without an agreement about the boundaries of the phenomenon to be explained, theory building and empirical analysis are doomed. For instance, how can we select cases for comparative research if there is no consensus about what counts as terrorism? In some cases there is almost universal agreement: nobody denies that the Red Brigades in Italy was a terrorist group. But what about other cases such as the Shining Path in Peru, the Tamil Tigers in Sri Lanka, the Resistance against Nazi occupation in World War II, the bombings of Hiroshima and Nagasaki, or Pinochet’s repressive regime? Depending on the definition that is privileged, the answer will vary. Definitions are too general when they characterize terrorism in terms of coercion. For instance, it is often held that terrorism operates through the distinction between the target of violence and the main target (Krueger 2007: 14; Rosendorff and Sandler 2005: 172; Schmid and Jongman 1988: 28): the terrorists kill someone (the target of violence) in order to coerce the many (the main target). However, this distinction applies also in many cases of coercion that have little to do with terrorism. When a small shopkeeper who refuses to pay for protection is killed by the mafia, that organization is sending a message to a larger audience (all those who can potentially be extorted). Most wars have elements of coercion that imply the distinction between the victims and the audience that observes the killing of the victims (Wagner 2000). As Schelling says regarding the two atomic bombs dropped on Japan in 1945, “[T]he political target of the bomb was not the dead of Hiroshima or the factories they worked in, but the survivors in Tokyo” (1966: 17). The attempt to terrorize an audience is not something unique to terrorism either. Although some definitions focus on the consequence of terrorist violence in terms of inducing fear in the population, fear is the generic consequence of coercion through violence. Terrorism is undoubtedly a highly refined manifestation of the power of coercion, but it does not have the monopoly over terror. States have a long record of terrorizing their own population through massive arrests, internment, torture, summary executions, or mass disappearances (Herreros 2006; Walter 1969). And terror is also used in warfare (for example, the bombing of London by the Nazi army). On the other hand, definitions are too narrow when they identify a feature that applies only in some cases. For instance, it is often said that terrorism is violence against civilians or noncombatants (Goodwin 2006a: 2028; Kydd and

384 Ignacio Sánchez-Cuenca Walter 2006: 52; McCormick 2003: 474). This statement derives from what might be called the “international terrorism bias.” Most authors who study terrorism focus on international or transnational attacks, whose targets are mainly civilians.The paradigmatic example, of course, is the 9/11 attacks.Those familiar with domestic terrorist attacks, which are much more numerous than the international ones, know that some terrorist organizations kill combatants in a systematic way. For instance, police forces and the military represent 57.3 percent of all fatalities of the Provisional Irish Republican Army (PIRA) and 59.3 percent of all fatalities of the ETA (Basque Fatherland and Freedom, military branch) (Sánchez-Cuenca 2007: 294). These are not minor deviations. It would make little sense to consider that more than half of those killed by the PIRA or ETA military are not victims of terrorism, or that these organizations are not terrorist ones. To escape from the morass of inductive definitions, we need to derive the concept of terrorism from a theory of violence. Schelling’s distinction (1966) between military power and the power to hurt (or Kalyvas’s distinction [2006] between extermination and compliance) provides an interesting point of departure. Military power corresponds to brute force and the power of destruction (extermination). The power to hurt, instead, is associated with coercion (compliance). Taking what you want is military power; making someone give it to you corresponds to the power to hurt. In modern warfare the power to hurt has become increasingly relevant. The whole idea of nuclear deterrence is based on the power to hurt: the atomic weapon is used if the other party does not comply. If we suppose that military power and the power to hurt define two extremes of a continuum, with many cases in between that combine in different proportions these two components, terrorism naturally falls in one of these extremes—namely, the power to hurt. Unlike other forms of violence, terrorism can be characterized by the fact that it is never intended to destroy or annihilate the enemy. This is why terrorism, understood as a type of action, is associated with tactics that cause pain and terror: car bombs, assassinations, kidnappings, selective shootings against security forces, or hostage-taking. In principle, any actor might carry out terrorist deeds. In practice, however, terrorism is practiced mainly by terrorist organizations. This is not tautological provided that we have an independent criterion about what a terrorist organization is. Obviously, the criterion cannot refer to terrorist tactics if it is to be truly independent. On the other hand, it should shed light on why these organizations resort in particular to terrorist violence and not to any other kind of violence. The key point here is that TOs are clandestine. They act within the enemy’s territory. TOs are not armies or guerrillas, because they lack a territorial base liberated from the state they are fighting against. In the absence of a territory, there is no physical battlefront. In guerrilla conflicts or civil wars, insurgents break the monopoly of violence by creating territorially segmented monopolies of violence (Kalyvas 1999: 259). And when the control of the territory is under dispute, Kalyvas talks of “fragmented sovereignty,” meaning that the control changes from one party to the other, sometimes in a brief span (for instance, the state controls the territory during the day, while the insurgents do so during

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the night). Terrorism, obviously, also breaks the state’s monopoly of violence, but because of the absence of a liberated area, it does not bring about either segmented monopolies or even fragmented sovereignty. The situation is rather that of a duopoly, with two (or more) actors producing violence simultaneously within the same territory. The lack of a liberated territory has far-reaching consequences for the dynamics of terrorist violence. Whereas TOs have very superficial contact with the population, guerrillas have to act as the new ruler in the liberated territory, establishing some sort of protostate of its own to control the local population, extracting rents and imposing order.That is why guerrillas kill so many civilians in the areas in which they rule (Wickham-Crowley 1990). Given the absence of their own territory, terrorist organizations cannot get involved in fully military operations against the enemy. Whereas guerrillas may constitute lightly armed bands that penetrate the enemy’s zone, terrorist organizations cannot aspire to launch military operations. Their aim is neither to weaken the state’s army nor to gain increasing portions of territory from the control of the state, making the state increasingly weaker. They can only try to inflict pain. Their feasible options are those compatible with the lack of a controlled area. Thus they can hijack a plane, ambush a police patrol, put a bomb in a public place, or shoot a politician. But they cannot maintain open combat with a real army. Terrorism is a certain kind of violent action aimed at hurting the enemy. In turn, TOs are those armed groups that, because they lack their own territory, cannot but engage in terrorist violence. Guerrillas can also carry out terrorist operations, particularly when they act out of their own territory and are subject to the same constraints as a terrorist organization. For instance, when the Shining Path exploded a car bomb in a bourgeois quarter of Lima on July 16, 1992, killing 25 civilians and injuring 155, that was a typical terrorist act. Since the perpetrators were in the enemy’s territory, they did not wear uniforms or insignia, having to act in complete secrecy. It is doubtful that states engage in terrorism. It is true, as said above, that states sometimes use violence to terrorize their own population. But the technology of repression is very different from that of terrorism. Repression, in its various forms, consists of massive arrests, torture, or internment camps. I do not see what we gain in analytical terms if we call state repression terrorism. Statesponsored terrorism is a different matter. Here we have a terrorist (clandestine) organization that obtains financial support, information, and logistics from the state, and some of its members may be civil servants acting on a nonofficial basis. Henceforth, I focus on terrorist organizations—that is, insurgent groups that do not control a territory and act within the enemy’s boundaries. Once an insurgent group without its own territory decides to use violence, it is constrained to resort to terrorist tactics such as the ones enumerated above.

Motivations At the individual level, those who share the political ends that TOs pursue face a classical collective action dilemma. Given the high cost of becoming a terrorist, the free-rider temptation looms large. Joining a terrorist organization

386 Ignacio Sánchez-Cuenca is a risky choice. The chances that the recruit will be arrested or killed are extremely high. Unlike with guerrillas, there is very little safety in numbers: many TOs are indeed small organizations, with fewer than a thousand activists. There is no evidence that terrorists suffer mental disorders (Victoroff 2005). If terrorists are ordinary people, why do they become terrorists? The empirical evidence shows that people who become terrorists act out of a feeling of outrage and injustice even if they are not necessarily the ones who suffer the most exploitation, poverty, or even foreign occupation. For instance, members of Palestinian terrorist organizations (Benmelech and Berrebi 2007; Berrebi 2007; Krueger and Maleckova 2003; Krueger 2007: ch. 1) and members of Al Qaeda (Sageman 2007) have educational skills well above the average. Krueger (2007) concludes from this fact that an improvement of economic conditions does not necessarily lead to a reduction of violence, since those who volunteer are not those who are most affected by economic backwardness. However, Bueno de Mesquita (2005a) has developed a model that accounts for this empirical pattern but reverses the policy implication. The mechanism he posits is the following: the lack of economic opportunities in places such as Palestine pushes people with higher qualifications into terrorism, since the economic opportunity cost of entering into a terrorist organization is lower. This means that economic development will certainly make terrorism less attractive. If we go beyond this particular issue about the influence of social conditions on individual motivations, how can the decision to become a terrorist be explained in rational choice terms? Selective material incentives do not seem to play an important role in the terrorist setting. Qualitative evidence, in the form of memoirs, interviews, and internal documents of TOs, shows that becoming a terrorist does not at all guarantee high standards of living. Terrorism is rarely a means of social mobility. Greed may be a powerful motivation in many civil wars in which the insurgents control natural resources or drug production in the liberated area (Collier and Hoeffler 2004; Fearon and Laitin 2003), but it plays a minor role in clandestine organizations such as TOs. Perhaps the most important selective incentive is prestige within the peer group and the community of support. But is this benefit sufficient to compensate for the enormous personal sacrifice that joining a terrorist organization entails? The literature tends to assume that the collective action dilemma is somehow solved by focusing on the analysis of the decisions made at the organization level.2 In fact, terrorists can easily be identified with the hard-core of unconditional participants that are assumed to exist in models of collective action (McCormick and Owen 1996: 381). The existence of this hard core is taken for granted and is not subject to further analytical scrutiny. However, the occurrence of such extreme acts of cooperation as terrorist suicide attacks makes a deeper analysis about motivations unavoidable. Suicide attacks challenge the assumptions usually made in the collective action literature, since the perpetrator cannot enjoy either collective or selective benefits after the deed. The expected benefits are zero if the agent is moved only by selfinterest. It is no wonder then that suicide attacks have aroused great intellectual curiosity among those who defend the universal application of rational choice theory. There is a growing body of literature on the rationality of suicide actions.

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One tempting suggestion to make sense of terrorist suicide attacks is afterlife rewards. Yet, religious motivations are neither a necessary nor a sufficient condition: we observe suicide attacks among people with no religious motivations (Russian anarchists around 1900, Tamil Tigers in Sri Lanka), and some fanatically religious groups abstain from suicide attacks (for example, the GIA—Armed Islamic Group—in Algeria). According to Hoffman and McCormick (2004: 252), only 60 percent of all suicide attacks that took place between 1983 and 2003 were carried out by religious organizations. Pape (2005: 210) provides an even lower figure: 43 percent. It has also been suggested that the payment that the families of the suicide bomber receive in Palestine or Lebanon could explain this kind of action. But, on the one hand, many suicide missions in other parts of the world are not rewarded in this way. And on the other, this afterlife payment is not strictly speaking a selective incentive, since the perpetrator does not enjoy it. It presupposes some altruist motivation, even if it is only kin-altruism. In fact, altruism has been the dominant motivational mechanism used in rational choice explanations. Azam (2005) considers a two-period utility function in which the agent is concerned about her own consumption level and the future consumption of her community. Under certain circumstances, it may be rational to give up all personal consumption with the aim of increasing (probabilistically) the consumption of the community. A terrorist suicide act becomes thus an extreme form of saving. Likewise, Bernholz (2004) suggests a Cobb-Douglas utility function U = Ax1 – ß y ß where x represents a private consumption good and y is the proportion of believers in the population. The agent engages in terrorism with the aim of increasing y. When ß → 1, y becomes what Bernholz calls a supreme value and the utility function represents in the extreme a lexicographic preference order in which ideological concerns trump selfinterest and make suicide behavior rational. Wintrobe (2006) proposes a more elaborate model. Agents derive utility from autonomy and solidarity (or adaptation to the social group the agent belongs to). The agent may trade autonomy for solidarity, adapting her beliefs to those of the group. The more the agent adapts to the group, the greater the solidarity reward. Wintrobe derives a multiplier effect of solidarity: once the agent trades autonomy for solidarity, the agent recalculates the optimal mix of the two goods. He establishes the conditions under which the multiplier produces interior and corner solutions. In the corner solution, the agent goes all the way down and renounces autonomy completely, identifying her utility with that of the group. Suicide behavior, understood as a total sacrifice for the group, is then a rational solution. The problem with all these models is that they tinker arbitrarily with preferences. Although at its most abstract level rational choice theory does not necessarily assume selfish motivations, the fact is that empirical applications always start from the self-interest assumption for methodological reasons (Sánchez-Cuenca 2008). It is often considered that if modelers can choose selfish or altruistic preferences at their convenience, all behavior is immediately rendered rational (see Green and Shapiro 1994). Why should we make room for altruistic preferences in the case of terrorist behavior but not in many other

388 Ignacio Sánchez-Cuenca cases of collective action? And if altruism is always a possibility, what is the explanatory power of rational choice theory? Ferrero (2006) has developed a simple model in which altruism plays no role. Everything hinges on selective incentives. Let bi be the benefit the agent receives for belonging to the terrorist organization in period i, i = 1, 2. Let p be the probability that the person is asked for martyrdom in period 2. And, finally, let s be the stigma the agent obtains in the case she reneges and does not commit suicide when asked to do so. If the agent commits suicide in period 2, the benefit is 0. The expected utility of accepting martyrdom (M) is: EU(M) = b1 + ((1 – p)b2 + p0)

(1)

In turn, the expected utility of reneging (R) is: EU(R) = b1 + (b2 – ps)

(2)

The contract for martyrdom between the organization and the agent is efficient when it meets both the participation and the incentive constraint. If U(N) represents the utility of not joining the terrorist organization (the reservation utility), where U(N) > 0, the participation constraint is simply EU(M) > U(N). The incentive constraint is EU(M) – EU(R) ≥ 0. The incentive constraint boils down to the condition s ≥ b2. That is, if the stigma is big enough, the person is better off committing suicide. This explanation seems to be just the opposite of those based on altruistic preferences. The utility function only incorporates selective incentives, with no room for ideological, moral, or religious convictions. Thus, persons who obtain expected benefits greater than the reservation utility should volunteer for suicide missions, regardless of their political ideas.3 Empirically, Ferrero cannot explain the cases of the anarchists in the nineteenth century, since there was no contract between the organization and the perpetrator and, as the author admits (2006: 866), there was no stigma associated with defection. Moreover, there are many other cases of political suicidal behavior, such as those of self-immolation (dying without killing; see Biggs 2005), that are carried out without contracts of any kind and without selective incentives. All these models, either based on altruistic preferences or on selective incentives, are disappointing for a deeper reason. It is one thing to describe certain behavior in the language of rational choice theory; it is quite another to explain that behavior. These models do not tell us much about why in some conflicts motivations for suicide missions are present or absent. They simply show that if preferences have some determinate features, suicide is not necessarily irrational. But what we need to understand are the conditions under which a conflict induces motivations that move some people to commit suicide for the cause.

Terrorist Strategies: Mobilization and Attrition What do TOs aim at when they engage in violence? What is terrorist violence supposed to achieve? TOs may pursue several ultimate goals, but these can basically be reduced to two for the sake of simplification: regime

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change and territorial independence (Hoffman and McCormick 2004: 245– 46). Regime change, for instance, is what anarchist, communist, fascist, and some Islamic TOs aspire to. They want to overthrow the existing regime and replace it with a different one that fits their political preferences. Many cases belong here. For instance, the Red Army Faction in Germany (also known as the Baader Meinhoff gang) (communist), Black Order (Ordine Nero) in Italy (fascist), or the Salafist Group for Preaching and Combat in Algeria (Islamic). Territorial independence (or its prevention) is what nationalist TOs seek. ETA wants the independence of the Basque Country, Hamas and other Palestine TOs the independence of the occupied territories, the EOKA (National Organisation of Cypriot Fighters) the independence of Cyprus, the IRA the independence of Northern Ireland from Great Britain (and integration with the Republic of Ireland), the UVF (Ulster Volunteer Force) the maintenance of Northern Ireland in the United Kingdom, Irgun the independence of British Palestine, and so on and so forth. Of course, the distinction between regime change and territorial independence is fuzzy in the real world. Hamas, for instance, wants to liberate the occupied territories, but also seeks to have an Islamic regime in these territories and, ultimately, the destruction of Israel. Likewise, the IRA and ETA have territorial demands (reunification with Ireland, independence for the Basque Country), but they also defend socialism. The crucial point here is whether the terrorist organization has territorial claims or not, regardless of the political jargon employed to pursue their goals. While the aforementioned organizations have clear territorial claims, the Red Brigades in Italy or the Red Army Faction in Germany did not. As will be seen below, the territorial claim has far-reaching consequences for the understanding of violence dynamics. Al Qaeda is perhaps the most difficult case. On the one hand, there is an element of territorial liberation: Al Qaeda rejects the presence of foreign troops on Islamic soil. Insofar as its attacks are aimed at the expulsion of foreign troops, its violence very much resembles that of terrorist groups with territorial claims. This is the perspective that Pape (2005) privileges in his analysis of suicide terrorism. But, on the other hand, Al Qaeda also wants to create massive popular support for the world caliphate project and for the creation of Islamic states in Muslim countries. As Holmes (2005: 168–72) has explained in an illuminating essay, once different local fights are coordinated at the supranational level, the national liberation project becomes a global one of higher reach, in which terrorism is aimed at a more grandiose goal: the religious war against Western civilization. There seems to be here a unique, unprecedented mix of national liberation and revolutionary struggle. If, despite the existence of important cases like Al Qaeda that do not fit well, I insist on the distinction between regime change and territorial independence, it is because each goal is associated with different strategies. When the goal is regime change, TOs understand that violence is mainly an instrument for mobilizing people. In contrast, when the goal is national liberation, violence is an instrument of attrition.Violence is supposed to impose such a cost to the state that the state will opt for withdrawing from the territory under dispute. Not everyone agrees with the point that the two basic goals of violence are attrition and mobilization. Kydd and Walter (2006) suggest a longer list:

390 Ignacio Sánchez-Cuenca attrition, intimidation, provocation, spoiling, and outbidding. It is remarkable that they omit mobilization, as this is perhaps the most often sought end of terrorist violence. But, more important, if we leave out intimidation, which is just another name for compliance, the other three goals—provocation, spoiling, and outbidding—are all clearly instrumental with regard to a more basic goal. Presumably, terrorists provoke the state to induce an excessive state reaction that will turn many to the terrorists’ side. Here provocation is a tactic within the broader strategy of mobilizing people. In turn, spoiling and outbidding are goals that have more to do with the survival of the organization. Outbidding has to do with competition among terrorist organizations for gaining supporters (see Bloom 2004; Gupta and Mundra 2005); spoiling refers to an attempt to foil a peace agreement that would marginalize the terrorist organization (Kydd and Walter 2002). Both outbidding and spoiling are thus connected to the ultimate aim of mobilizing followers. I explore next the logic of mobilization and the logic of attrition from a strategic point of view. In the case of mobilization, violence is intended to influence followers. In the case of attrition, violence is more pointedly directed at the state, and the strategic element of violence is clearer. mobilization Why should the exercise of violence by an underground organization mobilize anyone? Revolutionaries of different ideologies (anarchists, communists, Islamists) have believed that violence could ignite a mass uprising. In its original formulation, that of the anarchist “propaganda by the deed,” it was considered that violence was much more effective in transmitting a message than leaflets, pamphlets, or the press: violence has a greater echo in society than written material. In more recent times, left-wing revolutionary terrorism elaborated the doctrine of propaganda by the deed (Sánchez-Cuenca 2009). In the written materials of these groups, the following mechanisms are often mentioned: (i) violence polarizes conflicts, inducing more radical preferences; (ii) violence raises class consciousness, as workers learn the value of illegal forms of protest against the system; (iii) violence sets a path that others will follow; (iv) violence shows the fragility of the system, which is not as invulnerable as workers often think; and (v) violence forces the state to reveal its true repressive face. The very same logic can be found in Islamic revolutionary organizations such as Al Qaeda. The 9/11 attacks were intended to humiliate the United States. The choice of highly symbolic targets, such as the World Trade Center and the Pentagon, shattered the myth of the American superpower. Al Qaeda expected to boost its popularity and consequently to expand its base of supporters and its pool of recruits. The mobilization goal was obvious. The case of fascist terrorism is somewhat different. The so-called strategy of tension, as practiced mainly in Italy in the period 1969–80, and to a minor extent also in Spain and Portugal during their transitions to democracy, consisted of creating, through indiscriminate attacks against civilians, such a climate of anxiety and apprehension that public opinion would approve a military coup and the establishment of an authoritarian regime. The most famous attack took place in the Bologna train station, where a bomb killed eighty-five people and injured more than two hundred on August 2, 1980.The point was not to attract

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recruits but to terrorize society and induce the army to intervene. Instead of mobilizing the masses, they sought to mobilize the army. Rational choice literature has analyzed two different mechanisms by which violence could lead to popular mobilization. On the one hand, violence can affect the threshold levels of potential participants.Violence is a signal about the resources of the challenger (the terrorist organization) and about the fragility of the state. On the other hand, violence may trigger a repressive reaction from the state that increases the popular backing of the terrorists. Each of these mechanisms is examined next. Violence and participation Terrorists seem to assume that violence has catalytic power. This may make sense in terms of the threshold models originally developed by Schelling (1978). In these models there is a distribution of types in the population. People are willing to cooperate provided that a large enough fraction of the population does so. Each type has a different threshold of collective participation beyond which she will cooperate. Some people, usually a small percentage of the population, cooperate regardless of what others do. They are the unconditional participants, the critical mass that triggers the cooperation of conditional participants. There are some formal models that address this issue in the case of revolutionary violence (McCormick and Owen 1996; Ginkel and Smith 1999). The initial assumptions are rather restrictive, since the political regime is supposed to be autocratic. Given that most revolutionary TOs emerge in democratic countries, this is a serious limitation. McCormick and Owen (1996) adapted Schelling’s model to the case of revolutionary, underground organizations. The value of rebelling against the regime is conditioned by two factors: the probability p that the revolutionary movement succeeds, and how much the individual weighs the value of revolutionary success. In turn, p is a function of how many people do join the movement. Given the parameters of the problem, it is possible to specify a reaction function f(x) that tells us the fraction of the population that will cooperate if it is believed that a fraction x has joined the movement. Obviously, when x is such that f(x) = x, the process of mobilization reaches an equilibrium. In a typical collective action problem, the reaction function has an S-shape that crosses the 45º line three times, as can be seen in Figure 11.1. The 45º line is the set of points at which f(x) = x.The problem for the revolutionaries is how to move from the first equilibrium to the second one. Here is where violence enters into the model. According to McCormick and Owen, people are uncertain about the actual fraction of the population that supports the revolutionary organization. Let x stand for the fraction of population that is thought to support the organization. The crucial point is that the value of x depends on the behavior of the revolutionary organization. More concretely, violent deeds may convey the impression that the revolutionary organization is more powerful than initially thought. Violence has mobilizing power because it affects the value of x. The higher the level of violence, the higher the expectations about the social support of the organization. And it is not only a matter of the quantity

Population willing to participate

392 Ignacio Sánchez-Cuenca 1 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

Belief about the fraction of people that has joined the movement

figure 11.1. A typical S-shaped reaction function

of violence. Quality may be also important, as the symbolic nature of certain targets may considerably enhance the perception of the effectiveness and power of the organization.4 However, if violence is merely a signal to compensate for the lack of support of the revolutionaries, it is not a credible one. If people are rational, they should not be misled by violence: were the revolutionary organization really powerful, it would not need to use violence to attract supporters. In a more elaborate model, Ginkel and Smith (1999) address this problem.There are three actors: the regime, the revolutionaries, and the mob. The problem for the revolutionaries is the following: the easier it is for them to engage in violence, the less information the signal transmits to the mob about the weakness of the state. The signal is fully informative when the revolutionaries become violent despite a high risk of being repressed. It is then that the mob will join the revolutionaries. This is an interesting result in understanding the miserable failure of so many terrorist revolutionary organizations in the 1970s and 1980s. The Red Brigades (Italy), the Tupamaros (Uruguay), the Red Army Faction (Germany), the GRAPO (Spain), and the 17th November Revolutionary Organization (Greece) all failed completely in their attempts to mobilize the working class. The fact that all these organizations emerged in democratic countries may help to explain why people did not understand violence as a signal of the weakness of the state and of the bright prospects of revolution. Whereas in these models the organizations are underground and have to communicate with the masses through violence because of the repressive conditions of the regime, it is worth noting that in democracy the logic is the opposite: revolutionary organizations make the momentous decision of becoming underground because they consider that violence is the best instrument for mobilizing the masses. Violence and repression In most cases, the consequences of violence for popular mobilization are not independent of the state’s reaction. The literature on state repression and

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protest has shown that repression does have ambiguous consequences regarding violence (Pierskalla 2010). Theoretical models establish different functional forms for these two variables (linear, U-shaped, inverted U-shaped, S-shaped), and empirical analyses reach noncoherent results (Davenport 2007; Francisco 1996; Gleditsch, Hegre, and Strand 2009; Koopmans 1997, Muller and Weede 1990). We know that the effects of repression vary under different political circumstances, but we do not know why. The literature on terrorism has also contemplated the possibility that state repression backlashes (Ross and Gurr 1989), but, again, we ignore the mechanisms by virtue of which the mobilizing effects of repression may be greater than the deterrent ones. The use of game theory has shed some light on this vexed issue. Two almost simultaneous articles by Bueno de Mesquita (2005a) and Siqueira and Sandler (2006) have recently modeled the potentially contradictory effects of repression on terrorist violence. According to Bueno de Mesquita’s model, repression has three different effects: (i) the usual deterrent effect that prevents supporters from joining the terrorist organization; (ii) a negative effect on the economy that decreases the opportunity cost of becoming a terrorist, making it therefore more likely that supporters join the organization; and (iii) a positive effect in the form of an ideological benefit derived from the fact that the person fights against a system that she considers repressive (the greater the level of repression, the higher the ideological benefit).Whether repression leads to lower or higher violence depends on the sign of the sum of these three effects. Obviously, a shortcoming of the model is that these ideological benefits are not measurable at all. We remain ignorant as to what sort of conditions may affect these benefits. It might be interesting nonetheless to develop this line of inquiry a bit further. For instance, it could be argued that the more indiscriminate or arbitrary repression is, the higher the ideological benefit of fighting against the state. Siqueira and Sandler (ibid.) do not contemplate ideological benefits. I present here a rather simplified version of their model to illustrate the application of rational choice theory to terrorism. The population is distributed according to an index φ in the interval [0, 1]: higher values of φ mean greater closeness to the terrorists. Let v be the level of violence by some terrorist organization and r the level of repression by the state. If the terrorist organization wins, supporters get payoff S (success); if it fails, they get payoff F (failure), S > F. The probability of failure is π(v,r), with ∂π ∂π >0. φˆ, the person is mobilized and supports the terrorists. When φi < φˆ, the person does not support them. It is interesting now to calculate the derivatives in (5) regarding violence v and repression r. If the resulting derivative is negative, that means that the ideological threshold of supporting the terrorists is lower and therefore support grows. First, we incorporate the budget constraint β = g + αr into (5), replacing g with β – αr.The derivative with regard to violence is ∂ϕˆ ∂v

=

π v (S −F )

2

< 0.

(6)

What (6) shows is that an increase in violence implies an increase in mobilization. More violence means for followers a greater probability of the terrorists winning. This result parallels the main results of McCormick and Owen (1996) and Ginkel and Smith (1999) that we saw before, in which violence is a signal about the likelihood of victory. More interestingly, Siqueira and Sandler (2006) show that the derivative with regard to repression may have different signs depending on the parameters of the equation: ∂ ϕˆ

π r ( S −F )−α ( 1−λ )

≥

(7) 0. ≤ 2 ∂r The ambiguity of the sign in (7) captures the two possible effects of repression. When the derivative is positive, an increase in repression brings about a reduction in violence (more people are deterred). And when the derivative is negative, repression has counterproductive consequences, generating more violence. The mechanism here is purely economic. The lower the value of λ (the degree to which terrorists benefit from public goods), the more likely that repression produces violence. The explanation provided by Siqueira and Sandler is the following: most money is spent on repression, followers do not benefit from public goods, and therefore their =

=

Terrorism and the State 395

threshold for supporting the terrorists becomes lower. Their illustration is Israel vis-à-vis Hamas: the Israeli state invested heavily in the repression of Palestinians without providing them with public goods (low λ), inducing many of them to join the terrorists. The authors expand these results in several directions. For instance, an interesting implication of their model is that repression will be particularly effective when supporters are not territorially concentrated (for example, the Red Brigades in Italy versus Hamas in Israel). When supporters are spread all over the territory, it will be difficult to exclude them from public goods. It is difficult to say whether the role of access to public goods is as crucial as Siqueira and Sandler suppose.While it makes sense to suppose that the dramatic worsening of life conditions in Palestine has fueled support for organizations like Hamas, it is also the case that the tough counterterrorist policy of Israel has reduced the number of terrorist attacks against its population (regardless of other political considerations, the fact is that the separation wall and other repressive measures have been reasonably effective). In other cases of long-lasting terrorism, such as Northern Ireland or the Basque Country, it is difficult to ascertain whether public goods had any effect on the degree of support for terrorists. Other explanations are possible. For instance, it may be argued that the increase in support for TOs, particularly in the early phases of their activity, has to do with problems of information.When the state is challenged by clandestine organizations, it usually lacks information about the identity of the challengers and their networks of support. Under these circumstances, the state may engage in indiscriminate repression with the expectation that some terrorists will be captured. This was rather obvious in the battle of Algiers, in the Basque Country under Franco, or when the United Kingdom dispatched troops to Northern Ireland. But perhaps the most extreme manifestation is the war on terror launched by the United States against countries that have little to do with the terrorists. As Holmes (2007) has forcefully argued, this was the reaction of a state that did not know anything about the enemy, felt compelled to act, and acted as it used to do in the past, using military power. Once the state obtains some intelligence and learns to infiltrate the organization or its external networks of support, repression can become more selective. As I have suggested above, it could be that the ideological benefits of fighting against a repressive regime as explicated by Bueno de Mesquita (2005a) are a function of how indiscriminate repression is, indiscriminate repression being the natural consequence of imperfect information. Formal models of violence and repression have indeed introduced a great deal of analytical rigor. They distinguish the different effects that repression may have, and thanks to comparative statics they derive hypotheses about which effects will dominate under various circumstances. Yet these models are sometimes far removed from the empirics. They are based on anecdotal evidence that fits their conclusions and not on serious testing of their claims. This is particularly worrisome when this kind of data is used to motivate the model, since the bias of the evidence may be translated into the model itself.5

396 Ignacio Sánchez-Cuenca attrition In the case of national liberation terrorism, the main concern of the terrorists is to force the state to abandon the territory under dispute. Of course, national liberation TOs also want to have a strong base of support, but, to a point, this is an instrumental goal. The higher the popular support, the more powerful the terrorist organization will be in its fight against the state. Violence now is supposed to impose such a cost to the state that it will opt for abandoning the territory. As TOs do not have military power to defeat the state in conventional warfare, they resort to a peculiar war of attrition against the state. In the military field, a war of attrition refers to a protracted conflict with limited violence in which the party with greater resources wins.The losses of personnel, morale, and weapons through constant battle eventually lead one of the parties to give up. In the context of terrorism, attrition is not produced through depletion of weaponry or personnel. Terrorist violence produces economic costs to the state (Enders and Sandler 2006: ch. 9; Krueger 2007: ch. 3). According to econometric estimations, the GDP of the Basque Country would be 10 percent higher had it not been for ETA’s violence (Abadie and Gardeazabal 2003). But the attrition of terrorism is ultimately psychological. Most people are revolted by terrorist violence. National liberation TOs, aware of these feelings of revulsion, kill in the hope of breaking the enemy’s will to resist. The strategy of national liberation terrorism is closer to the game theory model of a war of attrition than to the military concept. The model was first developed by the biologist John Maynard Smith (1984: ch. 3) in order to understand the interaction between two animals fighting over territory. Here, instead of animals, we have a terrorist organization and the state, but the prize is still the control of a territory. The terrorist organization hurts the state by killing, kidnapping, and extorting people and by destroying infrastructure; in turn, the state captures, and sometimes kills, as many terrorists as possible. The analogy with an economic war of attrition between two firms is almost immediate.6 Suppose an economic activity that is a natural monopoly. If a second firm decides to enter into this market, the situation becomes that of a duopoly. The two firms then engage in a price war: they produce more than the equilibrium level in order to depress the price of the good. When the price falls the two firms have negative benefits, and therefore staying in the market is costly for them both.Yet if one firm resists longer than the other, the future benefits of being the monopolist may offset the costs of engaging in the war of attrition. It may be argued that the production of violence is itself a natural monopoly (Tilly 1985: 175). The state has the control over its territory when it is the monopolist in the market of organized violence (Weber 1978: 54). If a terrorist organization emerges, the state is challenged and the situation becomes one of a duopoly (since the terrorist organization acts within the state’s territory), with two actors fighting over the control of a territory. Some national liberation TOs see themselves as being involved in a protracted war of attrition with the state. Both ETA and the IRA have theorized their activity in terms of a war of attrition in which the goal is to outlast the enemy—that is, to break the will of resistance of the state (Sánchez-Cuenca 2007).

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From the point of view of game theory, there are various ways to model the war of attrition. It may be considered as an iterated Chicken game (Fudenberg and Tirole 1991: 119–21), as a Chain Store game with two-sided incomplete information (Kreps and Wilson 1982), or as a second-bid auction in which both the winner and the loser pay the second bid (Fudenberg and Tirole 1991: 216–17). Generally speaking, the higher the value of the territory under dispute, the more likely that the players stay. Whereas the United Kingdom withdrew from Aden in 1967 after fewer than forty soldiers had been killed, it was able to stay in Northern Ireland after almost two thousand people had been killed by Republican terrorist organizations. There were indeed some important concessions made in the peace process to the Republicans and the Catholic community more generally, but the unification with the Republic of Ireland, the IRA’s most basic demand, was denied.7 On the other hand, the higher the cost of staying one more period, the more likely that the players will eventually exit. This means that the more intense terrorist violence is, the more likely that the state will yield. The general strategic framework of the war of attrition model can be developed in several directions. For instance, there are some models that analyze the response of the state when there is asymmetric information (Lapan and Sandler 1988, 1993; Overgaard 1994). Suppose that the terrorists know everything about the state, but the state is uncertain about how serious the terrorist threat is. The state does not know whether the challenge corresponds to a weak or a strong organization. It has to calculate then the optimal response. In their seminal model, Lapan and Sandler (1993) conclude that full commitment power by the state not to make concessions is not optimal when the terrorists prefer to launch an attack even if they know that the state will not surrender. As a matter of fact, this amounts to granting commitment capacity to the terrorist organization. This assumption, however, seems dubious. Overgaard (1994) suggests a more realistic model. There are two types of TO, the low- and the high-resource types (resources being members, additional supporters, and money). With complete information, the optimal course of action for the state is to resist if it is fighting a low-resource organization and to make concessions if it is fighting a high-resource organization. With incomplete information, the state infers the strength of the organization from the level of violence. Violence, in other words, is a signal about the resources that the terrorists possess. But then a problem of adverse selection exists. The low resource organization might mimic the behavior of the high resource organization in an attempt to induce in the state the belief that the organization is powerful when actually it is weak. Overgaard collapses the indefinite nature of a war of attrition in a two-period model. The second round represents the future. The game has separating and pooling equilibria.The interesting result is that whether we observe pooling or separating equilibria depends on the flexibility of the state to act on the information transmitted by the signal. The more flexible the state is in its response, the more likely the separating equilibrium in which the high-resource organization attacks and the low-resource one does not. By contrast, if the state cannot react to the level of violence (for example,

398 Ignacio Sánchez-Cuenca it is committed to making no concessions), then a pooling equilibrium is more likely. These models suggest, in a counterintuitive way, that commitment capacity may be harmful for the state. The main shortcoming of models of incomplete information applied to terrorism is that some terrorist conflicts last for decades (in the Basque Country, in Northern Ireland, or in Palestine). As Fearon (2004) has argued in the context of civil war research, it does not make much sense to assume incomplete information when conflicts are protracted. After some time, all the information about the players has been revealed by their actions. Signaling games can be applied to short terrorist campaigns, but not to long ones. Unfortunately, one of the most conspicuous gaps in the literature on terrorism is precisely why some conflicts last much longer than others.

Killing under Constraints If TOs want to mobilize followers using violence as a signal of strength or as a cost imposed on the state, it seems logical to expect full use of resources and maximum levels of violence. However, in only exceptional cases do TOs employ all their potential destructive power. Although indiscriminate attacks attract maximum attention by the media, the fact is that, with some exceptions, Al Qaeda’s being prominent among them, the majority of TOs refrain from mass attacks. According to the data collected by Quillen (2002), there were only seventy-six terrorist mass bombings with twenty-five or more fatalities during the period 1945–2000. Although that number has increased considerably in recent years, because of the diffusion effects of Al Qaeda attacks, it is still true that many TOs do not fully employ their power to hurt. This forces us to consider the possibility that TOs act subject to certain constraints. We know very little about how TOs make decisions on who is to be killed and how the killing is to be executed. Given the generic aim of maximizing pain, there is wide variation in terms of the intensity of violence, the selectivity of the attacks, and the condition of the targets.8 We may think of two kinds of constraints to account for this variation: those related to resources and those related to support. Regarding resources, TOs must solve what McCormick (2003: 495–96) calls the security constraint. The more active the terrorists are, the higher the number of arrests by security forces. The security constraint is met when the rate of recruits compensates the rate of losses that the practice of violence entails. If the capacity to recruit does not offset the arrests made by security forces, the terrorist organization will have to lower its number of attacks to survive.9 One possible way to cope with the security constraint is to increase the rate of fatalities per attack, shifting from selective attacks to more indiscriminate ones: instead of shooting a politician, exploding a car bomb. Thus, with fewer attacks, the terrorists can kill more people. However, more indiscriminate attacks might have counterproductive effects under some circumstances. It is here where the popular support constraint enters. If supporters have more moderate preferences (for example, they reject the killing of civilians) than the terrorists and the terrorist organization depends

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heavily on popular support, the terrorists may feel forced to refrain from killing civilians in order to retain popular support.10 Kalyvas and Sánchez-Cuenca (2005) suggest a U-shaped relationship between killing civilians and popular support. Whereas TOs that have almost full support or almost none do not feel constrained in the form of violence they can use, TOs that have support conditional on violence not going beyond certain limits have to take into account the consequences of their type of attacks. Let us take the case of killing civilians.TOs fully isolated from the population may engage in indiscriminate violence against civilians, as the Italian fascists did in the period 1969–84. At the other extreme of the U, we have Palestinian TOs. Surveys reveal that during the second Intifada there was high popular support for the killing of civilians in Israel: around 60 percent of Palestinians approved of this in 2001 (Krueger and Maleckova 2003: 125). It should be no wonder then that more than 80 percent of the victims of Palestinian TOs were civilians. In the valley of the U, we find TOs that have some popular support, which is badly needed for the survival of the organization, but the followers do not approve of the indiscriminate killing of civilians. This might correspond to the cases of the IRA, ETA, or the Red Brigades, organizations with high selectivity in their killings. Obviously, there is substantial overlapping between killing civilians indiscriminately and launching suicide attacks (although these attacks can be rather selective, as in political assassinations, in general they tend to kill rather indiscriminately). Therefore, TOs that do not suffer the popular support constraint are more likely to engage in suicidal terrorism. Because of its frightening nature and its extension in recent years, there is a growing literature on why some TOs resort to suicide attacks.11 Now the point is not to understand motivations at the individual level but the strategic reasons that TOs consider in the decision whether or not to launch suicide attacks. These reasons can be linked to the resource and support constraints. Berman and Laitin (2008) suggest that suicide attacks may help to solve organizational problems that are related to the security constraint. TOs are highly vulnerable to defectors. If a terrorist abandons the organization and reveals her information to security forces, the ensuing arrests may end with the organization. Relying on Iannaccone’s economic model of the rationality of sacrifice in religious sects (Iannaccone 1992; Iannaccone and Berman 2006), Berman and Laitin consider that a terrorist organization that demands heavy sacrifices of its members, suicide being the highest one, solves the freerider problem. In their model, sacrifice generates a separating equilibrium in which only those highly committed, and therefore unlikely to defect, enter the organization. But, obviously, suicide attacks are not carried out only for organizational reasons. As Berman and Laitin claim, this type of attack is particularly convenient for “hard” targets. Hard and soft targets are distinguished by the likelihood that the perpetrator will be captured. To avoid the potential complications of capture, suicide attacks will be used mainly against hard targets. Soft targets will be approached with more conventional terrorist tactics. This may help to explain the puzzling empirical pattern that the authors find—namely, that 90

400 Ignacio Sánchez-Cuenca percent of suicide attacks are aimed at people whose religion is different from that of the perpetrators. The conjecture is that coreligionists are soft targets, while people from another religious community are hard ones.12 Other authors have emphasized other advantages of suicide attacks that can also be reduced to the security constraint.13 Hoffman and McCormick (2004) mention the greater destructive capacity of these attacks, their reverberation in the media, and their low cost in economic terms. Bloom (2004) considers that competition among TOs may lead to an escalation of violence that makes suicide terrorism more likely. While this seems to be the case in Palestine (Gupta and Mundra 2005; Pedahzur and Perliger 2006), there are many cases of tight competition without suicide missions (Italy in the 1970s, Republican organizations during the Troubles) and suicide missions without competition (the Tamil Tigers of Sri Lanka). In general, the conclusion that may be drawn from these analyses is that suicide attacks are always an effective device in overcoming the security constraint.They screen out free-riders, they reach hard targets, and they multiply the lethal effects of the attack. But then the question that comes immediately to mind is why suicide attacks are not more widely distributed. Why do so many TOs refrain from suicide attacks? The answer could lie in the support constraint (Kalyvas and SánchezCuenca 2005).14 Suicide attacks may alienate supporters when the latter reject both the tactic (for its extremeness) and its effects (indiscriminate or massive killings). Although the organization is aware of the security advantages of suicide attacks, it refrains from this tactic in order to keep its base of support. The most interesting case here is that of the IRA. The IRA fully understood the usefulness of suicide attacks against hard targets. In October 1990, the terrorists kidnapped the family of Patsy Gillespie (a civilian who worked in an army base). To liberate his family, Gillespie had to drive a car full of explosives following the route set by the IRA. When the car was close enough to an army checkpoint, the terrorists exploded the bomb by remote control. The operation was strictly similar to a suicide mission against a hard target, with the only difference being that the perpetrator did not volunteer and was coerced and misled by the terrorists. This is the closest that the IRA came to a suicide attack. The IRA did not pursue this path, since “the vast majority of Catholics in Derry were sickened by the attacks and no doubt let the IRA know what they thought” (Taylor 1997: 317). One of the most under-researched questions in the field of terrorism is the calculations that TOs make when they choose tactics and targets. In recent years, things have improved a little thanks to the growing interest in suicide attacks, but we still lack a satisfactory theoretical analysis of this question. From a rational choice point of view, I have suggested that, given the aim of TOs of producing pain, either to mobilize followers or to coerce the state, differences in tactics and targeting may be the result of the varying effects of constraints. To simplify this somewhat, I have divided constraints into two categories: constraints that have to do with resources, and more concretely with the security constraint, and constraints that have to do with popular support. A testable hypothesis establishes that when the support constraint is not binding, suicide missions are an effective way of overcoming the security constraint.

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The Counterterrorist Policy of the State What can the state do to prevent terrorist attacks? There are two types of answers, with very different implications. On the one hand, the state may observe the conditions that make terrorism more likely and then pass reforms to change those conditions. This policy does not try to deter terrorists, nor does it try to induce them to stop violence. Rather, it goes to the “root” causes and tries to act on them so that terrorism does not find a favourable niche. The potential “root” causes that are considered in the literature have to do with factors such as economic backwardness, lack of political rights, or occupation by a foreign power. Obviously, the change of these conditions may require a long-term horizon and may not be incentive-compatible with the interests of rulers. On the other hand, the state finds itself in a strategic context with TOs. Once there is a terrorist conflict, the state has to decide what kind of policy it is going to pursue. It may go for negative or for positive incentives, or for a mix. It is in this context where the rational choice literature on terrorism has made one of its more important contributions. Assuming that TOs react to the policy made by the state, the state has to decide what to do in a strategic way. Several distinctions are necessary at this point. Generally speaking, counterterrorist policy consists of raising the cost of attacks for the terrorists. The idea is that the more costly terrorist attacks are, the more likely it will be that terrorists will shift to nonviolent tactics. This can be achieved through negative (“stick”) or positive (“carrot”) incentives. Briefly put, negative incentives make violence more costly, whereas positive ones make nonviolence more attractive. Most rational choice analysis is devoted to the stick rather than the carrot. An interesting exception is Bueno de Mesquita (2005b), who has elaborated a formal game-theoretic model in which concessions made by the state have some positive consequences. Basically, Bueno de Mesquita argues that the state’s concessions provoke a split in the terrorist camp. Moderates accept a pact with the government, while radicals take control of the terrorist organization and increase violence in the short-run.15 However, because of the fact that moderates cooperate with the government, providing information, counterterrorism becomes more efficient and overall the level of terrorism is reduced. Most research focuses on negative incentives (see Enders and Sandler 2006 and Sandler and Arce 2007 for comprehensive reviews).16 Counterterrorist policy is basically intended to raise the costs of engaging in violence, rather than to raise the benefits of abandoning violence. Coercive counterterrorist policy may take two forms, the proactive and the defensive. Proactive policies try to neutralize terrorist groups by destroying their training camps, arresting activists, or infiltrating the organizations. Defensive policies try to protect the targets from attack. The destruction of Al Qaeda camps in Afghanistan was clearly a proactive measure, while the construction of the security fence in Israel is a defensive one. Proactive policies try to prevent attacks; defensive ones try to deter them. This distinction is particularly relevant in the case of international terrorism,

402 Ignacio Sánchez-Cuenca country 2 Proactive

country 1

Proactive

Doing nothing

Defensive

Doing nothing

Defensive

2B – c, 2B – c

B – c, B

B, B – c

0, 0

-C, b – C

b – C, -C

b – 2C, b – 2C

B + b – C, B – c – C

B – c – C, B + b – C

Assumptions: 2B > c > B & 2C > b > C

figure 11.2. The general game of counterterrorist policy. Source: Arce and Sandler 2005.

since proactive policies share some of the features of a public good, whereas defensive ones are more of a private one. The destruction of the attack capacity of a terrorist organization is a good from which countries that did not contribute cannot be excluded. Protecting a target, by contrast, benefits only that target, and it may be argued that it produces negative externalities to other potential targets.17 In fact, there is evidence of a substitution effect (sometimes called “transference”) by which defensive measures induce terrorist not to reduce violence but to shift targets. Enders and Sandler (1993) showed, for instance, that the introduction of metal detectors in airports decreased skyjackings, but increased kidnappings and assassinations. Likewise, Kaplan et al. (2005) found that during the construction of the security fence in Israel, there was a shift from protected cities to still unprotected ones. The public good nature of proactive policies creates a free-rider problem among countries that suffer international terrorism. According to Arce and Sandler (2005), this explains the prevalence of defensive policies as opposed to proactive ones. Using a simple normal form game, they show that under very general conditions, the Nash equilibrium of the game is the choice of defensive policies by all parties. Let us suppose that the actors are two neighbor countries, the terrorist organization being a third actor whose actions are not modeled. Let B stand for the public benefits of attack prevention, c the cost of the proactive policy, C the public costs of protecting a target in a defensive way, and b the private benefits of a defensive policy. Each country has three strategies: a proactive policy, a defensive policy, and doing nothing. The structure of the game is represented in Figure 11.2. If the two countries invest in proactive policies, the benefits are 2B and the cost of the policy for each country is c. If the two countries invest in defensive

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policies, the calculations are somehow less obvious. On the one hand, each country gets the private benefit b. But, on the other, each country pays the cost C of protecting the target and imposes also this cost to the other country. This may be because the terrorists will shift from one country to the other one, or because there may be citizens of country 1 living in country 2 and vice versa. Defensive policies, therefore, always impose a cost to the neighbor, regardless of what the neighbor does. The same logic holds for the payoffs of all other strategy profiles. The 3×3 matrix can be analyzed as the juxtaposition of two partial games. In Figure 11.2, these two games are highlighted in bold. The first one, in the northwest of the matrix, corresponds to a 2×2 game in which countries decide between a proactive policy and doing nothing. It is a Prisoner’s Dilemma, in which the strategy profile (Doing nothing; Doing nothing) is a Nash equilibrium. Each country is better off not paying the cost of preventing attacks, but the two countries would be even better if both of them paid the costs. In the second partial game, in the southeast of the matrix, the countries choose between doing nothing and a defensive policy. Again, the payoff structure corresponds to a Prisoner’s Dilemma in which the (Defensive; Defensive) is the Nash equilibrium. Although the two countries are better off if they collectively renounce defensive policies, each has incentives for unilateral protection of its national targets. It is easy to see that in the 3×3 game, when the three strategies are simultaneously considered, the defensive policy choice is a dominant strategy regarding the other two. The only Nash equilibrium of the whole game is therefore (Defensive; Defensive). Proactive policy is not observed due to the free-rider temptation. And the negative externalities that a unilateral defensive policy has for other countries forces them to adopt defensive measures too. Following Arce and Sandler (2005), the only way to change the equilibrium without a dramatic modification of the payoff structure is when targeting is asymmetric. If the likelihood of being hit by a terrorist attack is much higher for one country than for the other, the more vulnerable country may have incentives to implement a unilateral proactive policy regardless of what the other country does. Of course, this is just an extension of Olson’s result (1965) on the exploitation of the great by the small. After an attack of the magnitude of 9/11, the United States had incentives to invest in proactive policy even if other Western countries were not willing to reciprocate. In the context of domestic terrorism, the state is not subject to the freerider problem. Insofar as the state is the main provider of public goods, it will pursue proactive policies. Here, the problems are of a very different nature and have not been sufficiently analyzed from a rational choice point of view. As was mentioned earlier with regard to revolutionary and nationalist TOs, the state has to devise a counterterrorist policy that does not indirectly produce more popular support for the terrorists, as is usually the case when the state engages in indiscriminate forms of repression; likewise, it has to decide under what circumstances it is appropriate to establish negotiations with the terrorists, an issue that was dealt with previously.

404 Ignacio Sánchez-Cuenca

The Contribution of Rational Choice Theory to the Study of Terrorism: An Assessment In the last years, the field of terrorism studies has been divided into three streams of research. On the one hand, a long tradition of case studies and small-n comparative work has continued. On the other, the availability of new datasets has generated a growing literature that follows the large-n research design. Finally, we have purely theoretical work of rational choice persuasion. Little integration and cross-fertilization has been achieved among these three streams. One common shortcoming to all studies of terrorism is the lack of a clear conceptualization of the phenomenon. If terrorism is conceptualized as a type of violence that can be chosen by very different actors (underground groups, guerrillas, armies, states, and so forth) under very different circumstances, it is dubious that any systematic finding about the onset, intensity, strategy, and end of terrorism is ever going to be established. The heterogeneity of the actors and the diversity of situations in which terrorism thus understood occurs makes almost impossible any kind of theoretical analysis. Although there is not an obvious solution to this problem, the actor-sense of terrorism (basically, underground organizations that engage in political violence) lends itself more easily to theory development and large-n empirical analysis. Because of the lack of consensus about how to delimit the study of terrorism, no middle-ground theory in the line, for example, of Kalyvas’s masterful theory (2006) on violence in civil wars has yet been formulated. Rather, we have a number of partial approximations. The rational choice approach has produced many models on issues such as the effects of state repression on the terrorist organization, the negotiations between the state and TOs, the relationship between terrorist violence and popular mobilization, the choice of tactics such as suicide missions, or the consequences of different counterterrorist policies. Rational choice theory has brought to this field an unprecedented degree of rigor and analytical sophistication.To a large extent, it has contributed crucially to the end of the “methodological exceptionalism” that was associated with terrorism studies. But having said that, it must also be recognized that rational choice models present shortcomings of their own kind. Many of them are devoid of any empirical import, not because they are not tested but simply because they are not motivated by empirical findings. Or they are unable to generate testable comparative statics results. Or they are so disparate regarding the basic assumptions and the setting of the models that it is hard to think of ways of adding up the findings in an integrated framework. These criticisms, it goes without saying, are not intended to reject the rational choice approach in this area.18 Rather, they set high standards that have not yet been met. As in many other fields, the first generation of formal models is far removed from empirics. Future contributions will probably try to match theoretical and empirical concerns, as has happened in other areas of social and political research. In fact, the field is now under a deep transformation. The definitive implosion will take place when formal models become integrated with empirical, comparative research.

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More generally, the analysis of terrorism is fully taken by the agency vocabulary of rational choice theory. It is widely accepted that terrorist organizations are rational actors that pursue certain goals strategically, interacting with the state and social groups, under certain material and political constraints. The agenda for the future is how to develop more elaborate theories on terrorism that start from this basic assumption.

Notes 1. For a more thorough analysis of the concept of terrorism, see Sánchez-Cuenca and De la Calle (2009) and De la Calle and Sánchez-Cuenca (2011). 2. Siqueira (2005: 20): “[A]ssume that each faction solves the typical free-riding problem.” Bueno de Mesquita (2005a: 518) solves the collective action problem referring to Lichbach (1996). Pierskalla (2010: 136): “Like many other models, coordination and the free-riding dilemma are ignored by assuming the existence of an organization that can overcome these problems.” 3. Suppose that p is 1 or close to it, which is not an unreasonable assumption in many cases. Then the participation constraint is met when the selective incentives in the first period are greater than the reservation utility. But it is very unlikely that the selective incentives in the first period exceed the utility of continuing to live. 4. The relationship between x and violence that McCormick and Own (1996: 396) propose is:

[(

x =r k v+ c

∂v ∂t

)]

where v stands for violence and r for the symbolic quality of v (k and c being constants). The introduction of the term ∂v ∂t

implies that apart from the quantity and quality of violence, the rate of change of violence is also important. The organization needs to achieve a certain momentum to attract new recruits. 5. Sometimes this anecdotal evidence is wrong or biased. For instance, Bueno de Mesquita (2005b) opens one of his formal articles with the following empirical puzzle: “For instance, beginning in 1979, ETA engaged in a massive campaign of terror despite the fact that the newly democratized Spanish government granted partial autonomy to the Basque Country in 1978.” Yet the campaign started at the end of 1977, before the Spanish constitution was approved. Moreover, the number of killings fell dramatically after 1980, the year in which the first Basque parliament and government were constituted (supposedly representing big concessions to the terrorists). There is no basis for stating that ETA increased its killing at the time because of concessions. The ironic point is that Bueno de Mesquita uses this distorted fact to motivate the need for a formal model that concludes that concessions may lead to an increase in violence. 6. The economic model of war of attrition has also been applied to interstate wars: see Langlois and Langlois (2009). 7. This may also depend on reputational concerns. If the state faces several internal challengers, it may not concede in some case to build reputation (Walter 2006). 8. See Berman (2009: ch. 5) for some data on variation in lethality. 9. Sánchez-Cuenca (2007: 298–90) tests, in an indirect way, the security constraint for ETA and the IRA. It is shown how a greater number of attacks leads to more arrests and how arrests lead to fewer attacks. Kaplan, Mintz, and Mishal (2006) test

406 Ignacio Sánchez-Cuenca the effect on Palestinian suicide attacks of targeted killings and preemptive arrests by Israeli security forces. They find that whereas preventive arrests decrease the number of attacks, targeted killings have a boomerang effect, increasing attacks via a reinforcement of suicidal motivations. See also Jaeger and Paserman (2008). 10. The relationship between terrorists and supporters can be rather complex. One interesting possibility that has been examined is that activists in social movements turn into terrorists when the social movement loses popularity, so that the activists compensate with violence for lower popular backing. See Della Porta and Tarrow (1986) and Sánchez-Cuenca and Aguilar (2009). 11. About suicide attacks, see Gambetta (2005); Pape (2005); and Pedahzur (2005). An excellent overview of this field is Crenshaw (2007). See also Goodwin (2006b) and the general discussion in the review symposium in Perspective on Politics 5, no. 1 (2007). 12. For a discussion of this hypothesis, see Gambetta (2005: 288–92) and Pape (2005: 88–92). 13. I do not discuss here Pape’s theory (2005) of suicide terrorism. He holds that suicide attacks are always aimed at occupying democracies, are part of a national liberation struggle, and that the victims have a different religion from that of the perpetrators. Even if these empirical regularities hold (see Goodwin 2006b and Moghdam 2006 for critical assessments), they are far from being an explanation. We still do not know the reasons why the fulfillment of these conditions is conducive to, or requires, suicide attacks by the terrorist organization. 14. For a different approach, see Horowitz (2010). 15. Bueno de Mesquita (2005a) claims that this is what happened in the Basque Country and Northern Ireland.Yet it is not true that ETA increased its violence during the Spanish transition to democracy because of state concessions (ibid.: 145). There were no negotiations between the state and the terrorists. Moreover, the spiral of attacks began prior to the democratic constitution (December 1978) or the devolution process to the Basque Country (December 1979). It is also inaccurate to say (ibid.: 173) that the peace process in Northern Ireland led to “an increase in militancy.” The Real IRA was clearly a marginal group, and its most horrible attack, the Omagh bomb, which caused twenty-nine fatalities, was a consequence of an ill-planned operation. It is ironic that the motivating empirical pattern of the formal model is not grounded in facts. 16. As there are already some excellent reviews on this issue, a less detailed overview is offered here. 17. The literature does not contemplate other kinds of externalities. For instance, proactive policies at the domestic level may generate an international problem. That is what happened with the Japanese Red Army in the 1970s (Farrell 1990): as a result of the counterterrorist policy of Japan, the terrorists decided to become an international group acting in many countries, particularly in the Middle East. 18. For a provocative critique of rationalist analysis of terrorism, see Abrahms (2008).

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Terrorism and the State 407 Benmelech, Efraim, and Claude Berrebi. 2007. “Human Capital and the Productivity of Suicide Bombers.” Journal of Economic Perspective 21, no. 3: 223–38. Berman, Eli. 2009. Radical, Religious, and Violent: The New Economics of Terrorism. Cambridge: MIT Press. Berman, Eli, and David Laitin. 2008. “Religion, Terrorism, and Public Goods: Testing the Club Model.” Journal of Public Economics 92, nos. 10–11: 1942–67. Bernholz, Peter. 2004. “Supreme Values as the Basis for Terror.” European Journal of Political Economy 20: 317–33. Berrebi, Claude. 2007. “Evidence about the Link between Education, Poverty and Terrorism among Palestinians.” Peace Economics, Peace Science and Public Policy 13, no. 1: Article 2. Biggs, Michael. 2005. “Dying without Killing: Self-Immolations, 1963–2002.” In Making Sense of Suicide Missions, edited by Diego Gambetta, 173–208. Oxford: Oxford University Press. Bloom, Mia. 2004. “Palestinian Suicide Bombing: Public Support, Market Share and Outbidding.” Political Science Quarterly 119: 61–88. Bueno de Mesquita, Ethan. 2005a. “The Quality of Terror.” American Journal of Political Science 49: 515–30. ———. 2005b. “Conciliation, Counterterrorism, and Patterns of Terrorist Violence.” International Organization 59: 145–76. Bueno de Mesquita, Ethan, and Erick S. Dickson. 2007. “The Propaganda of the Deed: Terrorism, Counterterrorism, and Mobilization.” American Journal of Political Science 51: 364–81. Collier, Paul, and Anke Hoeffler. 2004. “Greed and Grievance in Civil War.” Oxford Economic Papers 56: 563–95. Crenshaw, Martha. 2007. “Explaining Suicide Terrorism: A Review Essay.” Security Studies 16: 133–62. Davenport, Christian. 2007. “State Repression and Political Order.” Annual Review of Political Science 10: 1–23. De la Calle, Luis, and Ignacio Sánchez-Cuenca. 2011. “What We Talk about When We Talk about Terrorism.” Politics and Society 39: 451–72. Della Porta, Donatella, and Sidney Tarrow. 1986. “Unwanted Children: Political Violence and the Cycle of Protest in Italy, 1966–1983.” European Journal of Political Research 14: 607–32. Enders, Alter, and Todd Sandler. 1993. “The Effectiveness of Antiterrorism Policies: A Vector-Autoregression-Intervention Analysis.” American Political Science Review 87: 829–44. ———. 2006. The Political Economy of Terrorism. Cambridge: Cambridge University Press. Enders, Walter, and Todd Sandler. 2006. The Political Economy of Terrorism. Cambridge: Cambridge University Press. Farrell, William R. 1990. Blood and Rage: The Story of the Japanese Red Army. Lexington, MA: Lexington Books. Fearon, James D. 2004. “Why Do Some Civil Wars Last So Much Longer than Others?” Journal of Peace Research 41: 275–301. Fearon, James D., and David D. Laitin. 2003. “Ethnicity, Insurgency, and Civil War.” American Political Science Review 97: 75–90. Ferrero, Mario. 2006. “Martyrdom Contracts.” Journal of Conflict Resolution 50: 855–77. Francisco, Ronald A. 1996. “Coercion and Protest: An Empirical Test in Two Democratic States.” American Journal of Political Science 40: 1179–204. Fudenberg, Drew, and Jean Tirole. 1991. Game Theory. Cambridge: MIT Press. Gambetta, Diego. 2005. “Can We Make Sense of Suicide Missions?” In Making Sense

408 Ignacio Sánchez-Cuenca of Suicide Missions, edited by Diego Gambetta, 259–99. Oxford: Oxford University Press. Ginkel, John, and Alastair Smith. 1999. “So You Say You Want a Revolution: A Game Theoretic Explanation of Revolution in Repressive Regimes.” Journal of Conflict Resolution 43: 291–316. Gleditsch, Nils Petter, Håvard Hegre, and Håvard Strand. 2009. “Democracy and Civil War.” In Handbook of War Studies III, edited by Manus Midlarsky, 155–92. Ann Arbor: University of Michigan Press. Goodwin, Jeff. 2006a. “A Theory of Categorical Terrorism.” Social Forces 84: 2027–46. ———. 2006b. “What Do We Really Know about (Suicide) Terrorism?” Sociological Forum 21: 315–30. Green, Donald, and Ian Shapiro. 1994. Pathologies of Rational Choice Theory: A Critique of Applications in Political Science. New Haven:Yale University Press. Gupta, Dipak K., and Kusum Mundra. 2005. “Suicide Bombing as a Strategic Weapon: An Empirical Investigation of Hamas and Islamic Jihad.” Terrorism and Political Violence 17: 573–98. Herreros, Francisco. 2006. “‘The Full Weight of the State’:The Logic of Random StateSanctioned Violence.” Journal of Peace Research 46: 671–89. Hoffman, Bruce, and Gordon H. McCormick. 2004. “Terrorism, Signaling, and Suicide Attack.” Studies in Conflict and Terrorism 27, no. 4: 243–81. Holmes, Stephen. 2005. “Al-Qaeda, September 11, 2001.” In Making Sense of Suicide Missions, edited by Diego Gambetta, 131–72. Oxford: Oxford University Press. ———. 2007. The Matador’s Cape: America’s Reckless Response to Terror. Cambridge: Cambridge University Press. Horowitz, Michael C. 2010. “Nonstate Actors and the Diffusion of Innovations: The Case of Suicide Terrorism.” International Organization 64: 33–64. Iannaccone, Laurence R. 1992. “Sacrifice and Stigma: Reducing Free-riding in Cults, Communes, and Other Collectives.” Journal of Political Economy 100: 271–91. Iannaccone, Laurence R., and Eli Berman. 2006. “Religious Extremism: The Good, the Bad, and the Deadly.” Public Choice 128: 109–29. Jaeger, David A., and M. Danielle Paserman. 2008. “The Cycle of Violence? An Empirical Analysis of Fatalities in the Palestinian-Israeli Conflict.” American Economic Review 98, no. 4: 1591–604. Kalyvas, Stathis. 1999. “Wanton and Senseless? The Logic of Massacres in Algeria.” Rationality and Society 11: 243–85. ———. 2006. The Logic of Violence in Civil War. Cambridge: Cambridge University Press. Kalyvas, Stathis, and Ignacio Sánchez-Cuenca. 2005. “Killing without Dying: The Absence of Suicide Missions.” In Making Sense of Suicide Missions, edited by Diego Gambetta, 209–32. Oxford: Oxford University Press. Kaplan, Edward H., Alex Mintz, and Shaul Mishal. 2006. “Tactical Prevention of Suicide Bombings in Israel.” Interfaces 36: 553–61. Kaplan, Edward H., Alex Mintz, Shaul Mishal, and Claudio Samban. 2005. “What Happened to Suicide Bombings in Israel? Insights from a Terror Stock Model.” Studies in Conflict and Terrorism 28: 225–35. Koopmans, Ruud. 1997. “Dynamics of Repression and Mobilization: The German Extreme Right in the 1990s.” Mobilization 2: 149–65. Kreps, David M., and Robert Wilson. 1982. “Reputation and Imperfect Information.” Journal of Economic Theory 27: 253–79. Krueger, Alan B. 2007. What Makes a Terrorist: Economics and the Roots of Terrorism. Princeton: Princeton University Press. Krueger, Alan B., and Jitka Maleckova. 2003. “Education, Poverty and Terrorism: Is There a Causal Connection?” Journal of Economic Perspectives 17: 119–44.

Terrorism and the State 409 Kydd, Andrew H., and Barbara F. Walter. 2002. “Sabotaging the Peace: The Politics of Extremist Violence.” International Organization 56: 263–96. ———. 2006. “The Strategies of Terrorism.” International Security 31: 49–80. Langlois, Catherine C., and Jean-Pierre P. Langlois. 2009. “Does Attrition Behavior Help Explain the Duration of Interstate Wars? A Game Theoretic and Empirical Analysis.” International Studies Quarterly 53: 1051–73. Lapan, Harvey E., and Todd Sandler. 1988. “To Bargain or Not to Bargain.” American Economic Review 78: 16–26. ———. 1993. “Terrorism and Signalling.” European Journal of Political Economy 9, no. 3: 383–97. Lichbach, Mark Irving. 1996. The Rebel’s Dilemma. Ann Arbor: University of Michigan Press. Maynard Smith, John. 1984. Evolution and the Theory of Games. Cambridge: Cambridge University Press. McCormick, Gordon H. 2003. “Terrorist Decision Making.” Annual Review of Political Science 6: 473–507. McCormick, Gordon H., and Guillermo Owen. 1996. “Revolutionary Origins and Conditional Mobilization.” European Journal of Political Economy 12: 377–402. Moghdam, Assaf. 2006. “Suicide Terrorism, Occupation, and the Globalization of Martyrdom: A Critique of Dying to Win.” Studies in Conflict and Terrorism 29: 707– 29. Muller, Edward N., and Erich Weede. 1990. “Cross-National Variation in Political Violence: A Rational Choice Approach.” Journal of Conflict Resolution 34: 624–51. Olson, Mancur. 1965. The Logic of Collective Action: Public Goods and the Theory of Groups. Cambridge: Harvard University Press. Overgaard, Per B. 1994. “The Scale of Terrorist Attacks as a Signal of Resources.” Journal of Conflict Resolution 38: 425–78. Pape, Robert A. 2005. Dying to Win: The Strategic Logic of Suicide Terrorism. New York: Random House. Pedahzur, Ami. 2005. Suicide Terrorism. Cambridge, UK: Polity Press. Pedahzur, Ami, and Arie Perliger. 2006. “The Changing Nature of Suicide Attacks: A Social Network Perspective.” Social Forces 84: 1987–2008. Pierskalla, Jan Henryk. 2010. “Protest, Deterrence, and Escalation:The Strategic Calculus of Government Repression.” Journal of Conflict Resolution 54, no. 1: 117–45. Quillen, Chris. 2002. “A Historical Analysis of Mass Casualty Bombers.” Studies in Conflict and Terrorism 25: 279–92. Rosendorff, B. Peter, and Todd Sandler. 2005. “The Political Economy of Transnational Terrorism.” Journal of Conflict Resolution 49: 171–82. Ross, Jeffrey Ian, and Ted Robert Gurr. 1989. “Why Terrorism Subsides: A Comparative Study of Canada and the United States.” Comparative Politics 21: 405–26. Sageman, Marc. 2007. Leaderless Jihad: Terror Networks in the Twenty-First Century. Philadelphia: University of Pennsylvania Press. Sambanis, Nicholas. 2004. “What Is Civil War?” Journal of Conflict Resolution 40, no. 1: 336–59. Sánchez-Cuenca, Ignacio. 2007. “The Dynamics of Nationalist Terrorism: ETA and the IRA.” Terrorism and Political Violence 19: 289–306. ———. 2008. “A Preference for Selfish Preferences: The Problem of Motivations in Rational Choice Political Science.” Philosophy of the Social Sciences 38, no. 3: 361–78. ———. 2009. “Revolutionary Dreams and Terrorist Violence in the Developed World: Explaining Cross-Country Variation.” Journal of Peace Research 46, no. 5: 687–706. Sánchez-Cuenca, Ignacio, and Paloma Aguilar. 2009. “Terrorist Violence and Popular Mobilization: The Case of the Spanish Transition to Democracy.” Politics and Society 37, no. 3: 428–53.

410 Ignacio Sánchez-Cuenca Sánchez-Cuenca, Ignacio, and Luis De la Calle. 2009. “Domestic Terrorism:The Hidden Side of Political Violence.” Annual Review of Political Science 12: 31–49. Sandler, Todd, and Daniel G. Arce. 2007. “Terrorism: A Game-Theoretic Approach.” In Handbook of Peace Economics. Vol. 2, edited by Todd Sandler and Keith Hartley, 775–813. Amsterdam: Elsevier. Schelling, Thomas C. 1966. Arms and Influence. New Haven:Yale University Press. ———. 1978. Micromotives and Macrobehavior. New York: Norton. Schmid, Alex P., and Albert J. Jongman. 1988. Political Terrorism. New Brunswick, NJ: Transaction Publishers. Siqueira, Kevin. 2005. “Political and Militant Wings within Dissident Movements and Organizations.” Journal of Conflict Resolution 49: 218–36. Siqueira, Kevin, and Todd Sandler. 2006. “Terrorists versus the Government: Strategic Interaction, Support, and Sponsorship.” Journal of Conflict Resolution 50: 878–98. Taylor, Peter. 1997. Provos:The IRA and Sinn Fein. London: Bloomsbury. Tilly, Charles. 1985. “War Making and State Making as Organized Crime.” In Bringing the State Back In, edited by Peter B. Evans, Dietrich Rueschemeyer, and Theda Skocpol, 169–91. Cambridge: Cambridge University Press. Victoroff, Jeff. 2005. “The Mind of a Terrorist: A Review and Critique of Psychological Approaches.” Journal of Conflict Resolution 49: 3–42. Wagner, R. Harrison. 2000. “Bargaining and War.” American Journal of Political Science 44: 469–84. Walter, Barbara F. 2006. “Building Reputation: Why Governments Fight Some Separatists but Not Others.” American Journal of Political Science 50, no. 2: 313–30. Walter, E. V. 1969. Terror and Resistance: A Study of Political Violence. London: Oxford University Press. Weber, Max. 1978. Economy and Society. Berkeley: University of California Press. Wickham-Crowley, Timothy P. 1990. “Terror and Guerrilla Warfare in Latin America, 1956–1970.” Comparative Studies in Society and History 32: 201–37. Wintrobe, Ronald. 2006. “Extremism, Suicide Terror, and Authoritarianism.” Public Choice 128: 169–95.

chapter

Choosing War: State Decisions to Initiate and End Wars and Observe the Peace Afterward

12

james d. morrow

War has been one of the great scourges of mankind. It evokes our strongest passions and most brutal instincts. At first glance then, it may seem odd to search for rational explanations of these bloodlettings great and small. Why would states choose to begin wars, why do they continue to fight at a horrible cost, and when do they end their wars with settlements that persist? This chapter presents a unified view of the outbreak of war, politics during wartime, and the making of peace afterward.1 Two broad arguments form the center of the view of war presented here. First, war is part of the process of bargaining between states. Governments of different states disagree about the desired outcomes of international issues, which could be territorial or cover international trade, ideological orientation of states, or the composition of their governments. Because international politics lacks a central authority to impose solutions to these issues, states bargain among themselves to resolve them. In some situations, a state turns to the use of force to secure an outcome it has not been able to achieve through negotiation. Bargaining theory—explanations of how and when bargaining fails or succeeds—leads us to understanding when war is chosen. The causes of war, and of its resolution, are the same as the causes of bargaining failure. Second, states are corporate actors and like all corporate actors face a principal-agent problem in getting their leaders to act in the interest of the corporate body rather than their own self-interest. Political leaders wish to remain in power, but war can lead to the removal of even a victorious leader. All political systems have ways of removing leaders from power and replacing them; however, they differ greatly in how they do so. The proclivity of states to engage in war depends on their political institutions because different institutions provide different ways of inducing their leader to pursue the interest of the politically relevant groups in society. These two arguments—that war results from the failure of bargaining and that domestic politics shapes leaders’ decisions in the face of war—are the core of the view in this essay. I lay out the critical points of logic within those formal models rather than review the details of them. These arguments have led to a

412 James D. Morrow broad rethinking of war in international politics. Earlier theories of war, such as neorealism (Waltz 1979) or power transition theory (Organski 1968), focused on how the structure of the international system dictated when war occurred. These theories lacked rigorous microfoundations that explained why those structures led states to fight at some times but not at others. The arguments presented here direct the focus away from systemic structure in favor of dyadic interaction, how pairs of states in conflict dealt with each other in a conflict. The stages of the outbreak of war, bargaining during wartime, and the consequences in the postwar situation structure the essay. I begin by discussing the general patterns of war to show the dimensions of the problem. I then lay out the bargaining argument and the principal-agent argument generally. This leads to the three stages and their specific features. I conclude the essay with some open questions.

The Dimensions of War This essay discusses interstate war, war between the armed forces of two states. Interstate war is easier to analyze than civil war or war between a state and a political entity not recognized as a state.The actors are clearly defined, and there is extensive historical literature on most of these wars. States recognize each other as legal equals in the sovereign state system, even though they rarely treat one another equally. War and peace are separable periods of time, with war occurring when both sides commit their troops to combat. None of these are true for other types of violent conflict. It may be difficult to identify the warring groups in a civil war or collect information on their strength. In the colonial wars of the nineteenth century, states did not recognize the nonstate polities they fought as their legal equals; governments rarely recognize rebel groups as legitimate.Violence in these conflicts can go for periods of months or years in which few are killed, followed by intense fighting that kills many. This variation makes it difficult to judge when the conflict has begun or ended. For these reasons, the literature on interstate war is more developed than those for these other types of war. The clarity of interstate war as a phenomenon allows scholars to create and use standard data collections. The Correlates of War (CoW) is the most-used data collection on interstate war (Singer and Small 1972; Small and Singer 1982; Sarkees 2000). It covers the period from 1815 to the present, identifying states; collecting when they engaged in disputes and wars with each other and formed military alliances; assessing their capabilities to wage war; and collecting other information such as membership in international organizations and diplomatic recognitions. State membership requires a population of at least half a million until 1920 and diplomatic recognition by the leading states in the system. After 1920, membership in the League of Nations or United Nations can override the population threshold. War occurs when two or more states commit their forces to combat against one another and at least one thousand are killed in battle, with each participant suffering at least one hundred battle fatalities. The death thresholds exclude smaller conflicts that were considered not to rise to the level of war. The threshold does exclude some violent conflicts in which the arguments here apply, such as the U.S. invasion of Panama in 1989. The

Choosing War 413

death threshold for each combatant state excludes states that declared war but did not take part in hostilities, such as Argentina during World War II. For some purposes, the large multilateral wars, particularly the two World Wars, are disaggregated into pairs of countries that fought each other—warring dyads (for example, Stam 1996). To study the onset of war, we also need a set of cases that could have gone to war but did not. The study of international politics defines crises as events with a heightened chance of war. What constitutes a crisis? CoW deals with this issue by collecting militarized interstate disputes (MIDs). A dispute, which is how I will refer to a MID, occurs when one state threatens to use military force, displays the use of its military forces, or actually uses military force against another state (Gochman and Maoz 1984; Jones, Bremer, and Singer 1996; Ghosn, Palmer, and Bremer 2004). Displays of force include mobilization of troops, movements of troops toward a common border, and deployment of naval forces in the vicinity of another country. Each dispute cites the parties involved, the most violent act they took toward the other side, whether each party suffered casualties, and its outcome. This definition brings precision to the idea of a crisis, but it includes many events that few think of as crises. Fishing boat seizures qualify as disputes, but only a few such instances escalate to produce a serious risk of war. Occasionally some events such as war scares that historians think of as crises do not qualify as disputes, because neither side makes an explicit threat. Still, this definition has been used widely and establishes a two-stage process—the initiation of a dispute and then its escalation to war—to explain the onset of war. An alternative collection, the Interstate Crisis Behavior (ICB) data set, provides a list of crises from 1919 onward. First, it should be said that interstate war is very rare. CoW lists only ninetyfive interstate wars between 1815 and 2007. Breaking them down into dyadic wars does not raise the total significantly; Stam (1996) breaks down seventynine interstate wars into eighty-eight separate wars in his analysis. If we adopt a very broad definition of war as any dispute in which both sides use force and suffer fatalities, there are still only 903 dyadic wars.2 The rate of disputes is also very low. Of the 676,118 dyad-years (one pair of countries for one year) in the CoW system between 1815 and 2001, there are only 3,545 dyadic disputes. Some restrict the dyads they examine to political relevant dyads, those in which the parties share a common border or are separated by only a small distance of water or where one state in the dyad is a major power. Even with this restriction, war and disputes are rare. Second, most disputes are resolved without escalating to war. Using even the broadest definition of war, the escalation rate is only 25.5 percent. A large share—59.7 percent—of disputes end without a clear resolution when the threat lapses or the parties cease to engage each other.These are the disputes that end not with a bang but with a whimper. Even discounting those unresolved disputes in the sense that the parties have not agreed on a concrete resolution of the issues at hand, only 34.7 percent of the disputes that are forced to a resolution end in reciprocated violence. I labor the point that disputes and war are rare to counter the impression that one may get from historians and some scholars of international politics that violence is pervasive in international politics. It is rare, not common, and any explanation of war should reflect that.

414 James D. Morrow tab le 12.1

Frequency of Great War over the Last 500 Years

Wars per Great Power-Year Nation-Years of War per Great Power-Year Average Fatalities per Great Power War (in thousands of battle deaths) Median Fatalities per Great Power War (in thousands of battle deaths) Average Fatalities per NationYear of Great Power War (in thousands of battle deaths) Median Fatalities per NationYear of Great Power War (in thousands of battle deaths)

1495– 1617

1618– 1713

1714– 1815

1816– 1913

1914– 1945

1946– 1975

.0912 .7275

.0274 .6018

.0157 .4223

.0069 .0187

.0193 .3459

.0057 .0642

32.2

284.9

449.3

112.8

5175.9

955.0

24.0

108.5

88.0

107.0

3875.1

955.0

2.9

12.9

16.7

41.8

289.2

84.5

3.5

8.9

4.4

42.5

140.4

84.5

note: Medians calculated as average of two middle values when number of wars in a given period is even.

Third, the frequency of war has declined over time. Jack Levy (1983) collected a list of wars involving at least one major power from 1495 onward. The average number of wars with a major power on each side and the number of years of such wars have dropped across the centuries; see Table 12.1. At the same time, the intensity of wars as measured by fatalities has risen over time, as one would expect with the growth of populations and the size of armies. Recently, interstate war has become rare, while more violent conflicts have been within states rather than between them. No interstate war of the last two centuries has lasted a decade, while it is not unusual for civil wars to last longer. The last pattern is that interstate wars tend to end quickly, particularly compared with civil wars. I raise these patterns for the reader outside the field of international relations. The explanations presented here were not created to explain these patterns, but they do provide arguments about why these patterns occurred. I will comment on candidate explanations of these patterns at appropriate points in the discussion. My focus is interstate war both by the design of the handbook and because the arguments have been developed at greater length for interstate war, and so are clearer. Having laid out the dimensions of the problem of interstate war, I turn to the two general arguments at the center of rational choice explanations of war.

War as the Failure of Bargaining On September 20, 2001, the United States made a series of demands on the Taliban government of Afghanistan—that the Taliban close all Al Qaeda training camps on Afghan territory, allow U.S. forces access to verify the closing of the camps, turn over all Al Qaeda leaders in Afghanistan for trial, and release foreign nationals they held. The Taliban chose not to meet those demands, responding that they were willing to consider evidence against those leaders, particularly Osama Bin Laden. The rejection led the Bush administration to

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begin military action against the Taliban in concert with rebel groups inside Afghanistan, especially the Northern Alliance. That effort led to the overthrow of the Taliban, its replacement by a new government, and a long, ongoing period of low-level civil strife in Afghanistan. Conflicts of interest underlie violent conflicts between states. States resolve their conflicts of interest by negotiation. Theories of bilateral bargaining are central to understanding the causes of interstate war. Violence and the threat of violence are tools to induce concessions from a state when the other side is not happy with what it has offered. Theories of bargaining from economics focus on other negotiations, such as pretrial negotiations in lawsuits, labor negotiations, and bargaining over the price of a sale. All of these negotiations are conducted in the shadow of other forms of recourse to induce the other side to make concessions; going to trial, a strike or lockout, or ending negotiations and seeking another deal, respectively, are the alternatives in these examples. Models of bilateral bargaining assume that the parties negotiate over the division of a standardized unit of all points between 0 and 1 inclusive, representing all the possible bargains. Each end represents one side receiving all the surplus from the negotiation, its maximal outcome. Each point in a model of bargaining over territory corresponds to a particular position of the border between the two states. If there are multiple issues, the unit represents where on the contract curve the parties strike their bargain (Morrow 1986). The points of the unit interval also represent all the possible outcomes of the issue after a war. Each side would like the settlement to be as close to its maximal outcome as possible. The side whose maximal outcome is 1 prefers settlements with higher numbers, while the other prefers lower numbers. Each side to the negotiation has a reservation point, the negotiated outcome where it is indifferent between fighting and settling for that outcome. I return to the factors that determine the reservation point later, because they differ from the prewar stage to wartime. A side’s reservation point divides all the possible outcomes into those closer to its maximal outcome than its reservation point—settlements it prefers to fighting—and those further away, for which it would rather fight than accept. The side whose maximal outcome is 1 prefers all settlements greater than or equal to its reservation point to fighting, while the other side prefers all settlements less than its reservation point.3 When the reservation point of the former side is less than that of the latter side, both of them prefer all agreements between their reservation points to fighting. This range is the zone of agreement. If it does not exist, then bargaining cannot solve the problem because there is no agreement that both sides prefer to disagreement. Because violence is destructive, there should always be a zone of agreement in negotiations where the alternative is fighting. Blainey (1988) points out that at least one side—the losing side—always regrets a war afterward. Both sides would be better off if they settled for the postwar settlement before fighting because they would avoid the resulting loss of life and property. The essential puzzle of war is why the sides fight when there are settlements that both sides prefer to fighting, a puzzle that holds for all three stages of the process. Why do they fail to reach one of the settlements that both prefer to fighting? There are two reasons.

416 James D. Morrow Each side knows its own reservation point but does not know the reservation point of the other. Reservation points are private information. Later, I discuss why reservation points are private. Private information is commonly modeled by assuming that a player is one of a set of types, where the other players know the set of types it could be but only the player knows which type it is. Here the set of types determines the range of reservation levels a side could have. If one side knew the other’s reservation point, it could offer the latter its minimally acceptable deal, and the latter would take it rather than fight. Because it does not know the other side’s reservation point, it has to make a judgment about what to offer. Offering too little could lead to violence, and offering too much leads to less than the best possible deal for the offering party.What to offer poses a risk-return tradeoff; asking for more increases a side’s return at some added risk of rejection and so costly conflict (Powell 1999). Each side has an interest in concealing its type and so its reservation point from the other and trying to persuade the other that it is a type with a higher reservation level to induce the other to make additional concessions. Both sides have an incentive to misrepresent their own types to secure a better deal from the other side. Consequently, parties to disputes will act more resolute, more confident in their ability to prevail through war, than they actually are. If such belligerent tactics work, the successful party gains a better deal without fighting. Each side, however, understands that the other has this incentive to misrepresent its willingness to fight, to talk tougher than they are. They will tend to disbelieve the claims of the other side regarding its willingness to fight if it does not receive what it has demanded. Simple claims of the resolve to fight or demands for further concessions are not convincing on their own, because a side can make such statements regardless of its actual willingness to fight. The underlying strategic problem is separation of types; how does a party with high resolve convince the other side that it will fight if it does not receive the concessions that it is demanding? Separation of types requires an action that some types are willing to take that others are not. Observers, including the other side, can determine that the acting party falls into the set of types willing to take that action. Negotiating positions are one such action, and I discuss others specific to crises later. Parties in a crisis try to judge the other side’s type, and their reservation level and how much they need to offer, from their actions.Those types with a high reservation level signal their type through actions that less motivated types are unwilling to take. This first reason for the failure of bargaining arises from the combination of private information and an incentive to obtain the most advantageous bargain possible. In general, private information in bargaining gives rise to bargaining inefficiency.4 This reason for bargaining failure is common to any negotiation where private information is present and the parties disagree about which bargain is best. The second reason for bargaining failure arises from its aftermath. Many bargains are struck over time. One party makes a concession now in the expectation that the other will reciprocate in specific ways in the future. The first party may worry that the second will violate their bargain after it has

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received its end of the deal. If its doubts are great enough, it might reject a deal that would benefit both sides if fully implemented. This second threat to reaching an agreement is a commitment problem, because one or both sides are concerned that the other is not committed to carry out the deal. Commitment problems do not rely on private information. Both sides could readily identify a bargain that both of them prefer to the violent alternative if they were certain it would hold. Commitment problems do require that the bargain persist over time. They may also occur in other forms; Fearon (1995) describes indivisibility of issues as a third source of bargaining failure, and hence war (see also Goddard 2006). Powell (2006) argues that indivisibility is just a form of a commitment problem.The parties could agree to flip a coin with the winner receiving the indivisible territory. Although both are better off taking their 50–50 chance of obtaining the territory, the loser of that coin flip may refuse to accept that outcome afterward, leading both to prefer to fight over the indivisible territory than accept the deal to flip the coin. The war between the United States and the Taliban illustrates the key points of this section. First, there were deals that would have made both parties better off than the fighting did. Mullah Omar would have been better off still running Afghanistan than hiding in whatever forsaken place he is now.The U.S. government also would have been better off with some negotiated deal short of the full demands made by the Bush administration. Although the costs of the overthrow of the Taliban to the United States were small, a deal with them would have avoided the need for occupation forces and would have brought in the top leadership of Al Qaeda for trial. Second, each side articulated an outcome that it would accept in lieu of war. However, neither of these positions stated their reservation point; both probably would have accepted something less. This reflects the incentive to misrepresent. Third, the sides failed to find a solution that both preferred to war. Wars are the result of the actions of both sides in a bargaining explanation. Both the U.S. government and the Taliban bear some responsibility for the outbreak of war because neither was willing to make the concessions that the other demanded nor reduced its own demands. Blainey (1988) states the joint responsibility for war clearly, in contrast to many explanations of wars in historical accounts or current affairs. Analysts must examine what both sides do before, during, and after war to explain why it occurred, why it lasted as long as it did, and why peace could not be sustained over time afterward.

States as Corporate Actors and the Political Control of Leaders The arguments above assume that states are unitary actors that can be treated as if they were individuals. They are not, and their internal political structure influences the decisions they make. As we will see later, democracies go to war and fight differently from other types of political systems. This observation was drawn out of the statistical patterns, but it opens up the question of why democracies differ. There are many candidate explanations because there are many differences between democracies and other systems. Seeking instead to understand why domestic politics matter for foreign policy is more likely to lead to a sound explanation.

418 James D. Morrow War is the province of states. States are corporate actors in that they are composed of many individuals organized to act legally and internationally as an individual. A state can assume legal responsibilities, and a state’s agents can act in its name. In particular, states have the right to wage war reserved to them in the sovereign state system. Rational choice explanations of war should also examine how states induce their agents to act in the state’s interest. Even if states operate like individuals, there may be differences between the interests of the state and its agents. Principal-agent theory models the problems of how a principal can control its agent to do as it wishes. The principal employs an agent to work on its behalf. The interests of the principal and agent are not identical. The principal is concerned that this difference in interests will lead the agent to work for its own interests over those of the principal. Principal-agent theory addresses how principals can induce their agents to act on their behalf rather than the agent’s personal interest. The principal could write a reward schedule into the agent’s contract. Uncertainty about exactly what the agent has done and the agent’s capabilities complicate the problem of control of agents. If the principal knew exactly the decisions of its agent and whether they were in the principal’s interest at the time they were made, it could verify that the agent was acting in its interest. When uncertainty clouds such judgments, the agent can obscure its decisions from the principal. Principals focus on performance because it is difficult to separate out effort and judgment from the factors beyond the control of the manager. In the problem of political control, the citizens are the principal and the leader of their state is their agent.5 They seek to induce their leader to adopt policies in their interest, from economic policy to decisions about war and peace. Unlike the business setting, where contracts provide different levels of reward based on performance, the tools of political control are cruder. Removal from office is the ultimate sanction for a failing leader, and so the primary focus of this literature. There are other tools, such as restricting the leader’s ability to accomplish other ends, that have not been explored. No matter what tool is used, the judgments of the principal are retrospective, reacting to how well the policies of the leader work out. In foreign policy, the interests of the principal and the agent could diverge in four ways. The decisions of a state leader influence but do not determine the outcome. The choices of the other side matter, and its motivations are not clear. War entails military decisions and elements of chance beyond the control of political leaders. First, the principal would like to induce good performance by its leader, but the risks of international politics complicate judging good performance. The leader could make correct decisions that turn out poorly, or poor decisions that end up being successful because of factors outside his control.When a policy is not successful, the leader will wish to blame that failure on circumstances out of his control rather than his own decisions. Second, leaders might differ in their ability to secure favorable outcomes, leading the principal to prefer a more competent leader. Less competent leaders would like to conceal their lack of ability. Third, if the populace rallies to support its leader in a time of international crisis, the leader might manipulate crises to boost his popularity. In these arguments, the leader would like to retain power when the

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principal would like to remove him. Fourth, the leader might pursue foreign policies that advance his own particular interest at the expense of the principal’s interests. These differences in opinion about the policies that the state should pursue could be ideological—think of President Wilson pushing the League of Nations on a reluctant U.S. Senate—as well as material. The principal-agent framework begs the question of who is the principal. War can affect the welfare of everyone in a country. Not everyone in society, however, has the political right to influence whether their leader should be removed or have her power restricted.The principal is the politically relevant set of people in a country. They alone possess the ability to act on their discontent with their leader. In a democracy, this group is the electorate; even if the leader is removed through a nonelectoral process, such as a vote-of-confidence, those removal processes exist in the shadow of elections. In autocracies, those who might possess the power to remove a leader are fewer in number, usually many fewer, than universal adult suffrage. Selectorate theory (Bueno de Mesquita et al. 2003) treats the political control of leaders as a principal-agent problem. National leaders retain power by keeping their supporters happy. To retain power, a leader must hold the support of a certain number of supporters, a characteristic of the political system referred to as the size of the winning coalition (W). In a democracy, W is roughly one-half of the electorate, depending exactly on the electoral rules. In an autocracy, W is a much smaller set. For a challenger to supplant a leader, she must convince enough supporters of the leader to abandon him to reduce his support coalition—the set of people who support the current leader—below W and also create a support coalition of her own at least as large as W. The politically relevant set are those people from whom the challenger could create her new support coalition, the selectorate (S). The selectorate of a democracy is the electorate; it can be the single political party of an autocracy, or the aristocrats who support a monarchy or oligarchy. Selectorate theory allows us to characterize all political systems across time and space in terms of these two concepts, W and S. It also expands the dichotomy between democracy and autocracy because W varies within each type of system. W expanded in democracies as suffrage grew to universal adult suffrage. Some autocrats answer to a small W of military leaders, while those who lead single-party states must hold the loyalty of a substantial fraction of a party of millions. A leader can use state resources to hold the loyalty of at least W supporters by producing either private benefits, which can be targeted to benefit specific supporters, or public goods that benefit everyone in society. Most public policies provide mixtures of private benefits and public goods, so the key is the balance between the two. Selectorate theory has two general results. One, as the size of the winning coalition increases, leaders shift their policies away from private benefits and toward public goods. This shift is a price effect; the size of the winning coalition is the price for buying support through private benefits. Raise its price, and the leader will shift effort away from private benefits and toward public goods. Two, the size of the selectorate determines the chance that a supporter of the current leader will be excluded from the support coalition if the challenger comes to power. A larger selectorate lowers the chance that a supporter will be a member of the challenger’s support coalition, and so receive private benefits.

420 James D. Morrow When W is small and leaders rely on private benefits to supporters, a larger selectorate makes supporters more loyal because the risk of exclusion from the support coalition if the challenger comes to power is greater. Selectorate theory does not capture all the institutions we associate with democracy. The power to set policy resides solely in the hands of the leader in the theory, and so it cannot analyze how separation of power between legislatures and executives might check leaders’ discretion. Political control of leaders could operate through channels other than just the removal of a leader. Most observers credit the Democratic Party’s gaining control of the House of Representatives in 2006 to the war in Iraq. President Bush paid the price of the frustration of his legislative goals because of the war. I turn now to survey how these arguments play out at each stage of the war process, before, during, and after fighting. There are important differences across these three stages, because of the specifics of how bargaining and the control of political leaders vary across them.

The Outbreak of War The outbreak of war entails two stages, one when force is threatened, and a second when force is used. In rare cases, the two stages may collapse together if one side launches a surprise attack before any explicit threat is made. Even in those cases, though, some period occurs where at least one side would like changes on the issues in dispute. The attack by Egypt, Syria, and their Arab allies against Israel in 1973 was not preceded by an explicit threat to use force, but there had been attempts by Egypt to open negotiations that proved fruitless. Generally, disputes open not with fighting but with coercive diplomacy, the attempt to induce the other side to agree to revisions in the status quo through the threat of war. A state uses coercive diplomacy to achieve its desired ends. The response of the target determines whether it is successful or whether it must contemplate the use of force to gain what it wants. Successful threats do not have to be carried out; the other side may grant the demanded changes before force is used. States may make threats they are unwilling to carry out in the hope of getting concessions short of war from the target. The costless nature of successful threats creates the problem of separation central to bargaining. Is the threatening state willing to carry out its threat, or is it simply testing the resolve of its target? If the threat always induces the target to make concessions, then any state would make a threat to gain those concessions, even one with neither intent nor desire to carry it out. But then threats are not credible in the eyes of their targets because even a state unwilling to use force is willing to make them. Threats become informative, and hence gain credibility, when states that are unwilling to carry out their threats are reluctant to make them. Separation—when those who are willing to carry out the threat take different actions from those who are not—allows the target of the threat to discern when a threat is credible. Before discussing how states can render their threats credible, it is helpful to consider how states evaluate threats and what drives the resulting range of outcomes. That range lies between the reservation points of the two sides.

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A side’s reservation point, and so what it considers when negotiating before war breaks out, reflects what it thinks will happen if war breaks out. Relative military power matters because winning battles helps win wars. A state with a more capable military than its prospective opponent should demand more in a crisis. Although many indicators of military power are readily observable, others may not be. Even if both sides in a crisis have reliable knowledge about the size and weaponry of each other’s militaries, they might disagree about which side would win. They might hold different ideas about how military capabilities produce victory on the battlefield (Smith and Stam 2004). Optimism, or pessimism, about how one’s forces will fare on the battlefield plays a large role in a state’s reservation point. Joint optimism, when each side thinks the other is over-rating its chances, is often given as a proximate cause of war (Blainey 1988). The importance of the issues at stake, as measured by each side’s willingness to suffer the costs of war, also plays a large role in determining reservation levels. Wars kill people and destroy property. States that are unwilling to suffer those costs for the stakes in dispute see little reason in fighting for those stakes, and so should be willing to settle before war. Further, a state that views the stakes as critical should be willing to fight on as long as it can. The value a state attaches to the stakes is its private information, something it knows but its opponent does not. signaling resolve A state’s evaluation of its chances should war occur and its willingness to suffer the costs of war determine its reservation level and are its private information. The essence of the signaling problem is how a state that is willing to fight for the stakes can communicate that resolve credibly to the other side. Making a threat is insufficient, because an irresolute state would be willing to make that threat if it persuaded the target to submit and give the threatening state what it demands. Separation of types—how a resolute type differentiates itself from an irresolute one—hinges on acts that the former are willing to carry out but the latter are not. Parties beyond the leaders of the two countries in the dispute could impose costs on those leaders as a consequence of their actions in a crisis. These audience costs could allow resolute types to separate themselves from irresolute ones (Fearon 1994). When leaders take actions that escalate the crisis, these audiences also heed the message that the leader believes the issue in dispute is important enough to fight over. If a leader later backs away from its demands, the audience may respond in the future. A leader does not suffer these costs if her state prevails in the dispute at hand. Leaders are careful about when they escalate a crisis unless they are confident that the other side will give them what they want or are willing to fight if it does not. Leaders who are unwilling to go to war will be reluctant to take the actions that create audience costs because they anticipate that they may have to make concessions to avoid war. Rather than creating costs they will suffer later, irresolute leaders make the necessary concessions to end the crisis early. Audience costs are a commitment device that make a state leader prefer war to granting concessions. Leaders are careful to use them only when they are willing to put themselves in that position.

422 James D. Morrow The audience could be domestic or international. Domestic groups care about the results of their state’s foreign policy and can impose costs on their leader. Removal from office (Bueno de Mesquita and Siverson 1995) is one tool for punishing a leader who has lost a crisis. Leaders of other states form the international audience. Anne Sartori (2002, 2005) argues that leaders seek to cultivate a reputation for honesty in crises. Rather than develop a reputation for being willing to fight in any situation, leaders signal their resolve honestly, making concessions when they do not deem the issue at hand critical to their state’s interests. They do so to preserve the ability to convince other states of their resolve when the issue is critical. In this view, being caught in a misrepresentation rather than backing down is the signal that triggers audience costs. Alexandra Guisinger and Alastair Smith (2002) combine these two audiences by tying reputations to leaders instead of their states. If a leader makes threats that prove to be empty, his international reputation is damaged, and other state leaders will be reluctant to believe his word in the future. His citizens may replace him and his poor reputation to restore their state’s ability to make credible threats short of war. Michael Tomz (2007) reports experimental evidence that U.S. citizens disapprove of presidents who back down in a crisis. This two-sided, domestic and international audience view is more efficient than the purely international reputation view. The latter requires a risk of war to enforce the sanction, while the former uses removal from office as the sanction for dishonest signals, and does not require a chance of war. Audience costs require that the audience can observe what the leader does during the crisis. Normally, the threats and demands are public acts; presidents of the United States have used nationally televised speeches to make demands and threats in international crises to engage the attention of the American people. Public threats and demands also engage the relevant audiences of the leader of the target of those threats. By raising the prominence of the issue to all audiences, the leader making the threat may commit himself to fight while making it difficult for his target to make the concessions he demands. Bahar Leventoğlu and Ahmer Tarar (2005) examine public commitments that raise the cost of making concessions. Public commitments before negotiations have the structure of a prisoners’ dilemma game; making the commitment is a dominant strategy for both players that leads to an outcome that is Pareto dominated by no commitments by either side. Shuhei Kurizaki (2007) argues that private threats work in some settings even though they are less credible than public threats. When public threats create audience costs for the target as well as the leader making the threat, both parties can find themselves trapped in a war. The private threat does not trigger those costs, giving both sides more flexibility to back down. It is credible because some types will go to war if the target does not make concessions. Interstate disputes are mostly public affairs; private threats work in some situations because they lie in the shadow of a public threat if the demands are not met. Mobilization for war signals resolve by preparing the country for war (Slantchev 2005). This raises its chance of winning should war break out, making war more attractive to the state mobilizing and rendering its threat more credible. Like audience costs, mobilization and other moves to prepare

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for war such as moving troops to the crisis area are commitment devices. They signal resolve by altering the leader’s decision in favor of fighting over making concessions. commitment problems and the outbreak of war There are at least three possible sources of commitment problems before war (Powell 2006). First-strike advantages—the higher chance of winning if a side attacks its opponent unaware—create a commitment problem. The side holding such an advantage cannot reveal it during prewar bargaining because the advantage is lost when the other side becomes aware of the surprise attack. Although the U.S. government correctly discerned that Japan was planning attacks throughout Southeast Asia in December 1941, it did not anticipate the surprise attack on Pearl Harbor. If Japan had revealed its plan, any bargaining leverage associated with the surprise would be gone. Bargaining over future power is a second source of a commitment problem. If prevailing today gives the victor control of resources that make him powerful enough to impose a much more favorable settlement later, the side being pressed for concessions might be unwilling to make them. Fighting today looks better than a small loss now and a large loss in the future. A shift in power over time, the third possible source of a commitment problem, is closely related to the second. Industrialization has driven the major shifts in power over the last 250 years (Organski 1968). An industrializing country grows in power, and other states cannot stop these shifts. If the shift in power is large enough, the side declining in power cannot offer enough today to compensate the rising power for what it will gain tomorrow. Accommodating the power shift requires a dynamic bargain over time; because the parties cannot commit to such deals, they prefer fighting to the short-term deals they can enforce on one another. Powell (2004b) shows that these commitment problems, and those from other areas of politics, have the same strategic structure. Commitment problems arise from the inability to commit to dynamic deals over time. When a side expects more in present value from fighting now than it can get if the other side grants it all available surplus from a bargain today and then returns to efficient bargaining, it prefers fighting today. Commitment problems also reverse the signaling problem in crisis bargaining. The signaling problem requires separating the wolves—resolute opponents who will fight if they do not receive large concessions—from the sheep in wolves’ clothing—opponents who demand concessions even though they are unwilling to fight. If a state believes a commitment problem makes war unavoidable, it might wait for the most opportune time before attacking. It will act like a wolf in sheep’s clothing, trying to reassure its opponent before it strikes. The opponent will not realize that war is at hand until it is too late. Commitment problems then could explain the rare cases in which a state attacks without coercive bargaining first. Commitment problems cause war even when the parties are fully informed about each other’s reservation levels. There are no settlements that both sides prefer to war when a commitment problem exists. Before a dispute occurs, both sides have lived peacefully with the status quo, an outcome both have preferred to war (Gartzke 1999). Put another way, the parties should already be at war if

424 James D. Morrow a commitment problem renders all settlements unenforceable. For this reason, I suspect that commitment problems alone do not cause the outbreak of war. Powell (2006) discusses the outbreak of World War II in Europe as an example of war caused by a commitment problem. Great Britain and France became convinced that Nazi Germany could not be trusted to honor any agreement, so war was the only way to forestall German long-run ambitions, even if there were concessions at any moment that both sides would prefer to war. Yet an explanation of the outbreak of World War II in Europe must also account for the German decision to trigger the war by invading Poland. Incomplete information, specifically Hitler’s judgment that Britain and France would not fight for Poland, was essential in that decision. Hitler did not know they were committed to war no matter what. After the defeat of France, Churchill refused all proposals inside his government to test the waters. Hitler offered a number of peace initiatives toward Britain during the summer of 1940, but none of them returned to the prewar status quo—the restoration of the independence of France and Poland. The outcome that both sides preferred to war before its outbreak was no longer possible. Other commitment explanations for the outbreak of war have similar problems. Cases suggest that states develop first-strike plans after they have concluded that they are unlikely to get a satisfactory outcome from negotiations. The Japanese developed the plan to attack Pearl Harbor after the United States raised its coercive pressure on Japan by placing an embargo on steel and oil exports. Their inability to secure an acceptable outcome led to the conclusion that war was the only way to secure that outcome, and surprise attack raises the chance of victory if one has to go to war.These countries might have secured a better deal if they could reveal their first-strike advantage while retaining it; the advantage does not appear to be the reason why they were not willing to accept. Long-term shifts in power could require concessions to the rising power over time that lack credibility. But appeasement of Nazi Germany in the 1930s was such a string of concessions, and that policy failed to satisfy Germany because Hitler’s ultimate goals exceeded what Germany could accomplish, not because the Western Allies were unable to accommodate demands commensurate with German power. I am not arguing that these commitment problems are irrelevant to the outbreak of war. They can reduce the zone of agreement by raising a side’s value for war, as first-strike advantages do. If agreements are more difficult to reach when the zone of agreement is small, then a commitment problem can make war more likely by shrinking the zone of agreement, increasing the chance that bargaining fails and war results. the democratic peace Democracies are much less likely to go to war with each other than are other pairs of states. This result is known as the democratic peace and has generated an immense literature over the last twenty years. The robustness of the pattern has been extensively explored, such as whether it is limited to particular periods of time and whether democracies are also less war-prone than nondemocracies.6 Many explanations have been proposed, but I discuss only those that use the explanations of war presented here.

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The institutions of democracies differ from other systems in many ways. All democracies allow open opposition to the government; most have a formal opposition party or parties. Autocracies commonly make opposition a crime, and mixed systems restrict opposition parties and rarely allow one to come to power. Kenneth Schultz (2001) argues that the opposition in a democracy serves as a second signal of the government’s resolve. A crisis is a political opportunity for the opposition. If the government escalates a crisis only to back down later, the opposition can use it against the government in the next election, particularly if the opposition criticized the government during the crisis. But if the government prevails in the crisis, the opposition loses by politicizing the issue and is better off supporting the government. The opposition, like the government, cannot know the outcome of a crisis in advance, but the opposition has a better read on the resolve of the government than does the other state in the crisis. It knows when the government is resolute and so likely to prevail, and when the government is not and so is unlikely to prevail. In the former case, the opposition should support the government during the crisis, because it cannot gain a political advantage by publicly opposing the stand of the government. In the latter case, the opposition can gain a political advantage and so should publicly oppose the government. The stance of the opposition is a second signal of its state’s resolve. When it supports the government, the government is resolute; when it opposes the government, the government is irresolute. This added signal of a democracy’s resolve has two effects. First, it allows the other state to judge a democracy’s resolve more readily than that of other systems. When the opposition supports the government, this added clarity of position makes it more likely that the other state will yield in the crisis. Second, the possibility of public opposition disciplines a democratic government from making speculative threats. If a democratic government threatens another state when it is unwilling to go to war, the opposition, sensing the lack of resolve in the government, will publicly oppose its stance. The other side will see this opposition, understand that the government is not resolute, and so be unwilling to make concessions to the government. This is not an attractive prospect for a democratic government. Democratic governments make threats only when they are resolute.Together, these two effects imply that democracies are less willing to make threats than nondemocracies, and those threats are more credible and hence more successful. Further, the opposition almost always supports the government in a crisis. Schultz provides statistical evidence that threats made by democracies are more credible than those by other types of states. Other tests of the proposition that democracies generate higher audience costs than autocracies assume that is true and then show that the evidence is consistent with that assumption (for example, Eyerman and Hart 1996; Partell and Palmer 1999; Gelpi and Griesdorf 2001).7 This argument does not directly lead to the democratic peace, although disputes between pairs of democracies should be easier to resolve because both sides can signal their resolve more credibly. Two democracies could find themselves in a crisis in which both are highly resolved. The opposition would support the government in both, and the two sides might not resolve their differences short of war. Bueno de Mesquita et al. (1999, 2003) exclude this

426 James D. Morrow possibility by exploring how selection institutions shape how democratic leaders evaluate risks in crises. Because democratic leaders answer to a large winning coalition, they incline policy to favor public goods over private benefits. In foreign policy, success is a public good (Bueno de Mesquita et al. 1999). Democratic leaders care about the success of their foreign policies, particularly when they go to war. Leaders who answer to a small winning coalition can placate their supporters for a failure in foreign affairs by offering them private benefits. Autocrats can indulge their taste for war because they can insulate themselves from the costs of failure. Selection institutions induce democratic leaders to be risk averse in crises and autocratic leaders to be risk acceptant. For democratic leaders, losing a war makes it likely that the leader will be replaced; winning helps solidify a democratic leader’s tenuous position (Bueno de Mesquita et al. 2003). Democratic leaders are willing to fight only when the odds are strongly in their favor. At the margin, they make concessions to avoid war when they are not confident in their ability to prevail through force. Autocratic leaders, in contrast, can compensate for losses with private benefits. Winning could make their strong position in power even more stable if it increases their ability to provide benefits to their supporters. Autocratic selection institutions induce their leaders to be risk acceptant, to be willing to wage war even when they stand a substantial chance of losing, provided that the consequences of losing are not disastrous. When two democracies face off in a dispute, it is very unlikely that both leaders will be willing to fight. Democratic leaders require a high probability of winning to take the risks of war. If the two democracies are roughly equal in power, neither leader should be confident in winning. Both should seek a compromise. If they are unequal in power, the leader of the stronger side is willing to use force, but the weaker side should yield. War is very unlikely in either case. The need to answer to a large winning coalition induces risk aversion and explains the democratic peace. This argument has other implications as well. Disputes between an autocracy and a democracy are even more dangerous than those between two autocracies. The leader of the autocracy knows that the leader of the democracy is probably willing to make concessions to avoid war, making the autocrat willing to initiate a dispute with a demand on the democracy. This leads that leader to initiate crises more often and use force against democracies more often. Often, it works. Sometimes, however, the leader of the democracy sees the issue as important enough and the military situation favorable enough that the democratic leader fights back. This argument is consistent with the results of Rousseau et al. (1996). Gelpi and Grieco (2001) show that democracies are targets of crises more often and initiators less often, although the main effect is that new leaders are more likely to be challenged. Democratic leaders on average have shorter tenures, and so democracies have an inexperienced leader more frequently than autocracies. Both of these arguments explain how disputes involving democracies differ from other disputes at the escalation stage, rather than the initiation of disputes. The initiation of disputes might be more likely under these conditions. The

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risk of escalation to war is one cost of initiating a dispute. If disputes between democracies are unlikely to escalate to war, this cost is low and initiation more attractive. Initiation of disputes may not be the appropriate place to look for evidence of the democratic peace.8 Existing data collections center on disputes and do not provide information about predispute negotiations; the effects of democracy could also be present before the conflict of interest becomes militarized. Then democracies might engage in fewer disputes because they could credibly communicate their position without military threats. Existing data leaves this question open. comparing the arguments to patterns in the data I opened with three patterns relevant to the occurrence of war. First, disputes and wars are rare. Few conflicts of interest between states become militarized, either remaining in the latent stage or not being pressing enough for either side to consider the threat of force. This observation is consistent with the costly nature of conflict. Even if war does not break out, initiating crises can be politically costly for leaders and their states. To be careful, the costs of a crisis do not provide a precise idea of how often conflicts should become militarized. Military force may not be an effective way to advance a state’s position on many international issues, such as trade barriers. Nevertheless, the rarity of conflict is inconsistent with views—such as neorealism (Waltz 1979)—that see war as an ever-present threat in international politics. Analyses of international politics that focus on the possible future conflicts of interest (for example, Huntington 1996) do not provide insight into where wars may occur in the future because they do not examine whether the parties will militarize the conflict or be able to resolve their differences short of war. Second, escalation of disputes to war is not common. Audience costs are generally sufficient to allow separation of types and the credible communication of resolve necessary for settlements short of war. Commitment problems may be an issue in rare situations, but they are not so pervasive that violent conflict is common. The evidence poses an important qualification to this conclusion; many disputes do not end with a clear outcome that favors one side. About 60 percent of disputes end either in outcomes of stalemate or unclear. Leaders may allow crises to end without a clear loser, contrary to the assumption in audience cost arguments. Third, war is declining in frequency over the very long run. I return to this topic in the discussion of open questions in the conclusion.

Bargaining while Fighting Most wars end with a negotiated settlement, rather than the complete and utter defeat of one side (Pillar 1983). Even in wars in which one side has clearly won militarily, such as the U.S. victory over Japan in World War II, the losing side still possesses some bargaining leverage. The central question of bargaining while fighting is how battlefield outcomes influence whether the sides can reach a settlement. Wittman (1979) provided a framework for bargaining while fighting.9 He analyzed how events during a war could change the reservation points of each

428 James D. Morrow side. Whether a side thinks it will win future battles, its costs of continuing to fight, and its value for settlements that might result from continued fighting define a side’s reservation point during war. Wittman assumes that there is no zone of agreement at the outbreak of war and that convergence of the warring parties’ reservation levels is necessary for a peace settlement. Developments that affect each side’s reservation level in opposite directions—increasing for one side and decreasing for the other—are indeterminate. They could decrease or increase the gap between the two sides’ reservation level. A major victory for one side leads it to demand more from continued fighting, while leading the losing side to be willing to offer more. Actions that increase or decrease costs of fighting—such as intensifying the fighting or de-escalating—increase or decrease the chance of a settlement by driving reservation levels toward or away from each other. Wagner (2000) generated the impetus to examine bargaining during war formally. Wittman’s arguments that the probability of settlement varies with the reservation points of the warring parties are probably correct even in current models of bargaining. The probability of agreement rises as the size of the zone of agreement expands.10 But the question now is, How does war reveal information that the parties could not uncover without war, and so lead them to resolve their differences (Goemans 2000)? signaling resolve by fighting War kills people, costs money, and destroys property. These tangible costs are not suffered until the shooting starts. It is one thing for a leader to claim that his state is willing to suffer the costs of war; it is another, far more convincing signal to actually suffer the hard hand of war. Fighting imposes the costs of war on both sides publicly, and these costs could separate the types, reveal where states’ reservation points are, and so accelerate movement to a settlement (Wagner 2000). If the warring parties disagree about their relative strength, combat provides public events—battles—that reveal which party is actually stronger. Smith (1998b) provides a simple model of war that can illustrate the issues here. The two sides fight a series of battles over a string of positions, call them forts, with a fixed chance that each wins a given battle. The side that wins a battle takes a fort away from the other side. If one side wins enough battles in a row to take all the forts, it wins a total victory and eliminates its opponent. In each round, both sides decide whether to yield the stakes of the war to the other side. These stakes are less valuable than total defeat, so the sides would rather surrender than suffer a total defeat. If they fight, both suffer the costs of battle. The result is a war-of-attrition model whereby the battles generate a stochastic process over the number of forts each side holds. Smith shows that each side will have a “break point” where it surrenders when it loses enough battles so that it has fewer forts than its break point. In terms of Smith’s model, the sides could be uncertain about each other’s costs of war or the probability of winning a battle. Other elements could also be uncertain; Filson and Werner (2002) assume that the sides mobilize costly resources out of their societies. Inducting manpower into the military and raising the money to pay for the weapons they fight with and the supplies they consume are costly to any society. Demonstrating the ability and willingness to

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mobilize the resources needed from society through war independently signals a state’s resolve. Smith and Stam (2004) allow the warring parties to have different “theories of war,” not only different probabilities of victory, but also different ideas about how military capabilities will lead to victory on the battlefield. As military technology has changed, military men have disagreed about how new weapons should be used. The Germans in World War II concentrated their tanks into armored divisions, while the French dispersed theirs across many infantry divisions. The 1940 campaign in Western Europe showed that the German organization was more effective, but that conclusion was not obvious beforehand.The actors in Smith and Stam learn about how capabilities translate to victory from the course of fighting, with their reservation points changing as they learn. Eventually, their views of their relative strength converge enough that settlements emerge. Slantchev (2003) represents the uncertainty about battle outcomes directly in the probability of victory, where one side knows the probability of winning each battle and the other does not. The latter learns about that probability from the results of battles, leading to convergence in their views and negotiating positions. Powell (2004a) allows for private information over the costs of war and the probability of winning battles. Reducing uncertainty over the latter is more difficult and important than the former. Battle outcomes are needed to reveal the true balance of forces between the sides, while their willingness to suffer costs can be revealed quickly in between battles. Powell supports Wagner’s claim that war reveals information that cannot be credibly revealed without fighting. commitment problems and the termination of war Commitment problems assert that the parties do not conclude settlements that both would prefer to continued fighting because they believe that the other will not live up to the terms of the deal. Goemans (2000) discusses a commitment problem that lengthened World War I. By 1918, it was clear that Germany and the Western Allies were roughly equal in power, and both sides had the ability to impose significant costs on the other before any victory could be achieved. The fighting in 1918, although decisive for the Allies, had the highest casualties of any year of the war for Germany, France, and Britain. While both sides could believe that they could win the war, both sides would have been better off with a settlement that restored the prewar status quo, or returned Alsace-Lorraine to France and allowed Germany to dominate Eastern Europe through the peace treaty forced on the Bolsheviks at Brest Litovsk.The French and British, however, feared that Germany would reopen the settlement in Western Europe once it had consolidated the economic benefits of its gains in Eastern Europe. France, with its smaller population and less advanced industrial economy, would always fear Germany unless it could impose a settlement that eliminated that difference, the primary objective of the Versailles Treaty. Britain and France were willing to fight on to final victory because partial victory now would only mean renewed war under less favorable conditions later. German control of the food and natural resources of Eastern Europe would, in the long run, undercut the efficacy of the British blockade that was slowly strangulating the German economy.

430 James D. Morrow Commitment problems loom in war because both sides clearly prefer fighting to any specific settlement. Unlike prewar bargaining, a return to the status quo is not an option. Even in cases in which the final outcome is close to the prewar status quo, as in the Korean War, they are not identical. War termination raises new commitment issues. Imagine two states at war that are roughly equal. They begin to fight, and one side wins the initial battles, with the balance of forces shifting slightly in its favor. The losing side should make small concessions to the winning side, the settlement that reflects the balance of forces at that time. If this settlement does not change the underlying balance of forces, the losing side can rebuild its forces after the war and challenge the settlement once their forces are equal again. The side winning in the short run demands a settlement that changes the underlying balance of potential capabilities or rests on a territorial feature that makes reopening the war unattractive to the side losing. If commitment problems contribute to the outbreak of war, how does fighting resolve those commitment problems? Leventoğlu and Slantchev (2007) model how fighting could solve a commitment problem posed by a first-strike advantage. Neither side is willing to settle at the outbreak of war, because each fears that the other will use the first-strike advantage to renew fighting in its favor.The destruction of combat solves the problem by reducing the first-strike advantage, eliminating the incentive to use it to overturn a peace settlement. Commitment problems that prolong war have not been modeled generally. Models of bargaining during wartime focus on closing the differences in the parties’ positions. A model of war with a commitment problem requires a postwar stage in which either side could reopen the war settlement through a new demand and crisis. Reiter (2009) compares commitment explanations for the duration of war with information revelation through fighting in a series of case studies. He finds cases in which each argument holds, although neither holds in all cases. At this time, we do not have general results on how commitment problems affect the duration of war. war aims The postwar commitment problem shapes the aims that states pursue during war (Bueno de Mesquita et al. 2003; Morrow et al. 2006). The MID data set codes the type of aim each side sought during a dispute and any resulting war, into territory, policy, regime, or other (including multiple aims).Territorial aims seek territorial concessions or adjustments to borders. Policy aims seek changes in policies of the other side to which the party in question objects, other than control or status of territory. Regime aims seek to remove the government of the other side. All war aims face a commitment problem at some level, but those problems are more significant for policy aims. Although the losing side could later challenge a change in territory, it would have either to coerce the victor into agreeing to a change or to fight a new war. Policy aims generally require the active cooperation of the defeated to produce the goals of the victor. After the Gulf War in 1991, the U.S.-led coalition sought to disarm Iraq’s weapons of mass destruction verifiably as part of the settlement. Even with UN inspectors, full verification of Iraq’s destruction of its weapons programs required Iraqi

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cooperation. Instead, Iraq sought to hinder and obstruct the inspectors and eventually expelled them from the country in 1998. Overthrowing the enemy leader and replacing him with a compliant replacement—a puppet—is one way to solve this commitment problem. During World War II, the United States and Great Britain sought the overthrow of the Nazi regime and demanded unconditional surrender because they did not believe that any negotiated settlement that left the Nazis in power would later hold. Their policy aims were the restoration of the states overrun by the Nazis, but the only way to enforce those aims was the removal of the Nazis. Regime aims are policy aims expanded to solve the postwar commitment problem. Overthrowing the enemy regime requires fighting a war to the complete defeat of the enemy, and hence is likely to be more costly than a war fought for more limited aims. Regime aims are more likely when one side has overwhelming power, as total victory over the other side is likely to be easy and not costly. The selection institutions of a state affect its war aims. Policy aims generally have the characteristics of public goods. Territory could produce either public goods or private benefits depending on the territory in question. Strategic territory can enhance the state’s ability to protect its citizens, and personal security is a public good that all states provide to their citizens. Territory with valuable resources or a productive population can produce greater state resources, which the leader can distribute as private benefits. Territorial gain from a rival could increase security if it shifts the balance of power in favor of the victor. Leaders who answer to a large winning coalition focus on providing public goods compared to those who answer to a small winning coalition, so they will be more likely to seek policy aims, strategic territory, or in the extreme seek to overthrow the enemy leader. Those who answer to a small winning coalition are more likely to seek valuable territory.The pattern of both state aims during disputes and war outcomes supports this argument (Bueno de Mesquita et al. 2003; Morrow et al. 2006). When victors impose a puppet on a defeated enemy, they prefer installing autocrats to democrats. Democratic leaders pursue policies that their citizens want, such as overturning an unpopular postwar settlement. An autocratic puppet can ignore the demands of his populace to follow the instructions of the power that installed him. The important exception to this argument occurs when the populace would like to align with their conqueror. In those cases, such as the installations of democracies in Germany and Japan after World War II, democracies align the interests of the leader in the defeated state with those of its populace and the victor. evidence on the duration and outcome of wars Bennett and Stam (1996) examine the duration of wars depending on the capabilities of the two sides, their political systems, and the military strategies employed.They find that democracies fight shorter wars, wars between unequal sides are shorter, and the interaction of military strategy has a large effect on the duration of wars. Following Stam (1996), military strategies are classified as maneuver, where a side seeks to use mobility to destroy enemy forces; attrition, where a side seeks to destroy the enemy through set-piece battles; and punishment, where a side seeks to raise the costs of war to the enemy. Bennett

432 James D. Morrow and Stam find that attrition and punishment strategies lengthen wars, although many combinations of strategies, such as both sides using punishment, do not occur in the historical record they examine. Signaling and commitment problems imply different hazard rates for war termination. Signaling processes imply constant hazard rates, as the types are commonly screened out at a constant rate. Because a side is generally indifferent between continuing and quitting in a screening equilibrium, its chance of quitting must match the costs of war the other side accumulates in the next period. This implies a constant hazard rate.11 Commitment problems imply a hazard rate that rises at first and then declines over time. Wars with commitment problems are unlikely to end quickly because a side has to win a sufficiently large victory to impose a settlement that will persist afterward. Later, the hazard rate should decline because the remaining cases have commitment problems large enough that the parties may have to fight until one side has a crushing victory. Vuchinich and Teachman (1993) report a declining hazard rate, but Bennett and Stam find that the hazard rate is not distinguishable from a constant rate once they add their other variables. Slantchev (2004) finds a declining hazard rate even after controlling for capabilities, terrain, and regime type. Stam (1996) finds similar results for these variables on the outcomes of wars. The stronger side is more likely to win. Maneuver strategies, whether offensive or defensive, raise the chance of victory, particularly against attrition strategies. Punishment strategies can be effective against attrition strategies. Terrain helps the defender. Reiter (1999) shows similar effects of strategy on decisions to initiate and escalate crises. States with maneuver strategies are more likely to initiate crises because they believe they can win if they have to fight. However, they escalate crises to war only when they face an opponent with an attrition strategy, backing off if their target has a maneuver strategy because the chance of winning is lower. Strategy during war appears to have effects before as well as during war. These results pose new puzzles. If maneuver strategies lead to victory, why do states use attrition strategies? Stam (1996) considers some possibilities. States may be forced to adopt attrition strategies after their maneuver strategy fails, such as the Germans in World War I, when the Schlieffen Plan failed.They may have limited aims for the war and not seek a total victory over their opponent. They might use an attrition strategy as a fait accompli where they occupy territory in dispute and challenge their opponent to launch a war to reverse the outcome they have imposed. Maneuver strategies are high-variance strategies, raising the chance of victory when they succeed but also posing the possibility of having one’s forces cut off if they fail. Initiators are more likely to win the wars they fight, but they must do so quickly. Slantchev (2004) first estimates the expected length of a war from the balance of military forces at the outbreak of the conflict, the reserves of each side as measured by population, and other characteristics of the war, such as the terrain fought over. This analysis estimates how long a war should last for a second analysis on how the expected duration of a war affects its outcome. That analysis finds that the longer the expected duration of the war, the worse the prospects of the initiator are. Greater reserves help the initiator because

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they allow it to overcome any early setback. Performance on the battlefield, as measured by relative battle deaths, also affects the outcome, as one would expect. An initial advantage in military forces deployed in the theater of fighting actually hurts the initiator, but large forces typically suffer more casualties. Finally, more important issues—those of national or regime survival and then territory—reduce the chance that the initiator will secure a favorable outcome because the target will fight longer and harder. Initiators’ prospects for victory are best in a short war; the longer the war runs, the more likely they will have to make concessions or accept defeat to end the war. democracies and war Democracies overwhelmingly win the wars they fight, roughly four out of five times. This rate is higher than for the stronger side (roughly 60 percent) or the side that begins the fighting (roughly 67 percent). Reiter and Stam (2002) examine four possible explanations: one, democratic leaders choose their wars carefully, fighting only when they are likely to win; two, democracies fight more effectively than other types of systems; three, democracies are more likely to support one another during wartime; and four, democracies have more productive economies. Only the first two explanations are supported by their evidence. Democracies almost always win when they initiate the war, suggesting that democratic leaders choose their wars carefully.They are more likely to win than autocracies when they are the targets of violence, suggesting that they fight more effectively than their opponents even when they do not choose the fight.They ascribe the greater fighting ability of democracies to the foundation of consent in democratic militaries, leading to higher quality militaries. Both arguments are consistent with Bueno de Mesquita et al.’s explanation (1999) of the democratic peace. Democratic leaders choose their wars more carefully than autocrats who can insulate themselves from the domestic political consequences of defeat by providing their support coalition with private benefits. Once in a war, democratic leaders also commit more of their resources to secure victory, while autocrats seek to retain military power and resources to fend off postwar challenges to their rule. Michael Desch (2002) challenges these conclusions, showing that democracy provides no advantage in “fair fights”—when the sides are roughly equal. If democracies select their wars more carefully, however, you cannot ignore the “unfair fights” because that is one of the main sources of the democratic advantage in wartime (Reiter and Stam 2003). Further, Desch’s cases focus on democracies not performing efficiently during wartime. Reiter and Stam’s claim is that democracies perform better than other systems, not that they perform efficiently.12 Slantchev’s results (2004) on why initiators must win quickly show that the advantages of democratic initiators arise from their ability to end wars quickly. In his estimation, democratic initiators fight shorter wars. In his analysis of the outcome, initiation by a democracy does not have a statistically discernible effect. Democracies prevail as initiators because they end their wars quickly, either because they choose strategies that make quick victory likely or settle for less than total victory. Their targets do not have the chance to increase their bargaining leverage by lengthening the war or are offered enough that they

434 James D. Morrow concede rather than fight on. Bennett and Stam (1998) find that democracies are much more likely to settle for draws as a war drags on; autocracies fight on with higher probabilities of eventual victory and defeat. This is consistent with the argument that small winning coalitions induce risk acceptance in their leaders. Why democracies win the wars they fight brings us to the question of politics inside states when they are at war. The domestic politics of war are closely linked to the domestic political consequences of war afterward, which I turn to now.

After the Shooting Stops Two questions are central to the postwar period. First, will peace hold? Second, what is the fate of leaders who lead their country in war? will peace hold? Eventually all wars end. The parties then face the issue of whether the peace will hold.Wars end with settlements of the issues at stake, even if that settlement is imposed or is merely exhaustion along a ceasefire line. Werner (1999) identifies and tests three different arguments for why peace fails and conflict is renewed. One, the underlying conflicts may not be solved because the war ends with the exhaustion of the two sides, not a settlement of their differences. The outcome of the issues in a war reflects the balance of forces at the end of the war, whether it is a negotiated settlement or just a ceasefire line between two exhausted combatants. Two, the losing state may seek to renegotiate the settlement later. Over time, the balance of forces may shift away from what it was at the end of the war, encouraging the loser to use its increased power to reopen the postwar outcome. Three, any agreement to end fighting has to be enforced, particularly during the early stages, when the armed forces of the two sides are separated. The settlement could fail if it does not address lowlevel violations that could trigger wider fighting. When two armies face each other across a ceasefire line, patrols may inadvertently cross that line or they may fire across it out of the fear of an unauthorized raiding party from the other side. The latter fear of violations triggering renewed fighting resembles the problem of enforcement of an agreement, commonly modeled by the prisoners’ dilemma. Werner tests these three arguments by examining the duration until the next dispute, violent dispute, or war. For the argument about unresolved issues, territorial issues are more likely to be reopened short of war, but none of imposed settlements, military stalemates, or wars ended by mediation have a statistically discernible effect on renewed demands or war. For the renegotiation argument, renewed demands are more likely if one side suffers a nonconstitutional change of government and as the difference in the growth of power of the two sides increases, with the risk of renewed war increasing with the latter as well. Costly wars with more than two countries involved are less likely to be reopened with new demands or lead to another war because both sides anticipate that another war would also be costly. Constitutional changes of government do not affect the probability of new demands or another war. For the enforcement

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argument, the hazard rate is falling, suggesting that the immediate period after the war is the most likely time for new demands and another war. Demands and particularly war are less likely when the victor imposes a new leader on the defeated state. Making the agreement clear in a peace treaty does not have a statistically discernible effect on either new demands or war. A third party guarantee of the agreement makes new demands and another war more likely, contrary to what we would expect if the guarantee remedied the enforcement problem. Fortna (2003, 2004) examined the enforcement argument in greater detail with data on post–World War II ceasefire agreements. Agreements with stronger enforcement measures last longer. Full demilitarized zones, third-party guarantees, new peacekeeping missions, joint commissions from the two sides to resolve disputes, and any formal settlement increase the stability of a ceasefire agreement.The hazard rate falls over time, implying that enforcement problems are greatest in the immediate aftermath of a war. Werner and Yuen (2005) reanalyze Fortna’s data adding variables for whether the war was interrupted by third parties and the consistency of battle outcomes. Ceasefires that interrupt wars are very likely to fail, while wars where one side consistently wins most of the battles are much less likely to fail. These two variables fit the “give war a chance” argument; peace is most likely to hold when the parties fight long enough to determine that one of them is clearly stronger than the other. Interruptions by third parties stop that process. Werner and Yuen also point out the hazard rate of the ceasefires first increases for about seven years and then declines for another seven until reaching a stable and low level. When they use models that allow the hazard rate to rise and then fall, the statistical effect of the strength of the agreement disappears. Lo, Hashimoto, and Reiter (2008) reanalyze this data after extending it back to 1914 and adding variables for regimes in the defeated state imposed by the victor. They find that foreignimposed regime change makes peace much more stable; it is the most effective tool in creating enduring peace. Forces that give states the ability to renegotiate after war pose the greatest threat to peace. Commitment issues also loom, but not as large. Enforcement issues also matter, but least of all three sources of renewed war. war and the fate of leaders War has consequences for leaders who commit their states to war. Bueno de Mesquita, Siverson, and Woller (1992) found that the risk of violent regime change, such as a coup or revolution, after a war depends heavily on whether the country in question won or lost the war and was the initiator or the target. Losing doubled the risk for the target of the war, but winning for initiators effectively eliminated the risk, while losing for an initiator doubled the risk. Higher casualties also raised the risk. Bueno de Mesquita and Siverson (1995) showed that more costly wars decreased future tenure, and winning the war increased it. They also found that the risk of removal declined with tenure in office for authoritarians but not democracies. These studies examined the effect of wars on leaders’ fate afterward. Audience costs arguments imply that leaders who take their countries into losses suffer the consequences of their failures. Bueno de Mesquita et al. (2003: ch. 9) tests

436 James D. Morrow the consequences of dispute outcomes for whether the leader of a country at the beginning of a dispute is still in power a year after the dispute ends. This analysis assumes that the political consequences of a dispute are realized quickly. Bueno de Mesquita et al. (ibid.) examine interactions of selection institutions, whether the dispute escalated to violence, and the aims of the parties. First, winning is better than a draw, which is better than losing for leaders no matter what the selection institutions are in their state.The risk of removal increases as the outcome is worse for their state. Second, the magnitude of these differences in the probability of retention is larger for systems with large winning coalitions. Losing is not good for an autocrat; removal is nearly certain for a democratic leader who loses a dispute. Third, leaders who have to use violence in a dispute raise their risk of removal. Prevailing without having to resort to violence is best for any leader. Leaders of democracies face a greater threat to their hold on power when they must use violence to defend the status quo. Fourth, leaders who answer to a small winning coalition benefit if they seek territory and prevail. Small winning coalitions induce leaders to seek territorial expansion to increase state resources and the private benefits they can offer supporters. Chiozza and Goemans (2004) challenge this view with a study of leader tenure focusing on the effects of crises and wars. They examine the effect of ICB crises on leader tenure, including separate effects for those that end in war.13 Challengers increase the chance of holding office afterward, no matter what the outcome. Escalation to war does not reduce leader tenure. Their earlier work (Chiozza and Goemans 2003) shows similar effects. Both studies find that losing is much worse for leaders than draws, and victory is better still. If the losses in war and the costs of war harm leaders’ hold on power, then leaders should anticipate these consequences during wars and try to take measures to adapt to them. George Downs and David Rocke (1994) argue that leaders whose country is losing a war may “gamble for resurrection”— take risks to turn the tide of the war and so resurrect themselves politically. States might also choose more hawkish leaders during wartime because those leaders will prosecute the war more aggressively, will be less willing to settle, and so may coerce a better deal out of the opponent (Smith 1998a). Goemans (2000) combines these ideas and argues that leaders of mixed systems, neither democracy nor autocracy, pose the greatest risk of leaders who gamble for resurrection. Autocrats can maintain power in the face of a defeat by oppressing their population, while democrats can appease a population suffering from war by offering them political concessions. Leaders of mixed systems lack the power to oppress their population but political concessions will lead to the fall of their regime. The German regime during World War I was unwilling to make concessions to the left out of the fear of losing power completely. Consequently, they sought to forestall reform and revolution by taking large risks to win the war, like unrestricted submarine warfare in 1917. Britain, on the other hand, made concessions to the working class to compensate them for the men they lost in the trenches.

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The Long-Term Trends in War Rather than reiterate the broad arguments about how bargaining failure and domestic institutions explain the outbreak, course, and aftermath of war, I turn to the explanation of long-term trends in the occurrence of war. This essay began with a description of two trends in the patterns of interstate conflict in the last two centuries. First, states fight much less frequently than they did earlier. Second, war is more lethal. How might we explain these changes? The number of democracies has grown over the last two centuries, but this change does not explain the long-term decline in war. The expansion of democracy is a recent phenomenon with noticeable increases in the number of democracies after World War II and the end of the Cold War. While these increases raised the number of democratic dyads, and so decreases the overall chance of war, it also has increased the number of democratic-autocratic dyads that have the highest chance of war.The net effect on the aggregate probability of war is unclear. A common explanation is the increase in wealth created by the combination of the spread of capitalism and industrialization. Peace pays more than war now. Azar Gat (2006: 536–42) points out the limitations of this argument and advances a variation on it (587–97). Before industrialization, production relied on muscle power, and expansion was the only way that leaders could acquire more resources and wealth. Industrialization opened an alternative path to material accumulation. Trade allows states access to resources and goods produced elsewhere without the need to directly control them. This argument, however, falters because there is no agency in it. National leaders can command even more resources, and so benefit, from conquest of industrial states as the Nazis did. Gat points to the combination of liberal democracy and industrial capitalism as key to the long-term decline in the frequency of war. The frequency of war by nondemocratic states has also dropped over the last three hundred years, even if not as much as it has for democracies. I return to how the size of the winning coalition shapes war aims. As W increases, leaders shift from territorial aims toward policy ends. Historically, the size of the winning coalition has grown first with the spread of constitutional government in the nineteenth century (Finer 1997: 1567–1608) and then with the advent of democracy and the expansion of suffrage to the working classes and women in the early twentieth century. Modern autocracies also rely on larger winning coalitions than did the absolute monarchies. The declines of territorial wars and the frequency of war are consistent with the growth of the size of the winning coalition. This period has also seen a shift from private diplomacy among kings to public diplomacy, which allows leaders to create domestic audience costs. If the former requires some risk of war to render credible signals while the latter uses the risk of removal, this shift could account for some of the decline in the frequency of war. The nature of war has also changed over time. Armies in early modern Europe were raised by military entrepreneurs with funds provided by rulers after war broke out. The modern state moved to mass armies raised by conscription with a substantial peacetime military supported through the

438 James D. Morrow ability of the state to extract resources—people and production—from society. War and state-making have been interdependent in the Western world. In the famous epigram by Charles Tilly, “[T]he state made war, and war made the state.”The growth in mobilized military power made war more lethal, primarily by increasing the number of soldiers mobilized.14 Growth in population induced by industrialization is the primary source of the growth in the size of armies; conscription plays a smaller role.The advent of the standing army in the middle of the 1600s may have reduced the frequency of war by strengthening deterrence. Bruce Bueno de Mesquita and David Lalman (1992: 129–34) show that the frequency of war dropped after Louis XIV introduced the standing army in France in 1660. The state making literature has focused on the second half of Tilly’s epigram, leaving the first half unexamined.Why did states fight so often in early modern Europe? Kings had motivation to increase state extraction of resources even when they were not at war. In a small-W system, the leader is the residual claimant of state resources. This was the era of the palaces of Versailles and Potsdam, where rulers used state resources to create their opulent lives. They did fight very often, in part because territorial expansion would add to state resources and their own power and wealth. The nature of war in early modern Europe, sieges, and incremental advantages rather than decisive battles and conquest made war more attractive to rulers. The limited nature of war in this period made it more attractive to risk-averse leaders (Fearon 1997). Neither state nor leader survival was at stake in these struggles. Leaders could wage war knowing that their losses were limited, as were their gains. The era of decisive battles with wars that ended with the occupation of the enemy capital came only with Napoleon. Decisive ways of war deterred leaders from fighting by increasing the variance of the consequences of war. It raised the risks of removal, both domestic and foreign, for leaders, again encouraging caution.

Notes I would like to thank Henk Goemans, Edgar Kiser, Margaret Levi, Dani Reiter, Ignacio Sanchez-Cuenca, Anne Sartori, Paul Seabright, Allan Stam, Franz Stokman, and Rafael Wittek for their comments on an earlier draft of this essay. 1. Powell (2002) and Reiter (2003) are two other recent surveys of this literature. 2. The multilateral wars account for much of the expansion in numbers in moving from wars to dyads at war. World War I has 44 warring dyads, World War II 230, and the Korean War 28. 3. It is indifferent between settling and fighting at its indifference point, so it could fight or settle if that point is offered. It is commonly assumed that indifferent parties accept a settlement as the other side could always offer slightly more. 4. This result is the Myerson-Satterwaite theorem on the incompatibility of private information, incentive compatibility, and ex post efficiency in bargaining. 5. See Ferejohn (1986) for an early effort examining the political control of leaders. 6. On whether democracies are more peaceful, see Benoit (1996) and Rousseau et al. (1996). 7. Jessica Weeks (2008) argues that autocracies can generate audience costs when the supporters of the leader can coordinate to remove the leader, they view backing down in a crisis as bad, and the politics of leader removal are transparent enough that

Choosing War 439 leaders of other countries understand that the autocrat was removed for backing down. She presents evidence that threats by single-party regimes and dynastic monarchies are as effective as those by democracies. 8. Oneal and Russett (2001) is the best-known example of using dispute initiation to test the democratic peace. 9. This paper, with Blainey (1988) and Bueno de Mesquita (1981), are the fonts of this research. 10. To be honest, I do not know of a paper that demonstrates this point generally. One would have to be careful about how the size of the zone of agreement is measured. Is it the space between the most resolute types of the parties (the minimum size possible), or is it the actual size of the zone of agreement between the two types playing? The former could be assessed in principle; the latter requires knowing each side’s private information. 11. To be careful, the hazard rate depends on the rate at which the parties suffer costs. If this rate fell as a war grew longer, a screening model of bargaining implies a falling hazard rate. 12. Desch’s presentation of his statistical analyses is misleading because he compares the effect of a unit change without regard to the scales of the units (Reiter and Stam 2003). 13. There are many important methodological differences between Chiozza and Goemans (2004) and Bueno de Mesquita et al. (2003). Chiozza and Goemans use a different time period, data set (ICB instead of MID), disaggregate democracies into presidential and parliamentary, and include many other control variables. They also use a Cox proportionate hazard model with a frailty parameter that allows each country to shift the hazard rate up or down. It is difficult to tell exactly which of these decisions leads to their radically different results. 14. Gat (2006: 474–76, 524–28) points out that larger modern armies are driven primarily by the growth in population; mobilization rates are not much higher in the last two hundred years than they were earlier. Rates higher than 1 percent of the population can be sustained only for short periods of time. This means that twentiethcentury armies were a larger share of the population than earlier centuries, in part because states were at war only for short periods of time. They could tolerate drawing a large share of their population into the military because it had to be done only for short periods.

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440 James D. Morrow Bueno de Mesquita, Bruce, Randolph M. Siverson, and Gary Woller. 1992. “War and the Fate of Regimes: A Comparative Analysis.” American Political Science Review 86: 638–46. Bueno de Mesquita, Bruce, Alastair Smith, Randolph M. Siverson, and James D. Morrow. 2003. The Logic of Political Survival. Cambridge: MIT Press. Chiozza, Giacomo, and Henk Goemans. 2003. “Peace through Insecurity: Tenure and International Conflict.” Journal of Conflict Resolution 47: 443–67. ———. 2004. “International Conflict and the Tenure of Leaders: Is War Still “Ex Post” Inefficient?” American Journal of Political Science 48: 604–19. Desch, Michael C. 2002. “Democracy and Victory: Why Regime Type Hardly Matters.” International Security 27, no. 2: 5–47. Downs, George W., and David M. Rocke. 1994. “Conflict, Agency, and Gambling for Resurrection: The Principal-Agent Problem Goes to War.” American Journal of Political Science 38: 362–80. Eyerman, Joe, and Robert A. Hart, Jr. 1996. “An Empirical Test of the Audience Cost Proposition: Democracy Speaks Louder than Words.” Journal of Conflict Resolution 40: 597–616. Fearon, James D. 1994. “Domestic Political Audiences and the Escalation of International Disputes.” American Political Science Review 88: 577–92. ———. 1995. “Rationalist Explanations for War.” International Organization 49: 379– 414. ———. 1997. “The Offense-Defense Balance and War since 1648.” Accessed from http: //www.stanford.edu/~jfearon/. Ferejohn, John. 1986. “Incumbent Performance and Electoral Control.” Public Choice 50: 5–25. Filson, Darren, and Suzanne Werner. 2002. “A Bargaining Model of War and Peace: Anticipating the Onset, Duration, and Outcome of War.” American Journal of Political Science 46: 819–38. Finer, S. E. 1997. The History of Government From the Earliest Times, vols. 1–3. Oxford: Oxford University Press. Fortna,Virginia Page. 2003. “Scraps of Paper? Agreements and the Durability of Peace.” International Organization 57: 337–72. ———. 2004. Peace Time: Cease-Fire Agreements and the Durability of Peace. Princeton: Princeton University Press. Gartzke, Erik. 1999. “War Is in the Error Term.” International Organization 53: 567–88. Gat, Azar. 2006. War in Human Civilization. Oxford: Oxford University Press. Gelpi, Christopher, and Joseph M. Grieco. 2001. “Attracting Trouble: Democracy, Leadership Tenure, and the Targeting of Militarized Challenges, 1918–1992.” Journal of Conflict Resolution 45: 794–817. Gelpi, Christopher F., and Michael Griesdorf. 2001. “Winners or Losers? Democracies in International Crises, 1918–94.” American Political Science Review 95: 633–47. Ghosn, Faten, Glenn Palmer, and Stuart Bremer. 2004. “The MID3 Data Set, 1993– 2001: Procedures, Coding Rules, and Description.” Conflict Management and Peace Science 21: 133–54. Gochman, Charles S., and Zeev Maoz. 1984. “Militarized Interstate Disputes, 1816– 1976: Procedures, Patterns, and Insights.” Journal of Conflict Resolution 28: 585–616. Goddard, Stacie E. 2006. “Uncommon Ground: Indivisible Territory and the Politics of Legitimacy.” International Organization 60: 35–68. Goemans, H. E. 2000. War and Punishment: The Causes of War Termination and the First World War. Princeton: Princeton University Press. Guisinger, Alexandra, and Alastair Smith. 2002. “Honest Threats: The Interaction of Reputation and Political Institutions in International Crises.” Journal of Conflict Resolution 46: 175–200.

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Huntington, Samuel P. 1996. The Clash of Civilizations and the Remaking of World Order. New York: Simon and Schuster. Jones, Daniel M., Stuart A. Bremer, and J. David Singer. 1996. “Militarized Interstate Disputes, 1816–1992: Rationale, Coding Rules, and Empirical Patterns.” Conflict Management and Peace Science 15: 163–213. Kurizaki, Shuhei. 2007. “Efficient Secrecy: Public versus Private Threats in Crisis Diplomacy.” American Political Science Review 101, no. 3: 543–58. Leventoğlu, Bahar, and Branislav L. Slantchev. 2007. “The Armed Peace: A Punctuated Equilibrium Theory of War.” American Journal of Political Science 51: 755–71. Leventoğlu, Bahar, and Ahmer Tarar. 2005. “Prenegotiation Public Commitment in Domestic and International Bargaining.” American Political Science Review 99: 419– 33. Levy, Jack S. 1983. War in the Modern Great Power System, 1495–1975. Lexington: University of Kentucky Press. Lo, Nigel, Barry Hashimoto, and Dan Reiter. 2008. “Ensuring Peace: Foreign Imposed Regime Change and Postwar Peace Duration, 1914–2001.” International Organization 62: 717–36. Morrow, James D. 1986. “A Spatial Theory of International Conflict.” American Political Science Review 80: 1131–50. ———. 1994. “Alliances, Credibility, and Peacetime Costs.” Journal of Conflict Resolution 38: 270–97. Morrow, James D., Bruce Bueno de Mesquita, Randolph M. Siverson, and Alastair Smith. 2006. “Selection Institutions and War Aims.” Economics of Governance 7: 31– 52. Oneal, John, and Bruce Russett. 2001. Triangulating Peace: Democracy, Interdependence, and International Organizations. New York: Norton. Organski, A. F. K. 1968. World Politics. 2nd ed. New York: Knopf. Partell, Peter J., and Glenn Palmer. 1999. “Audience Costs and Interstate Crises: An Empirical Assessment of Fearon’s Model of Dispute Outcomes.” International Studies Quarterly 43: 389–405. Pillar, Paul R. 1983. Negotiating Peace: War Termination as a Bargaining Process. Princeton: Princeton University Press. Powell, Robert. 1999. In the Shadow of Power. Princeton: Princeton University Press. ———. 2002. “Bargaining Theory and International Conflict.” Annual Review of Political Science 5: 1–30. ———. 2004a. “Bargaining and Learning while Fighting.” American Journal of Political Science 48: 344–61. ———. 2004b. “The Inefficient Use of Power: Costly Conflict with Complete Information.” American Political Science Review 98: 231–42. ———. 2006. “War as a Commitment Problem.” International Organization 60: 169– 203. Reiter, Dan. 1999. “Military Strategy and the Outbreak of International Conflict: Quantitative Empirical Tests, 1903–1992.” Journal of Conflict Resolution 43: 366–87. ———. 2003. “Exploring the Bargaining Model of War.” Perspectives on Politics 1: 27– 43. ———. 2009. How Wars End. Princeton: Princeton University Press. Reiter, Dan, and Allan C. Stam. 2002. Democracies at War. Princeton: Princeton University Press. ———. 2003. “Understanding Victory: Why Political Institutions Matter.” International Security 28, no. 1: 168–79. Rousseau, David L., Christopher Gelpi, Dan Reiter, and Paul K. Huth. 1996. “Assessing the Dyadic Nature of the Democratic Peace, 1918–88.” American Political Science Review 90: 512–33.

442 James D. Morrow Sarkees, Meredith Reid. 2000. “The Correlates of War Data on War: An Update to 1997.” Conflict Management and Peace Science 18: 123–44. Sartori, Anne E. 2002. “The Might of the Pen: A Reputational Theory of Communication in International Disputes.” International Organization 56: 121–49. ———. 2005. Deterrence by Diplomacy. Princeton: Princeton University Press. Schultz, Kenneth A. 2001. Democracy and Coercive Diplomacy. New York: Cambridge University Press. Singer, J. David, and Melvin Small. 1972. The Wages of War, 1816–1965: A Statistical Handbook. New York: Wiley. Slantchev, Branislav L. 2003. “The Principle of Convergence in Wartime Negotiations.” American Political Science Review 97: 621–32. ———. 2004. “How Initiators End Their Wars: The Duration of Warfare and the Terms of Peace.” American Journal of Political Science 48: 813–29. ———. 2005. “Military Coercion in Interstate Crises.” American Political Science Review 99: 533–47. Small, Melvin, and J. David Singer. 1982. Resort to Arms: International and Civil Wars, 1816–1980. Beverly Hills, CA: Sage. Smith, Alastair. 1998a. “International Crises and Domestic Politics.” American Political Science Review 92: 623–38. ———. 1998b. “Fighting Battles, Winning Wars.” Journal of Conflict Resolution 42: 301– 20. Smith, Alastair, and Allan C. Stam. 2004. “Bargaining and the Nature of War.” Journal of Conflict Resolution 48: 783–813. Stam, Allan C. 1996. Win, Lose or Draw: Domestic Politics and the Crucible of War. Ann Arbor: University of Michigan Press. Tomz, Michael. 2007. “Domestic Audience Costs in International Relations: An Experimental Approach.” International Organization 61: 821–40. Vuchinich, Samuel, and Jay Teachman. 1993. “The Duration of Wars, Strikes, Riots, and Family Arguments.” Journal of Conflict Resolution 37: 544–68. Wagner, R. Harrison. 2000. “Bargaining and War.” American Journal of Political Science 44, no. 3: 469–84. Waltz, Kenneth N. 1979. Theory of International Politics. New York: Random House. Weeks, Jessica L. 2008. “Autocratic Audience Costs: Regime Type and Signaling Resolve.” International Organization 62: 35–64. Werner, Suzanne. 1999. “The Precarious Nature of Peace: Resolving the Issues, Enforcing the Settlement, and Renegotiating the Terms.” American Journal of Political Science 43: 912–34. Werner, Suzanne, and Amy Yuen. 2005. “Making and Keeping Peace.” International Organization 59: 261–92. Wittman, Donald C. 1979. “How a War Ends.” Journal of Conflict Resolution 23: 743–63.

chapter

Rational Choice Approaches to State-Making

13

edgar kiser and erin powers

One of the most important contributions that rational choice theory can make to the social sciences is discovering the causal mechanisms and tracing the processes responsible for the initial formation of institutions. The structure of rational choice theory, building from simple assumptions about individual action toward macrolevel outcomes, is especially useful for explaining the emergence of institutions. The purpose of this chapter is to provide a summary and critical appraisal of rational choice accounts of the making of political institutions. We will employ a broad definition of rational choice theory, including everything from standard rational choice models in economics (see Becker 1976 for examples) to the broader and more inclusive versions employed in sociology (see Hechter and Kanazawa 1997). We devote some of the chapter to describing profitable areas for future study and analysis, point to several directions in which the scope of rational choice work on state-making could be expanded, and show how it could contribute to the resolution of ongoing debates in many disciplines. The general and interdisciplinary nature of rational choice theory makes it well suited to both intervening in debates about state-making in particular eras, and tying them together by showing the similar causal mechanisms at work in different times and places. We also discuss work in other theoretical traditions that is implicitly rational choice in its theorizing, and review cross-disciplinary empirical research that is conducive to rational choice analysis. We argue that the impact of rational choice has been much broader than is usually recognized, because many rational choice causal mechanisms are essential to arguments that are not labeled as rational choice, including some that explicitly repudiate rational choice theory. Two types of theories that have dominated analyses of statemaking in sociology are especially important in this respect. First, versions of macrosociological materialist analyses are compatible with rational choice since they usually implicitly use rational choice microfoundations (see Elster 1985 on “Analytical Marxism” and Taylor 1988 on Skocpol 1979; Hechter and Kanazawa 1997; Goldthorpe 2000). Second, Weber (1978: 6) argued that theorists should begin by assuming instrumental rationality for methodological

444 Edgar Kiser and Erin Powers reasons, and many of his arguments (including those about the state), and thus those of many contemporary Weberians, are based on this assumption and thus compatible with rational choice (see Kiser and Hechter 1998; Kiser and Baer 2005).1 State-making has occurred throughout history, so the empirical scope of our survey will be broad. We begin with the initial formation of states from tribal chiefdoms in several parts of the world, then turn to the formation of the first “modern” states in the medieval and early-modern eras (primarily in Europe), and transition into issues of contemporary state-making in Africa, Latin America, and Eastern Europe. We conclude by assessing the strengths and weaknesses of extant rational choice work in each substantive area, and suggesting promising avenues for future research. The sweeping empirical scope of this chapter is necessitated by the topic, and moves us beyond the pervasive Eurocentrism in this area, but is also useful in that it allows us to explore the extent to which similar causal mechanisms are operative in these very different contexts. The cross-disciplinary aspect of the chapter is also empirically necessary, since the first set of cases is discussed mainly in anthropology, the second mainly in history and comparative-historical sociology, and the third primarily in political science and area studies. The breadth of our focus requires a broad definition of the state—how else could the Aztec state, medieval England, and contemporary South Africa be included in the same category? We will thus define the state simply (and, unfortunately, loosely) as an institution with sufficient centralized control of both rule-making and coercive power to generally enforce rules in a given territory.2 We also want to explain differences in the types of states that are formed—whether they are strong or weak, autocratic or democratic, centralized or decentralized, patrimonial or bureaucratic. Therefore, in addition to discussing state formation generally, we will focus on the development of voting institutions and on the centralization and bureaucratization of political institutions (using models of credible commitments for the former and agency theory for the latter). Although each period of state-making we analyze is in some respects unique, many general causal variables and causal mechanisms recur across our cases, and theoretical debates within rational choice and between it and other theories often have similar themes. With respect to microfoundations, some scholars see the process of state-making as a zero-sum game between actors maximizing power, whereas others view it as a positive-sum game between actors interested primarily in maximizing wealth. At a more macro level, perhaps the most consistent difference across theories is between scholars who see the state as emerging to solve collective action problems, create credible commitments, and provide public goods, and those that view the state as an institution created by some groups to suppress or exploit others. Several of the best rational choice models combine the two, often by viewing rulers as maximizing some combination of wealth and security of rule, and viewing games between rulers and subjects as mixing cooperation and conflict. Finally, it is important to analyze the structural context within which state-making occurs. Warfare plays the largest role across our historical cases, but environmental factors, international trade, and class conflict are also important in several instances.3

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Initial State Formation: From Implicit to Explicit Rational Choice Analyses We begin at the beginning, with the formation of initial (sometimes called “pristine”) states in several parts of the world (Mesopotamia, China, Mesoamerica, and Peru; some include Egypt and Minoan Crete as well).4 There are ongoing debates about the causes of the initial formation of states,5 and although almost none of the protagonists define themselves as rational choice theorists, all of the major arguments use rational choice causal mechanisms (among others). The microfoundations of these theories are often implicit and always underdeveloped, so we will elaborate this aspect of these arguments in this section and throughout the chapter. The earliest debates in the anthropological literature pitted functionalist (called integrationist or consensus) theories against various versions of conflict theories. The distinction between these two types of theory is not as clear as one would guess, since the functionalist theories often argue that elements of conflict initiate the state formation process, and both camps include heterogeneous arguments. The main distinction seems to be that the functionalist/integrationist theories see the state as willingly chosen by the people, acting primarily in their interests, and having some legitimacy as a result. In contrast, conflict theories tend to depict the state as ruling by coercion alone in the interests of a small subgroup of the population. In part as a result of the looseness of the distinction between these two camps, synthetic theories combining elements of each have come to dominate the anthropological literature on initial state formation.6 The anthropological literature on state formation draws from classics of political philosophy; one of the earliest conflict theories developed out of the Marxist tradition that viewed states as reflections of class conflict. Engels (1942) argued that increasing stratification produces economic winners (a ruling class) and losers, and the winners use the state as an instrument to protect their economic position and property. The role of initial states was the same as all class-based states that followed them: to use coercion and ideology to allow exploitation of one class by another. Childe (1936) and Fried (1967) developed this argument further, tracing the development of class stratification to the rise of agriculture (which allowed the accumulation of surpluses not possible in previous economic systems) and the decline of kinship systems as the main form of social organization. This argument is a classic form of “Analytical Marxism” (Elster 1985) with self-interested corporate actors maximizing their wealth and power, but the rational choice microfoundations are not made explicit. As is often the case when the microfoundations of an argument are left implicit, the argument made by Childe (1936) and Fried (1967) is underdeveloped at key points. Most important, it is unclear why the state is not also viewed as an independent actor with its own interests, instead of only a passive instrument in the hands of the dominant class. The argument also rests on an empirical claim that is disputed, that class stratification preceded the development of the state (Haas 1982: 52–53; Winzeler et al. 1976; Brumfiel 1983). Functionalist/integrationist theories basically argue that the state arises to

446 Edgar Kiser and Erin Powers solve various collective action and public goods problems, although they do not use this rational choice language.7 Generally as a result of increases in the size and complexity of society (but sometimes because of external military threats), the demand for a centralized institution that could provide social order internally and defense externally increased. The state arose principally to satisfy this demand and for purposes of redistribution—chiefs would facilitate the process of storage and distribution of food (Malinowski 1926; Service 1975). These theories thus turn Engels on his head: states take from the rich in order to give to the poor (or, intertemporally, they take in good times and redistribute in bad). Other consensus theories argue that the state arose to facilitate trade (Rathje 1971; Wright and Johnson 1975) or to manage irrigation, a public good critical for agriculture (Wittfogel 1957; Kipp and Schortman 1989). Many functionalist theories also stress the importance of ecological factors— principally enclosure. The two types of enclosure referenced are environmental circumscription—more habitable land surrounded by less habitable land— and “social” or military circumscription, which entails being surrounded by more organized, and therefore threatening, tribes. In a given environment, if demographic pressures increase the size of societies at the same time that mobility is constrained by circumscription, this will heighten intergroup competition and create incentives to make war in order to gain additional resources (Carneiro 1970).8 States are thus formed to pursue this potentially profitable project more effectively. If this account is right, then war is not the consequence of class-divided society as Fried (1967) and other class-based conflict theories argue, but rather war-making creates the conditions for social classes to emerge in primitive societies.9 The main problem with this argument is empirical; several anthropologists have demonstrated that population pressure was not a precondition for state formation (Brumfiel 1983; Stanish 2001), and environmental circumscription may not have been either (Webster 1975).10 Theories that see war as the main causal mechanism producing states came from both conflict and consensus camps, and indeed war is generally viewed in anthropology as the single most important factor in the initial formation of states (Claessen and Skalnik 1981: 474). Herbert Spencer (1876) developed an early version of this argument from a functionalist (public goods) perspective, arguing that the state arises through the general process of social differentiation as an institution specializing in military activities, and expands its functions from there. Conflict versions of militarist theories also suggest that the state originated in warfare (Oppenheimer 1975). Elementary state structures arise to organize collective violence and distribute booty, conquered territories, and slaves (Lenski 1966; Keeley 1996). Militarization was also responsible for secondary state formation, as neighboring tribes were forced to centralize rule in order to defend against encroachment by expansionist states. This process produces conglomerate states, as governing structures are forced on the losers by the winners of wars, and used primarily to repress the vanquished. As Nisbet (1976: 101) puts it, “[T]he state is indeed hardly more than the institutionalization of the war-making apparatus.” This argument about war and state-making is also prominent in theories of the formation of medieval and early-modern states, as discussed below. The anthropological literature has identified several factors—war,

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demographic pressure, stratification, long-distance trade—associated with early state formation. What the field lacks, however, is a theory to arbitrate between the cumulated case studies emphasizing particular variables. Claessen and Skalnik (1981: 484) describe the issue as follows: [No] single variable or combination of variables can be used to formulate an effective theory of early state origin. It does not seem probable that another case study, or a number of case studies will reveal a combination of particularistic variables explaining all cases.Therefore, the primary problem appears to be one of theory, not one of more data.This theory must address the question of why states develop . . . [italics in original].

Rational choice theory would thus appear well positioned to contribute to the study of early state formation. In fact, two prominent theorists have developed explicit rational choice arguments about the initial formation of states. Both build on existing theories, but by making the rational choice microfoundations of the arguments more explicit they are able to show more clearly how changes in structural conditions lead to the emergence of states. First, North (1981) agrees with the anthropological consensus view that the formation of states was triggered by the shift to settled agriculture. He argues that this shift made collective decision-making more difficult because of the increasing size and complexity of society, and that the state evolved to mitigate this difficulty. This argument clearly shows how rational choice microfoundations can help fill in arguments in the consensus tradition. Increases in the size and complexity of society increase the costs of not resolving collective action problems. States arise because they are institutions uniquely suited to coordinating group activities. A second rational choice argument about initial state formation comes from Olson (2000: 6–13). He begins by using an analogy between the state and organized crime (see Lane 1958 and Tilly 1975 for earlier arguments developing this analogy). He suggests that states emerge when “roving bandits” discover they can gain more wealth by using their advantage in coercive power to take over one area permanently and become “stationary bandits.” Although this sounds like a classic conflict argument up to this point, Olson stresses the fact that the stationary bandit will not be purely predatory. The bandit (now an autocratic leader of a state) will find that he can maximize his wealth by limiting the amount he steals (now called taxes) and even by providing some public goods so that he will have more to steal in the future (because he is now stationary, his discount rate is lower). For this reason, the people find that they prefer this stationary bandit to any roving bandits, and the state even begins to gain some legitimacy (just as people prefer Hobbes’s Leviathan to the anarchic state of nature in which everyone is a roving bandit). Olson thus ingeniously combines conflict and consensus arguments.11 The literature on early state formation illustrates the ways in which theoretical frameworks not associated with rational choice theory draw on rational choice reasoning and causal mechanisms. It also shows that the failure to be explicit about microfoundations leaves arguments incomplete and often results in sloppy analysis. Recent work from a rational choice perspective (North 1981; Olson 2000) has begun to address these problems, and it is clear that the emerging synthetic work on initial state formation could benefit from incorporating rational choice theory more explicitly. The main limitation to

448 Edgar Kiser and Erin Powers progress in this area is the scarcity of data on the societies in which initial states emerged, and that situation is unlikely to change, making unified general theory like rational choice all the more important.

The First Phase of the Formation of European States:The Origins of Representative Voting Institutions in Medieval Europe We turn now to arguments about the formation of the modern state. One of the most important aspects of the modern state is representative voting institutions, so any discussion of state formation must explain their origins. Since the modern version of representative voting institutions originated in medieval Europe, arguments about medieval state formation have tended to focus on these institutions.12 We begin with the initial development of voting institutions in medieval states, focusing especially on the first and most durable, the English Parliament. Debates about the formation of voting institutions in medieval states are in many ways similar to those about initial state formation. They can be divided into two groups, one stressing power and conflict and the other focusing on cooperation and efficiency (although the latter do not take the functionalist form common in the literature on initial state formation). The first of these is not explicitly rational choice (although it employs rational choice causal mechanisms), whereas the second is. The basic argument made in the macrosociological power/conflict tradition is that voting institutions arise only when autocratic rulers are too weak to maintain their monopoly on decision-making power. They begin by assuming corporate actors (states and classes) with different interests (given by their structural positions) involved in zero-sum games (Weber 1978: 1013, 1087; Bendix 1978: 189; Hintze 1975: 309, 313; Poggi 1978: 36–37, 47; Downing 1992: 225; Tilly 1990: 64). For example, Weber (1978: 1057, 1352) argues that medieval rulers bargained with subjects in voting institutions only when they lacked the power to coerce tax payments from them beyond their customary feudal obligations. Weber’s focus on the power of rulers relative to subjects has influenced many contemporary scholars. Blockmans (1978, 202–3) and Poggi (1978: 36–42) argue that representative voting is likely to emerge when towns become powerful relative to rulers.13 Tilly (1990) claims that representative voting emerges as a result of military pressures created by competing states in Europe, and supports Blockmans’s and Poggi’s suggestions that the main differences in the form and persistence of voting institutions are caused by variations in the strength of towns. There are serious empirical problems with the power/conflict argument. The historical record shows that voting institutions initially developed in both England and France under relatively strong rulers (Strayer 1956: 18; Major 1960: 16; Barzel and Kiser 1997). Moreover, English rulers were far more powerful than their French counterparts prior to the development of voting institutions (Lewis 1972: 3), but voting developed first and was strongest in England. In addition, the rise of towns was not independent of the rulers but rather took place with their consent and under their charters (from which they profited handsomely). The fundamental source of these empirical problems is the insufficient attention to microfoundations in these arguments. All of them

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implicitly assume that the interests of monarchs and powerful social groups (primarily aristocrats) are always irreconcilable, and that these actors are thus involved in zero-sum games with no possibility of cooperation. Although it is of course true that the interests of these actors did often conflict, a more fully developed rational choice analysis would also allow for the possibility that they might find ways to make cooperation mutually beneficial and thus make their zero-sum game positive-sum. A second type of argument, coming explicitly from rational choice theory, does just that. It suggests that rulers and subjects are rational actors maximizing a combination of wealth and security, and argues that voting institutions such as the English Parliament and the French Estates General emerged as an unintended outcome of wealth-seeking by rulers and subjects (Kiser and Barzel 1991). In the context of the Middle Ages, national voting institutions were mechanisms that allowed rulers and subjects to cooperate with each other on mutually profitable projects by enabling rulers to make credible commitments to subjects.The stress on the need for credible commitments in the relationship between rulers and subjects has created a new view of the state that models conditions in which rulers will willingly cede power to some of their subjects (North and Weingast 1989; Root 1989; Bates and Lien 1985; Kiser and Barzel 1991; Barzel and Kiser 1997). Barzel and Kiser (1997) note that an autocratic ruler who maximizes wealth and security of rule can gain wealth by cooperating with subjects on joint ventures such as war and defense.14 Rulers will choose to share residual claimancy15 with participating subjects in projects like war to provide their partners with adequate incentives to ensure sufficient effort.Voting institutions are created to help resolve three sets of problems that arise in joint ventures between rulers and subjects: decision-making by multiple individuals, rulers’ confiscation of subjects’ gains, and subjects’ confiscation from each other.16 One function of voting institutions is to facilitate the collective action needed for the choice and management of large projects such as war. By expressing the view of the majorities, voting institutions provide information to rulers on the projects that generate benefits to voters in excess of their contributions (taxes). The second potential problem in these joint ventures is rulers confiscating from subjects. By providing an organizational basis for collective action, voting institutions decrease the threat of confiscation by the ruler, and thus contribute to the ruler’s ability to make credible commitments. Since the ruler is more powerful than any individual subject but not more powerful than all of them, his commitments can be made credible if he can facilitate subjects’ collective action. Third, subjects with voting rights must guard against confiscation by each other. This problem will be avoided by linking the amount paid in taxes to the amount of benefit received as a result of the policy. Continual, frequent meetings create a repeated game situation that raises the costs of confiscation and increases the incentives for cooperation. In order to function effectively, once the vote is taken, all beneficiaries must be forced to pay their share of the project. Not only is this use of coercion consistent with the voluntary nature of participation, it is a necessary condition for it.17 Like the literature on initial state formation, the main debates about state formation in medieval Europe are between models of conflicts over power in

450 Edgar Kiser and Erin Powers zero-sum games and models of mixed cooperation and conflict in positivesum games. In both cases, the latter seem more promising. The rational choice arguments made by Bates and Lien (1985) and Kiser and Barzel (1991) in the medieval context are in this general respect very similar to Olson’s analysis (2000) of initial state formation—they show that rulers interested in both wealth and security of rule are able to create political institutions that facilitate cooperation with their subjects in the production of public goods. At the macro level, theories of state-making in both eras see war as one of the most important facilitating factors.

The Second Phase of the Formation of European States: War and State-Making Early-modern state formation (roughly 1500 to 1789) is largely synonymous with centralization and, in some cases, partial bureaucratization of state functions and institutions, as states take over military, judicial, and revenue collection duties. As with initial state formation and the development of voting institutions in medieval states, there are several different theoretical arguments that either implicitly or explicitly draw on rational choice theory. After discussing Adam Smith’s interesting analysis of early-modern state formation, we turn to general arguments about war and state-making. The final section uses agency theory to explain the bureaucratization of states, one of the most important aspects of the formation of modern states. The first and in many respects still the most interesting argument about early-modern state formation comes from Adam Smith (1976 [1776]). He sought to explain the transition from a feudal system in which coercive power was decentralized (in the hands of many aristocrats) to the centralized coercive apparatus of the absolutist monarchy. Why, he asked, would rational, selfinterested aristocrats give up their military power? Perhaps not surprisingly, Smith locates the answer in the market. The rise of foreign trade makes many new manufactured goods and luxury items available to the nobility. This expansion of their choice set gives them the option of continuing to spend much of their money on feeding, housing, and arming a band of military retainers (the source of their coercive power) or buying luxury consumption goods for themselves. Smith argues that because people generally prefer to spend money on themselves than on others, nobles chose luxury goods over maintaining military retainers. In Smith’s unforgettable language, these aristocrats traded their military power for shoes with diamond buckles, and the result of their choice was that the central state was left with a monopoly of coercive power. The aristocrats Smith discusses are basically making the same sort of choice as the monarchs analyzed by Kiser and Barzel (1991)—ceding some of their power in order to increase their wealth—although in this context the outcome is very different. Most contemporary arguments about the formation of early-modern states focus on the role of war. Some of this work is explicitly rational choice, and some is macrolevel structuralist analyses consistent with rational choice theory. In comparative-historical sociology, the neo-Weberian, state-centered argument that war made states has now clearly supplanted the Marxist argument focusing

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on economic structure and class power. In this section we address how and to what extent interstate military competition affected the formation and the structure of early-modern states, discussing how rational choice accounts relate to macrosociological work in the field. Some of the first arguments about war and early-modern state-making come from rational choice theorists. Bean (1973) begins with the assumption that states are in many ways similar to economic firms, and thus argues that in both cases shifts in technology led to changes in optimal size.The shift from the small political units of the feudal system to the much larger ones of absolute monarchies was the result of changes in military technology. The increase in the importance of infantry and the use of cannons gave larger political units competitive advantages over smaller ones, and, in addition, competition between units eventually caused all to increase in size or be eliminated (Tilly 1975 makes a related argument).18 Ames and Rapp (1977) argue that the advent of “seemingly permanent war” increased subjects’ demand for protection and thus induced them to cede power to absolute monarchs. Similarly, North (1981) argues that subjects’ dependence on rulers for defense from external threats enabled rulers to extract high taxes and engage in rent-seeking deals with subjects, producing inefficient property rights. Hechter and Brustein (1980) develop an innovative argument that combines Marxist and rational choice mechanisms.They assume that the state is a revenuemaximizing institution providing public goods (protection and justice). If this is true, states should arise in regions with the most political divisions and thus the least commonality of interests between powerful actors. In such situations, both groups can make credible threats to harm each other, providing each an incentive to cede power to a state to prevent this outcome. Therefore, states formed in Europe in the sixteenth century in regions that had been dominated by the feudal mode of production, since both nobles and the rising bourgeoisie were powerful and antagonistic there. Arguments about the relation between war and early-modern state formation have been most developed by comparative-historical sociologists working outside the rational choice tradition, especially Charles Tilly. Tilly (1975, 1985, 1990) argues that “war made states” in the early-modern era (see also Mann 1986). Perhaps the most important contribution of this historical sociology literature is empirical, using detailed narratives and comparative analysis to show the impact of war on state-making in many different cases. Two recent elaborations of the war and state-making argument show how the timing and type of warfare are important for state formation. The first (Ertman 1997) implicitly assumes rational actors; the second (Kiser and Linton 2001) does so explicitly. Ertman (1997) argues that the timing of the onset of sustained geopolitical competition determined the form of state administration. States that faced frequent warfare prior to about 1450 tended to construct patrimonial administrations, whereas those that experienced war only after 1450 developed more effective bureaucratic systems. States that were forced by war to develop early had to use older and less effective institutional arrangements, had a limited supply of trained personnel, and had only two cultural models of organization available to them (ecclesiastical and feudal). This argument explains why they initially used

452 Edgar Kiser and Erin Powers patrimonial administrations characterized by proprietary offices (venal offices and tax farmers), but not why those systems persisted for centuries in spite of the existence of what Ertman claims were more effective alternatives. Here Ertman relies on a very strong version of path dependence—once patrimonial officials became entrenched, they were generally powerful enough to block any reforms, so the choices made by medieval rulers determined the administrative forms of their states for the next five or six centuries. The structure of this argument is essentially the same as the power/conflict argument about the development of voting institutions, except that in this case the main conflict occurs within the state administration. The second recent work on the timing of war and state formation explicitly uses rational choice theory. Kiser and Linton (2001) use statistical analyses of early-modern England and France to show that individual wars did not lead to the growth of the state in early-modern Europe, but that the cumulative effect of long periods of war created large states. This provides empirical support for the argument made by Ames and Rapp (1977) that state formation was the result of permanent warfare. Moreover, warfare did not lead to state growth in all conditions. The process was intensified when administrative centralization increased the extractive capacity of states. This rational choice account more precisely specifies the causal mechanisms linking war and state-making. The multiple effects of war on state formation is the main theme in the literature on early-modern state formation, as it has been in the prior two sections. Initially, this literature was dominated by macrosociological arguments that have much in common with the power/conflict theory of the development of medieval voting institutions. These arguments did a great job of discovering the main macrolevel causes of early-modern state formation, but they were not very good at elaborating the specific causal mechanisms producing this relationship. Rational choice arguments are now beginning to do this (Ames and Rapp 1977; Hechter and Brustein 1980; North 1981; Kiser and Linton 2001), both theoretically and empirically, but there is still a lot of theoretical and empirical work necessary to develop more detailed accounts of this important historical process.

The Formation of Centralized Bureaucratic States: An Agency Theory Bureaucratization is one of the most important parts of the formation of modern states because bureaucracy provides the main organizational structure of developed modern states. In fact, the transition from patrimonial to bureaucratic state structures is often thought to be the most important defining feature of modern states (Weber 1978). Agency theory provides a useful model of the structure of the state, and can be used to analyze the causes of bureaucratization (Kiser 1994; Kiser and Schneider 1994; Kiser 1999; Kiser and Kane 2007). Rational choice work in this area begins by assuming that all actors are rational and self-interested, and models tax collection systems as agency relations in which the ruler is the principal and state officials, to whom authority to carry out state policies is delegated, are agents (Kiser 1994; Kiser and Tong 1992). Applying this model to taxation, rulers are interested in maximizing net tax

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revenues (given the tax rate), officials try to maximize the sum of their legal and corrupt income from tax collection (minus the costs of sanctions for corruption), and taxpayers attempt to minimize the sum of their tax payments and penalties for tax evasion. Rulers’ interests in maximizing the flow of net revenues are composed of a short-term interest in maximizing current net revenues and a long-term interest in increasing the tax base. These two interests can conflict, therefore the discount rates of rulers (the rate at which they discount future gains or losses relative to current ones) sometimes influence their actions (Levi 1988; Kiser 1994). The goal of the principal is to create a situation in which the maximizing behavior of the agent conforms to the principal’s objectives by developing mechanisms to monitor and sanction the agent’s actions at as low a cost as possible to the principal (Jensen and Meckling 1976; Hechter 1987; Kiser 1999). Since principals do not have perfect information, the mechanisms they create to control agents are not always optimally efficient, and they often produce unintended consequences. Under different conditions rulers will use different forms of agency relations (patrimonial versus bureaucratic forms of recruitment, monitoring, and sanctioning). Whether rulers choose different types or aspects of patrimonial or bureaucratic administration depends first and foremost on their monitoring capacity. When monitoring is poor, stronger sanctions are necessary to compensate (Becker and Stigler 1974). Since bureaucracy relies on fairly weak positive and negative sanctions (fixed salaries and the threat of dismissal), it will be efficient only when monitoring capacity is well developed.19 Monitoring capacity in turn is affected by several factors. The cost and difficulty of monitoring agents vary with the size, geography, and climate of a country. The effects of size and the environment on the efficiency of tax collection are contingent on the level of development of technologies of communications, transportation, and information processing, since these technical factors determine the ease with which principals can acquire information about agents (Weber 1978: 224; Kiser 1994). The better these technologies, the greater the monitoring capacity of rulers, and thus the greater the development of bureaucracy. Agency theory allows us to explain a great deal of the variation in the formation of bureaucratic states (Kiser and Cai 2003; Kiser and Baer 2005). England developed aspects of bureaucratic administration (especially in excise taxation) prior to other European states (Brewer 1989), mainly as a result of its relatively small size and more rapid development of effective communications and transportation systems (Geiger 1994: 19; Szostak 1991: 55–57). Technological shifts also explain the general temporal pattern of bureaucratization because of their effects on monitoring capacity. Most civil administrations bureaucratized in the eighteenth and nineteenth centuries. The reason for this is that transportation speeds began to increase significantly only in the late eighteenth century: prior to that time early-modern states could move information and officials no faster than they could in the Roman Empire (Braudel 1949: 369; Wachter 1987: 96). War affects the form of agency relations between rulers and officials, and thus levels of bureaucratization (Weber 1978: 291, 966; Tilly 1990; Kiser and Schnieder 1994; Ertman 1997; Kiser and Cai 2003).There are two very different

454 Edgar Kiser and Erin Powers rational choice arguments about the effect of war on bureaucratization.20 First, war tends to increase the discount rates of rulers because it threatens their security of rule, making them more likely to alter tax administration to produce short-term increases in revenue at the expense of long-term efficiency (Levi 1988). For example,Weber (1978: 966) saw the sale of offices as primarily caused by war: “[T]he direct purchase of offices . . . occurs when the lord finds himself in a position in which he requires not only a current income but money capital—for instance, for warfare or debt payments.” War increased the sale of offices in early-modern Continental Europe (Swart 1949: 21), creating an entrenched group of officials that blocked reforms. In England, with far less military pressure because of its insular geography, the sale of offices was much less common (Brewer 1989: 20–24). On the other hand, war can also facilitate the transition from patrimonialism by breaking the power of entrenched officials to block reforms (Kiser and Schneider 1994). Bureaucracy did not always develop when structural conditions made it more efficient than patrimonial alternatives—the role of power must also be considered. If the support of powerful groups is necessary for security of rule, these groups can often obtain a monopoly of profitable positions in the tax administration (what Weber [1978: 1058–59] called closure).21 Because meritocratic bureaucratizing reforms would break their monopoly on positions and remove many lucrative opportunities for corrupt profits, groups with entrenched power often blocked them. Long and devastating wars, or those resulting in severe loss, can sweep away entrenched powerful agents.22 External pressures that both reveal the necessity for reform and redistribute power to facilitate it can enable drastic change in which much of the existing administrative structure is removed. This explains, for example, the very early bureaucratization of the Chinese state in the Qin era (221–206 B.C.) (Kiser and Cai 2003).The Chinese aristocracy was dislodged from its profitable position in the patrimonial state several centuries before its European counterparts. Kiser and Cai (ibid.) show that the duration and severity of warfare in the Spring and Autumn period (722–481 B.C.) and the Warring States era (480–221 B.C.) devastated the aristocracy, literally killing the main barrier to administrative reform. This paved the way for the development of a partially bureaucratic administration.23 Agency theory illustrates the power of rational choice models to explain variation across types of state formation. By facilitating the analytical disaggregation of the state, agency theory allows us to explain spatial and temporal differences in the transition from patrimonial to bureaucratic states. War again plays a major role in the process, but it has multiple and contradictory effects on bureaucratization—a negative effect through increasing the discount rates of rulers and a positive effect through breaking the power of entrenched patrimonial officials. One of the current limitations of this literature is a failure to specify fully the conditions under which each of these causal mechanisms will be strong or weak, which is necessary for predicting the effects of war on the formation of bureaucratic states.

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Contemporary State Formation: Latin America, Africa, and Eastern Europe In this section we discuss issues of modern state-making in regions that experienced colonial or socialist rule, specifically sub-Saharan Africa, Latin America, the former Soviet Union, and Eastern Europe. Unfortunately, there is not a large literature on state formation in these cases, and little of it uses rational choice theory.24 However, looking at contemporary state formation is still useful because it allows us to explore the dynamics of the process in very different contexts. These cases of state-making differ from their premodern predecessors in significant and theoretically interesting ways. Most important, the role of path dependence, a concept developed by rational choice theorists (David 1985; Arthur 1994), is especially strong in contemporary state-building. With the exception of the initial formation of states in tribal societies, all state formation has in fact been the transformation of prior political institutions, but contemporary cases highlight this fact. Most scholars argue that the formation of states in postcolonial states is better understood as the very partial transformation of colonial states. Relative to earlier episodes of statebuilding, war played a much smaller role in contemporary state formation, and internal heterogeneity and conflicts played a larger role. The timing of state formation was dramatically condensed, and in some cases is far from completed, which allows us to explore factors that impede the process of state formation and consolidation. Geographical and environmental factors are also more heterogeneous in these cases, and often had significant effects on state-making, as they did on initial state formation and early-modern bureaucratization. The role of colonialism/foreign occupation varies widely across our cases. It ended almost two centuries ago in Latin America, about half a century ago in most African states, and less than a decade ago in Eastern Europe.25 The effects of colonialism are seen most dramatically in Africa, because of a combination of its duration and the recent independence of most states on the continent. The new leaders of African states had two choices at the end of the colonial era: completely dismantle the colonial state structures inherited in most cases from Britain or France and build new states from scratch, or retain the basic structures of the colonial states and staff them with new personnel. In almost all cases—particularly “extractive” economies rather than those based upon agricultural production (see Boone 1998)—they chose the easier solution, working with existing colonial structures (Ake 1991). Fatton (1990) argues that colonialism had two main consequences: normal class development was prevented (most important, there was not a strong indigenous bourgeoisie, which Moore [1966] argued was essential for democracy), and the African people were mired in relations of dependence for decades of colonial rule. In contrast to this, some scholars argue that the effects of colonialism on state formation in contemporary Africa have been overstated. Herbst (2000) notes that colonial states were not strong and did not penetrate the societies they ruled beyond controlling capital cities and commodity exports (see also Bates 2001). In Latin America, because many states have been independent since the

456 Edgar Kiser and Erin Powers 1830s, and the period of war and conflict that lasted for most of the nineteenth century wiped out most vestiges of colonial rule, the colonial legacy plays much less of a role (López-Alves 2000). There is less consensus about the consequences of foreign rule in former Soviet states and Eastern Europe, in part because of the complicating factor of socialism. Studies of post-Soviet states such as Ukraine (Motyl 1997; Kuzio, Kravchuk and Anieri 1999) note that its lack of independent state institutions has hindered its state-making process.26 As a former republic of the highly centralized Soviet Union, the new Ukrainian state faced unique challenges after Soviet collapse. Most significantly, Soviet centralization meant that Ukraine lacked “indigenous” civil servants (since these posts had been filled by Moscow) and autonomous political institutions. In such situations, the state truly must be formed anew. We are beginning to see more work on postsocialist state formation that is rational choice in its approach. For example, Smith and Remington (2001) show that the situation is very different in the heart of the former Soviet Union, Russia.Their analysis of the formation of the Russian Duma (the country’s lower parliament and most significant voting institution) shows that it was highly path dependent, keeping many of the structures and practices of the old Russian Supreme Soviet that preceded it.The institutional features and practices that were changed can easily be accounted for by the electoral interests of the legislators who created it. Even in the postcolonial period, developing states’ current ties to more powerful states and economies have shaped their trajectories in several ways. For example, it is hard to analyze the ongoing process of state formation in Africa without addressing the role of other states and international organizations. African state-building has been affected by Cold War geopolitics in its early phase and by the resources provided by international organizations such as the World Bank and IMF in the most recent phase. Grants from these organizations typically come with strings attached, dictating aspects of state structure and state policies, so state formation itself is in important respects controlled externally. Perhaps most important, when states can get revenue from external sources (or from their control of internal natural resources), they have lower incentives to bargain and cooperate with societal groups.27 This inhibits state consolidation and democratization, since it obviates the need for bargaining with social groups over taxation that led to the creation of voting institutions in Europe (as discussed in the section on medieval state formation, above) (Bates 2001). War, the most important factor in the formation of premodern states, has played much less of a role in contemporary state formation. Centeno (1997, 2002) shows that war did not impact state-making in Latin America the way it did in early-modern Europe (see also López-Alves 2001), and Herbst (2000) argues that war was not a prominent factor in African and Latin American state development. The same is true of postsocialist states in Eastern Europe, although their independence has been attributed to the end of the Cold War and the decline of the Soviet Union. In a study of postcolonial states in Africa, the Middle East, and Asia from 1975 to 2000, Thies (2004) also finds little support that war affects contemporary state-making, but he argues that external rivalries may have served a similar function. Since warfare also often unifies groups against external enemies, the relative lack of it in these cases could also limit state legitimacy and nation-building.

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Instead of being shaped by external warfare, contemporary state formation has often been shaped by ongoing internal conflicts based on religious, racial, ethnic, linguistic, and tribal divisions. The Latin American case is especially interesting in this respect, as scholars agree that state formation has been shaped and distorted by internal conflict (Adelman 1998; Centeno 2002). These internal conflicts kept most Latin American states infrastructurally weak (in spite of despotic power in many cases) and decentralized, unable to collect taxes or maintain order in many provinces (Centeno 2002; López-Alves 2001). Some of the postsocialist states in Eastern Europe have also been torn by conflict, with the former Yugoslavia being the most prominent example. In Africa, many internal divisions coincide with an urban-countryside cleavage that hinders consolidation of state power, not to mention development (Boone 1998; Herbst 2000). To some extent these conflicts predated colonialism, but in the African case especially they were exacerbated by the construction of artificial state boundaries reflecting the interests of colonizers rather than natural divisions on the continent.28 These conflicts have often been worsened by the use of patronage systems favoring some groups and excluding others, a function of the patrimonial nature of many African states.29 As we noted above, the availability of external revenue and the relative lack of warfare could inhibit the development of both national identity and state legitimacy. Laitin (1992) provides a compelling rational choice analysis of one aspect of this, the attempt by postcolonial polylingual states to develop a national language (“language rationalization”). Laitin provides a game theoretic analysis of why 3 +/- 1 languages, not linguistic homogeneity, is a stable, longterm equilibrium outcome for most African states. His more recent analysis (1998) of Russian-speaking diasporas in post-Soviet states assesses the prospects for assimilation or separatism in these groups using sophisticated mixed methodology and a much broader version of rational choice that incorporates cultural views and status considerations. Solnick (1998a) applies a very interesting rational choice analysis of how states deal with the problems of heterogeneity to the post-Soviet case. He models state-building as an ongoing center-periphery bargaining game. The model is complicated, because there are several players (multiple peripheries or federal subunits), each with very different bargaining power, and the outcome is highly path dependent (constrained by past bargains). He argues that outcomes can range from a peripheralized federal state, to a centralized state, to various forms of asymmetric federalism (in which different provinces have different rights and powers). Many scholars of postsocialist transition emphasize the weakness of these new states (see especially Stoner-Weiss 2006 on the Russian Federation). Treisman (1999), on the other hand, argues that for Russia, what appears as weakness was actually a rational central policy—“selective fiscal appeasement”—which enabled a weakened and resource-depleted center to hold a vast and heterogeneous federation together. Treisman argues that only a rational choice approach (rather than standard cultural or historical arguments) can explain the (unpredicted) diminution of regional separatism in the late 1990s and the durability of the Russian Federation. Geographical and environmental factors have also hindered contemporary state formation. Herbst (2000) attributes the variation between earlier European

458 Edgar Kiser and Erin Powers and modern African state-building (and the consequent instability of African rule) to the very stark contrast between each continent’s “political geography” (see Centeno 2002: 75–76 for similar arguments about geographical obstacles to state-making in Latin America). The African continent has much wider variability in environmental conditions and geographic features than Europe, including many inhospitable areas containing low densities of people. Because land in Africa was more available and less developed agriculturally, it was less valuable than in Europe and Asia, making exit preferable to competition. Power was marked not by control of land but of people, making geographical boundaries and territorial control less significant in precolonial Africa. Contemporary state formation is still far from complete. Many states in Latin America and especially in Africa are weak, and some are on the verge of state breakdown (Centeno 2002; Boone 1998; Bates 2005). At the most basic level, many African states have been unable to maintain anything close to a monopoly of coercive power within their borders. Bates (2005) notes that 45 percent of African states have had either civil wars or large groups of citizens taking up arms between 1970 and 1995. This high level of state breakdown has been caused by: (1) the insecurity of rule (increasing the discount rates of rulers, and thus their exploitation of the population); (2) tax rates being either too high (initiating revolt, as discussed below) or too low (providing insufficient funds for the state to maintain its coercive power); and (3) high levels of valuable natural resources that increase the gains of capturing state power (ibid.: 18). The same is true in Latin America, although to a slightly lesser extent. Although many postsocialist Eastern European states are strong, the Russian Federation was, at least for much of the 1990s, also notoriously weak (Treisman 1999; Solnick 1998). This weakness should not be surprising. It took European states centuries to complete the state formation process, and African states have had only a few decades, post-Soviet states only a few years. We have thus far seen only the beginning of the process of contemporary state formation.30

Conclusion In this chapter we have reviewed work on the causes and conditions associated with prehistoric through contemporary state-making.Where rational choice accounts are minimal or yet to be developed, we have incorporated work from other approaches compatible with rational choice theory, and revealed the extent to which they rely implicitly on rational choice assumptions. The literature on initial state formation (primarily from anthropology) was initially divided into functionalist and conflict theory camps, and is now dominated by ad hoc syntheses of the two. This chapter shows that the explicit use of rational choice models by North (1981) and Olson (2000) has begun to lay the foundation for a theoretically driven synthesis that can show how early states formed both out of conflict and to provide public goods for all members of society. For early state formation in particular, since the data are sparse, it makes sense to start with rational choice accounts, since more is known about material conditions than cultural patterns. Much of the work in this area is replete with rational choice assumptions, whether or not they

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are explicitly stated, nicely situating rational choice theory to make important contributions that are synergistic with work outside sociology and under alternative theoretical paradigms. The only limitation to further progress in this area is the scarcity of data on initial state formation, but this again highlights the importance of theoretically grounded work. The discussion of medieval state formation led to a similar conclusion. Most of the historical and sociological analyses of medieval state formation (focusing on the rise of voting institutions) took a conflict theory approach, assuming that nobles and monarchs had irreconcilable interests, and that voting institutions arose only when monarchs were too weak to prevent this encroachment on their power. Rational choice work on credible commitments (Root 1989; North and Weingast 1989) has been used to develop arguments that put this conflict in the context of attempts to reach consensus on policies that would benefit both parties, and see voting institutions emerging to facilitate that (Bates and Lien 1985; Kiser and Barzel 1991; Barzel and Kiser 1997).This work could be the foundation for more compelling analyses of democratization in contemporary states. Early-modern European state formation also illustrates the power of rational choice theory. Rational choice theorists were the first to make the argument that war made states in this period (Bean 1973; Ames and Rapp 1977), and set the stage for the further development and empirical testing of this argument by comparative-historical sociologists (Tilly 1975, 1985, 1990; Mann 1986; Ertman 1997). Moreover, this section of the chapter shows how agency theory has been used to explain one of the most important aspects of state formation, the centralization and bureaucratization of the organizational structure of the state (Kiser 1994, 1999).The use of agency theory to model the internal structure of states has also been used to study contemporary administrative developments, making it one of the most widely applicable rational choice models of state formation. Rational choice theory has also contributed to analyses of contemporary state formation. The developments in postcolonial and postsocialist states over the last few decades demonstrate the utility of studying state collapse and consolidation together, rather than separately. Contemporary state formation should be one of the major growth areas in rational choice analyses of state formation, because this process is still in its infancy, better data are available, and there is as yet little rational choice work.The generality of many rational choice models will allow their application to new developments in contemporary state formation as they happen. Because it has explicit microfoundations and precise, general causal mechanisms, rational choice theory holds an advantage for analyzing state formation. Because the effects of these mechanisms will often depend on features of the context, rational choice models should always be used in conjunction with detailed knowledge of the cases being studied. Rational choice is also singular in that it generates clear predictions, making it falsifiable and highlighting anomalous cases, something that most comparative historical accounts cannot claim. Thus it has the potential to unite the findings— particularly detailed case study work—in history, anthropology, archaeology, sociology, political science, and area studies.

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Notes We would like to thank all participants in the Handbook of Rational Choice Social Research, a conference funded by the Russell Sage Foundation, New York, November 2007, for very useful comments and suggestions. 1. As Weber (1978: 6) wrote, “For purposes of a typological scientific analysis it is convenient to treat all irrational, affectually determined elements of behavior as factors of deviation from a conceptually pure type of rational action. The construction of a purely rational course of action in such cases serves the sociologist as a type (ideal type) which has the merit of clear understandability and lack of ambiguity.” 2. Since we are interested in analyzing the general process of state formation, we do not include Weber’s requirement (1978) that this centralized coercive power be legitimate, because that cannot be known for many of our cases, and would no doubt exclude some of them. 3. Although our primary focus in this chapter will not be on methodology, it is worth noting the diversity of methods used to study state-making. Initial state formation is studied primarily by anthropologists, so archeological and ethnographic methods are dominant. Social scientific analyses of medieval and early-modern state formation usually take the form of theoretically informed case studies of small-n comparisons, and rely mainly on archival data, secondary historical sources, or some combination of the two. The study of contemporary state-making and unmaking also uses case studies and small-n comparisons, but since more quantitative data are available, we see an increasing number of statistical analyses of large numbers of cases. Each of these methods has specific strengths and weaknesses. Ethnographies, historical case studies, and small-n comparisons can produce rich narratives that show how causal mechanisms work in particular cases, but the ability to generalize from them is often limited. Largen statistical studies can control for many more potential causal factors and facilitate broad generalization, but they often lack richness and detail. Since each method to some extent compensates for the weakness of others, the study of state-making and unmaking benefits from the presence of multiple methods. 4. Our focus is on the theories, so we will not discuss any of these empirical cases in detail. See Claessen and Skalnik (1981) for a good collection of detailed case studies. 5. These debates have been very difficult to resolve because of the scarcity of systematic data (Haas 1982: 127), although there is some archeological and anthropological evidence. 6. The difficulty in classifying theories as in the functionalist or conflict camp can perhaps best be seen from a rational choice perspective if we consider how one would classify an early theorist of state formation, Thomas Hobbes (1960 [1651]). The process begins with rampant conflict between self-interested individuals in the “state of nature,” but then concludes with these individuals realizing that they would be better off if they traded some of their freedom for social order and security by ceding rule-making and coercive power to a centralized state (Hobbes’s “Leviathan”). Is this a conflict theory, or a theory of the way in which a state is functional for society as a whole? Obviously, it is both. The fact that rational choice models can incorporate both of these elements is one of their main advantages over both functionalist and conflict approaches. 7. In translating these functionalist theories into rational choice terminology, we necessarily jettison the now discredited parts of classical functionalism and replace them with more reasonable rational choice models and mechanisms. For example, instead of assuming that societies have needs, and that the state and other institutions arise to satisfy those needs, we argue that changes in exogenous factors increase the demand for public goods like social order and defense from external threats, and that under certain conditions collective action problems in providing these goods can be resolved and

Rational Choice Approaches to State-Making 461 institutions like states can arise to satisfy the demand for those public goods. Moreover, in contrast to functionalist theories, rational choice theory assumes these states are controlled by self-interested individuals who in the absence of constraints will often use them to serve their own interests rather than those of the society as a whole. In other words, although we do not have the space to do so here, we are arguing that it would be possible to construct an “Analytical Functionalism” in some respects similar to Elster’s “Analytical Marxism” (1985). 8. Deflem’s analysis (1999) of the nineteenth-century Zulu kingdom provides some support for functionalist arguments made by both Carneiro (1970) and Service (1975). Population growth and warfare were important causal factors, but the state also engages in much legitimacy-enhancing redistribution of resources. 9. Note that this argument might also be framed in terms of Hirschman’s rational choice exit/voice model (1970): when exit is constrained as a result of environmental circumscription, incentives to form institutions allowing voice are increased. 10. Michael Mann (1986: 34–129) has developed a new argument about initial state formation that combines ecological and economic factors, and conflict and consensus theories, and thus stands as a good example of the new synthetic approach. He argues that states form when groups are very dependent on particular areas, such as rich river valleys, because of the high costs of exit.This “caging” (a version of the circumscription argument) allows states to form and extract resources from subjects.The state, as such, is viewed as essentially predatory and coercive. 11. There is a considerable body of work in anthropology on the relationship between nomads and sedentary agriculturalists and state formation that is consistent with this (see review by Cohen 1978). 12. Although there were important voting institutions in antiquity in both the Greek city-states and republican Rome, we do not discuss them here because of the lack of both adequate historical data and rational choice arguments about them. 13. Poggi (1978) develops this argument in an interesting way, departing from the standard conflict theory assumption that classes could not cooperate with the rulers of states. He notes that the main conflicts prior to the rise of towns were between nobles and monarchs, and that when towns became powerful they turned a dyadic game into a triad, and became what Simmel (1955) called the “enjoying third” in that triad. Since both monarchs and nobles could gain by having the towns side with them, the question was, Which would the towns choose? The outcome turned on the primary interest of towns, the protection of trade over long distances. Because monarchs controlled much larger territories than any noble did, they could provide this collective good, and nobles (because they couldn’t solve the collective action problems necessary to do so) could not. The towns thus sided with monarchs and were given positions in voting institutions in order to make rulers’ commitments to them credible (this is our language, not Poggi’s, but does not significantly modify his argument). 14. Note that this argument, suggesting that state institutions emerge to take advantage of profitable war projects, is similar to some theories of initial state formation (Spencer 1876; Lenski 1966; Carneiro 1970). 15. A residual claimant is an actor who has a claim on the residual (the profit or loss) generated by a joint venture. 16. Bates and Lien (1985) provide a related causal mechanism for the general argument linking economic development and voting in medieval England and France. They argue that taxes on movables facilitated the development of voting institutions, since rulers had to give voting rights to subjects with mobile resources to keep them from concealing their resources or exiting with them. However, there are problems with this argument. The expansion of voting institutions in England preceded the tax on movables and lasted beyond them. If taxes on movables were the main cause of the development of medieval

462 Edgar Kiser and Erin Powers parliaments, why were these voting institutions retained in England after 1334, when the shift to lump sum collection meant that movables were no longer being taxed? Can the development of a voting institution that has lasted for centuries be explained by a tax that lasted for only forty-five years? Their argument is even less compelling for France, since movables were an even less important source of taxation there. 17. In spite of their utility, many voting institutions (including the French Estates General) eventually declined. The decline of voting institutions is an interesting example of the unmaking of this key part of the state. Weber (1978, 1086–87) makes the classic conflict theory argument about the decline of voting institutions: when rulers developed bureaucracies they had the power necessary to extract taxes from subjects without negotiation, so they did away with voting institutions. Barzel and Kiser (1997) argue that they declined primarily as a result of increases in factors that impede cooperation, most importantly heterogeneous voter interests and ruler insecurity. Heterogeneity weakened voting institutions by increasing both decision costs and the probability that some voters would confiscate from others. Insecurity of rule weakened voting institutions by decreasing the credibility of rulers’ commitments, decreasing the amount of contracting, producing a separation of tax payments and voting rights, and causing rulers to fear the organizational capacities of assemblies of subjects. In this situation, voting institutions become very fragile. Alternatively, Poggi (1978) argues that as technological and organizational developments began to favor the offense in military conflicts, the value of rapid and effective defense (and hence, quick decision-making) increased sharply. In this context, the costs of allowing voting institutions to make decisions about war and taxes for war were simply too high. 18. Recall that several arguments in the literature on initial state formation suggest that warfare selects for better-organized political units (Spencer 1876; Carneiro 1970; Keeley 1996). 19. When monitoring capacity is poor, two types of patrimonial systems will outperform centralized bureaucracy. The first are systems that include the stronger sanctions necessary to induce agents to comply, such as tax farming (privatized tax collection in which agents retain the profits or take the loss) or severe negative sanctions (see Kiser 1994; Kiser and Schneider 1994). The second type of system is a decentralized administration that makes central monitoring less important, such as feudalism or prebendalism, which is characterized by payment in land or the profits from land (see Barkey 1994 on the Ottoman Empire). However achieved, monitoring capacity is a necessary condition for bureaucratic state formation. 20. War also affects both of the determinants of monitoring capacity, size and technology (Kiser and Baer 2005). First, war often determines the size of states, and changes in size over time. Success at war often increases monitoring problems by increasing the size of the country, whereas losing land as a result of war often decreases monitoring problems, and thus facilitates bureaucratization. Second, war can have a direct impact on technologies of control. Certain types of war can facilitate the development of infrastructure such as roads and bridges that can also be useful for administration. 21. For example, nobles in many early-modern states used their power to monopolize positions in the tax administration by demanding ascriptive recruitment based on noble status, and used those positions to increase their wealth at the expense of both rulers and peasants. Rulers in premodern states frequently become dependent on these powerful patrimonial agents. In some feudal and prebendal cases they were necessary for maintaining rulers’ power; in others (France and Spain are classic cases) they had purchased offices that rulers lacked the resources to buy back, and sometimes they operated large tax farms that rulers lacked the skill or capital to operate, as in late republican Rome (Levi 1988) and early-modern England and France (Kiser 1994).

Rational Choice Approaches to State-Making 463 22. Olson’s argument (1982) about interest groups that produce inefficiencies in politics also made this connection—both revolutions and losses at war are seen as necessary conditions for eliminating entrenched interest groups. 23. Revolutions, while neither necessary nor sufficient conditions for bureaucratization, had effects similar to war as a result of the same causal mechanism, breaking the power of entrenched groups (Kiser and Kane 2001). 24. This is especially true of the postsocialist transition literature, which has focused almost exclusively on democratization and the development of markets, mostly ignoring more general issues of state-building (Kuzio 1999: 1–2). 25. There are of course many other variations in the nature of colonialism in these cases, primarily the result of differences in its timing and the goals of the colonizer. 26. Kuzio (1999) argues that the transition in the Ukraine should be studied as a postcolonial transition, and that it has much in common with African transitions. 27. Boone (1998: 131) notes that these sorts of state-building bargains between rulers and social groups are more likely to occur when the economy is dominated by small peasant producers than when it is based on large plantations or the extraction of natural resources. 28. Herbst (2000) contends that, though undeniably irrational, colonial boundarymaking (and an international context favoring the inviolability of national boundaries) actually facilitated the state-building efforts of independence leaders. See Robinson (2002) for an assessment of Herbst’s controversial argument. 29. One of the difficulties in discussing state formation in the African context is that the types of states that have developed are so heterogeneous. In the early postcolonial phase (up to about the mid-1970s), there was a transformation from democratic states based on the French and British models to one-party states, and then to military dictatorships on most of the continent (Southall 1974). Since that time, there has been some trend toward democratization, although it is still unclear how widespread and durable this transition will be. 30. Agency theory can explain not only when premodern states will first bureaucratize but also when bureaucratic administration will be more effective than alternatives in contemporary states. All leaders look to the administrative systems used by apparently successful states as models, and often attempt to imitate them. In many cases this borrowing is very useful, but there is one recurring problem: the organizational forms that are most efficient in the most developed states often do not work well in the very different structural conditions present in less-developed states. For example, most less-developed countries have attempted to model their administrative systems on Western bureaucracies, and almost all have found that this type of reform significantly increases the costs of administration without decreasing either tax evasion or official corruption (Gillis 1989; Shaw 1981: 149). This makes sense because their technologies of control (transportation, communications, recordkeeping) are more like those in early-modern states than those in contemporary developed states. These countries might be right to imitate Europe, but they would do better imitating the administrative systems of early-modern rather than modern Europe (Kiser and Baker 1994; Kiser and Sacks 2011). As it is, much of their inefficiency is the result of overbureaucratization. One of the most interesting trends in contemporary less developed states is a move away from centralized bureaucracy toward more decentralized and partially privatized administrative systems. In the last decade or so many African states have begun to decentralize along several dimensions (Tordoff 1994: 556). In the last fifteen years or so, there has been a trend toward creating SemiAutonomous Revenue Authorities (SARAs) in Latin America and Africa. It remains to be seen whether the trend toward decentralization and privatization in Africa and Latin America will continue.

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Rational Choice Approaches to State-Making 467 Kiser, Edgar, and Yong Cai. 2003. “War and Bureaucratization in Qin China: Exploring an Anomalous Case.” American Sociological Review 68, no. 4: 511–39. Kiser, Edgar, and Michael Hechter. 1998.“The Debate on Historical Sociology: Rational Choice Theory and Its Critics.” American Journal of Sociology 104(3): 785–816. Kiser, Edgar, and Danielle Kane. 2007. “The Perils of Privatization: Tax Farming in the Roman Republic and Empire.” Social Science History 31, no. 2: 191–212. Kiser, Edgar, and Joshua Kane. 2001. “Revolution and State Structure: The Bureaucratization of Tax Administration in Early Modern England and France.” American Journal of Sociology 1071: 183–223. Kiser, Edgar and April Linton. 2001. “Determinants of the Growth of the State: War, Revolt, and Taxation in Early Modern France.” Social Forces 802: 411–48. Kiser, Edgar, and Audrey Sacks. 2011. “African Patrimonialism in Historical Perspective: Assessing Decentralized and Privatized Tax Administration.” The ANNALS of the American Academy of Political and Social Science 636(1): 129–49. Kiser, Edgar, and Joachim Schneider. 1994. “Bureaucracy and Efficiency: An Analysis of Taxation in Early Modern Prussia.” American Sociological Review 592: 187–204. Kiser, E., and X. Tong. 1992. “Determinants of the Amount and Type of Corruption in State Fiscal Bureaucracies: An Analysis of Late Imperial China.” Comparative Political Studies 253: 300–331. Koehn, Peter. 1995. “Decentralization for Sustainable Development.” In Development Management in Africa:Toward Dynamism, Empowerment, and Entrepreneurship, edited by Sadig Rasheed and David Luke, 71–81. Boulder, CO: Westview Press. Kuzio, Taras, Robert S. Kravchuk, and Paul D’Anieri (eds). 1999. State and Institution Building in Ukraine. New York: St. Martin’s Press. Laitin, David. 1992. Language Repertoires and State Construction in Africa. New York: Cambridge University Press. ———. 1998. Identity in Formation: The Russian-Speaking Populations in the Near-Abroad. Ithaca, NY: Cornell University Press. Lane, Frederick. 1958. “Economic Consequences of Organized Violence.” Journal of Economic History 18: 401–17. Lenski, Gerhard. 1966. Power and Privilege. Chapel Hill: University of North Carolina. Levi, Margaret. 1988. Of Rule and Revenue. Berkeley: University of California Press. ———. 1997. Consent, Dissent, and Patriotism. New York: Cambridge University Press. Lewis, P. 1972. “The Failure of the French Medieval Estates.” Past and Present, Jan., 3–24. Liu, J. T. C. 1967. “Sung Roots of Chinese Political Conservatism: The Administrative Problems.” Journal of Asian Studies 26: 457–63. López-Alves, Fernando. 2000. State Formation and Democracy in Latin America, 1810– 1900. Durham, NC: Duke University Press. ———. 2001. “The Trans-Atlantic Bridge: Mirrors, Charles Tilly, and State Formation in the River Plate.” In The Other Mirror: Grand Theory through the Lens of Latin America, edited by Miguel Angel Centeno and Fernando López-Alves, 153–76. Princeton: Princeton University Press. Lynn, John A. 1996. “The Evolution of Army Style in the Modern West, 800–2000.” International History Review 18, no. 3: 505–45. Major, J. Russell. 1960. Representative Institutions in Renaissance France, 1421–1559. Madison: University of Wisconsin Press. Malinowski, Bronislaw. 1926. Crime and Custom in Savage Society. London: Kegan Paul. Mann, Michael. 1986. Sources of Social Power,Vol. 1. Cambridge: Cambridge University Press. McNeill, William. 1982. The Pursuit of Power. Oxford: Blackwell. ———. 1995. Keeping Together in Time. Cambridge: Harvard University Press.

468 Edgar Kiser and Erin Powers Meyer, J., J. Boli, G. Thomas, and F. Ramirez. 1997. “World Society and the Nation State.” American Journal of Sociology 1031: 144–81. Moore, Barrington. 1966. Social Origins of Dictatorship and Democracy. Boston: Beacon. Motyl, Alexander J. 1997. “Structural Constraints and Starting Points: The Logic of Systemic Change in Ukraine and Russia.” Comparative Politics 29(4): 433-47. Nisbet, R. 1976. The Social Philosophers. St. Albans: Granada Publishing. North, Douglass C. 1981. Structure and Change in Economic History. New York: Norton. North, Douglass C., and Robert Thomas. 1973. The Rise of the Western World. Cambridge: Cambridge University Press. North, Douglass C., and Barry R. Weingast. 1989. “Constitutions and Commitment: The Evolution of Institutional Governing Public Choice in Seventeenth-Century England.” Journal of Economic History 49, no. 4: 803–32. Olson, Mancur. 1982. The Rise and Decline of Nations. New Haven: Yale University Press. ———. 1990. “The Logic of Collective Action in Soviet-type Societies.” Journal of Soviet Nationalities 1, no. 2: 8–27. ———. 2000. Power and Prosperity: Outgrowing Communist and Capitalist Dictatorships. New York: Basic Books. Oppenheimer, Franz. 1975. The State. New York: Free Life Editions. Parker, Geoffrey. 1995 [1979]. “The ‘Military Revolution’—A Myth?” In The Military Revolution Debate: Readings on the Military Transformation of Early Modern Europe, edited by Clifford J. Rogers, 37–54. Boulder, CO: Westview. Peterson, Claes. 1979. Peter the Great’s Administrative and Judicial Reforms. Lund: Bloms Boktryckeri AB. Poggi, Gianfranco. 1978. The Development of the Modern State. Stanford: Stanford University Press. Prest, Wilfred. 1998. Albion Ascendant: English History, 1660–1815. Oxford: Oxford University Press. Przeworski, Adam. 1985. Capitalism and Social Democracy. Cambridge: Cambridge University Press. Rathje, William L. 1971. “The Origin and Development of Lowland Maya Classic Civilization.” American Antiquity 36: 275–85. Roberts, Michael. 1995 [I967]. “The Military Revolution, 1560–1660.” In The Military Revolution Debate, edited by C. Rogers, 13–36. Boulder, CO: Westview. Robinson, James A. 2002. “States and Power in Africa by Jeffrey I. Herbst: A Review Essay.” Journal of Economic Literature 40, no. 2: 510–19. Root, Hilton. 1989. “Tying the King’s Hands.” Rationality and Society 1: 240–58. Schelling, Thomas. 1960. Micromotives and Macrobehavior. New York: Norton. Skocpol, Theda. 1979. States and Social Revolutions. Cambridge, UK: Cambridge University Press Service, Elman R. 1975. Origins of the State and Civilization: The Process of Cultural Evolution. New York: Norton. Shaw, G. 1981. “Leading Issues of Tax Policy in Developing Countries: The Economic Problems.” In The Political Economy of Taxation, edited by A. Peacock and F. Forte, 148–62. Oxford: Blackwell. Simmel, Georg. 1955. Conflict and the Web of Group Affiliations. New York: Free Press. Smith, Adam. 1976 [1776]. The Wealth of Nations. Chicago: University of Chicago Press. Smith, Steven S., and Thomas F. Remington. 2001. The Politics of Institutional Choice:The Formation of the Russian State Duma. Princeton: Princeton University Press. Snyder, Robert S. 1999. “The End of Revolution?” Review of Politics 61, no. 1: 5–28. Solnick, Steve. 1998a. “Will Russia Survive? Center and Periphery in the Russian

Rational Choice Approaches to State-Making 469 Federation.” In Post-Soviet Political Order: Conflict and State-Building, edited by Barnett Rubin and Jack Snyder, 58–80. London: Routledge. ———. 1998b. Stealing the State: Control and Collapse in Soviet Institutions. Cambridge: Harvard University Press. Southall, Aidan. 1974. “State Formation in Africa.” Annual Review of Anthropology 3: 153–65. Spencer, Herbert. 1967 [1876, 1882, 1896]. The Evolution of Society. Selections from Principles of Sociology, Vol. 1: 1876;Vol. 2: 1882;Vol. 3: 1896. Edited with introduction by Robert Carneiro. Chicago: University of Chicago Press. Stanish, Charles. 2001. “The Origin of State Societies in South America.” Annual Review of Anthropology 30: 41–64. Stoner-Weiss, Kathryn. 2006. Resisting the State: Reform and Retrenchment in Post-Soviet Russia. New York: Cambridge University Press. Strayer, Joseph R. 1956. “Philip the Fair: A Constitutional King.” American Historical Review 62: 18–32. Swart, K. W. 1949. Sale of Offices in the Seventeenth Century. The Hague: Martinus Nijhoff. Szostak, Rick. 1991. The Role of Transportation in the Industrial Revolution: A Comparison of England and France. London: McGill-Queen’s University Press. Taliercio, Robert. 2004. “Designing Performance: The Semi-Autonomous Revenue Authority Model in Africa and Latin America.” In World Bank Policy Research Working Paper 3432. Washington, DC: World Bank. Taylor, Michael. 1988. :Rationality and Revolutionary Collective Action.” In Rationality and Revolution, ed. Michael Taylor, 63–97. Cambridge: Cambridge University Press. Thies, Cameron. 2004. “State-Building, Interstate and Intrastate Rivalry: A Study of Post-Colonial Developing Country Extractive Efforts, 1975–2000.” International Studies Quarterly 48: 53–72. Tilly, Charles, ed. 1975. The Formation of National States in Western Europe. Princeton: Princeton University Press. ———. 1985.“War Making and State Making as Organized Crime.” In Bringing the State Back In, edited by D. Reuschmeyer, T. Skocpol, and P. Evans, 169–91. Cambridge: Cambridge University Press. ———. 1990. Coercion, Capital, and European States, AD 990–1990. Cambridge, MA: Blackwell. ———. 1993. European Revolutions 1492–1992. Oxford: Blackwell. ———. 1995. Popular Contention in Great Britain, 1758–1834. Cambridge: Harvard University Press. Tordoff, William. 1994. “Decentralisation: Comparative Experience in Commonwealth Africa.” Journal of Modern African Studies 32: 555–80. Treisman, Daniel. 1999. After the Deluge: Regional Crises and Political Consolidation in Russia. Ann Arbor: University of Michigan Press. Vengroff, Richard, and Alan Johnston. 1987. “Decentralization and the Implementation of Rural Development in Senegal:The Role of Rural Councils.” Public Administration and Development 7, no. 3: 273–88. Volkov, Vadim. 2002. Violent Entrepreneurs: The Use of Force in the Making of Russian Capitalism. Ithaca, NY: Cornell University Press. Wachter, J. 1987. The Roman Empire. London: Dent and Sons. Way, Lucan. 2005. “Authoritarian State-Building and the Sources of Regime Competitiveness in the Fourth Wave: The Cases of Belarus, Moldova, Russia, and Ukraine.” World Politics 57: 231–61. Weber, Max. 1978 [1921/1922]. Economy and Society. New York: Bedminster. Webster, David. 1975. “Warfare and the Evolution of the State: A Reconsideration.” American Antiquity 40, no. 4: 464–70.

470 Edgar Kiser and Erin Powers Werlin, Herbert H. 1979. “The Consequences of Corruption: Ghanaian Experience.” In Bureaucratic Corruption in Sub-Saharan Africa, edited by Monday U. Ekpo, 247–60. Washington, DC: University Press of America. Winzeler, Robert L., Ronald Cohen, Robert Hunt, Karl L. Hutterer, Michel Izard, Michel Panoff, Fred W. Riggs, J. M. Van Der Kroef, and Malcolm C. Webb. 1976. “Ecology, Culture, Social Organization, and State Formation in Southeast Asia (and Comments and Reply).” Current Anthropology 17, no. 4: 623–40. Wittfogel, Karl A. 1957. Oriental Despotism. New Haven:Yale University Press. Woodruff, David. 2000. “Rules for Followers.” Politics and Society 28, no. 4: 437–82. Wright, Henry T., and Gregory Johnson. 1975. “Population, Exchange, and Early State Formation in Southwestern Iran.” American Anthropologist 77: 267–89.

chapter

Market Design and Market Failure

14

carlos cañón, guido friebel, and paul seabright

Introduction Markets are institutions that enable the exchange of valued goods and services—what are sometimes called economic transactions—between consenting partners.1 They are not the only institutions to play this role: transactions can take place within families, within firms, in social networks, and in many other kinds of social context. What is distinctive about markets is that they are anonymous. By this we mean not that the participants in market exchange are necessarily unaware of each other’s identity, but rather that they are able to trade with each other purely through participating in the market and not through any prior privileged relationship. The market makes it possible for market participants to carry out exchanges they would otherwise not be able to do. The market does its work when parties who might benefit from transacting need a structured setting in which to make that transaction possible. It is hard to overstate how important have been the development of markets in the history of humanity.The division of labor is a very ancient phenomenon in the animal kingdom, at least as old as the origin of sexual reproduction, though it takes a very rudimentary form in most species. Conscious exchange of favors or resources between individuals is a phenomenon more common in birds and mammals, especially in the higher primates,2 though it tends to take the form either of assistance to close kin, or the exchange of food for immediate favors, typically either status recognition or sexual access to females. Human beings differ from most other mammals, including our closest relatives, the great apes, in having an elaborate sexual division of labor with substantial paternal care. In addition, it seems likely that within the hunter-gatherer bands that constituted the setting for almost all our physical and psychological evolution, there was some intragender specialization of work by skill, and there is also suggestive evidence of sporadic exchange of goods. However, none of these activities required markets in our sense of the term. Most economic exchange prior to the adoption of agriculture was mediated by kinship networks, or took place between individuals or groups who, though

474 Cañón, Friebel, and Seabright not closely related, had built up ties of familiarity over a long period of time. Markets, by contrast, were necessary once human beings perceived the need to exchange with strangers—a phenomenon essentially unknown in the rest of the animal kingdom, and very rare indeed even between human beings prior to the Neolithic era. For markets to become established has required overcoming some important natural obstacles—but without markets to enable exchange between strangers, none of the development of human civilization would have been possible. The market in itself is a remarkable innovation created to make transactions between strangers possible, but the process of institutional innovation does not stop at the creation of the marketplace as such. There has been a continuous historical process of innovation responding to the various problems that market exchange has revealed. In this chapter we provide a very summary overview of the now vast literature on how markets emerge, how markets can work, how they can fail to work,3 and finally, on the conditions under which conscious market design, by individuals, groups, or whole societies, has sought to remedy some of the defects of markets. Economists have traditionally thought differently from other social scientists about markets. Various scholars in sociology have studied how market and social relationships interact, re-enforce, or contradict each other. Two bodies of literature have emerged, one on the social dimension of the market, looking at information transmission, social norms, and identity, the other on “relational contracting,” which investigates how bilateral relations are embedded in the forces and temptations of the market.4 These new developments, while fascinating, are of limited relevance to the issues of market design, so our review will adopt a somewhat more traditional economic approach.We look at markets with a large number of (potential) participants who cannot influence market outcomes and do not have the means to build up social networks or bilateral relationships that can support or replace the market as the main coordination and exchange mechanism. The defects of the market can take many forms, as we describe in detail below. Transactions may provoke accusations of unfairness either on the part of some of their participants or on the part of those who do not or cannot participate. There can likewise be many types of response to these defects. Political authorities may decide to regulate transactions by legislative or administrative intervention. Alternatively, individuals or groups of individuals may decide to create private organizations, groups, or networks to deal with the problem. Finally, governments or groups of individuals may seek to modify the design of the market in question, or design a new market where none has existed. The focus of this paper is market design, a relatively young field of economics that has proven one of the most fruitful and relevant applications of economic theory for the real world, and whose “inventors” Alvin E. Roth and Lloyd S. Shapley have been awarded the 2012 Prize in Economics in memory of Alfred Nobel of the Swedish Riksbank. It is nonetheless noteworthy that the three solutions—external or government regulation, organization through formal institutions such as firms or informal ones such as networks, and market design—have coexisted for a long time. None of them are intrinsically superior

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to the other solutions in general, though some solutions seem to be more appropriate for some types of problems. Among ways of regulating prices, external political regulation, though by no means free of problems, is a great improvement on letting firms self-regulate in a cartel or through unrestricted mergers. For limiting entry of producers to those suitably qualified, both external regulations and self-regulation through guilds can work, but market design is a less appropriate tool. By contrast, although the environment can be protected by government regulation that imposes emission standards, an even better instrument may be to design a market on which pollution rights can be traded. Finally, a firm may seek to overcome the uncertainties of the market by integrating with its suppliers. But an effective alternative may be to create a network with them, or to use business-to-business Internet platforms to deal more efficiently with them. In a nutshell, different problems call for different solutions. We here focus on the improvements to existing markets and the creation of new markets in response to the perception of market failure. We provide a short description of how markets have come to be established and have evolved over time, and then look at the characteristics of market outcomes, both their achievements and their failings. This provides the structure to examine various initiatives undertaken to improve on market outcomes where markets fail to achieve good solutions for society or where they do not exist at all.

The Establishment and Evolution of Markets Exchange occurs fairly naturally between people who are closely related by blood and between those who interact repeatedly and know each other well, but in groups larger than the typical hunter-gatherer band, more formal settings may be needed to make trade possible. Swedberg (2005) discusses the historical evolution of markets without distinguishing between those that naturally arose, and those that were consciously designed (see Figure 14.1 overleaf). Although it is tempting to classify all states of market evolution between these two categories, we will not do so, because there is no consensus in the literature. The author argues that in early stages of human societies markets were external only, in the sense that commerce took place between different groups. Groups were, however, small enough that within each group there could be a division of labor without need of markets. The author also suggests that commerce was accomplished mainly through barter, as there was no “external” money. The absence of money in early stages of human evolution reflects the fact that commerce requires a network of political and legal regulations. Such conditions are complex and naturally arise first inside each ethnic group. Several historical examples can be identified. An early documented case, according to Bowles (2004), is the commerce between the Libyans and the Carthaginians in the fifth century B.C., as described by Herodotus. Trading practices were very particular: the Carthaginians approached first, dropped their merchandise, and withdrew. Then the Libyans approached, inspected the merchandise and left gold, withdrawing without taking the goods. Then the Carthaginians approached again and adjusted the amount of merchandise toward what they considered equivalent in value to the gold provided by the

476 Cañón, Friebel, and Seabright 1. External Markets: Libyans and Carthaginians commerce example

2. Internal Markets: The Athenian Agora example

3. Periodic Markets: Fairs examples

4. National Markets

figure 14.1. Historical evolution of markets. 5. Modern Mass Markets

Libyans. This process continued until both parties reached an agreement. The second stage in market evolution is what Swedberg calls internal markets. In this stage, members from the group have commerce among themselves using “internal” money,5 as well as with other groups. The Athenian Agora represents an appropriate example because their societies had achieved great sophistication, and because these city-states were not subordinate to any other city.6 Athenian institutions aimed to provide conditions under which internal commerce could take place. For example, they created the post of agoranomoi, whose mission was to ensure the quality of goods in the market (a concern for the consumer echoed in medieval times in the long debates about the “just price”). They also guaranteed the quality of all coins used at the Agora. Other examples of internal markets can be found in the literature. Rosenfeld and Menirav (2001) study prices in the third to fourth centuries A.D. in Roman Palestine.They show that prices were not seasonally fixed, but were continually changed based on market forces; however, the Roman authorities constantly supervised prices so as to avoid great fluctuations. Another example is provided by Warburton (2000), who studies the role of the Egyptian state at the end of the third millennium B.C., whose economic success, the author argues, was the result not of technological innovations or market-based policies but rather substantial state spending financed by taxes. Usually, long-distance trading rents are higher than local trading rents, so that the next step in the evolution of markets is the periodic meeting of merchants from very distant places in a secure location. This type of market is a combination between “external” and “internal” markets. Merchants from different communities may gather to take advantage of significant trading opportunities, but the new market must provide conditions similar to those in

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“internal” markets, so as to reduce the various kinds of costs and risks associated with the transactions. Fairs that took place in Europe between the eleventh and fourteenth centuries represent a good example of these periodic markets.7 According to Swedberg, fairs had a major impact because ordinary people could participate, and also because products were brought from all over Europe. Such an event was not easy to organize. Fairs were usually hosted by a local baron, who provided the appropriate physical security. Fairs began to decline when growing trade volumes required permanent rather than periodic markets. Many scholars have studied the nature of fairs and their impact. Epstein (1994) argues that fairs during the fourteenth and fifteenth centuries represent institutional innovations that helped reduce transaction costs and whose impact was mainly regional. In particular, fairs fostered regional specialization that shaped long-term growth in Europe,8 especially after the Black Death. Fairs became also popular in other parts of the world.9 There are strong ties between fairs and local or regional associations. Indeed, any association was entitled periodically to organize a fair at which traders could show their products, exchange experiences, and learn about their competitors. Eventually, regional associations’ interests could be strong enough to create broader associations, of which one well-known example is the Hanseatic League,10 an association of German towns from Holland to Finland that controlled the Baltic and North Sea from the thirteenth through the sixteenth centuries.11 They created their own regulation, and according to Daenell (1909), were responsible for promoting and securing ships and for improving conditions of trade.12 The step toward national markets, the next phase in market evolution, is not an easy one. In particular, national markets must unify many local markets that need not previously have used the same rules. Kings, nation-states, and other supraregional institutions played an important role in overcoming inconsistencies between the rules of small local markets.13 For example, Louis XI of France helped to consolidate a national market by unifying weights and measures. Unification of local markets can also be achieved without the public sector. For the case of nineteenth-century Japan, Miwa and Ramseyer (2006) argue that Japan’s impressive economic growth was anticipated by a revolution in the financial industry, but one that was the result of the private sector rather than the Japanese state. Modern mass markets are the most recent stage of market evolution. Markets need no longer be confined to a particular geographical area but can spread across national and regional boundaries in ways limited only by transport and communication costs, which have fallen massively over time and for some goods and services are now close to zero anywhere in the world. While examples from finance and information technology spring readily to mind, it is worth being reminded that market integration has proceeded rapidly for many much less glamorous products. For example, consider the case of the international rice market, a good that was not as popular in the West as in the East. Coclains (1993) documents the rise of this particular market as an example of how new mass markets boosted product consumption and production in areas not used to consuming or producing it.

478 Cañón, Friebel, and Seabright We are currently in the early phase of a new surge in market design, some of whose manifestations we describe in detail below. In such an early stage the problems of market design can sometimes loom larger than the successes. The main challenge for future market engineers, according to Roth (2002), is to understand market details so that policies end up achieving their objectives. For example,Vermeulen, Buch, and Greenwood (2007) study the failed state-driven attempt to introduce granular, a recycled (and hence environment-friendly) substitute for primary materials like sand and gravel into the construction industry in the Netherlands. In particular, if policy-makers do not fully understand the incentives that incumbent organizations and market players face, new policies will not easily achieve their goals.14 New markets have brought remarkable consequences. One of the most important is the dramatic changes in people’s eating, working, and clothing habits, and the spectacular increase in health, prosperity, and longevity that this has made possible across the world, with the disturbing exceptions of persistent mass poverty in some parts of the Third World. Another consequence is that people in many countries depend on the performance of other economies, and their prosperity can be undermined by events occurring on the other side of the world. And finally, a new type of firm, the multinational corporation, has since the twentieth century played a decisive role in the development of the world economy.

How Can the Market Possibly Work? On the face of it the development of markets that link the globe and have revolutionized living standards represents a triumph of cooperation by a species of large-brained ape that, as Seabright (2010) emphasizes, is so violent and devious that it never seemed cut out for global cooperation at all. However, the profound impact of Adam Smith’s The Wealth of Nations (1776) lay in its demonstration that such large-scale cooperation appeared to require rather little of its participants, and in particular that it did not require them to be benevolent, but merely intelligently self-interested. Later generations of economists, notably Walras (1874) and Arrow and Debreu (1954), developed and refined these arguments, proving in particular the two fundamental theorems of welfare economics. The first theorem states that an economy consisting purely of self-interested individuals interacting in perfectly competitive markets will have an equilibrium that is Pareto-efficient, in the sense that all opportunities for mutually beneficial interaction have been exhausted and that any further potential improvements in the welfare of one individual would have to be at the expense of some other individual. Paretoefficient outcomes may not necessarily be desirable (in particular they may be highly inequitable), but the second theorem states that any Pareto-efficient outcome, including those that have desirable equity properties, can be attained as an equilibrium of perfectly competitive markets with purely self-interested participants, starting from some initial allocation of endowments. The conditions embodied in the hypothesis of perfectly competitive markets are weak in the sense that they do not require any degree of altruism or cooperative spirit.They are, however, highly demanding in terms of the cognitive capacities of

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the participants and the sophistication of their institutional arrangements. Most real people—even sophisticated financial players—seem to be limited in their cognitive capabilities, and most real markets do not even begin to approximate these highly demanding conditions, which leaves open the question of how satisfactory we can expect the outcomes they deliver to be. There has been important research both documenting the limited cognitive capabilities of agents,15 and exploring ways in which markets might be regulated, designed, or otherwise modified to take these cognitive limitations into account. For instance, evidence that consumers are highly sensitive to the framing of choice possibilities (such as choices to participate in programs for health insurance, retirement savings, or organ donation) implies a possible role for regulation of the way in which such choices may legitimately be presented to them.16 Surveying this literature is beyond the scope of this chapter, but readers should be aware that this is an important and growing field of research. In addition, the theorems do not explain how individuals might reach such an equilibrium beginning from a state in which no trade has yet taken place, and therefore do not cast much light on the processes by which market evolution historically occurred. The next question is therefore to identify and explain how market participants reach equilibria such as those described in the two welfare theorems. Three recent strands of literature have begun seriously to examine this question.17 The first, which maintains the assumption that individuals are self-interested and lack intrinsically cooperative characteristics, considers the dynamics of convergence to equilibrium in conditions resembling markets. In the so-called general equilibrium model of Walras (1874), an artificial central authority was invoked. The role of this “auctioneer” was to signal prices to market participants and to adjust these prices (through a process known as “tâtonnement”) so that supply and demand would match in all markets. It is now known, however, that stability of equilibrium in both continuous and discrete models is ensured only under unrealistically stringent conditions on this tâtonnement process.18 How could markets evolve in time so that prices and quantities in a decentralized model—that is, one without an auctioneer—converge to marketclearing allocations?19 What kind of conditions do preferences, prices, and markets have to satisfy for this to occur? Although no analytical solutions are available at the moment, new empirical studies based on computer simulations have obtained interesting results. Following Schinkel, Tuinstra, and Vermeulen (2002), it is possible to trace to Arrow (1959) the first attempt to explain how prices are formed in a model of general equilibrium without an auctioneer; in his version, followed by many others, prices are also a choice variable of the firms. Fisher (1983) proposes a different story: he conceived several dealers, each specialized in one good, whose role is to coordinate and set prices; dealers are not auctioneers and have market power.20 Hahn (1989) modeled a process of monopolistically competitive price-setters. More recent attempts include the work of Schinkel,Tuinstra, and Vermeulen (2002). The novelty of their work is that firms are uncertain about the demand they face. Each firm makes a conjecture about demand based on previous

480 Cañón, Friebel, and Seabright information on prices and sales. Moreover, firms will periodically update the parameters of their demand based on new information using Bayesian criteria. Within this framework the price process will be globally stable. Gintis (2007) explores the general equilibrium dynamic of a fully decentralized Walrasian economy using computer simulations.21 He succeeds in constructing a decentralized Walrasian economy that, under wide conditions, exhibits a unique and globally stable equilibrium that is “very close to” the Pareto-efficient outcome. The key requirement for obtaining such a result is that prices cannot be public;22 agents have private prices. Agents will have reservation prices that they will use to decide with whom they will trade, prices will be updated by trial and error, and by imitating the behavior of highperformance agents. Using a simplified version of the Gintis model (2007), Gintis (2006) shows that a “price system” can be obtained in the medium run when agents have such private prices,23 and it is also shown that in the long run the “price system” converges to a stationary distribution that may be understood as a system of Walrasian competitive prices. The main lesson from Gintis (2006, 2007) for this chapter is that imitation is the driving force behind market dynamics. In particular, Gintis assumes that in each period a fraction of low-performance agents will mimic the behavior of high-performance agents; loosely speaking, weak agents are successively replaced by stronger agents, which makes the role of markets very Darwinian in the sense that only the “strongest” agents survive. It follows from this that successful markets, those whose outcomes are considered desirable, must evolve in time. And market evolution must have certain characteristics—specifically that it should reward successful agents.24 The second strand of literature is devoted to understanding the dynamics of realistic economic systems using only mathematical and computational tools.25 These contributions explore in particular the extent to which complex market systems may be unstable under plausible descriptions of the way in which their component processes evolve over time. Asada et al. (2006) propose a generalization of a standard Aggregate Supply-Aggregate Demand dynamic growth model,26 capable of generating business cycles.27 Their most important result is to show that even when there is no stable steady state of the model, it makes an important difference whether the cycles that can occur around the steady state remain bounded or whether they can become explosive, resulting in large-scale “crises.”28 Finally, a small strand of literature has explored whether market evolution may be more likely if participants have more cooperative characteristics than those that were apparent to Adam Smith.29 This is particularly important given that Walrasian models of markets (including those that discuss disequilibrium dynamics) typically ignore the question of how participants can be sure that the agreements they reach will be enforced—the key issue being whether and how they will reach agreements that, if enforced, would be efficient. In reality, of course, the enforceability of agreements has often been something about which market participants have had very justifiable doubts. We now turn to the question of what happens when markets are established, but under conditions that fall short of the Walrasian ideal type. What kinds of outcome can be expected?

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Why Markets May Fail Above we have discussed how individuals may master the cognitive challenge posed by market interactions. For the fundamental theorems of welfare economics to hold there are, however, additional and quite stringent conditions: • Contracts for trade in markets must be costlessly signed and costlessly enforceable; • Markets must be perfectly competitive in the sense that there must be a large number of buyers and sellers so that no individual participant has the ability to influence the market price—in other words, there must be no “market power”; • There must be no asymmetric information—information known to one party but not to others—though there can be shared uncertainty about what will happen in the future (uncertainty over which individuals may wish to trade in insurance markets); • Markets must be complete, in the sense that they must exist not only for all actual commodities but also for all named and contingent commodities. The notions of named and contingent commodities deserve some clarification. Named commodities represent the effects of transactions on third parties. For many goods these are negligible, but they are important for externalities such as pollution, where one party’s consumption or production causes a loss of welfare for a third party, when there is typically no market in which the polluter and pollutee can reach a mutually satisfactory accommodation. Contingent commodities are those that occur only in some (uncertain) circumstances, and without markets for contingent commodities there will be inefficiently low levels of insurance. It is evident that no real markets anywhere have ever precisely satisfied these conditions, but they are nevertheless analytically useful, for two reasons. One is that markets that are in some sense “close” to satisfying the conditions may also produce outcomes “close” to efficient ones. The second is that the kinds of pathologies that real markets display can be understood much better if one knows which of the conditions most significantly fail to hold. Thus markets where there is important monopoly power by one party behave quite differently from markets where the main problem is an asymmetry of information between buyers and sellers, and differently again from those where externalities are a major concern. In a nutshell: • When there are transaction costs in writing and enforcing contracts, and when there are costs of haggling in the marketplace, market interactions may be less promising than moving the interactions within the boundaries of organizations, as Coase (1937) and Williamson (1970) have shown. • Where one or more firms have market power, they will often seek to raise prices so as to make some of their clients pay more, thereby excluding from the market those who would have been willing to pay the competitive price but not the higher price. These excluded customers represent the “deadweight loss” of monopoly power.30 Solutions to market power are the domain of competition policy,31 where it is possible to keep markets

482 Cañón, Friebel, and Seabright reasonably competitive,32 and of direct regulation of prices and other behavior where it is not possible to do so.33 • Asymmetric information typically leads to two kinds of problem. In the first, known as adverse selection, low-quality goods driving out high-quality ones, because suppliers of high-quality ones cannot credibly distinguish themselves from the rest. These problems pervade all kinds of markets, from used cars (Akerlof 1970) to insurance (Rothschild and Stiglitz 1976).The second kind of problem is known as moral hazard,34 and results when the unobservability of behavior prevents market participants from committing themselves to behave in ways that would be to the advantage of all—for instance, insured parties may be unable credibly to promise to take reasonable care to protect against risk. • Externalities typically result in inefficiently large amounts of the activity creating negative externalities and inefficiently little of the activity creating positive externalities. Historically this has often been regulated by direct controls on activities (so-called command-and-control methods); in recent years more often by taxes and subsidies, and much more recently (as we discuss below) sometimes by direct creation of markets in which “pollution” rights can be directly traded by any parties that have an interest in them. This last approach is the most consistent with the analysis of externalities as involving a problem of “missing markets.” There is a truly vast literature on “market failure” that we cannot realistically review in this chapter.What we shall do instead is to consider examples in which markets have failed, not so much because of contracting problems or market power but because of information asymmetries and externalities. We will focus on conscious efforts at comprehensive market design to deal with information asymmetry and externalities. Economic analysis has demonstrated that in the presence of externalities and asymmetric information it is not realistic to expect perfect solutions to incentive problems. Bengt Holmström’s celebrated Impossibility Theorem has shown that no incentive system for a production task where one individual’s productivity depends on the efforts of others (which implies the presence of externalities), and in which individuals’ efforts cannot be observed, can satisfy simultaneously the requirements of Pareto-efficiency, individual rationality (as expressed in the notion of Nash equilibrium), and budget balance—namely, that all revenues created by the production process are distributed to the agents. Market design can improve upon laissez-faire, but Pareto-efficiency may not be a realistic result to expect from the market design process. However, the precise implications of Holmström’s Theorem for market design remain unclear, and will doubtless be the subject of much discussion in the future. We begin with some of the best known examples of market design—the markets for rights to inflict externalities such as pollution.We go on to consider market-based solutions to asymmetric information problems, and conclude with some of the most intricate market-design initiatives of all—those involving matching markets such as the markets for professional placements, where both externalities and asymmetric problems matter simultaneously, and where timing problems magnify the extent of mistakes.

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In evaluating these initiatives it is important to use a realistic standard, which as we explained above does not usually mean the criterion of Pareto-efficiency. For instance, we know that when borrowers know more than lenders about the quality of their projects, credit markets will always lead to some inefficient outcomes; there will always be some loans that lenders would not have made had they known as much as the borrowers did. A much more useful question is whether credit markets are working as effectively as they reasonably could, given that borrowers will always know more than lenders (this is sometimes known as the standard of the “second best”). The answer is often that they do not, and market design will be judged effective if they lead to significant improvements rather than being found wanting for failing to re-establish “firstbest”—that is, fully efficient—outcomes.

Examples of Market Design externalities The best known example of artificially created markets is the U.S. market for pollution rights created by the Title IV Clean Air Amendment of 1990; its objective was to reduce pollution emissions drastically, but to do so at acceptable cost by issuing firms with emissions rights that they could subsequently trade. Recent studies show benefits substantially outweighing the costs of having a cleaner environment. The second example is New Zealand’s response to the problem of overfishing by the creation of the Individual Transferable Quotas System. Its objective was to define a maximum annual catch, and to define and enforce the rules for trading individual quotas.35 Several studies show that this artificial market became progressively thicker with time; the perceived benefits led to the adoption of similar schemes by several other countries. The third example is another market for pollution permits—this time the one established by the European Union for carbon dioxide emissions permits, a market that began trading in 2005 and faced a major collapse in the trading price early in the process. This last example serves as a lesson that even well-conceived artificial markets can face significant problems of implementation if important details are overlooked. Externalities are not a new problem for policy-makers.36 Long before economists such as A. C. Pigou or E. Lindahl started studying externalities, policy-makers knew that it is only on rare occasions that individual decisions can be treated in complete isolation. Current examples of externalities that preoccupy policy-makers include SO2 and NOx emissions,37 carbon dioxide emission and its effect on global climate change, and the effect of fishing on marine ecosystems. Even if we can state in general terms that externalities are a problem where there are no markets allowing them to be internalized, following Heller and Starrett (1976) it is often useful to go deeper and examine the reasons why these markets fail to exist. Four main obstacles are (1) difficulties in defining property rights, (2) market power, (3) asymmetric information, and (4) indivisibilities in production or the impossibility of combining certain goods.38 Consider the example of SO2 emissions in China. The fact that thermoelectric generation in China produces too much SO2 is the consequence of the absence

484 Cañón, Friebel, and Seabright of any clear property rights regime that entitles factories to produce a certain amount of SO2 and for those that suffer from pollution to bargain for emissions reductions. Irrespective of the cause, the fact that externalities imply missing markets has led many policy-makers to consider creating artificial markets as a method to correct externalities. Three examples will be considered in detail. Two of these are markets for pollution permits; the third is a novel implementation in fisheries.

U.S.Title IV Clean Air Act Amendment of 1990 Prior to the Clean Air Act (CAA) there had been two partially successful attempts to reduce pollutant emissions in the United States. The first was an initiative of the Environmental Protection Agency (EPA) in the 1970s to allow states to take independent measures to control air pollutant emissions using a form of tradable permits. The second was the imposition of stringent standards on leaded gasoline and ozone-depleting chlorofluorocarbons.39 The CAA had one main objective and was designed in two phases. The U.S. government stated that the CAA should ensure that SO2 emissions would, by the year 2000, be 10 million tons below the 1980 level, and half of the 1980 level by 2010. Although the main objective was not fully achieved—SO2 emissions were in excess of 7 million tons below 1980 levels—emission reductions were substantial, especially in places with higher emissions.40 In order to achieve the objective the CAA stipulated a maximum level of emissions for each polluting unit, and designed a tradable market for SO2 permits that began working in 1993.41 The first phase of the CAA took from 1990 until 1995. Stavins (1998) documents that in this phase sixty-one utility units, which controlled a total of 110 electric utility plants, were endowed with individual emission limits.42 The criteria for assigning permits was unavoidably ad hoc, with the endowment of each “polluting unit” depending on its fuel input share in 1987–88. However, the performance of the CAA has been largely satisfactory (see Stavins 1998 Schmalensee et al. 1998). Since 1993 the market for permits has become increasingly sophisticated. More recent studies, such as Chestnut and Mills (2005), argue that even using the most conservative methods to quantify CAA benefits on human health and on the environment, the benefits greatly outweigh the cost, largely because studies in the last two decades have shown that SO2 and NOx are more harmful than previously believed.43 Several factors explain the success of the CAA.The first and most important is its recognition that firms have different abatement costs, and its provision of means to allocate emission reductions to those able to undertake them at lowest cost. Firms with lower abatement costs will sell some of the permits in their entitlement, and firms with higher abatement costs will buy additional permits. By the same reasoning, high abatement-cost firms will have incentives to reduce costs in the long run, since unless they do so competition will drive them out of the market. The second reason for the success of the CAA is that permits could be banked. That is, firms could choose to emit less than their entitlement in a

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given period and emit more later. Bankable permits were a useful tool because firms were easily able to predict their future emissions requirements, though evidently that would be more difficult in some other industries (such as the New Zealand fisheries we examine below).44 The third reason for the success of the CAA is that the EPA created a means of reducing market failures caused by asymmetric information between public utilities. Much trade in permits is private between utilities, but the annual auction of permits sponsored by the EPA enables firms to learn about market conditions and the opportunities open to other firms, an important benefit of the open system according to Stavins (1998) and Schmalensee et al. (1998). new zealand’s fishing market 45 Another interesting example of a designed market is New Zealand’s Individual Transferable Quotas (ITQ) System.46 New Zealand currently leads the world in fisheries management, both economically and environmentally. Its example was subsequently followed by Australia, Canada, Iceland, and the United States. Fisheries suffer from the disadvantages of all common-property resources. Without appropriate regulation, fishing firms will not necessarily internalize the cost of overfishing, so that the overall annual catch is likely to exceed a sustainable level. New Zealand, like many other countries, was urged by the mid-1980s to establish and enforce a maximum level of catch (named Total Annual Catch, hereafter TAC). As a result, the 1986 Fisheries Amendment Act was passed. The fishing market created by that act resembles the emissions market created by the CAA. The New Zealand government determines the amount of fish that may be caught in a particular area. The TAC is not necessarily the economically efficient annual level of catch; but it is designed to be a sustainable maximum level of catch. Next, the government allocates quotas for fishing in a specific area, quotas that may be bought and sold and even leased in fractions.47 There are two differences compared with the CAA market. First, as we have indicated, it is more difficult for a firm to predict the future level and composition of the catch, than for a polluting unit to predict the future level of emissions. At an intuitive level, this is because more factors must be taken into account in the fishing industry.48 Among the consequences of this difficulty of prediction is that firms must bear more residual risk; in addition. quotas are not as liquid as pollution permits. Fishing quotas are generally tradable only for the same fish stock, and are not tradable across regions or years. Quotas are still bankable, but trading possibilities are more limited than for pollution permits. Newell, Sanchirico, and Kerr (2005), using data covering fifteen years of transactions, argue that New Zealand’s market is becoming more and more competitive.They claim that market thickness has steadily improved—meaning that more sellers and buyers are coming to the market every year. In addition, market price dispersion has decreased, suggesting that firms’ market power has decreased as well. The main remaining problem, they argue, is asymmetric information

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between market participants, and they advocate creating a central trading center to address this. the european union emissions trading scheme The European Union Emission Trading Scheme (EU ETS), which opened for trading in 2005, shares a number of features with the U.S. emissions markets. First, its objective is to reduce CO2 emissions by controlling the major emitters. Secondly, each year the authorities issue a fixed number of emission permits to emitting firms. Thirdly, emitters may trade their allowances based on their current and future needs. There are also many differences between the European Union and the United States; we shall address only one.49 The EU ETS is the world’s largest multinational gas emission trading scheme. Political economy issues, such as industry and country lobbying, are much more complex than in the U.S. scheme. Even in the early life of the scheme these have had a major impact on its operation. The EU ETS was conceived in three phases. The first (2005–7) covered twelve thousand emitting firms from several industries,50 which accounted for 40 percent of the EU’s CO2 emissions.The second phase (2008–12) planned to include greenhouse gases other than CO2, including the aviation industry, and to include non-EU members.51 The last phase (2013–20) extends the controls over new sectors (petrochemicals, ammonia, and aluminum among others) and over new gases, specially Nitrous Oxide. Figure 14.2 shows the price of allowances and the volume of trade from August 2005 to October 2007; in particular, the price reached a peak of 30 euros per ton of CO2 in April of 2006. But in May of 2006 the market crashed when it became clear that most governments had issued so many allowances that very few firms would need to reduce their CO2 emissions, so that there would be few buyers in the market and a potentially large number of sellers. By October 2007 the price had fallen to 0.05 euros per ton of CO2, and trade volume had reached a historical minimum. It was widely hoped that Phase II provided stricter levels of initial allowances that ensured significant aggregate reductions of CO2 emissions for the EU zone. The experience illustrates an important lesson for market design. By devolving to member countries the right to choose initial allocations of permits, the EU scheme replicated at the market implementation stage the same kinds of externalities that the scheme was designed to correct. Carbon dioxide emissions create global, not local, externalities, so countries have an incentive to free-ride on the reduction efforts of others. It is not enough to create a market; the details of that market have to respond to the problem the market is intended to solve. market design in the presence of externalities: general arguments What can we learn that is of general value from these and other experiments? According to Ledyard and Szakaly-Moore (1994), the performance of any organization that allows trading of property rights such as emissions permits

488 Cañón, Friebel, and Seabright depends on two factors: market design and political viability. Moreover, the two desiderata may not be simultaneously attainable. For example, although an optimally designed auction of permits will be efficient, it may be politically infeasible if it does not consider wealth distribution implications. On the other hand, if the government distributes all permits based on a particular arbitrary criterion (called grandfathering from hereon), this method will be politically feasible but may be inefficient—in particular, when reallocation of the grandfather rights is forbidden or made difficult by other features of the institutional design (such as a “use-it-or-lose-it” rule, which encourages using of rights even when it would be efficient to forgo them). Optimally designed pollution-rights trading organizations will therefore have two components, one political and other market-based.52 While the former typically safeguard society’s status quo from significant wealth redistributions, the latter will correct the externality, but there may be a tension between the two, as the EU’s ETS illustrates.There is no a priori golden rule for constructing such two-part optimal organizations;53 following Roth (2002), as the success of new artificial markets relies on paying attention to details, optimal organizations will be case specific.54 Despite the heterogeneity of well-designed organizations, they tend to have certain basic objectives in common. In the case of the CAA, Stavins (1998) describes these as flexibility, simplicity, monitoring, and enforcement. The most important consequence of having a flexible market is that the market will be thick—that is, there will be incentives ensuring that most permit transactions are made inside the market. The last three goals—simplicity, monitoring, and enforcement—are closely related. For the particular case of SO2 emission control, simplicity means that the emissions of polluting units should be easily measured, and trading rules should be unambiguously stated. Stavins showed that monitoring was successful. Finally, monitoring and enforcement are always costly, but these costs are reduced by simplicity. The kinds of problem that can plague markets for permits include market power, transaction costs, intertemporal trade, liquidity, noncompliance, and correlated externalities.55 Market power and noncompliance are closely related topics. By the early 1980s (see Hahn 1984), it was known that when participants in a trading market had some degree of market power, the initial allocation of property rights would affect both the eventual ex post allocation and the degree of noncompliance, unlike the case of competitive markets.56 Additionally, Malik (2002) shows that market power and noncompliance can be mutually offsetting—in particular, noncompliance of competitive firms diminishes the market power of others; on the other hand, market power is welfare improving when it offsets the noncompliance of competitive firms. The design of such markets is not a purely technocratic matter but is often influenced by the active participation of citizens, individually and through organizations of civil society. Malueg and Yates (2006) document several cases.57 They argue that citizens can exert influence in two ways, either by lobbying to modify the initial endowment of permits or quotas, or by directly participating in the trading market. Their theoretical results show that citizen behavior will greatly depend on how property rights entitlements are determined. Under

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efficient entitlements citizens will not participate in the trading market, but they will do so if the entitlements are inefficient.58 Intertemporal trade and market liquidity are also closely related. The main message from Yates and Cronshaw (2001) and Brechet, Lambrecht, and Prieur (2005) is that forbidding intertemporal trade is like restraining liquidity. In practice not all designed trading pollution markets share the same intertemporal trading regulations; the authors argue that regulation is case-specific. Environmental problems usually do not occur in isolation. In the last three decades regulation has focused largely on one problem at a time, but in reality pollutants have multiple sources; thus mechanisms conceived to control pollution from a single source are typically incomplete. Caplan and Silva (2005) focus on cases in which negative externalities, such as those that cause global warming or sulphuric acid, are correlated. They propose a control mechanism allowing regional authorities to define their own regulation, while national environmental authorities can achieve coordination by using intraregional income transfers.59 asymmetric information Asymmetric information about product quality Asymmetric information about the quality of goods provides a clear instance of the potential of market-based solutions to overcome market failures. An important insight is that there are different kinds of asymmetric information, depending on whether and when the hidden information in question ever becomes available. There are goods whose quality can be verified before purchase (perhaps at a cost), goods whose quality can be verified after purchase, and goods whose quality cannot easily be verified by the consumer even after purchase. Following Tirole (1988), we will call them “search goods,” “experience goods,” and “credence goods,” respectively.60 Experience and credence goods will be the focus of this example. The literature on search goods has typically not considered the mere presence of asymmetric information about quality; instead it has focused on the optimal quality level and degree of product diversity. Additionally, as quality can be observed after purchase, firms are usually able to write warranties that consumers understand as quality proxies; the better the insurance, the higher the quality.61 The main difference between experience and credence goods is that utility losses and gains can be calculated for the former but not for the latter. Experience goods suffer from agency problems if the relationship between firms and consumers is a short-term one,62 for instance in the case of restaurants or taxicabs in tourist places. Then, quality is usually provided at a minimal level. Here the problem is one of moral hazard, and the literature has discussed various market-based solutions. If some consumers are informed about quality, the remaining uninformed consumers will mimic the decisions of informed consumers. Policies that increase the proportion of informed consumers will thereby also benefit the uninformed. When the problem is one of adverse selection rather than moral hazard, the decision faced by firms is not what level of quality to provide but whether to put a good of given quality on the market. Intuition suggests that when prices

490 Cañón, Friebel, and Seabright do not provide information about quality, firms will put goods on the market only when their quality is low. As a consequence, markets will shrink. These points are relatively well understood; in what follows we look at examples of market-based solutions that go beyond these familiar strategies.

Certification Mechanisms It is important to distinguish certification-oriented policies from certification-providing firms. Jin and Leslie (2003) identify under the former heading policies such as food labeling, energy efficiency of new home applications, gas mileage of new cars, and accounting for publicly traded firms. Indeed, these government policies provide consumers with valuable information about quality, without which each market is likely to be more limited in its operation. Certification firms can be private or public-sector, or may take any hybrid form. Taking examples from Jin, Kato, and List (2006), we can cite U.S. Educational Testing Services, which provides the SAT; U.S. News and World Report, which ranks universities; laboratories that certify the quality of industrial products; Moody’s and S&P’s, which provide bond ratings; and accounting companies that audit financial reports for public corporations. The certification industry is important for two reasons. Not only can it provide information to consumers about product quality—it can also provide information to firms about consumers and other firms.

Certification-Oriented Policies According to Jin and Leslie (2003), compulsory information disclosure through regulation has some clear effects. Besides the natural impact on asymmetric information about the quality of products, there will be an effect on strategic competition between firms. For example, a better knowledge by consumers of product characteristics could intensify competition if products are homogeneous.63 The authors suggest two additional effects of information disclosure. First, the demand for quality increases. Secondly, firms will expend more resources on improving their quality standards. Consider the 1997 case of Los Angeles County hygiene report cards.64 During November 16–18, 1997, CBS broadcast a three-episode report about the hygiene of several L.A. county restaurants, entitled “Behind the Kitchen Door.” As a result, by December 16, the L.A. County Board of Supervisors had created a new hygiene regulation for full-service and limited-service restaurants, and by January 16 of 1998 the ordinance was implemented at the county level. Jin and Leslie (ibid.) found the hygiene report cards ordinance produced several desirable effects. First, restaurants made an effort to increase their annual score, and scores on average improved every year. Second, consumers demanded higher levels of hygiene. Third, authors showed that hospitalizations caused by food-borne illnesses were reduced. Finally, although restaurants were not compelled to make their score public, voluntary disclosure of hygiene scores was remarkably high. Hygiene report cards were successful for two reasons. The methodology used

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for computing the score avoided subjective evaluations, and the standard format allowed consumers easily to verify individual inspection results. Different states in the United States adopted similar measures, given the success of the Los Angeles experiment; however, the details of their application varied from state to state.

The Certification Industry The literature about this particular industry is quite recent. Lizzeri (1999) shows that a monopolist who is able clearly to identify quality at zero cost will provide a pass/fail certification. Guerra (2001) used the same model to show that a monopolist will use another certification method if consumers can observe a noisy proxy for quality: the new method uses a finer grading mechanism, such as A, B, C. Finally, Hvide and Heifetz (2001) assume free entry conditions and show that new firms will end up differentiating their grading methods; they also show that in equilibrium the finer the grading method the higher the fee.65 Jin, Kato, and List (2006) perform two controlled experiments about how entrants behave and about the information they provide compared with the case of a monopolized industry. The authors find that the new entry will improve information provision under certain conditions.66 Information disclosure does not necessarily occur in the same way as with certification-oriented policies.67 The theoretical literature provides testable predictions about voluntary disclosure: the higher the disclosure costs, the lower the disclosure; higher demand for quality increases disclosure; dispersed consumers’ prior beliefs about quality increase benefits from differentiation, thus disclosure increases.68 Finally, Jin (2005) argues that there is no consensus so far about the impact of competition on a firm’s disclosure information decisions; more empirical work is needed on these matters. Consider the case of the U.S. healthcare system. Now more than half of the U.S. population is enrolled in a managed care plan, whose objective loosely speaking is to organize the provision of health and payment for that service. Among the most important managed care firms we find health maintenance organizations (HMOs), preferred provider organizations (PPOs), and pointof-service plans (POS). Recent empirical studies have analyzed information disclosure by HMOs. The objectives of HMOs are to reduce the cost of healthcare services for those needing them, and to reduce healthcare expenses for those who pay for the services. HMOs are popular because of their low costs; however, they impose restrictions, such as requiring patients to visit only doctors inside the network, and to use only drugs approved by the healthcare plan. The National Committee for Quality Assurance (NCQA) was the first, and still remains the most important, verification agency of HMOs.69 Participation is voluntary; information can be public or private. NCQA provides a wide supply of healthcare quality evaluation services, and also two major data sources. The data sources are: the Health Plan Employer Data and Information Set (HEDIS), and a consumer survey for each participating HMO at the Consumer Assessment of Health Plan Satisfaction (CAHPS). HEDIS and CAHPS are publicly available.

492 Cañón, Friebel, and Seabright The main concern of Jin (2005) is why not all HMOs voluntarily disclose information to the NCQA.70 Indeed, Jin shows that by 1998 less than half of all HMOs were voluntarily certified by NCQA. Does competition among HMOs shape the pattern of information disclosure? Jin observed that with few HMOs, firms tried to differentiate as much as they could; consequently, disclosure via NCQA was widespread. But as new HMOs entered into the market, such behavior changed, and HMOs stopped using NCQA as they had previously done.Thus Jin (ibid.) emphasized that the common wisdom about the effect of competition on information disclosure is not always true. But how valuable is this information? Until recently most researchers have assumed that all revelation of new information would be valuable, but few have attempted to measure the size of the benefits. Jin and Sorensen (2006) conclude that the average value in dollars of new information is modest, but it is still enough to outweigh significantly the costs of collecting and distributing it.71 Certification firms and information disclosure can also affect political decisions, as illustrated by the example of the report on “America’s Best Colleges” produced by U.S. News and World Report (USNWR). Jin and Whalley (2007) show that USNWR reports influence expenditure decisions on public colleges, and also, they argue, reduce political agency problems in the provision of public funds to public colleges. Rankings make it easier to know whether public education funds have been efficiently allocated. The certification industry faces new challenges in the new economy, with Internet auctions providing a leading example. Jin and Kato (2007) report that auction fraud is the most common offense reported to the FBI’s Internet fraud unit. They also conclude that there is no strong correlation between price, quality, and reputation.72 Two features help explain these findings. First, eBay’s reputation mechanism is not foolproof; Jin and Kato argue that sellers can easily change their identity; identity theft is remarkably common. Secondly, rational sellers can choose to build up a reputation by first using goods whose quality is easy to ensure and that can be easily delivered at low cost; they then can begin dealing in goods whose quality is more costly to ensure, or even selling expensive items that are then not delivered. The crisis in subprime mortgage lending that unfolded in the summer of 2007 illustrated that the certification industry is not an infallible solution to the problems of asymmetric information that plague the industries certified—for who can certify the certifiers? Credit rating agencies gave ratings to issuers of securitized mortgages that in retrospect were clearly unrealistic; it is too early to tell whether these were indicative of a generalized and systematic set of failings in the credit rating industry, or whether they illustrate merely that no system is perfect. But they do underline the more general message of this chapter that perceptions of market failure are in perpetual evolution, with market development creating new problems even as it alleviates old ones. Asymmetric information about personal characteristics In the last three decades another group of markets has received a great deal of attention from both academic economists and policy-makers. Among the

Market Design and Market Failure 493

most important are various insurance markets,73 and the labor market. In all of these markets, asymmetric information can give rise to problems of two kinds, known collectively as agency problems:74 • moral hazard, when individuals change their behavior as a result of their market transactions (as when insured individuals become less careful to avoid risks), and • adverse selection, when the average behavior of the population of individuals in the market changes (as when low-risk individuals decide not to purchase, leaving only high-risk individuals in the market).75 Following Bennardo and Chiappori (2003), the impact of asymmetric information on market outcomes can be analyzed in two ways. In the first, also called the strategic approach (SA), firms acknowledge that they have some market power; consequently strategic interaction becomes a key element of analysis. In the second, called the general equilibrium approach (GEA), firms are too small to affect market outcomes and so take prices as given.

Strategic Approach General results under the SA are still rare. The most widely used model for this topic is the principal agent model; see Laffont and Martimort (2002); and Bolton and Dewatripont (2005). Among its multiple variants, the multipleprincipal multiple-agent formulation is the one that best fits insurance and labor markets. Indeed, in the case of insurance markets one finds multiple firms offering a menu of insurance contracts, and multiple individuals eager to buy insurance. Results in this specific formulation are just starting to emerge.76 The first problem is to identify ways to distinguish moral hazard from adverse selection in market data. Chiappori and Salanié (2000) argue that there is a different direction of causality between chosen contracts and the accident probabilities that are observed in the insurance markets.77 With adverse selection, what explains the empirical observation that different insurance plans are bought by different people is that individuals are not all equally cautious. Thus accident probabilities are a function of individual characteristics. With moral hazard, accident probabilities are the consequence of the incentives embodied in the insurance contracts. Thus estimates of the extent to which variations in accident probabilities can be explained by individual characteristics or the characteristics of contracts provide a good first means of estimating the relative importance of moral hazard and adverse selection in these markets. However, both types of agency problem will lead to positive correlations between the extent of insurance purchased and the risk of accidents, and no distinction can be drawn between them in this regard.78 Two main sources of evidence can be brought to bear. The first is natural experiments.79 They are rare, though, so an important additional way to differentiate between moral hazard and adverse selection is by using panel data.80 Chiappori (2000) identifies two methods by which this can be done. The first is to assume that all offered contracts in the insurance market are optimal.81It is more realistic, of course, to allow for the possibility that contracts are not optimal. The burden of this second method relies on the extra information

494 Cañón, Friebel, and Seabright required; in particular, researchers need individual level information that is usually difficult to obtain. Chiappori (ibid.) shows that adverse selection and moral hazard effects can be empirically distinguished using the observed behavior of insurance buyers through time. Using French data, Abbring, Chiappori, and Pinquet (2003a) are unable to reject the null hypothesis that there is no moral hazard in automobile insurance. There remains controversy about such findings, though, with Dionne, Michuad, and Dahchour (2004) and Israel (2007) finding significant moral hazard in similar markets using different estimation techniques and different data; still there is no consensus as yet on the appropriate techniques to use, though research is active on ways to derive testable predictions from theory (see Chiappori, Jullien, Salanié, and Salanié (2006)).

General Equilibrium Approach The objective of most of these studies is to determine the conditions and the nature of a competitive equilibrium under asymmetric information. Prescott and Townsend (1984) showed that under general conditions it is possible to decentralize efficient allocations using the standard competitive equilibrium framework with asymmetric information. In particular, they found that a competitive equilibrium with moral hazard always exists, while for economies with adverse selection existence is not guaranteed. There is also an important body of literature in GEA specialized in moral hazard economies. Helpman and Laffont (1975) were the first to show that a Walrasian equilibrium may not exist under moral hazard, since it may introduce discontinuities in the demand functions. Furthermore, Arnott and Stiglitz (1993) show that equilibria in insurance markets may yield positive profits to firms even though there are no barriers to entry and firms are too small to enjoy any monopoly power. It makes an important difference whether firms in insurance markets can observe other trades undertaken by insured parties. If they cannot do so, firms will adapt their contracts to take account of the possibility that individuals may have other contracts. Arnott and Stiglitz (1991) argue that firms will offer contracts that are “excessively” large, a prediction that is in principle testable empirically. Market-based approaches to timing problems An important type of market is one in which intermediaries match two different types of participant so that each can make transactions. Examples include real estate agencies (matching buyers and sellers), broadcasters (matching viewers and advertisers), and employment agencies (matching employers and employees). Such markets, which we call hereafter two-sided matching markets (TSMM),82 often suffer from timing problems, in which individuals can seek to “jump the gun” in making contacts with the other side of the market, as many people involved in real estate transactions know from personal experience. Since Roth (1984) there has been a great deal of research effort devoted to studying such phenomena, and in some cases centralized clearinghouses have been established as a means of correcting such market failures. Not every TSMM requires using clearinghouses. Niederle and Yariv (2007)

Market Design and Market Failure 495

provide useful insights using a simple decentralized model in which firms make direct offers to workers. They identify two important factors that determine the outcome of such a process, and consequently the benefits, if any, from the use of a clearinghouse: the way firms make offers to workers, and market participants’ information about the preferences of others. The authors show that the outcome of the bidding process will be stable if firms cannot make exploiting offers, or if workers and firms have complete information. A similar result follows when workers only know their private preferences and firms can make any kind of offer. Under some kinds of asymmetric information, stability will depend on market thickness, with thin (illiquid) markets paradoxically being more likely to be stable than thick ones. Roth (2008) shows that unstable markets have experienced three kinds of problems that have led them to seek centralized clearinghouse solutions. The first problem is an unraveling in appointment dates. Several examples are cited, notably the market for entry-level positions for North American doctors. The second problem is seasonal congestion; many matching markets experienced significant delays when processing information during highvolume transaction periods. Finally, and as a consequence of the incentives created by timing problems, many market participants use complex strategies that involve hiding their true preferences, to the detriment of the market’s ability to match the different individuals on each side. What is the impact of using centralized clearinghouses in practice? One of the most cited examples in the literature is the National Resident Matching Program (NRMP) in the United States. Residency is the entrylevel position for U.S. doctors; it represents an important step in a doctor’s professional career and also provides the main labor force for U.S. hospitals.83 The residency program was established in 1900, and for the first four decades it worked without a centralized clearinghouse. During this period residency programs and applicants tended to make earlier and earlier job agreements, a problem that was addressed for the first time in 1945. Medical schools agreed to hold applicants’ recommendation letters and transcripts until a specific date. But the rules proved too vulnerable to manipulation, and in the early 1950s a centralized clearinghouse was established. Roth and Xing (1997) have studied the effect of using a similar matching methodology, but one that also decentralizes offers and deadline decisions, in the U.S. market for clinical psychologists. The outcomes from the NRMP and the market for clinical psychologists have been very different, and so therefore has been the strategic behavior of their participants. Roth and Xing show that by imposing a fixed termination date the residency program suffers an important adverse bottleneck. As a consequence, market participants engage in very aggressive behavior: residence programs give applicants just a few minutes to make a decision, and applicants frequently contact their highestranked residence programs in advance to convince them that they will accept an offer.84 Roth and Xing derive two additional results. First, the higher the correlation between firms’ preferences, the more congestion there will be at the beginning of the market, and the longer it will take an applicant to receive an offer. Second, the higher the correlation between applicants’ preferences, the fewer

tab le 14.1

Labor Markets That Adopted the Roth-Peranson Clearinghouse Design after 1998 (and date of first use of a centralized clearinghouse of some sort) • Postdoctoral Dental Residencies in the United States o Oral and Maxillofacial Surgery (1985) o General Practice Residency (1986) o Advanced Education in General Dentistry (1986) o Pediatric Dentistry (1989) o Orthodontics (1996) • Psychology Internships in the United States and Canada (1999) • Neuropsychology Residencies in the U.S. and Canada (2001) • Osteopathic Internships in the United States (before 1995) • Pharmacy Practice Residencies in the United States (before 1994) • Articling Positions with Law Firms in Alberta, Canada (1993) • Medical Residencies in the United States (NRMP) (1952) • Medical Residencies in Canada (CaRMS) (before 1970) • Specialty Matching Services (SMS/NRMP): o Abdominal Transplant Surgery (2005) o Child & Adolescent Psychiatry (1995) o Colon & Rectal Surgery (1984) o Combined Musculoskeletal Matching Program (CMMP) • Hand Surgery (1990) o Medical Specialties Matching Program (MSMP) • Cardiovascular Disease (1986) • Gastroenterology (1986–99; rejoined in 2006) • Hematology (2006) • Hematology/Oncology (2006) • Infectious Disease (1986–90; rejoined in 1994) • Oncology (2006) • Pulmonary and Critical Medicine (1986) • Rheumatology (2005) o Minimally Invasive and Gastrointestinal Surgery (2003) o Obstetrics/Gynecology • Reproductive Endocrinology (1991) • Gynecologic Oncology (1993) • Maternal-Fetal Medicine (1994) • Female Pelvic Medicine & Reconstructive Surgery (2001) o Ophthalmic Plastic & Reconstructive Surgery (1991) o Pediatric Cardiology (1999) o Pediatric Critical Care Medicine (2000) o Pediatric Emergency Medicine (1994) o Pediatric Hematology/Oncology (2001) o Pediatric Rheumatology (2004) o Pediatric Surgery (1992) o Primary Care Sports Medicine (1994) o Radiology • Interventional Radiology (2002) • Neuroradiology (2001) • Pediatric Radiology (2003) o Surgical Critical Care (2004) o Thoracic Surgery (1988) o Vascular Surgery (1988) s o u rc e : Roth, 2008.

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the transactions needed to clear the market, and the fewer incentives for manipulating the rules. Recently Niederle and Roth (2003) have provided further evidence for the case of Gastroenterology Fellows (GIF). This is an interesting case because a clearinghouse has been adopted twice in the last three decades. Two data sources were used, one coming from the American Medical Association (AMA), and another from the Graduate Medical Education Library. Using the first data source, Niederle and Roth suggest that,85 without a clearinghouse, the GIF market becomes thinner, and job placements and employment opportunities decline. They find that after the clearinghouse collapsed in 2000, fellows were more likely to undertake the GIF at the hospital where they had already been residents in internal medicine. Moreover, small programs suffered more than larger programs. Furthermore, using the second data source, the authors conclude that wages in specialties that use the centralized clearinghouse are not significantly lower than those that use a decentralized method, suggesting that centralization does not result in significant hospital buyer power. Additional studies have documented the effect of unraveling in different markets. Avery, Jolls, Posner, and Roth (2001, 2007) analyze its effect on the market for federal judicial clerks in the United States. Avery, Fairbanks, and Zeckhauser (2003) study college admissions. Recently, Fréchette, Roth, and Ünver (2007) have provided evidence about efficiency gains in the matching of postseason college football games in the United States. Imposing a centralized clearinghouse does not guarantee that inefficiencies will disappear, since problems may remain in the design or implementation of the matching algorithm. According to Roth (2002), algorithm stability is a key condition for success. Unstable algorithms will be less likely to solve unraveling problems than stable algorithms,86 since they will create incentives for employment offers to be made outside the clearinghouse. The most widely known matching algorithm was created by Gale and Shapley (1962) and further developed by Roth and Pearanson (1999); it is known as the Deferred Acceptance Algorithm (DAA). This algorithm is now extensively used in different markets, as we show in Table 14.1. Modifications to the original algorithm were implemented based on each application characteristic.87

Conclusion:The Achievements and the Future of Market Design A wide range of markets in a complex modern economy are plagued by market failure, in particular for reasons of externalities and information asymmetries between market participants: industries pollute without taking into account the environmental externalities they cause; fishermen overfish the oceans, consumers face suppliers who provide products of uncertain quality. The remedies may be quite different, but many feature conscious and often ingenious market design. Whether market design is a more appropriate solution to such market failures than others, such as bypassing of the market by networks and by organizations such as large firms, or regulation of market activity by a government body,

498 Cañón, Friebel, and Seabright is not something about which general conclusions can be drawn. What we have witnessed in recent times is a surge in the relative popularity of market design. This is partly owing to new technologies such as the Internet, partly also to intellectual developments such as the game theoretic revolution and its offspring, industrial organization and contract theory. However, it should not be forgotten that the popularity of market design is quite fragile. To the extent that more highly developed markets are also more interlinked and may react more violently to shocks than do less developed but isolated markets, there is the temptation to call for quick fixes when things go wrong. Crucially, any market is embedded in a broader social and political context; wherever there are market failures there will be a public demand for reassurance through regulation.This reassurance is often supplied by politicians, who sometimes offer quick and simple remedies for the failure at the cost of planting the seed of further failures in the future. In a world of imperfect certification, for instance, risk-taking may cause bankruptcies that bring substantial costs to individuals and communities. Bailing out bankrupt firms and entrepreneurs, or subjecting lenders to heavy regulation, may sometimes be the lesser of two evils, but may also create substantial perverse incentives for the future. In a nutshell, there is a dynamic and quite complex relationship between markets that become more efficient by ingenious design, their potential abuse by equally ingenious entrepreneurs who exploit their operation in pursuit of their own advantage, and the behavior of political entrepreneurs who respond to a shaken belief in markets by advocating restrictive regulation. The topic is beyond the scope of our paper, as it extends into the realm of political economy, but it is important to understand that all the solutions we have highlighted are subject to political constraints and activities, which may correct some failures while typically creating others in the process.

Appendix tab le 14.2

Markets That Fit Roth and Xing (1994) Classification 1. Stage 1 o Market for federal court clerkships o Market for new associate positions in large law firms o Market for postseason college football bowls o MBA graduates of American business schools o New professors of marketing in business schools 2. Stage 2 o Market for new humanities and social-science graduates of elite Japanese universities o Market for clinical psychology interns in the U.S. 3. Stage 3 o Dentistry and optometry o Fraternities and sororities o Medical specialties 4. Stage 4 o More medical markets o Canadian lawyers

Market Design and Market Failure 499

Notes We are grateful to Rafael Wittek and to the many other participants in the Russell Sage Foundation conference who provided excellent comments and suggestions for improvement. Remaining shortcomings are our own responsibility. 1. We therefore exclude transfers between thieves and their victims, slave-owners and their slaves, and other such involuntary transfers of which history provides lamentably many examples. 2. For evidence of markets in primates, see Kappeler and Van Schaik (2006). 3. The objectives of explaining how markets can work and how markets emerge are not achieved by the same means. While in the former we explain how market outcomes are affected by market imperfections, in the latter we explain the necessary conditions for a particular market to emerge at all. Of course, obstacles that discourage economic agents from participating in a market may also explain why the market works badly, but they are not the only type of explanation. 4. See Levin (2003). 5. By this is meant a type of money accepted by members of the city-state but not necessarily accepted outside the city’s perimeter. “External” and “internal” money need not be the same. 6. See Salmon (1999) for a detailed exposition of Greek cities’ economic organization. 7. See Britnell (1979) for fairs under King John’s rule, and Hodgen (1942) for fairs under Queen Elizabeth. 8. Epstein (1994) argues that most trade had a local or regional basis. 9. Loosely (1933) studies the Puerto Bello fairs that attracted traders from all over the Americas, in particular from Peru, and from as far away as Spain. Betts (1953) documents agricultural U.S. fairs in early nineteenth century, and just like Epstein (1994), suggests that they were a vehicle to economic regional integration; other examples for the United States are Hamilton (1912) and Lemmer (1943). Kendall (1936) studies fairs in the French department of Gers, and Sit (1987) studies the case of China. 10. See Bitros and Karayiannis (2006) for the Delian League. 11. Daenell (1909) cites seventy towns during the fourteenth through fifteenth centuries. 12. Literature about the Hanseatic League goes beyond this chapter’s scope. The curious reader could turn to Walford (1881), Palais (1959), and Rotz (1977). 13. Even when a supraregional institution dictates the right policies its effect depends on how well agents can make use of them. Carlos, Key, and Dupree (1998) argue that legal changes and changes in property rights law during England’s Glorious Revolution were effective because investors already knew how to use them. They argue that the London capital market already provided investors an adequate training in how to make money by exploiting arbitrage, and on how to cover risk using financial tools. 14. “High-grade” use of granular contrasts with “low-grade” and is one of the main components of concrete. The primary difference is that the former is better from an ecological point of view. The conclusions of Vermeulen, Buch, and Greenwood (2007) are threefold. First, market participants will exploit inconsistencies between new policies and existing government structures to entrench the status quo. Second, incumbent market players can create professional associations to lobby in favor of their interests. Third, market rules can become so complex than even market players are unable to understand them. See Buschena and Perloff (1991), who explain how institutional changes during the 1970s in the Philippines coconut oil industry fostered market concentration. 15. See Shiller (2006).

500 Cañón, Friebel, and Seabright 16. See Sunstein and Thaler (2008) for an overview, albeit from two unabashed enthusiasts for such interventions. 17. As will be shown below, the third approach is relatively undeveloped in comparison to the other two. 18. See Saari (1996). 19. A different literature studies Walrasian general equilibrium allocations as the limit of a process not of price formation but of attempts by coalitions of economic agents to cooperate to improve their payoffs with respect to the status quo: the “core” consists of those allocations that no coalition of agents (including the grand coalition of all agents) can improve upon by unilateral action. This enabled important progress to be made in modeling economies without the Walrasian assumption that agents are atomless. Aumann (1964) proved that the core approaches the Walrasian equilibrium when number of traders approaches infinity. This result, though quite robust, may not hold under asymmetric information; see Serrano,Vohra, and Volij (2001). 20. As a referee kindly suggested, we should relate this intermediary with what are known in economic/financial sociology as security analysts. According to Zuckerman (1999), security analysts have three features: they represent the main target for investor relation campaigns, they provide recommendations that greatly affect investors’ decisions, and they tend to specialize in a particular industry. Notice that these particular intermediaries can affect prices but do not buy the output from the producer to sell on to consumers. On the other hand, Fisher’s intermediary (dealer) (1983) serves as a bridge between market participants, and as a consequence obtains a positive rent. Finally, Zuckerman’s intermediary (1999) is a special case of Fisher’s (1983). 21. In this sort of model agents are provided with software-encoded strategies that govern how to play the game, how to gather information, and how to update their behavior. See Taylor and Jonker (1978) for further details. 22. Gintis argues that having public prices will create too much correlation among agents’ decisions, and that is the reason why complex or even chaotic behavior could arise in simple economic systems. If prices are not completely public, agents’ decisions will not be so correlated and the dynamics will foster desired convergence patterns. 23. Instead of “price system” Gintis uses the term “quasi-public prices” to denote the price distribution emerging after agents, who were assumed to use private-prices, complete their bilateral exchange. We decided not to include the original notation to avoid unnecessary technicalities. 24. See Samuelson and Zhang (1992) for a broader discussion of selection dynamic processes. 25. See Giocoli (2003) and Punzo (2006) for a detailed exposition of Pantaleoni’s and Goodwin’s contributions. 26. See Chen, Chiarella, Flaschel, and Semmler (2004) for a cleaner and more intuitive version of the model; the novelty is that it is empirically implemented with postwar U.S. data. See also Skott (2006). 27. This model fits into the class of disequilibrium models that were extensively used in the 1960s and 1970s. It is possible to trace recent studies that also use disequilibrium models. See Özdemir and Turner (2008) for a disequilibrium model used to evaluate the role of fiscal discipline in achieving sustained disinflation processes. See Riddel (2004) for a disequilibrium model used to study the U.S. housing market between 1967 and 1998. Finally, see Velupillai (2006) for a macroeconomic disequilibrium model very close to that of Asada et al. (2006). 28. Many studies already have shown how to construct macroeconomic models with explosive or even chaotic dynamics. For recent examples, see Bignami, Colombo, and Weinrich (2004); and Raberto, Teglio, and Cincotti (2006). 29. See Bowles and Gintis (2007) for a comprehensive treatment.

Market Design and Market Failure 501 30. There is also evidence that firms in monopoly positions are more likely to be productively inefficient—that is, to operate with higher costs than if they were under competitive pressure. 31. See Motta (2005) for a comprehensive recent treatment. 32. This may include creating markets where none previously existed, as for public procurement, or in such cases as auctions of the radio spectrum for third-generation mobile telephony in a number of countries. 33. See Laffont and Tirole (1996). 34. See Bolton and Dewatripont (2005) for further detail. 35. Details about how quotas were defined and how quota rights can be traded will be explained later in more detail. 36. This is a plain definition of an externality from A. C. Pigou (1932): “Here the essence of the matter is that one person A, in the course of rendering some service, for which payment is made, to a second person B, incidentally also renders services or disservices to other persons (not producers of like services), of such a sort that payment cannot be extracted from the benefited parties or compensation enforced on behalf of the injured parties.” For a more formal treatment, see MasCollel, Whinston, and Green (1995). 37. NOx is a generic label for those gases containing nitrogen and oxygen in different proportions. A usual example of a polluting nitrogen oxide is NO2, which is responsible for brown/red clouds over urban areas. 38. In the jargon these are known as “non-convexities” in production. 39. See Stavins (1998) for details. 40. See http: //www.epa.gov/airmarkets/resource/docs/marketview.pdf for a brief but detailed synthesis. 41. A similar approach was used for the NOx emission control program. 42. In particular, most of these electric utility plants were located along the Mississippi River and used coal as input. 43. Chestnut and Mills (2005) document that SO2 and NOx contribute to the formation of PM2.5, which has proven to be very harmful to human health. Additionally, acid and nitrogen depositions also have proven to be more difficult to eliminate than expected by 1990. 44. Bankable quotas in fishing markets are less useful tools because it is hard to predict the amount of fish in a particular area and the composition of future catches. 45. Gordon (1954) provided the first economic approach to the issue of harvesting common-property resources. Recent studies, such as Pascual and Perrings (2007), advocate similar strategies for attaining biodiversity conservation. 46. This example is taken from Newell, Sanchirico, and Kerr (2005). New Zealand’s fishing industry represents a small fraction of world supply, but 90 percent of fishing revenues come from exports. 47. By 1986 legislation covered only nine species offshore and seventeen inshore, but by 2004 more than seventy species were covered. Endowments in 1986 were denominated in fixed tonnages, but by 1990 that had changed to a percentage of annual TAC. 48. See Newell, Sanchirico, and Kerr (2005) for a more detailed explanation. 49. A detailed comparison between EU and the U.S. CO2 emission markets exceeds the scope of this chapter. Interested readers should visit http: //ec.europa.eu/ environment/climat/emission.htm. 50. The mineral industry and other industries associated with covering energy activities, production, and processing of ferrous metals, among others. 51. Iceland, Norway, Liechtenstein, and Switzerland. 52. Ison and Wall (2003) analyze the case of traffic-related pollution in the UK.

502 Cañón, Friebel, and Seabright They conclude that market-based measures are not widely used, for political reasons, so that in reality both market-based and non-market-based policies are implemented. See MacLean and Lave (2003) for a deeper study of traffic-based pollution. 53. Ledyard and Szakaly-Moore (1994), for example, explain two in great detail. 54. See Bolduc (2004) for a reflection about the right way to use market-based instruments, and about the role of details in designing optimal instruments. The author uses the SO2 emission control problem case. See also Cramton and Kerr (2002), who isolate the case of carbon permit trading organizations and argue that auctions are preferable to grandfathering on efficiency grounds.The authors do not analyze if such a proposal is politically feasible. See Antle et al. (2003) for the case of carbon sequestration in agriculture. 55. Aside from liquidity and correlated externalities, Malik (2002) provides a brief literature survey on each of these elements. On market power, see Hahn (1984); Tietenberg (1985); Van Egteren and Weber (1996); Westskog (1996); and Malueg and Yates (2006). On transaction costs, see Tschirhart (1984) and Stavins (1995). On intertemporal trade, see Rubin (1996); Cornshaw and Kruse (1996); and Kling and Rubin (1997). On noncompliance, see Malik (1990, 1992) and Keeler (1991). 56. Intuitively, this is because firms with market power move too little toward the competitive allocation, selling or buying fewer permits than they need in order to influence the market price in their favor. 57. The first is the SO2 emission control policy by the U.S. Environmental Protection Agency; the other two are grazing cattle permits in the state of Arizona and on the Grand Canyon plateau. 58. Malueg and Yates (2006) argue that under grandfathering, rather than auctions, citizens will participate in the trading market. See also Smith and Yates (2003) for a model in which citizens participate in the trading market but cannot lobby; they characterize conditions for the optimal property rights endowment. 59. Recall that Roth (2002) argues that market design success depends on understanding the details of each market. 60. See Nelson (1970) for search and experience goods, and Darby and Karni (1973) for credence goods. Let’s take the example of a banana. A search good is a banana in good shape, meaning a product that seems ready to eat and that seems fresh. An experience good is a banana produced without pesticides harmful to human health. And a credence good is a banana produced by a company that did not engage in unethical behavior toward employees and union representatives; see http: //news.bbc.co.uk/2/hi/business/6732739. stm. 61. There is a caveat. Full warranties create a moral hazard problem for consumers because they do not internalize the costs of damage claims made by them. Data shows that firms rarely provide full warranties. See Tirole (1988: ch. 2) for a better explanation of the role of warranties. 62. In a dynamic setting analysis is more sophisticated, Tirole (1988) shows how repeated purchases and reputation can partly correct market failures. Agency problems still remain, and moral hazard problems can be outweighed, increasing the number of informed consumers; adverse selection is more subtle and goes beyond this chapter’s scope. 63. Sometimes ignorance is a blessing. Imagine the case if information disclosure reveals that goods’ characteristics are very different; then, instead of facing tougher competition, each firm could behave as a monopolist. 64. See Jin and Leslie (2003, 2005); and Aguirre et al. (2005) for further details. 65. The theoretical literature goes back, according to Jin, Kato, and List (2006), to Grossman (1981), Milgrom (1981), and Biglaiser (1993). The first two authors study how intermediaries help to make markets attain full information revelation.

Market Design and Market Failure 503 66. Welfare is not necessarily increasing in the number of firms in the industry. Beyond a certain number of firms additional firms may not provide benefits that outweigh the costs of entry. 67. Jin and Leslie (2003) documented high rates of voluntary disclosure for the L.A. county hygiene report cards policy. 68. Jin (2005) provides a small survey of empirical studies about disclosure and product differentiation. The interested reader can find the following cases: nutrition labels in the salad dressing market before and after the 1990 U.S. Labeling Act, the motel industry in isolated areas of the United States, supermarkets’ quality offer according to geographical proximity, and adoption of magnetic resonance image machines between competing hospitals. 69. The NCQA was founded in 1979 by two managed care associations, becoming independent in 1990 with the help of the Robert Wood Johnson Foundation. 70. There are other firms that provide the same service as NCQA, but in reality this firm is the most important. 71. Jin and Sorensen (2006) compute only direct benefits and ignore indirect benefits such as increased competition between HMOs, so their estimates should be considered lower bounds. 72. In particular, Jin and Kato (2007) perform a controlled experiment using baseball cards. They find that, controlling for successful delivery, quality from reputable sellers is not higher than that from sellers without reputation. This suggests that reputation is mostly about ensuring delivery actually takes place. 73. The most prominent ones are the automobile insurance market, the health insurance market, and the life insurance market. 74. See Bolton and Dewatripont (2005). 75. See Finkelstein and Poterba (2004, 2006) for two recent attempts to test for the presence of adverse selection using observables usually not employed in insurance pricing. 76. See Attar and Chassagnon (2006). 77. See Chiappori and Salanié (1997) for an early survey. 78. Another drawback of using the static approach to asymmetric information is that past events do not affect the correlation between accidents and bought insurance. 79. For example, Dionne and Vanasse (1997) use regulatory changes in 1978 and 1992 in Quebec’s automobile insurance market; Fortin et al. (1996) study how Canadian worker’s compensation and unemployment insurance programs affect workplace accidents, and Chiappori, Durand, and Geoffard (1998) use regulatory changes in French health insurance markets in 1993. Other natural experiment examples are Dionne and St-Michel (1991); Chiappori, Geoffard, and Kyriadizou (1998); Chiappori and Salanié (1997); and Cardon and Hendel (2001). 80. Or through multiple cross-sections (see Abbring, Chiappori, Heckman and Pinquet 2003a). 81. For example, Dionne and Doherty (1994) use California automobile insurance data to test different theoretical model predictions using insurance firm pricing strategies. 82. The industrial organization literature acknowledges that there is an important relationship between TSMM and two-sided markets; further research is needed to understand this link. For two-sided markets in general, see Rochet and Tirole (2006). 83. See Roth (1984); and Roth and Peranson (1999) for details. 84. Theorem 1 of Roth and Xing (1997) states that without imposing a fixed termination date, the outcomes from the U.S. market for clinical psychologists and the NRMP are the same. 85. See Niederle and Roth (2003) for a detailed analysis.

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510 Cañón, Friebel, and Seabright for In Situ Biodiversity Conservation in Agricultural Landscapes.” Agriculture Ecosystems and Environment 121: 256–68. Pigou, A. C. 1932. The Economics of Welfare. 4th ed. London: Macmillan. Prescott, E., and R. Townsend. 1984. “Pareto Optima and Competitive Equilibria with Adverse Selection and Moral Hazard.” Econometrica 52: 21–46. Punzo, L. 2006. “Towards a Disequilibrium Theory of Structural Dynamics: Goodwin’s Contribution.” Structural Change and Economic Dynamics 17: 382–99. Raberto, M., A. Teglio, and S. Cincotti. 2006. “A Dynamic General Disequilibrium Model of Sequential Monetary Production Economy.” Chaos, Solutions and Fractals 29: 566–77. Riddel, M. 2004. “Housing-market Disequilibrium: An Examination of Housingmarket Price and Stock Dynamics 1967–1998.” Journal of Housing Economics 13: 120–35. Rochet, J. C., and J. Tirole. 2006. “Two-Sided Markets: A Progress Report.” RAND Journal of Economics 37: 645–67. Rosenfeld, B., and J. Menirav. 2001. “Methods of Pricing and Price Regulation in Roman Palestine in the Third and Fourth Centuries.” Journal of the American Oriental Society 121: 351–69. Roth, A. 1984. “The Evolution of the Labor Market for Medical Interns and Residents: A Case Study in Game Theory.” Journal of Political Economy 92: 991–1016. ———. 2002. “The Economist as Engineer: Game Theory, Experimental Economics and Computation as Tools for Design Economics.” Econometrica 70: 1341–78. ———. 2007. “Repugnance as a Constraint on Markets.” Journal of Economic Perspectives 21: 37–58. ———. 2008. “Deferred Acceptance Algorithms: History, Theory, Practice, and Open Questions.” International Journal of Game Theory 36: 537–69. Roth, A., and E. Peranson. 1999. “The Redesign of the Matching Market for American Physicians: Some Engineering Aspects of Economic Design.” American Economic Review 89: 748–80. Roth, A., and X. Xing. 1994. “Jumping the Gun: Imperfections and Institutions related to the Timing of Market Transactions.” American Economic Review 84: 992–1044. ———. 1997. “Turnaround Time and Bottlenecks in Market Clearing: Decentralized Marching in the Market for Clinical Psychologists.” Journal of Political Economy 105: 284–329. Rothschild, M., and J. Stiglitz. 1976. “Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information.” Quarterly Journal of Economics 90: 629–49. Rotz, R. 1977. “The Lubeck Uprising of 1408 and the Decline of the Hanseatic League.” Proceedings of the American Philosophical Society 121: 1–45. Rubin, J. 1996. “A Model of Intertemporal Emission Trading, Banking and Borrowing.” Journal of Environmental Economics and Management 31: 269–86. Saari, D. 1996. “The Ease of Generating Chaotic Behavior in Economics.” Chaos, Solitons and Fractals 7: 2267–78. Salmon, J. 1999. “The Economic Role of the Greek City.” Greece and Rome 46: 147– 67. Samuelson, L., and J. Zhang. 1992. “Evolutionary Stability in Asymmetric Games.” Journal of Economic Theory 57: 363–91. Schinkel, M., J. Tuinstra, and D. Vermeulen. 2002. “Convergence of Bayesian Learning to General Equilibrium in Mis-specified Models.” Journal of Mathematical Economics 38: 483–508. Schmalensee, R., P. Joskow, A. Ellerman, J. Montero, and E. Bailey. 1998. “An Interim Evaluation of Sulfur Dioxide Emissions Trading.” Journal of Economic Perspectives 12: 53–68.

Market Design and Market Failure 511 Seabright, Paul. 2010. The Company of Strangers: A Natural History of Economic Life. 2nd ed. Princeton: Princeton University Press. Serrano, R., R. Vohra, and O. Volij. 2001. “On the Failure of Core Convergence in Economies with Asymmetric Information.” Econometrica 69: 1685–96. Shiller, Robert. 2006. Irrational Exuberance. 2nd ed. Princeton: Princeton University Press. Shimer, R., and L. Smith. 2001. “Nonstationary Search.” Mimeo. Princeton: Princeton University Press. Sit,V. 1987. “Urban Fairs in China.” Economic Geography 63: 306–18. Skott, P. 2006. “Comments on ‘Integrated Keynesian Disequilibrium Dynamics.’” Journal of Macroeconomics 28: 131–35. Smith, S., and A.Yates. 2003. “Optimal Pollution Permit Endowments in Markets with Endogenous Emissions.” Journal of Environmental Economics and Management 46: 425– 45. Stavins, R. 1995. “Transactions Costs and Tradable Permits.” Journal of Environmental Economics and Management 29: 133–48. ———. 1998. “What Can We Learn from the Grand Policy Experiment? Lessons from SO2 Allowance Trading.” Journal of Economic Perspective 12: 69–88. Stranlund, J. 2008. “Risk Aversion and Compliance in Markets for Pollution Control.” Journal of Environmental Management 88: 203–10. Sunstein, Cass, and Richard Thaler. 2008. Nudge: Improving Decisions about Health,Wealth and Happiness. New Haven:Yale University Press. Swedberg, R. 2005. “Market in Society.” In The Handbook of Economic Sociology, edited by N. J. Smelser and R. Swedberg, 233–53. 2nd ed. Princeton, NJ: Princeton University Press. Taylor, P., and L. Jonker. 1978. “Evolutionarily Stable Strategies and Game Dynamics.” Mathematical Biosciences 40: 145–56. Thompson, H. 1960. “Activities in the Athenian Agora: 1959.” Hesperia 29: 327–68. Tietenberg, T. 1985. Emissions Trading: An Exercise in Reforming Pollution Policy. Washington, D.C.: Resources for the Future. Tirole, J. 1988. The Theory of Industrial Organization. Cambridge, MA: The MIT Press. Tschirhart, T. 1984. “Transferable Discharge Permits and Profit-Maximizing Behavior.” In Economic Perspectives on Acid Deposition Control, edited by T. D. Crocker. Boston, M.A.: Butterworth. Ünver, U. 2001. “Backward Unraveling over Time:The Evolution of Strategic Behavior in the Entry Level British Medical Labor Markets.” Journal of Economic Dynamics and Control 25: 1039–80. Van Egteren, H., and M. Weber. 1996. “Market Permits, Market Power, and Cheating.” Journal of Environmental Economics and Management 30: 161–73. Velupillai, K. 2006. “A Disequilibrium Macrodynamic Model of Fluctuations.” Journal of Macroeconomics 28: 752–67. Vermeulen, P., R. Buch, and R. Greenwood. 2007. “The Impact of Governmental Policies in Institutional Fields: The Case of Innovation in the Dutch Concrete Industry.” Organizational Studies 28: 515–40. Walford, C. 1881. “An Outline History of the Hanseatic League, More Particularly in Its Bearings upon English Commerce.” Transactions of the Royal Historical Society 9: 82–136. Walras L. 1874. “Principe d’une théorie mathématique de l’échange,” Séances et travaux de l’Académie des sciences morales et politiques (Institut de France), Collection, 33éme année, nouvelle série, 101: 97–116. Warburton, D. 2000. “Before the IMF: The Economic Implications of Unintentional Structural Adjustment in Ancient Egypt.” Journal of the Economic and Social History of the Orient 43: 65–131.

512 Cañón, Friebel, and Seabright Westskog, H. 1996. “Market Power in a System of Tradable CO2 Quotas.” Energy Journal 17: 85–103. Williamson, O. E. 1970. Corporate Control and Business Behaviour. Englewood Cliffs: Prentice Hall. Yates, A., and M. Cronshaw. 2001.“Pollution Permit Markets with Intertemporal Trading and Asymmetric Information.” Journal of Environmental Economics and Management 42, no. 1: 104–18. Zhang, Z. 1999. “Should the Rules of Allocating Emissions Permits Be Harmonised?” Ecological Economics 31: 11–8. Zuckerman, E. 1999. “The Categorical Imperative: Security Analyst and the Illegitimacy Discount.” American Journal of Sociology 104: 1398–438.

chapter

Organizational Governance

15

nicolai j. foss and peter g. klein

Introduction: Organizational Governance “Organizational governance” describes the instruments of governance that organizations deploy to influence members and other stakeholders to contribute to organizational goals. While the term is not widely used, it is consistent with the more frequently used terms “organizational control,” “governance structures,” and “mechanisms of governance.” These refer to arrangements inside and between organizations that influence behaviors in desired directions (Scott 1992;Williamson 1996). Organizational governance is not a distinct field but a set of (partly overlapping) fields and subfields and applied topics including organizational economics, organizational sociology, organizational behavior, organizational theory, the theory of the firm, and corporate governance that draw on the base disciplines of economics, sociology, psychology, political science, law, industrial engineering, and others. Adopting a rational-choice perspective (Coleman 1990; Abell 1991) on organizational governance reduces its scope considerably, and large parts of organizational theory and organizational behavior fall outside such a perspective (see, for example, March and Simon 1958; Scott 1992). A rational-choice perspective on organizational governance suggests the following understanding of organizational governance: Organizational governance studies how agents, pursuing their own interests, and with different preferences, knowledge, information, and endowments, use instruments of control to mitigate the problems of coordination and motivation they confront when transacting within or through the purposefully designed social systems known as “organizations.” “Instruments of control” includes both “hard” instruments such as managerial authority and formal incentive systems and “soft” instruments such as culture, psychological contracts, and framing. Behavior, and therefore ultimately organizational outcomes, may be influenced through influencing the motivations, beliefs, preferences, and information of organizational members.1 The above is obviously a highly abstract and general definition; note for the

514 Nicolai J. Foss and Peter G. Klein moment that the definition involves a notion of rational design (undertaken to reach preferred outcomes), takes individual agents (rather than “the organization”) as the relevant decision-makers, conceptualizes these agents as sufficiently informed and farsighted to recognize the interaction problems they may face, and (implicitly) frames these problems in game-theoretic terms.These are key to the rational-choice approach. While important early contributions to the study of organizational governance came from economists such as Knight (1921) and Coase (1937), the origins of the field lie primarily in sociology (for example, Roethlisberger and Dickson 1939). Organizational sociology coalesced in the 1950s (Scott 2004), at a time when few economists took an interest in organizations (but see Simon 1951; Downs 1957). Important early contributions include Selznick (1957), Crozier (1964), and Pfeffer and Salancik (1978), but most of this has remained fairly resistant to rational-choice approaches. Indeed, organizational sociologists have often been very strongly critical of strong (though instrumental) notions of rationality (for example, Perrow 1986, 2002; but see, for example, Scott 1995; Nooteboom and Six 2003; and Buskens, Raub, and Snijders 2003 for more conciliatory approaches). There is little rational-choice sociology literature that deals with organizational governance (but see Lawler 2002; and Lindenberg 2003), and little relevant political science literature (but see Hammond and Miller 1985; Miller 1992). The part of “rational” organizational theory approaches (Scott 1992) that is often called the Carnegie school (March and Simon 1958; Cyert and March 1963) largely emerged from a friendly and immanent critique of the rational-choice model. Still, the main home of the rational-choice approach to organizational governance is organizational economics, and the chapter focuses mainly on this research stream.

A Primer on Organizational Governance organizations In their classic Organizations, March and Simon (1958) broadly define organizations as systems of coordinated action among individuals who differ in the dimensions of interests, preferences, and knowledge. Many writers have echoed this understanding (for example, Arrow 1974; Mintzberg 1979). However, a problem with the definition is that it would seem to include what Hayek (1973) calls “spontaneous orders”—that is, those orderly structures and states that are the unintended results of the interaction of intentional individuals. For example, a competitive equilibrium is indeed a pattern of coordinated action among agents who differ in the said dimensions, where the actions taken, and therefore the resulting allocation, are a result of the specific institutions (“systems”) under which trade takes place. At some level, this may perhaps be called an “organization,” and indeed economics work on mechanism design would seem to bring such allocations within the orbit of conscious design (Hurwicz 1973; Arrow 1974). However, the allocation that results is an unintended consequence of intentional actions (Buchanan 1979; Coleman 1990). Relatedly, it is customary (and enlightening) to make a distinction between “organizations” and “institutions” (Coase 1937; Hayek 1973; North 1990; Coleman 1991; Williamson 1996; Scott 1995). The former

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are purposively constructed for specific ends and on the basis of specific rules, whereas the latter may be emergent, are based on abstract rules, and are not constructed for specific purposes (Hayek 1973; Coleman 1991).The subjects of this chapter are organizations in the former sense, particularly firms. Rational-choice approaches to organizational governance share a strong design ambition with a number of approaches in organization theory (notably contingency theory). Many of the root sources of modern formal work in this vein—notably implementation theory and mechanism design theory (Guesnerie 1992)—are thus fundamentally design-oriented analytical enterprises (compare also Bowles 2004). Design approaches in organization studies have often been criticized for focusing all the attention on formal organization to the neglect of (the potentially far more important) informal organization, a critique going back to the Hawthorne experiments (Roethlisberger and Dickson 1939; Gillespie 1991) and Barnard (1938). Although the preoccupation in rational-choice work on organizational governance with property rights, ownership, contracts, incentives, and the like may seem to reflect a similar bias, this is in fact hardly the case. Thus scholars in the field have been busy studying power (Rajan and Zingales 1998), leadership (Hermalin 1998), attempts at influencing hierarchical superiors (Milgrom and Roberts 1988a), informal authority (Aghion and Tirole 1997), corporate culture (Kreps 1990; Cremer 1990), and psychological contracts (Foss 2003a; Foss, Foss, and Vasquez 2006). The underlying conjecture is that such “soft” phenomena can be studied using exactly the same methods, tools, and fundamental conceptualization of agents that are applied to the study of the “harder,” more formal aspects of organization, in contrast to scholars in organization studies who, for example, often stress the need for invoking “multiple rationalities” (for example, Dyck 1997). However, it should be noted that the organization/institution distinction is somewhat vague. Note that there are cases that are not easy to classify, such as firm networks that mix the planned and the emergent and where governing rules are partly abstract and partly specific. More generally, the organization/institution distinction should be thought of as endpoints of a spectrum. Thus, many organizations, particularly large ones, embody elements of the spontaneous order. Fundamentally, they do so, because large firms, like whole economies, embody a fundamental division of knowledge that makes an efficient centralization of dispersed knowledge in the hands of a centralizing authority prohibitively costly, and perhaps even impossible, given the tacit nature of much relevant knowledge. Such organizations must provide rules—and often rather abstract ones, as in the case of corporate cultures (Kreps 1990)—in the expectation that beneficial, but partly unforeseen, outcomes will result (Hayek 1973). Moreover, there are cases in which elements of hierarchy, such as extensive information exchange and authority-like relations, are clearly prevalent in market relations, as in the case of franchising (see Imai and Itami 1984; Langlois 1995). Governance structures and governance mechanisms In his extremely influential version of transaction cost economics (TCE), Williamson (1985, 1996) argues that organizational governance is a specific

516 Nicolai J. Foss and Peter G. Klein form of “governance structure”—namely, the one that he terms “hierarchy.” Williamson argues that governance structures can be classified in the categories of either the market, the hybrid, or the hierarchy.2 These categories exhaust all possible governance structures without remainder. Williamson defines governance structures as mechanisms for (mainly) settling ex post (that is, after contract agreement) disputes, and predicts that forward-looking agents will adopt the governance structures that are best suited to handle the transaction(s) they carry out between them. Thus, contractual relations are embedded in governance structures. Borrowing from Simon’s discussion (1962) of marginal analysis versus comparative analysis of systems, Williamson thinks of such structures as four-tuples, consisting of the “attributes” of incentive intensity, administrative controls, how adaptation to external change is handled (that is, whether in an “autonomous” or a “coordinated” manner), and contract law. These attributes are “governance mechanisms”—that is, the mechanisms within a governance structure that actually coordinate activities and align interests. While governance structures can vary within a category—thus, the hierarchy structure encompasses the M-form, the U-form, matrix forms, and much else—it still remains that the hierarchy, in contrast to the market, makes use of its own contract law (what Williamson calls “forbearance”), deploys (relatively) low-powered incentives, adapts to disturbances in a coordinated manner, and can deploy a rich administrative machinery (Williamson 1996: ch. 4). The claim of a strong complementarity between such attributes has been subjected to a forceful critique by Grandori (1997, 2001), who argues that the set of coordination mechanisms is larger than portrayed by Williamson (it also encompasses voting, teaming, negotiation, and norms and rules), and that Williamson grossly exaggerates complementarities between such mechanisms. She presents theoretical arguments as well as empirical arguments that governance structures are much less discrete than portrayed by Williamson. Rather than explaining the existence/emergence of particular discrete governance structures, Grandori rather sees the explanatory problem as one of explaining why particular governance mechanisms are bundled in specific ways to handle specific transactions and activities. Thus she is more interested in the “micro-organization” of specific governance mechanisms than the more macro issue of governance structures. These positions are summarized here in order to indicate that the problem of “explaining organizational governance” is far from being unambiguous. What exactly is the explanandum is author-dependent, as well as dependent on belonging to specific subfields within organizational economics. Thus initial/ pioneering work in organizational economics saw the task as one of explaining the emergence of the employment contract in a market economy (Coase 1937; Simon 1951)—that is, essentially one governance mechanism (authority) and its contractual (and perhaps legal, compare Coase 1937) underpinning. Williamson’s work shifted the focus to governance structures, changing the explanatory task to explaining not only the efficiency rationales of specific governance mechanisms but also why they are clustered in discrete governance structures, and much work in contract economics has, following Milgrom and Roberts (1992) and Holmström and Milgrom (1994), taken a similar approach, stressing the notion of (Edgeworth) complementarities (Weiss 2007). The

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highly influential property rights approach associated with Hart and Moore in particular (Grossman and Hart 1986; Hart and Moore 1990) brought back simplicity in the sense that the analytical effort was concentrated on explaining the allocation of ownership rights (and therefore authority), and sidestepping the issue of governance structures as discrete bundles of interlocking governance mechanisms. Finally, some writers, notably Grandori (1997), have emphasized explaining the rationales of the specific mechanisms that may make up a particular instance of organizational governance, and giving pretensions of strong complementarities between such elements. why does organizational governance emerge? James Coleman (1990, 1991) argues that firms exist for the same reason that money does: they reduce the problem of the “double coincidence of wants.” Thus, Coleman adopts the counterfactual approach characteristic of rational-choice approaches to organizational governance: organizational governance exists because markets “fail” (transactions are very costly to carry out), and governing transactions inside organizations is superior to market contracting (both are necessary conditions). However, while Coleman may identify a possible benefit of organizations, this benefit is neither a necessary nor a sufficient condition for the existence of organized entities. Specifically, Coleman does not provide a reason why such benefits cannot be realized through (possibly sophisticated) market contracting. Indeed, if there are no frictions to market contracting, there are no reasons why markets should not be capable of doing exactly this. The inference that monetary theorists have drawn from such reasoning is that a medium of exchange exists because of “transaction costs” (Starr 2003). Organizational economists have made a similar inference. While the set of rational-choice approaches to organizational governance contains heterogeneous elements, all approaches may be at least reconstructed as beginning from the premise that it is necessary to throw some analytical monkey wrenches into the machinery of the perfectly competitive model (of Debreu 1959) to explain the raison d’etre of organizational governance. This clearly unites all economics approaches, from Knight (1921) (where the argument is set particularly clearly out), over Coase (1937) and his transaction cost successors (Williamson 1996) to modern contract theory (Salanié 1997; Laffont and Martimort 2002). While the relevant frictions come in many forms, from (genuine) uncertainty (Knight 1921), imperfect foresight/ bounded rationality (Coase 1937; Kreps 1996; MacLeod 2002), small numbers bargaining (Williamson 1996), haggling costs (Coase 1937), private information (Holmström 1979), cost of processing information (Marschak and Radner 1972; Aoki 1986; Bolton and Dewatripont 1994) or inspecting quality (Barzel 1982, 1997), imperfect legal enforcement (Hart 1995; Williamson 1996), and others, what is common to them all is that they make contracting imperfect relative to the full complete contingent contracting model (Debreu 1959). The consequence of imperfect contracting is, usually, that created value (“welfare,” “wealth”) falls short of the maximum that is imaginable. Thus, a first-best situation is taken as a benchmark. The typical benchmark invoked by rational-choice scholars working on organizational governance is—in

518 Nicolai J. Foss and Peter G. Klein spite of the heavy methodological critiques of, for example, Demsetz (1969) against this “Nirvana approach”—the value creation that would have obtained if agents had been interacting in an entirely frictionless setting. Such settings may be represented by the conditions underlying the Coase theorem (Coase 1960) or the first theorem of welfare economics (Debreu 1959). Under these conditions maximum value creation obtains; thus, it is not possible to rearrange resource uses, coalitions, and so forth so that more economic value is produced. A notable feature of these situations is that they are, to a large extent, institutionally and organizationally neutral, in the sense that unconstrained market competition based on privately held property rights will implement the optimal allocation—as will full-scale socialism. By a similar token, whether resources are primarily allocated by firms or by markets does not, strictly speaking, matter for allocational outcomes.3 Of course, such first-best efficiency conditions never obtain in actuality, and institutions and allocations are therefore not neutral in allocational terms. Moreover, different institutions and organizations, embodying different mechanisms for governing inputs, typically have different allocational consequences, depending on the specifics of the situation (that is, what is assumed about transactions, property rights, informational conditions, and so forth). Indeed, a key heuristic that underlies all rational-choice approaches to organizational governance is that of matching the relevant unit of analysis (whether this is a transaction, an activity, or an input) to a member of the set of organizational alternatives (whether governance structure or a governance mechanism) on the basis of some efficiency criterion, what Williamson (1985) calls “discriminating alignment.” It is typically forwarded, often in an “as if ” manner, that rational agents are efficiency-seeking agents, and that changing a situation with inefficient alignment of, for example, transactions and governance structures to one with efficient alignment will create so much extra transferable utility that potential losers from the change can be compensated (for example, Milgrom and Roberts 1992). If transaction costs are such that efficiencyimproving changes cannot be made, inefficient organizational choices may instead be weeded out by other forces, notably selection forces (Williamson 1985). Note in passing that it is, of course, such matching processes that give explanatory and predictive content to rational-choice approaches to organizations. To be sure, discriminating alignment is not a feature of these approaches alone. Organizational sociologists and management scholars working on organization theory, notably those working from a “contingency” or “information processing perspective” (Lawrence and Lorsch 1967;Thompson 1967; Galbraith 1974), have stressed notions of “fit,” typically of organizational structures and environmental conditions. However, these approaches only implicitly make use of efficiency as the criterion of discrimination, are macro (organization-level), and seldom spend much time on characterizing agents in cognitive and motivational terms.4 The argument that organizational governance arises when markets fail for certain transactions or activities and organizations are superior means of governing these transactions or activities does not in itself inform us about the involved mechanisms, and without specification of such mechanisms borders on

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the tautological. Obviously, scholars have spent much energy on identifying and theorizing the relevant mechanisms. The leitmotiv of the relevant work over the last three decades has been that of incentive conflicts emerging from prisoners’ dilemma–like situations. Some rational-choice work in the field of organizations has taken a team theoretical starting point (Marschak and Radner 1972; Aoki 1986; Radner 1986; Bolton and Dewatripont 1994), or has started out from pure common interest games (Camerer and Knez 1996); accordingly, such work downplays incentive issues. However, it is usually argued, and generally agreed, that while this approach can further the understanding of those aspects of internal organization that relate to information processing, it cannot explain the existence and boundaries of organizations (Williamson 1985; Hart 1995; Foss 1996). To see how incentives may conflict in a nonorganizational (market, small numbers bargaining) context, and how organizational governance can remedy particular kinds of incentive conflicts, but possibly also introduce new ones, consider a simple example. an example The example (which is borrowed from Wernerfelt 1994) lays out the basic logic of “incomplete contracting” theory, one of the dominant currents in organizational economics. The specifics cannot automatically be transferred to other approaches, but the fundamental reasoning and assumptions are quite similar. The example is illustrated by the strategic-form games shown in Figure 15.1. Following Hurwicz (1972), one can imagine economic agents choosing game forms, and the resulting equilibria, for regulating their trade. Although the example highlights only two agents (players), “B” can initially be taken as representative of a number of potential agents (for example, firms) that might want to cooperate with A. That is, “large numbers” conditions obtain, and we can think of the situation as taking place, at least initially, in a market setting. Assume that agents initially want to regulate such trade under conditions in which they maintain their independence (that is, they are distinct legal persons). Efficiency requires that agents choose the game form and equilibrium that maximizes the gains from trade. The two players begin by confronting Game 1. In this game, the Pareto criterion is too weak to select a unique equilibrium,

Game 1

Game 2

B left up

2,2

B right

left

0,0

A

up

2,2

down

0,0

right 0,0

A down

0,0

4,1

figure 15.1. Two strategic form games

4 – u,1 + u

520 Nicolai J. Foss and Peter G. Klein since both {up, left} and {down, right} may be equilibria on this criterion. However, the {down, right} equilibrium has a higher joint surplus than the {up, left} equilibrium, so that it will be in A’s interest to bribe B to play {right}. Surplus maximization suggests that this equilibrium is the agents’ preferred one. Their problem then is to design a contractual arrangement that will make them choose strategies such that this equilibrium results. Note that this problem captures the spirit of work on specific investments (Klein, Crawford, and Alchian 1978; Williamson 1985; Hart 1995), in which an agent (or possibly both agents) has to choose a strategy (in this case {right}) that, while surplus maximizing (when the other agent plays his best-response strategy), is not necessarily attractive for the agent (he gets only 1). The apparent solution is to choose a side-payment, u, that can be chosen (1 < u < 2) to implement the equilibrium where A plays {down} and B plays {right}. If the contracting environment is such that this contract can be (costlessly) written and enforced, the agents will choose the efficient strategies. Apparently, there is no need for organizational governance as defined here, and the small numbers bargaining situation is viable. However, different contracting environments may give different results. For example, it may be too costly to describe all contract stipulations in a comprehensive manner (for example, “u” may be intangible, such as “goodwill,” and hard to describe precisely). This may happen because of information costs, the limitations of natural language, the unavoidable emergence of genuine novelties, and so forth. The contract ends up being incomplete. Or, while the parties may be sufficiently smart to write down all the manifold possible aspects of their relationship, a third party who is supposed to enforce the contract does not have the wits to enforce the contract efficiently (Hart 1990). In the latter case, contract terms are said to be “nonverifiable.” Or the costs of contracting may outweigh the gains (Saussier 2000). In all of these cases, it may not be possible to sustain the first-best outcome— that is, the one that maximizes joint surplus. In the context of the example, A may be confronted with a contingency that is not covered by the contract, refuse to pay B the bribe, and B may have no recourse. However, B may well have the wits to anticipate this possibility. Thus the contract stipulating the side payment may not be sustainable in equilibrium (that is, the outcome where the agents get [4 – u, 1 + u] may not be subgame perfect).Value is destroyed relative to the optimal outcome, because B will not rationally choose {right}. Whether an efficient or an inefficient outcome occurs will in many situations be critically sensitive to the timing of the game. However, in the specific example, timing doesn’t really matter if the contracting environment is such that the promise to transfer u in return for B playing {right} is, for whatever reason, a nonenforceable one: thus if A gives B the bribe before the game begins, B will not play {right}, which means that A will decide not to give B any bribe. And if A promises B to pay the bribe after the game, B will realize that this will not be in A’s interest, and will still play {left}. This captures the idea that agents that anticipate opportunism on the part of their contractual partner will refrain from taking efficient actions or making efficient investments. The bottom line is that contracts cannot completely safeguard against the reduction of surplus or loss of welfare stemming from incentive conflicts (given risk preferences). The analytical enterprise is therefore one of comparing alternative

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contracting arrangements, all of them imperfect. A specific contracting arrangement is represented by the authority relation. This obtains when one of the players becomes an employee, accepting the other player’s orders to play a specific strategy (for example, {right}) against a compensation. In other words, the underlying idea is that transferring a transaction or activity from a market to an organization context means that the agreement will be honored. According to, for example, Williamson (1985), the reason lies in a change of incentives: when an agent changes his status from independent entrepreneur to employee, he becomes less of a residual claimant. His incentives to engage in behavior that results in suboptimal equilibria are correspondingly diminished. In terms of the example, B (or A) may have nothing to gain from playing {left} (rather than {right}) once he has assumed employee status, and will therefore obey A’s (B’s) orders. The law regulating labor transactions may reinforce such docility (Masten 1988). Or, nonopportunistic behaviors may be sustained by the repeated nature of the employer-employee relation and the attendant buildup of valuable reputation capital (Kreps, 1990, 1996). Problems of organizational governance Internalizing a transaction or an activity—that is, transferring it from market to organizational governance—does not in general, however, allow the relevant players to reach the first-best situation. In fact, Hart (1995) essentially argues that hold-up of the kind discussed can still take place within the hierarchy,5 so that the problem of choosing efficient organizational boundaries (for example, should A internalize B or vice versa, or neither) becomes one of choosing the mode that minimizes losses from opportunistic hold-up. Moreover, if asymmetric information conditions can be assumed to exist, “A internalizing B” (or vice versa) may merely transform the problem of contractual hold-up into a problem of moral hazard—that is, B who has now assumed employee status faces lower-powered incentives relative to the situation in which he was an independent agent/residual claimant, and may therefore shirk his duties. Recourse to high-powered incentives may be sought to alleviate such moral hazard, but this may be problematic to the extent that the employee is engaged in multitasking and some tasks are costly to measure: the provision of incentives for measurable activities may imply that other activities are neglected (Holmström and Milgrom 1991), such as the proper maintenance of equipment (Williamson 1985; Barzel 1997). In multitasking environments, high-powered incentives may therefore actually call forth morally hazardous behavior. Note that such problems are not necessarily organizational. To be sure, the vast body of agency theory deals with incentive problems that may well beset internal organization; however, many of these problems, including multitasking problems, might also play out in a market context. However, organizations, or more narrowly, hierarchies, may be beset by distinct incentive problems. It is generally agreed that relatively little work has been done on organizational failures in this sense compared with the huge bodies of work on market failure (and political failure). However, some exists, mainly relating to what may be called the “costs of authority.” A key theme in the economic approach to organizational governance (for example, Coase 1937; Williamson 1996;

522 Nicolai J. Foss and Peter G. Klein Wernerfelt 1997) is that the exercise of managerial authority in response to changes in the environment or in response to conflicts that are internal to the organization provide reasons why firms exist. Thus the implicit thrust of most of this work is that managerial authority is always beneficial.6 There are, however, various incentive costs to the exercise of authority. Rent-seeking. The best-known cost of authority is Milgrom and Roberts’s notion (1988a) of “influence activities” and their associated costs. Influence activities are agents’ expenditures of time, effort, and tangible resources aimed at influencing decision-makers to act in the agent’s favor. The agent could be an individual seeking to curry favor with a supervisor, or a division manager seeking to acquire a greater share of corporate resources (Scharfstein and Stein 2000). Such behavior is costly to the firm not only because of the opportunity cost of the agent’s time but also because the principal receives biased signals of the agent’s performance and characteristics.To minimize costly rent-seeking, firms can reduce the discretion of principals, relying on fixed rules (for example, for promotions and favorable assignments) rather than the discretion of supervisors. This reduces the principal’s ability to intervene where appropriate, however. Selective intervention.Williamson (1985: 132) raises a fundamental issue: “Why can’t a large firm do everything that a collection of small firms can do and more?” Consider two competing firms. Net gains may be expected from a merger, because of savings on overheads, economies of scale, coordination of pricing decisions, and so forth. What were previously autonomous firms may now be units with semiautonomous status, facing the same high-powered incentives. The decisions that are most efficiently made at the levels of operations will be made there. “Intervention at the top thus occurs selectively, which is to say only upon a showing of expected net gains” (ibid.: 133). This implies that the combined firm can do everything the stand-alone firms could and more, so that “integration realizes adaptive gains but experiences no losses” (ibid.: 161). However, integration is associated with various commitment problems (ibid.). Thus it may be costly for the firm that takes over another firm to make it credible that it will honor promises regarding, for example, transfer prices or promotion prospects, the costliness stemming from a lack of third-party enforcement. Milgrom and Roberts (1996: 168) argue that “the very existence of centralized authority is incompatible with a thorough going policy of efficient selective intervention. The authority to intervene inevitably implies the authority to intervene inefficiently” (see also Coase 1937 on managerial mistakes). Attempting to flesh out such inefficient intervention, Baker, Gibbons, and Murphy (1999) (theoretically), and Foss (2003a) and Foss, Foss, and Vasquez (2006) (empirically) focus on managerial problems of committing to not overruling employees. From the point of view of organizational governance, the design problem is to maximize managerial intervention “for good cause (to support expected net gains)” while minimizing managerial intervention “for bad [causes] (to support the subgoals of the intervenor)” (Williamson 1996: 150–51).

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Overall characteristics of rational-choice approaches to organizational governance The discussion so far illustrates several key characteristics that distinguish organizational economics from other approaches to organizations. Methodological individualism. In accordance with its legacy in mainstream economics and its rational-choice methodology, organizational economics is entirely methodological individualist: the aim is to explain contractual and organizational forms fully in terms of individual action and interaction. While organizational incentives and other means of organizational governance influence the decision situations that organizational members find themselves in, organization level phenomena are fully explained in terms of individual action and interaction. These features arguably give organizational economics a “state of nature” or “under-socialized” character that has been subject to a great deal of critique (Granovetter 1985). Rationality and efficiency. In terms of what is assumed about behavior, all organizational economists are located within the rational-choice camp. To be sure, bounded rationality (Simon 1955) has been invoked by many organizational economists, notably Williamson, but it is characteristic that the use that is actually made of bounded rationality is quite limited. For example, the attempt is not to characterize real decision-making (á la the CarnegieMellon approach to organization theory; March and Simon 1958; Cyert and March 1963), but to use bounded rationality as an explanation of contractual incompleteness (Foss 2003b). Cognition. Particularly in its formal versions (for example, Holmström 1979; Grossman and Hart 1986; Holmström and Milgrom 1994), organizational economics follows standard economics in making strong assumptions about the cognitive powers of agents. This reflects a strong reliance on information economics and game theory. Some formal organizational economists have argued that there is no need for bounded rationality (even in the above weak sense): the contracting problems that are studied in organizational economics can be approached making use of the more tractable notion of asymmetric information (Hart 1990). Relatedly, because of the Bayesian underpinning of game theoretical contract theory, “Knightian,” “deep,” “radical,” and so forth uncertainty has no role to play. Even those organizational economists who have taken an interest in behavioral decision theory (for example, MacLeod 2002) have not in general strayed far from the paradigmatic expected utility model. Much is taken to be given. In existing research, and reflecting the modeling approach of the literature, much is taken as given (Foss and Foss 2000). For example, because of the strong assumptions that are made with respect to agents’ cognitive powers, decision situations are always unambiguous and “given.” The choice of efficient economic organization is portrayed as a standard maximization problem in the case of contract design or as a choice between given “discrete, structural alternatives” (Williamson 1996) in the case of the choice of governance structures. There is no learning and no need for entrepreneurial discovery. In the above representation, strategies are thus given. Motivation. Motivation is assumed to be wholly extrinsic (Frey 1997); hence, stronger monetary incentives always call forth more effort (in a least one

524 Nicolai J. Foss and Peter G. Klein dimension). Moreover, motivation is entirely self-directed (that is, there are no other-regarding preferences) (Fehr and Gächter 2000). Finally, preferences are taken as given, and organizational governance has no role in shaping preferences. Organizational governance shapes only extrinsic motivation and possibly beliefs (because of signaling; see, for example, Kreps 1990). The function of economic organization. Problems of economic organization may in generic terms be represented as games where the Nash equilibrium is not Pareto-optimal. While this formally includes, for example, coordination games of the stag-hunt variety (Camerer and Knez 1996), the main thrust of organizational economics is to sidestep coordination-type problems. The function of contracts, governance structures, and mechanisms such as reputation is to influence incentives in such a way that agents choose those strategies that result in the choice of an equilibrium that is Pareto-superior relative to the Nash equilibrium. By placing the whole explanatory emphasis on problems of aligning incentives, it is arguable that coordination problems of organizational governance are placed outside of the explanatory orbit of organizational economics (Camerer and Knez 1996; Langlois and Foss 1999; Grandori 2001). Mode of explanation. Efficient economic organization is supposed to be consciously chosen by well-informed, rational agents. Alternatively, evolutionary arguments are invoked, so that selection processes sort between organizational forms in favor of the efficient ones (Williamson 1985). Thus, explanation is either fully “intentional” or “functional-evolutionary” (Elster 1983; Dow 1987). For example, one may compare Nash equilibria that result from different distributions of bargaining power (for example, as given by ownership patterns) (Hart 1995). The link to observed economic organization is established by asserting that what is observed is also efficient, for example, because of the existence of effective selection forces rapidly performing a sorting among firms with different efficiencies. Alternatively, it is established by claiming that because agents are supposed to be so clever, they can always calculate and choose optimal economic organization.7

A Closer Look at Rational-Choice Approaches to Organizational Governance While the preceding section identified some of the main methodological and substantive themes running through the economic theory of the firm, the present section takes a more detailed view, organized chronologically and around key contributions. The firm in economics: changing conceptions Although economists have employed the notion of “the theory of the firm” at least since the early 1930s (for example, Robinson 1933), the meaning of the term has undergone subtle but important changes, and it is only within the last decades that economists have generally recognized the need for distinct theorizing relating to the firm. Of course, economists have for a long time employed a distinct apparatus relating to the firm’s cost curves, and so forth.Yet firms were for a long time taken to be unitary actors on par with consumers, the internal organization of the firm being treated as essentially a black box. Indeed, the indifference curve/budget constraint analysis of basic consumer

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theory is virtually identical to the isoquant/isocost analysis that is used to derive the firm’s cost functions (Boulding 1942). The “theory of the firm” as that term would have been understood by prominent interwar economists, such as Pigou or Viner, is therefore something rather different from the meaning that more contemporary theorists, such as Coase, Williamson, or Hart, would ascribe to it. This reflects the change of the theory of the firm from being concerned with developing a vital component of price theory—namely, firm behavior—to being concerned with the firm as an interesting subject in its own right. At the same time the basic explananda of the theory of the firm has changed, from the firm’s pricing decisions, combination of input factors, and the like, to the questions of why firms exist, and what explains their boundaries and internal organization (Holmström and Tirole 1989). (To capture the latter meaning, reference in this chapter is to “organizational economics.”) That different questions are asked does not mean that organizational economics is developed in complete separation from more aggregate issues. For example, Coase (1992) sees it as an integral part of the “institutional structure of production”; Hart (2000) has applied his property rights approach to bankruptcy law; Williamson (1987) emphasizes the antitrust implications of transaction cost economics; agency approaches (Jensen and Meckling 1976) play an important role in the understanding of corporate governance systems; and so forth. However, it means that the modern view of the firm is a significantly less anonymous ideal type (in the sense of Schütz 1964) than the firm in economics three or four decades ago, so that analytical attention is devoted to the manifold of organizational forms and the different combinations of governance mechanisms that characterize such forms. In addition, attention has been focused on governance structures that lie “between” the market and the firm governance structures. Coase and beyond Frank Knight, in Risk, Uncertainty, and Profit (1921), was the first economist to explicitly argue that economic principles can render intelligible the different forms of business organization found in the real world. However, Knight was primarily interested in explaining the existence of profit, and the connection between his theory of profits and his theory of the firm is not entirely clear. Nevertheless, Knight hints at alternative explanations of the firm and internal organization, explanations involving morally hazardous behavior (Barzel 1987), noncontractibility of entrepreneurial judgment (Langlois and Csontos 1993; Foss 1993), and the optimal allocation of risk (Kihlström and Laffont 1979). The latter theory is the critical point of departure for Coase in “The Nature of the Firm” (1937), the paper that is now conventionally regarded as the founding paper in the theory of the firm. It is not surprising that this paper has achieved the status of a true classic: it defines a clear program for research in organizational economics, identifies the key questions, and provides answers to the question that all revolve around a new analytical category—namely, that of transaction costs. Coase clearly argues for the explanatory centrality of incomplete contracts and transaction costs (“the costs of using the price mechanism”), and puts forward a basic contractual conceptualization of the firm and an efficiency approach to its explanation.

526 Nicolai J. Foss and Peter G. Klein Most important, he defines the main desiderata of a theory of the firm—namely, to “discover why a firm emerges at all in a specialized exchange economy” (that is, the existence of the firm), to “study the forces which determine the size of the firm” (that is, the boundaries of the firm), and to inquire into, for example, “diminishing returns to management” (the internal organization of the firm). All this, Coase explains, can be reached by adding the category of “costs of using the price mechanism” to ordinary economics. In following the program thus sketched, organizational economics is fundamentally Coasian.8 For various reasons, some of them explained above, Coase’s seminal analysis was neglected for more than three decades in the sense that although its existence was known and acknowledged, it was not used (Coase 1972). For a long time, it did not give rise to a cumulative theory development. Analytical advances driving organizational economics Apart from isolated contributions (for example, Simon 1951), there was essentially no development of organizational economics until well into the 1970s. Of course, important work on organizations by economists was done, notably the managerial (Baumol 1962;Williamson 1963) and behavioral (Cyert and March 1963) theories of the firm.While it is possible to see anticipations of organizational economics in these contributions (for example, the managerial theory highlighted incentive-conflicts between firm owners and managers), and while the behavioral theory focused on incentive conflicts between intrafirm agents, none of these were taken up with addressing the fundamental desiderata of a theory of the firm as defined by Coase—that is, the explanation of the existence and scope of firms. In Williamson’s terms (1985), Coase’s analysis awaited its “operationalization” for many decades. Coase (1937) had listed several sources of the “costs of using the price mechanism” that give rise to the institution of the firm. In part, these are the costs of negotiating and writing contracts. The “most obvious cost of ‘organising’ production through the price mechanism is that of discovering what the relevant prices are” (ibid.). A second type of cost is that of executing separate contracts for each of the many market transactions that would be necessary to coordinate some complex production activity. However, Coase had given few further details on transaction costs and their determinants. Coase’s 1960 paper was more explicit on these issues, and although it was not a paper about economic organization per se, it is quite arguable that the 1960 paper put more analytical flesh on the explanatory skeleton of the 1937 paper (Barzel and Kochin 1992: 25). In the World War II period, microeconomists were at work either as applied price theorists, notably in the Chicago and UCLA traditions, or as mathematical economists who were preoccupied with refining the Walrasian model (incorporating public goods, refining the understanding of uncertainty, trying to find room for a medium of exchange, and so forth) (Bowles 2004). However, these two rather different occupations of the microeconomist gave important impetus to the construction of the expanding toolbox that assisted the takeoff of organizational economics in the mid-1970s. So did other theoretical developments throughout the 1950s and 1960s. The contributions took place on somewhat different levels. Some were purely analytical in the sense of furthering, for example, the conceptualization of uncertainty in the

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Walrasian model (for example, Radner 1968), while others were of a more basic, almost methodological nature, such as the growing appreciation of the notion that there are imperfect institutional and contractual alternatives for governing transactions and activities (Coase 1960; Demsetz 1969), and that transaction costs play a key role in understanding the relevant imperfections. The emergence of social choice theory (Arrow 1951; Downs 1957, 1967; Buchanan and Tullock 1962) demonstrated how rational-choice approaches could be applied to nonmarket decision-making, while information economics (Arrow 1962; Akerlof 1970) suggested, in part, that firms arise as responses to market failures that arise under conditions of externalities and information asymmetries. A parallel but less formal set of developments that may be associated with Coase include property rights economics and law and economics (Alchian 1965; Coase 1960; Demsetz 1969) and the Chicago/UCLA approach to industrial organization. These approaches stressed the possible efficiency properties of “non-standard” contracting practices and promoted a comparative institutionalist approach. In sum, organizational economics may be seen as part of and growing out of a broader (if hardly concerted) attempt to move beyond the confines of the market institution and also inquire into the rationales and functioning of alternative institutions for resource allocation (see also Arrow 1987; Furubotn and Richter 1997; Salanié 1997; Bowles 2004), parts of which are often summarized under the heading of “the new institutional economics.”9 The fact that the above developments to a large extent took off independently and continued for a long time to develop independently helps explain the presence of different streams of research in the modern theory of the firm. For example, “nexus of contract theory” is largely an outgrowth of the 1960s literature (almost exclusively verbal) in property rights economics, whereas “formal agency work” is largely an outgrowth of often highly mathematical work that aimed at making the Arrow-Debreu model more realistic. However, the two bodies of theories are concerned with rather overlapping themes; what is different is perhaps most of all the style of theorizing. On the basis of the above, work began to blossom within the theory of the firm in the mid-1970s. As already mentioned, as late as 1972 Coase lamented that his 1937 paper had been “much cited and little used.” However, at the time of Coase’s lamentation, serious work on the theory of firm had begun to take off, notably with Williamson (1971) and Alchian and Demsetz (1972). Other approaches also took off in the beginning of the 1970s, primarily the team-theoretic approach of Marschak and Radner (1972) and the evolutionary theory of the firm (Nelson and Winter 1974). What has more recently become known as “contract theory” also began approximately in the beginning of the 1970s with the first contributions to formal principal-agent theory (Ross 1973). The result was what Demsetz (1997) has called a “quiet revolution” in economics. Research streams in organizational economics Among rational-choice approaches to organizational governance there is considerable variety, even on fundamental issues like transaction costs. For example, one stream highlights contractual incompleteness, where this may

528 Nicolai J. Foss and Peter G. Klein tab le 1 5.1

Streams of Research in Organizational Economics Conceptualization of the firm

Rationality

Contracting

Nexus of contracts

A legal fiction

Maximizing

Complete

Formal principal / agent theory

No distinct conceptualization

Maximizing

Complete

Incomplete contracts: coordination Incomplete contracts: asset spec. and prop. rights

An authority relation

Mostly bounded

Incomplete

A collection of residual decision rights to physical assets

Williamson: bounded Hart: maximizing

Incomplete

Organizational governance

The reality of authority is denied. No substantive difference between market governance and organizational governance. Input monitoring dominates in organizations; output monitoring in markets. Insights in informativeness principle, incentive intensity, multitasking, etc.; however, these are not particular to organizations. Authority is the defining characteristic of the firm. Ownership rights to alienable assets confer authority (Hart). Authority and hierarchy is a private ordering (Williamson).

Transaction costs considered

Ex post TC, e.g. monitoring and bonding costs

Costs of monitoring

Haggling and communication costs Costs of drafting complex contracts

be explained by pointing to the ink costs of drafting long complex contracts. Another stream highlights the costs of measuring productivity. A related distinction has to do with whether one begins from complete contracts—that is, contracts that have all relevant decisions depending on verifiable variables—or not (see Tirole 1999). All these approaches reject the Arrow-Debreu model (in which firms do not exist). Incomplete contracting theories focus on costs of drafting complex contracts (Williamson 1985; Grossman and Hart 1986), while other approaches allow agents to write elaborate contracts characterized by ex ante incentive alignment, but only under the constraints imposed by the presence of asymmetric information and (divergent) risk preferences. The following sections discuss in greater detail the contents of various streams within organizational economics—namely, the nexus of contracts stream, formal principal-agent work, incomplete contracts; the coordination view, and incomplete contracts; the asset specificy/property rights view. Table 15.1 provides an overview of the specific streams of research that may serve as a point of reference for the following. The nexus-of-contracts view The “nexus-of-contracts view” (Hart 1989), aka the “measurement branch of transaction cost economics” (Williamson 1985), derives its name from a passage in one of the best known contributions to this stream—namely, Jensen and Meckling (1976: 311). The private enterprise or firm is simply one form of legal fiction which serves as a nexus for contracting relationships and which is also characterized by divisible residual claims on the assets and cash flows of

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the organization which can generally be sold without permission of the other contracting individuals. Similar reasoning can be found Alchian and Demsetz (1972), in Fama (1980), and, perhaps most forcefully, in Cheung (1983); indeed, Cheung goes as far as doubting whether it is at all productive to use the very notion of “the firm.” Much more is at stake here than a methodological individualist skepticism of working with aggregate social entities. The theoretical point is that it is misleading to draw a hard line between firms and markets (a key point in Coase 1937). Firms are legal entities, and this has important economic implications (for example, limited liability, the right to deduct input purchases from tax statements, infinite lifetime, and so forth), but they are nevertheless best seen as merely special kinds of market contracting. What may distinguish them relative to other market contracts lies primarily in the continuity of association among input owners (Demsetz 1988). A nexus of contracts may be more “firm-like” when, for example, residual claimancy becomes more concentrated, but it is not in general productive to talk about “firms” as distinctive entities. As Alchian and Demsetz (1972) explicitly argue, a consequence of this view is that the distinction in Coase (1937) between the authority-based and the price-based modes of allocation is superficial. In reality, they argue in a famous passage, there is no basic difference between “firing” one’s grocer and firing one’s secretary, and what looks like a long, open-ended employment contract is in reality a cover for a continuous process of implicit negotiation between employers and employees. Rather, what is peculiar about the firm relative to other instances of market contracting is “team production” (that is, production with inseparable individual production functions).This technology implies that marginal products are costly to measure, which creates a free-rider problem, as team-production can be a cover for shirking. The solution to this problem is to appoint a monitor who is given the right to fire and hire members of the team, based on his observation of employees’ marginal productivities. Giving him rights to the residual income of the team furthermore means that he is given incentives to perform the efficient amount of monitoring. This arrangement results in a specific form of organizational governance—namely, the distribution of rights known as “the classical capitalist firm.” Thus the firm is explained in terms of the reduction of postcontractual measurement cost. As has been pointed out many times since the publication of Alchian and Demsetz (1972), their view raises problems: the monitor need not be the same person as the employer, but may be an employee of a firm, specialized in monitoring services (Holmström and Tirole 1989). Is it really meaningless to speak of authority if the employer/monitor has the right to deprive the employee of the right to work with his tools and equipment to which the employee may be specialized (Hart 1989)? More firms seem to be observed than can be explained by team-production (for example, conglomerates).While firms indeed consist of collections of contracts, intrafirm contracts may be qualitatively different from interfirm contracts; for example, courts will rarely intervene in intrafirm disputes, leaving the firm’s managers as the ultimate authorities for resolving disputes (Williamson 1996a). Jensen and Meckling (1976), which may have been even more influential than Alchian and Demsetz (1972), is in many ways an extension of the Alchian

530 Nicolai J. Foss and Peter G. Klein and Demsetz reasoning, to include more fully the agency problem between owners and managers. However, a crucial difference is that Jensen and Meckling do not think of team-production as essential to explaining the corporation. Instead, organizational governance is structured so as to minimize all sorts of agency costs, which they define as (1) the costs of monitoring, (2) bonding costs (that is, credible commitments), and (3) the residual loss (evaluated relative to the actions that would maximize the principal’s welfare). Using this definition, Jensen and Meckling focus on the agency costs of outside equity and debt, and define optimal capital structure as the combination of debt and equity that minimizes agency costs.10 Historically, both nexus of contracts theory and principal-agent theories (or simply, agency theory) are often argued to reach back to early debates on the shareholders/managers relation. Following the observation by Berle and Means (1932) that ownership of U.S. firms allegedly had become separated from management and control, managerialist theories modeled firm behavior as the maximization of managerial objectives (firm size, growth, sales maximization) under a profit constraint (Williamson 1964). The story that was told to explain this was that managerial objectives were positively correlated with managerial compensation and power. The attendant conflict of interest is, of course, an example of a principal-agent conflict. Indeed, work on this conflict forms the theoretical backbone of most of the heavily expanding field of corporate governance. Formal agency theory Formal work on agency theory takes off at about the same time as the nexus-of-contracts approach, but only fully picks up steam in the 1980s with all sorts of extensions of the basic model, such as layers of principal-agent relations, multiple agents, agents that carry out multiple tasks, agents that can collude, long-term PA setting, and much else.11 Indeed, in the 1980s, principal-agent models became virtually synonymous with “contract theory.”12 The canonical agency models are formal representations of the situation in which an informed party trades with an uninformed party, and where the private information in question may either concern what the agent does (“hidden actions”) or who he is (“hidden characteristics”). Models are conventionally classified according to the timing of the moves in the corresponding games (that is, if the informed or the uninformed party moves first) (Salanié 1997; Laffont and Martimort 2002): there is a distinction between adverse selection models (where the uninformed party is imperfectly informed of the characteristics of the informed party); signaling models, which have the same informational structure but in which the informed moves first; and moral hazard models, in which the uninformed party moves first but is imperfectly informed of the actions of the informed party (ibid.: 4). The agency problem in its moral hazard manifestation basically stems from a conflict between insurance and incentives. The theory of optimal insurance demonstrates that sharing profit between a risk-neutral principal and a riskaverse agent (that is, standard assumptions about risk preferences in the agency literature) has the risk-neutral principal bearing all of the risk. This leads to the first-best outcome. However, this is only if incentive issues are set aside (or the

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agent has no choice of action). In the standard bilateral setting, the principal in fact cannot propose a first-best contract to the agent because the agent’s action is assumed not to be verifiable; hence, cannot be written into the contract. The asymmetric information in question may be a matter of either hidden action or hidden knowledge (that is, the principal does not know some characteristics of the agent that are relevant to the relation). The (moral hazard) problem then is that the agent selects an action that has random consequences, and those consequences are verifiable, but the action and the state of nature (that both “produced” the consequences) are not. In this case, risk-sharing and incentive considerations will interact. The contract will specify a reward schedule so that the agent is paid by the principal as a function of the verifiable consequences. In general, such a contract will only be second-best. This basic analysis is set out in Ross (1973) and developed more fully by Holmström (1979). The starting point for the analysis is the idea that when only payoffs/outcomes can be observed, optimal contracts will be secondbest because of the problem of moral hazard. However, creating additional information systems (such as accounting) or in other ways extracting extra information about the agent’s actions or states of nature, it is possible to improve on contracts, even though the additional information may be imperfect. Holmström derives a necessary and sufficient condition for additional information to be valuable.This is clearly an important step toward an economic approach to such important phenomena as accounting systems or management information systems, and Holmström’s work has been of substantial inspiration for scholars who adopt formal, rational-choice approaches to understanding such aspects of organizational governance (for example, Antle and Demski 1988). In general, principal-agent theory has brought a wealth of insights that are helpful for understanding contractual arrangements in general and important dimensions of organizational governance in particular. Agency models highlight the tradeoff between providing high-powered incentives (to encourage agent effort) and insuring risk-averse agents against events beyond their control (making it easier to attract and retain agents). Most of the applied literature in corporate finance and corporate governance (executive compensation, the structure of debt agreements, board composition, and so on) is based on agency theory. Holmström’s “informativeness principle” (1979) suggests that principals should use all performance indicators that are available at low cost, to provide a more precise estimate of the agent’s (unobservable) effort; this explains why executive compensation agreements tie compensation to multiple measures of performance such as accounting returns, stock performance, sales growth, market share, and the like. Holmström and Milgrom (1991, 1994) explore multitask principal-agent models that show, as noted above, that pay-forperformance schemes based on objective performance metrics can induce a distortion of effort if some tasks are more easily observable than others. Under these circumstances, subjective performance measures may be valuable when used in conjunction with objective metrics (Baker, Gibbons, and Murphy 1994). Contrary to common perception (for example, Ghoshal and Moran 1996), agency theory does not recommend that incentives in organization be made

532 Nicolai J. Foss and Peter G. Klein as powerful as possible. In a striking piece of work, Holmström and Milgrom (1991) wonder why payment schedules are usually simpler and less highpowered (even when good output measures are seemingly available) than basic agency theory would predict. The answer involves the idea that employees often work on multidimensional tasks. In this situation, incentive pay not only influences efforts and allocates risk; it also allocates the effort of agents across tasks. Some possibly essential tasks (or dimensions of a task) may be very costly to measure for the principal; as a result, the principal risks that the agent will allocate all his effort to tasks (dimensions of a task) that are easier to measure. If principals want agents to allocate effort to all tasks (dimensions of a task), they may be better off offering a fixed wage—that is, low-powered incentives (see also Gibbons [2005] for more detail).This also provides insights into job-design and task assignment—that is, issues of organizational specialization and roles: tasks that are easily measurable may be bundled and assigned to certain kinds of jobs, whereas costly-to-measure tasks are assigned to other jobs. High-powered incentives can be provided for the first kind of jobs but not the last kind. Although agency theory in important ways furthers the understanding of organizations, agency theory is not a theory of the firm per se (Hart 1989).The reward schedules that may modify the effects of asymmetric information are independent of any particular organizational structure. In principle, a reward schedule for a legally independent supplier firm may be completely identical to an employee reward schedule. Thus, principal-agent essentially does not discriminate between interfirm and intrafirm transactions, whereas the main point of Coase is exactly that there is a fundamental difference. Incomplete contracts: the coordination perspective Differences go further, for it is notable that Coase (1937) did not emphasize, or even mention, incentive conflicts as a part of the understanding of organizational governance.13 Coase’s explanation (ibid.) of organizational governance is probably best understood as a coordination theory: the firm is an institution that lowers the costs of coordination in a world of uncertainty. Of course, this view is closely tied to the view of the employment contract as the defining characteristic of the firm. As Simon (1951) points out, an employee is distinguished from an independent contractor by the nature of his contract: while the employee is subject to the authority of the manager of the firm, an independent contractor acts autonomously. Simon compares the employment contract and the market contract thus understood in terms of efficiency. Whereas the market contract specifies the action to be performed in the future and its price, the employment contract specifies a range of acceptable orders and establishes the right of the employer and the duty of the employee to accept orders within this range (“the zone of acceptance”). As in Coase, the advantage of the employment relationship lies in its flexibility (see also Wernerfelt 1997). The action of the employee can be adapted to whatever state of nature will occur. Simon also points out that the employment relationship is to some extent reliant upon the employer’s reputation for not abusing his authority, a theme later pursued by Kreps (1990, 1996). The need for trusting the employer is less if the employee is nearly indifferent between different tasks.

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Incomplete contracts:Williamson’s TCE and (new) property rights perspectives Incomplete contracts theory of the two kinds under scrutiny here—the approach associated with Oliver Williamson and the one associated with Oliver Hart—are united in their focus on the organizational implications of ex post opportunistic behavior in the presence of relation-specific investment. There are, however, a number of differences that warrant a separate treatment (see also Bajari and Tadelis 2001; Whinston 2001; Williamson 2000; Lafontaine and Slade 2007). Williamson. In a string of influential contributions, Williamson (for example, 1971, 1975, 1985, 1996) has constructed a theory that while built on Coasian foundations also incorporates ideas from psychology and contract law. The behavioral starting points in Williamson’s theorizing are, first, Simon’s concept of bounded rationality, which to Williamson implies the presence of contractual incompleteness and a need for adaptive, sequential decision-making.The second crucial behavioral assumption is opportunism, which is defined as “self-interest seeking with guile.”The implication of opportunism is that contracts will often need various types of safeguards, such as “hostages” (for example, the posting of a bond with the other party). The unit of analysis in Williamson’s work is the multidimensional transaction. In addition to uncertainty (which is “frozen”), the dimensions of transactions that are primarily determinative of the costs of those transactions are frequency and asset specificity. In an early contribution, Klein, Crawford, and Alchian (1978) linked asset specificity to the concept of appropriable quasi-rent. Assume an asset is owned by one individual and rented to another individual. The quasi-rent value of the asset is the excess of its value over its salvage value—that is, its value in its next best use to another renter. The potentially appropriable specialized portion of the quasi rent is that portion, if any, in excess of its value to the second highest-valuing user (Klein, Crawford, and Alchian 1978). Following Klein, Crawford, and Alchian, asset specificity has increasingly become the central character in Williamson’s analysis. Williamson (1996) now identifies six different reasons why assets may be costly to redeploy—namely, because of specialized knowledge (that is, human capital specificity), attachment to a brand name, a need to take quick actions (“temporal specificity”), market size (“dedicated assets”), localization, and physical characteristics. Specific assets open the door to opportunism. If contracts are incomplete as a result of bounded rationality, they must be renegotiated as uncertainty unfolds, and if a party to the contract (say, a supplier firm) has incurred sunk costs in developing specific assets (including human capital), that other party can opportunistically appropriate an undue part of the investment’s pay-off (“quasi-rents”) by threatening to withdraw from the relationship.This situation leads to a Pareto-inferior outcome—for example, a no-trade outcome. Efficiency dictates the internalization within a firm of transactions that involve highly specific assets. More generally, Williamson (1985: 68) argues that variety in contracts and governance structures “is mainly explained by underlying differences in the attributes of transactions.” The general design principle of discriminating alignment dictates aligning transactions that differ in the dimensions of uncertainty, frequency, and asset specificity with governance

534 Nicolai J. Foss and Peter G. Klein structures that differ in the capacities to handle different transactions (compare the earlier discussion of governance structures and governance mechanisms) in transaction cost discriminating way. Thus, specific constellations of (values for) uncertainty, frequency, and asset specificity maps directly into specific governance structures. This is the main predictive content of Williamsonian transaction cost economics. In Williamson’s view, the hierarchy possesses certain inherent advantages over market contracting: “[W]hen conflicts develop, the firm possesses a comparatively efficient resolution machinery. To illustrate, fiat is frequently a more efficient way to settle minor conflicts (say differences of interpretation) than is haggling or litigation” (Williamson 1971: 114). Although it has been present in Williamson’s work from the beginning, this advantage in particular has come to play an increasing role in Williamson’s work. Thus he has placed increasing emphasis on the argument that organizational governance is characterized by its own implicit contract law, what he calls “forbearance.” To illustrate, whereas divisions will not normally be granted standing for a court, corporate headquarters and headquarters function as the firm’s “ultimate court of appeal.” For example, Williamson (1991) points out that disputes that arise within the firm—for example, between different divisions—may be easier to resolve than disputes arising between firms that sometimes require the use of the court system. Thus managerial authority partakes of an important role as arbitrator in the face of conflicts and disputes over unforeseen contingencies; in other words, Williamson’s extension of the Coasian view of authority is to analyze it as a “private ordering,” a private legal institution (Williamson 2002). Part of that argument is Williamson’s assertion that there are qualitative and quantitative differences between the information structures that are available under market contracting and those that are available in the firm, an argument put to work in Williamson’s work on the M-form as an internal capital market (Williamson 1975). These are claims that have been disputed by what is often referred to as the new property rights theorists of the firm.14 In the words of Grossman and Hart (1986: 691): “[T]he transaction cost-based argument for integration does not explain how the scope for such behavior changes when one of the self-interested owners becomes an equally self-interested employee of the other owner.” Hart:The New Property Rights Approach. This approach is often seen as a formal version and development of important elements in Williamson’s work (but for a critique of this interpretation, see Kreps 1996; Williamson 2000; Lafontaine and Slade 2007). In fact, the founding new property rights paper—namely, Grossman and Hart (1986)—was explicitly motivated by an attempt to model Klein, Crawford, and Alchian (1978) and Williamson’s ideas on asset specificity, using modeling conventions and ideas developed in (complete contracting) agency theory (particularly Holmström 1982). However, the outcome of that attempt was essentially a new theory. As in Williamson’s work, a central assumption is that real-world contracts must necessarily be incomplete in the sense that the allocation of control rights cannot be specified for all future states of the world (Grossman and Hart 1986; Hart and Moore 1990). Ownership is defined as the possession of residual rights of control—that is, rights to control the uses of assets under

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contingencies that are not specified in the contract. Thus control implies the ability to exclude other agents from deciding on the use of certain assets—for example, the owner has the right to pull out the assets he owns from a relation. Such ownership rights can confer bargaining power, and play an important role in the determination of the efficient boundaries of the firm. Thus control rights that according to Hart and his associates determine the boundaries of the firm: a firm is defined as a collection of jointly owned assets. The basic distinction between an independent contractor and an employee— that is to say, between an interfirm and an intrafirm transaction—turns on who owns the physical assets that the agent utilizes in his work. An independent contractor owns his tools and so forth, while an employee does not. The importance of asset ownership derives from the fact that the willingness of an agent to undertake a contractible investment (say, exertion of effort or investment in human capital) that is specific to the asset depends on who owns the asset. If the agent who undertakes the investment does not own the asset, she may, as in Williamson’s work, be subject to a hold-up by the owner. On the other hand, the ability to deprive an agent of the piece of capital with which she works (and to which she may be heavily specialized) is what provides room for authority. Efficiency then dictates that the agent who is to make the most important (noncontractible) asset-specific investment should own the asset. It is not that opportunism can be avoided by internal organization/integration per se. Integration may shift incentives for opportunistic behavior, but it does not remove such incentives. Given this, one should choose the ownership arrangement that via its impact on incentives minimizes the consequences of opportunism. Transaction cost economics and the new property rights view. Grossman and Hart (1986) and Hart and Moore (1990) were recognized immediately as path-breaking contributions to the study of incomplete contracting. Indeed, Williamson (1996: 372–73) argued that TCE had progressed from “pre-formal” (that is, Coase’s work) to “semi-formal” (that is, Williamson’s own work), and “fully formal” (that is, the new property rights view) stages. However, in a later discussion Williamson (2000) finds the new property rights substantially different from his own framework in several key respects. For instance, formal incomplete-contracting models assume that levels of relationship-specific investments are completely unobservable and noncontractible; yet ex post bargaining over the division of the surplus is costless.15 Moreover, the GrossmanHart-Moore approach emphasizes the direction of integration; even under integration, the firm’s central managers cannot observe or verify subordinates’ ex ante relationship-specific investments, so it matters whether integration results from Party A acquiring Party B or vice versa. In contrast, Williamson argues that integration should be modeled as a hierarchy in which the allocation of decision rights is independent of the process by which integration occurred. Finally, bounded rationality has been an issue of contention. Thus, whereas Hart (1990) explicitly denied the need in organizational economics for a notion of bounded rationality (but see Hart and Moore 2007 for a different view), to Williamson contractual incompleteness is clearly derived from bounded rationality (rather than from some assumed noncontractibility of the use of the assets in a relation as in the property rights approach). To Williamson

536 Nicolai J. Foss and Peter G. Klein organization structure and information channels influence the boundedness of rationality (Williamson 1970) and may for this reason have implications for value creation. The incomplete contracting debate. Whereas debate between proponents of transaction cost economics and the new property-rights perspective has concerned which elements of the theoretical structure should primarily be stressed (asset or investment specificity, costless or costly ex post bargaining, and the like), the property-rights approach has been more fundamentally contested concerning its fundamental logic. The point of contention is what may explain ex ante misaligned investment incentives. Under complete contracting, agents can (1) perfectly foresee contingencies, (2) write contracts, and (3) enforce them. The implication is that in order to dilute investment incentives, some transaction costs involving assumptions (1) through (3) must be invoked. Thus some aspects of future trades cannot be foreseen and must be left to future negotiation, and/or writing costs mean that writing a complete contract is seldom optimal, and/or the parties’ valuations are not verifiable by a court and therefore cannot be contracted over. However, what is questioned by Maskin and Tirole (1999) and Tirole (1999) is whether such transaction costs constrain the set of feasible contracts relative to the complete contracting benchmark. If that is not the case, transaction costs are not sufficient to establish either the possibility of inefficient investment patterns, or a role for ownership (within the particular setups adopted in contract theory). According to these critics, the problem stems from the fact that although valuations are not verifiable, they may still be observable by the parties, which implies that trade may be conditioned on message games between the parties. These games are designed ex ante in such a way that they can effectively describe ex post all the trades that were not described ex ante. The key to this argument is the assumption (which is routinely made in the new property-rights literature) that parties allocate property rights and choose investments so that their expected utilities are maximized, knowing (at least probabilistically) how payoffs relate to allocations of property rights and levels of investment.16 Maskin and Tirole (1999) then provide sufficient conditions under which the indescribability of contingencies does not restrict the payoffs that can be achieved, a sort of “irrelevance of transaction costs” theorem. As Hart and Moore (1999) point out, however, unless the contracts governing these message games are renegotiation-proof—that is, the parties can commit ex ante not to renegotiate ex post if the possibility of mutual gain arises—such contracts are not much better than the incomplete contracts in the original Grossman-Hart-Moore model (see also Segal 1999). Moreover, the contracts governing these message games can be extremely complex and prohibitively costly (Anderlini and Felli 2004). Extensions The critical point, associated with Williamson, that there is little ex post action in formal organizational economics implies that most of organizational governance is reduced to issues of ex ante incentive alignment and allocation of residual ownership rights. “Softer” but very real management and organizational

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governance issues such as how to cultivate organizational citizenship behavior, avoid breach of psychological contracts, and the like, seem difficult to press into such an ex ante design-oriented perspective. However, organizational economists have made significant strides forward with respect to linking ideas on ownership and incentives to such softer issues. A starting point is the fact that human capital is inalienable. However, as Rajan and Zingales (1998: 388) argue, “[T]here is a sense in which employees ‘belong’ to an organization . . . . This sense of belonging arises from the expectation ‘good citizens’ of an organization have that they will receive a share of future organizational rents.” Starting from the new property rights perspective, they treat this kind of belonging in terms of “access,” which means that agents are allowed to work with critical resources, specialize themselves relative to these resources, and make themselves valuable in this way. Since a specialized employee can control her own specialized human capital, she now has additional power, although she doesn’t possess more residual rights of control. In their theory, access may sometimes provide better incentives than ownership. Thus, Rajan and Zingales elegantly manage to incorporate “soft” aspects of organizations, such as power and the development of capabilities, into the incomplete contracts approach. In general, there are ample opportunities to make room for softer aspects of organizational governance in the context of the incomplete contracts approach.When it is difficult to write complete statecontingent contracts—for example, when certain variables are either ex ante unspecifiable or ex post unverifiable—people often rely on “unwritten codes of conduct”—that is, on implicit contracts. These may be self-enforcing, in the sense that each party lives up to the other party’s (reasonable) expectations from a fear of retaliation and breakdown of cooperation. Baker, Gibbons, and Murphy (2002) further explore the “relational” aspects of incomplete contracting. As they point out, vertical relations should be characterized not only according to ownership (make or buy), but also according to frequency (one-time or recurring). For repeated transactions, the choice is not between “spot outsourcing” and “spot employment,” but between “relational outsourcing” and “relational employment.” Klein and Leffler (1981) noted that reputation can substitute for hierarchy in mitigating opportunistic behavior among trading partners. Baker, Gibbons, and Murphy (2002) add that asset ownership (in the Grossman-Hart-Moore sense) affects parties’ incentives to renege on a relational contract, both outside and inside the firm. They construct a repeated game in which a downstream party makes a noncontractible promise to pay a bonus to an upstream party for delivering high quality. Integration increases the downstream party’s incentive to renege on the promise (under nonintegration, if the downstream party reneges, the upstream party can sell the good to an alternative user). Nonintegration, however, increases the upstream party’s incentive to increase the value of the traded good to the alternative user, giving her a stronger bargaining position should the downstream party renege. The tension between these incentives gives rise to the trade-off between integration and nonintegration.The analysis is very much in the spirit of the incomplete-contracting approach, but extended to a repeated-game setting.

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Applications and Evidence public bureaucracies Organizational governance, as defined in this chapter, refers primarily to arrangements that govern private, profit-seeking enterprises. While the literature on the organization and governance of nonmarket institutions such as public bureaucracies, nonprofit institutions, religious bodies, and the like has evolved largely independently of organizational economics, there has been important cross-fertilization between these fields. Much of the modern literature in “positive political economy,” for example, takes models developed in the economic analysis of organization and applies them to nonmarket settings (Moe 1984, 1990; Shepsle and Weingast 1987; North and Weingast 1989; Weingast 1997). Building on the core insights from theories of rent-seeking and public choice (Downs 1965; Tullock 1967; Niskanen 1971), this literature seeks to explain how political actors craft governance structures, or institutions, to facilitate efficient production and exchange of political goods and services. These studies are part of the “rational-choice” tradition in political science, broadly speaking, but focus on coalition formation, the role of reputation, formal and informal contracts (that is, constitutions), and similar structures as means of organizational governance. antitrust and regulation Organizational economics, particularly in its transaction-cost incarnation, has obvious implications for antitrust, regulation, and other aspects of government policy toward business. Indeed, the subtitle of Williamson’s 1975 book Markets and Hierarchies is “Analysis and Antitrust Implications,” and significant parts of his work take issue with what he calls the “inhospitality tradition” in antitrust—that is, the notion characteristic of antitrust thinking in the 1960s in the United States and until recently in the European Union that firms engaged in nonstandard business practices such as vertical integration, customer and territorial restrictions, tie-ins, franchising, and so on, must be seeking monopoly gains. Of course, Williamson’s argument was that many of such nonstandard practices in actuality enhanced efficiency by economizing on transaction costs. Antitrust practice is now, generally speaking, very lax on vertical arrangements (the typical exception being resale price maintenance), and it is quite arguable that much of the changed antitrust climate in this regard can be traced to the rather general acceptance in the economics profession of transaction cost (and contract theory) arguments concerning the efficiency properties of such arrangements. As Shelanski and Klein (1995) explain, transaction cost economics, in particular, have actual or direct implications for other contracting practices and regulations. They invoke Barker and Chapman’s argument (1989) that closedshop agreements in labor markets may serve to protect workers’ job-specific training rather than to exploit a monopoly position. They also point to studies of optimal contract design, notably Crocker and Reynolds’s examination (1993) of Air Force procurement contracts as guides to public policy toward government purchases of goods and services.

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mergers and acquisitions and diversification Organizational economics also has important implications for mergers, divestitures, and restructurings as mechanisms for changing firm boundaries and governance structure, as well as implications for diversification and diversification’s impact on firm performance, key issues in corporate finance as well as strategic management. The choice between acquisition and internal growth can be modeled as a transaction cost problem, and the vast theoretical and empirical literature on the gains from M&A and corporate reorganizations can be viewed as applications of the economic approach to organizational governance (mostly, agency theory). The literature on boundaries goes far beyond textbook explanations for economies of scope in production. As Teece (1980, 1982) pointed out, scope economies imply joint production, not integration; absent transactional difficulties, two separate firms could simply contract to share the inputs, facilities, or whatever accounts for the relevant scope economies. If they do not, it must be because the costs of writing or enforcing such a contract are greater than the benefits from joint production. Diversification also has little to do with risk reduction, as investors can reduce firm-specific risk by holding diversified portfolios, consisting of shares in a variety of single-product firms.17 Williamson (1975: 155–75) offers an account of the multiproduct firm based on intrafirm capital allocation. In his theory, diversified firms arise when limits in the capital market permit internal management to allocate and manage funds more efficiently than the external capital market. These efficiencies may come from several sources. First, the corporate office typically has access to information unavailable to external parties, which it extracts through its own internal auditing and reporting procedures (ibid.: 145–47). Second, managers inside the firm may also be more willing to reveal information to the corporate office than to outsiders, since revealing the same information to the capital market would also reveal it to rival firms, potentially hurting the firm’s competitive position. Third, the corporate office can intervene selectively, making marginal changes to divisional operating procedures, whereas the external market can discipline a division only by raising or lowering the share price of the entire firm. Fourth, the corporate office has residual rights of control that providers of outside finance do not have, making it easier to redeploy the assets of poorly performing divisions (Gertner, Scharfstein, and Stein 1994). More generally, these control rights allow headquarters to add value by engaging in “winner picking” among competing projects when credit to the firm as a whole is constrained (Stein 1997). Fifth, the internal capital market may react more “rationally” to new information: those who dispense the funds need only take into account their own expectations about the returns to a particular investment, and not their expectations about other investors’ expectations, eliminating speculative bubbles or waves. On the other hand, some writers argue that cross-subsidization is harmful, leading to rent seeking by divisional managers (Scharfstein and Stein 2000), bargaining problems within the firm (Rajan, Servaes, and Zingales 2000), or bureaucratic rigidity (Shin and Stulz 1998). Intrafirm resource allocation can be “sticky,” and resources may not flow to their highest-valued uses. Empirical evidence on the relationship between diversification and

540 Nicolai J. Foss and Peter G. Klein performance is mixed. Influential studies by Lang and Stulz (1994), Berger and Ofek (1995), and Servaes (1996) found that multisegment firms traded at a discount relative to more specialized firms, or to portfolios of nondiversified firms from the diversified firm’s industries. More recently, however, Chevalier (2000), Villalonga (2000), Campa and Kedia (2002), and Graham, Lemmon, and Wolf (2002) argue that diversified firms trade at a discount not because diversification destroys value, but because undervalued firms tend to diversify. Diversification is endogenous, and the same factors that cause firms to be undervalued may also cause them to diversify. Even the conventional wisdom on the 1960s has been challenged, with Matsusaka (1993), and Klein (2001) finding evidence for efficiency gains from some conglomerate mergers. evidence There is a large body of empirical literature examining various issues in organizational governance. Besides the work on diversification described above, many empirical studies have examined the make-or-buy decision, focusing mainly on the transaction cost approach.18 Despite challenges associated with the measurement and definition of key variables, the role of asset specificity, comparison with rival theories, and causality, the transaction cost model seems to have straightforward empirical implications, such that observed forms of organizational governance can be explained in terms of asset specificity, uncertainty, frequency, and so on.

Critiques and Discussion Ever since its takeoff period in the mid-1970s, organizational economics has been subject to intense debate. Much debate has been an internal one between scholars who are within, or at least stay relatively close to, the economic mainstream (for example, Dow 1987; Hart 1995; Kreps 1996; Furubotn and Richter 1997; Maskin and Tirole 1999; Foss and Foss 2000; Furubotn 2002; MacLeod 2002). However, there are also many external critiques that are represented by sociologists, heterodox economists of various stripes, and management scholars. Williamsonian transaction cost economics in particular have been a favorite Prügelknabe for about three decades (Hodgson 1989; Perrow 2002), but agency theory has also drawn a fair amount of fire (Donaldson, 1996). Thus early critics argued that transaction cost neglected power relations (Perrow 1986), as well as trust and other forms of social embeddedness (Granovetter 1985), and paid too little attention to evolutionary considerations, including Knightian uncertainty and market processes (Langlois 1984). Such critiques have been echoed and refined in numerous contributions until this day. cognition Formal economics, including formal manifestations of organizational economics, typically assumes that agents hold the same, correct model of the world, and that that model does not change. These assumptions are built into formal contract theory through the assumption that payoffs, strategies, and the like are common knowledge. These assumptions are at variance with the

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notion of bounded rationality (Simon 1955), and in formal organizational economics bounded rationality is almost entirely neglected (but see, for example, Mookherjee 1998). In contrast, bounded rationality is often invoked in Williamson’s less formalized work (1985, 1996), but its role here is mainly to explain why contracts are incomplete. The reason may be that the theory is taken up with comparative institutional exercises, and hence has no room for the process aspects introduced by more substantive notions of bounded rationality (for example, Furubotn 2002).19 In contrast, bounded rationality has long been a central assumption in organization theory (for example, March and Simon 1958; Cyert and March 1963; Grandori 2001). In fact, recent critics of organizational economics have drawn explicitly on these older sources to develop alternative, evolutionary views emphasizing the role of bounded rationality in problem-solving, and the role of firms as cognitive structures around such problem-solving efforts (for example, Dosi and Marengo 1994). Other critics, also echoing behavioral organization theory, argue that a key characteristic of firms is that they tend to shape employee cognition (Kogut and Zander 1996; Witt 1999). Few economists of organization have reacted to the above critiques, arguably because taking these critiques seriously means questioning fundamental tenets of mainstream economic modeling; thus, bounded rationality questions, for example, subjective expected utility theory, the independence of payoff utilities, the irrelevance of labeling, and common prior beliefs (Camerer 1998). However, a handful of contributions, mainly to contract theory, do try to model agents that are boundedly rational in a more substantive sense. For example, Mookherjee (1998) shows how ambiguity may lead to incomplete contracting; Carmichael and MacLeod (2003) show that if boundedly rational agents care about sunk costs, this may solve the hold-up problem. motivation In critiques of organizational economics, the notion of opportunism seems to be the favorite bete noire. The critique takes various forms. Thus some may dismiss the relevance of opportunism by pointing to the low frequency with which opportunistic action can be observed, an argument that misunderstands the counterfactual nature of reasoning in the theory of the firm: opportunistic behavior is seldom observed because governance structures are chosen to mitigate opportunism. According to a more recent argument, the primary problem with the treatment of motivation in organizational economics is not opportunism per se, but rather that all motivation is of the “extrinsic” type (Ghoshal and Moran 1996; Osterloh and Frey 2000). In other words, all behavior is understood in terms of encouragement from an external force, such as the expectance of a monetary reward. (In contrast, when “intrinsically” motivated, individuals wish to undertake a task for its own sake.) Ghoshal and Moran (1996) argue that organizational economics misconstrues the causal relation between motivation (for example, the tendency to shirk) and the surrounding environment (the type of governance structure in place). “Hierarchical” controls, they state, reduce organizational loyalty and thus increase shirking. Williamson’s approach becomes a “self-fulfilling prophecy,” and is therefore “bad for practice.”

542 Nicolai J. Foss and Peter G. Klein Such arguments do not necessarily deny the reality of opportunism, moral hazard, and so on, but assert that there are other, more appropriate ways to handle these problems than providing monetary incentives, sanctions, and monitoring. The arguments are often based on social psychological research (Deci and Ryan 1985) and on experimental economics (for example, Fehr and Gächter 2000). It is characteristic of much of the literature that the social psychology research that is cited is very seldom questioned. Still, working with alternative motivational assumptions may be a fruitful way forward, and arguably one that may be more fruitful than working with alternative cognitive assumptions: it seems easier to doctor utility functions than cognitive assumptions. Moreover, the implications for economic organization may also seem more immediate (see Lazear 1991; Fehr and Gächter 2000, for concrete examples). everything is given A major problem with modern economic theories of the firm is that they ignore the entrepreneur (Furubotn 2002; Foss and Klein 2005). Still, a few attempts to put entrepreneurship into organizational economics do exist (for example, Casson 1997; Foss and Klein 2005). For example, starting from a notion of entrepreneurship as judgmental decision-making under conditions of uncertainty that are hard to contract, Foss and Klein (2005) establish a link to asset ownership and the start-up of a firm. In this approach, resource uses are not data, but are created as entrepreneurs envision new ways of using assets to produce goods.The entrepreneur’s decision problem is aggravated by the fact that capital assets are heterogeneous, and it is not immediately obvious how they should be combined. Asset ownership facilitates experimenting entrepreneurship: acquiring a bundle of property rights is a low-cost means of carrying out commercial experimentation. process issues Many critics have taken issue with the presumed ahistorical, nonprocessual nature of organizational economics, such as its neglect of path dependence (for example, Winter 1991: 192). It is correct that organizational economics has largely neglected how the governance of a particular transaction may depend on how previous transactions were governed. However, if such path dependence is actually present (what Argyres and Liebeskind 1999 call “governance inseparability”), firms may rationally rely on governance structures that appear inefficient at a particular time, but which make sense as part of a longer-term process. Changes in governance structure affect not only the transaction in question but also the entire temporal sequence of transactions. This may make organizational form appear more “sticky” than it really is. A related process issue turns on the explanation of economic organization in terms of efficiency that characterizes organizational economics. This has been one of the most frequently criticized characteristics of the theory of the firm: assuming that agents can figure out the efficient organizational arrangements seems to collide with the assumption of bounded rationality (Dow 1987; Furubotn 2002). Presumably in response to this problem, early work in the theory of the firm often explicitly assumed that market forces work to cause an “efficient sort” between transactions and governance structures, an assumption that is not in general tenable. While appealing to market selection, Williamson

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(1985: 174) also clearly recognizes that the process of transaction cost economizing is not automatic. Still, he maintains that the efficiency presumption is reasonable, offering the argument that inefficient governance arrangements will tend to be discovered and undone (Williamson 1985: 119–20). Clearly, this assumption is not an innocuous one. It is in fact a key underlying assumption in virtually all empirical work in the theory of the firm. A general problem with the empirical literature on organizational form is that we usually observe only the business arrangements actually chosen. However, if these arrangements are presumed to be efficient, we can draw inferences about the appropriate alignment between transactional characteristics and organizational form simply by observing what firms do. The problem is that the efficiency assumption has always been taken as an essential, but untested, background assumption.

Conclusion Despite continuing questions about the scope of the relevant theories, their robustness to alternative behavioral assumptions, the degree to which they are substitutes or complements, and related issues, the broad set of rationalchoice approaches to organizational governance discussed here have proved highly successful in explaining what firms are, what firms do, and how firms are structured. Less is known about how firms change through time and how “soft” characteristics such as leadership, culture, and capabilities affect the performance of the firm. Still, modern theories of organizational governance have made considerable headway in shedding light on the core problems of firm organization and management. As described above, the most common theories of organizational governance differ in many details. Still, they share important features: an emphasis on maximizing behavior, imperfect and incomplete information, costs of monitoring or costs of contracting, and the like. They share common roots in the explosion of “Coasian” approaches to economic organization that emerged in the mid-1970s. Is this a weakness? Almost two decades ago Paul Milgrom and John Roberts (1988b: 450) argued that the “incentive-based transaction costs theory has been made to carry too much of the weight of explanation in the theory of organizations,” predicting that “competing and complementary theories” would emerge, “theories that are founded on economizing on bounded rationality and that pay more attention to changing technology and to evolutionary considerations.” However, no serious competitors have emerged so far. One possible reason is that mainstream organizational economics is sufficiently successful that competitors have a hard time gaining a foothold. Still, as we have stressed throughout this chapter, many of the critiques do in fact point to weaknesses in the theory of the firm that should ideally be remedied. A further reason is that the critics tend to focus on phenomena that are difficult to model. Innovation, entrepreneurship, bounded rationality, learning, evolutionary processes, and differential capabilities are examples of such phenomena. The formal tools that can handle such phenomena may not exist or may not have been developed to a sufficient extent.

544 Nicolai J. Foss and Peter G. Klein

Notes 1. Note that organizational governance includes but is broader than the notion of “organizational control.” The latter refers mainly to the governance of human capital inputs inside an organization (and sometimes only with the monitoring and evaluation of human capital services), and implies a notion of the corporate person of the firm as the principal and human capital owners as agents. The notion of organizational governance is broader, in that it includes a broader set of stakeholders, such as owners of capital and input suppliers. 2. Williamson’s notion may not be entirely fortunate for those firms that are largely nonhierarchical—namely, partnerships. 3. Nevertheless, it is usually argued that with perfect and costless contracting, it is hard to see room for anything resembling organizations. In fact, it is held that even one-person firms would not exist under such conditions, since consumers could contract directly with owners of factors services and would not need the services of the intermediaries (that is, firms) (for example, Cheung 1983). 4. Notions of agents as information processors and as facing attention allocation problems are sometimes loosely developed, but such insights are seldom cast within an overall optimizing logic. Moreover, motivational issues are seldom highlighted in this branch of organizational theory. 5. Although the exact mechanisms through which this happens are somewhat opaque; perhaps one may imagine divisions holding each other up on transfer prices. 6. It is arguable that one reason for this is that there is a tendency in the literature to think of the exercise of authority as being highly informed, so that the right to control translates into effective actual control over decisions (see Foss 2002). However, the right to decide need not confer effective control over decisions, as Aghion and Tirole (1997) point out. In their story real authority is determined by the structure of information in the organization. An increase in an agent’s real authority is assumed to promote initiative, but also to lead to control losses from the point of view of the principal. 7. In the words of Hart (1990: 699): “[E]ven though the agents are not capable of writing a contract that avoids hold-up problems, they are clever enough to understand (at least roughly) the consequences of their inability to do so.” For a skeptical discussion of this feature, see Kreps (1996). 8. However, when reading Coase’s paper today, one is struck by the absence of references to incentive conflicts, arguably the main explanatory focus of today’s economics of organization. Rather, Coase’s perspective emphasizes flexibility: in an uncertain world, there is a need for adaptation to more or less unanticipated events, and the employment relation (Coase 1937: 391). 9. A certain, limited interaction with neighboring disciplines has also played a role in the development of the theory of the firm. Thus Oliver Williamson’s interaction at Carnegie-Mellon University with the likes of Herbert Simon, Richard Cyert, and James March as well as his reading of Alfred Chandler’s accounts (1962) of American business history influenced the development of the transaction cost economics approach (Williamson 1996). Still, the impact of insights from psychology, sociology, business history, and business administration is not really clear. 10. Important subsequent work in this stream includes Fama (1980) and Fama and Jensen (1983), both essentially critiques and extensions of the Jensen and Meckling paper. Fama highlights the role of the managerial labor markets in disciplining firm management; Fama and Jensen further elaborate on the division of labor between decision management and decision control. 11. See Hart and Holmström (1987) and Laffont and Martimort (2002) for surveys.

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12. At least until Grossman and Hart (1986) defined the “new” property rights perspective. 13. In his assessment of modern organizational economics, Coase is explicitly critical of the overriding contemporary emphasis on incentive conflicts (Coase 1991a). 14. “New” to distinguish these theorists from “older” property rights theorists such as Coase, Alchian, Demsetz, and others. 15. In his words: “GHM vaporize ex post maladaptation by their assumptions of common knowledge and costless ex post bargaining” (Williamson 2000: 605). 16. In the jargon of the literature, they can perform “dynamic programming,” which essentially is intertemporal optimization with discounting in a stochastic setting. 17. Moreover, risk pooling at the firm level should be more costly than risk pooling at the level of the individual investor, since the transaction costs of buying or selling stock are presumably lower than the transaction costs of adding or liquidating a division (Williamson 1975: 144). Diversification to reduce risk benefits only managers, who can reduce their own “employment risk” at the expense of the value of the firm (Amihud and Lev 1981). 18. Comparatively little empirical work looks at agency theory (excepting corporate finance and governance applications), the resource-based view, and the property-rights approach. The empirical TCE literature is surveyed and summarized in Masten (1984), Joskow (1988), Shelanski and Klein (1995), Klein and Shelanski (1996), and Macher and Richman (2006); the bulk of the evidence is interpreted as consistent with the predictions of TCE (see David and Han 2004; and Carter and Hodgson 2006 for a contrary view. 19. Dow (1987) argues that it is inconsistent to invoke bounded rationality as a necessary assumption in the analysis of contracts and governance structures, and then assume that substantively rational choices can be made with respect to the contracts and governance structures (that are imperfect because of bounded rationality). See also Kreps (1996) for a similar point.

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chapter

Rational Choice and Organizational Change

16

rafael wittek and arjen van witteloostuijn

Introduction Since the beginning of the twentieth century, the number of profit-making enterprises has grown exponentially. In the United States alone, their number has risen from little more than 300 in 1916 (Wu 1974) to more than 5.8 million in 2004.1 These and not-for-profit organizations are key agents in any modern society. Time and again, people have to deal with organizations, in their capacity of citizens with authorities, of consumers with enterprises, of employees with employers, and so forth. Organizations are not static entities— to the contrary. They often change: they merge, they move, they disappear, they downsize, they reorganize. From a sociological perspective, this raises two key questions: why do organizations change, and what are the consequences of such change? By now, there is a huge multidisciplinary literature dealing precisely with this dual question of the antecedents and consequences of organizational change. For example, economists have explored corporate governance, psychologists have studied the downsides of downsizing, and sociologists have focused on the institutional forces driving organizational change. Indeed, in business schools, organizational change has been looked at from a wide array of different perspectives: sometimes contradictory, but often complementary. But the sociological rational choice angle is not one of them. Organizational change is a topic that went largely unnoticed in the sociological rational choice tradition. It is not that sociologists are not interested in issues of organizational change—they are. Clear cases in point are the many organizational change analyses in institutional sociology (for example, DiMaggio and Powell 1983) and organizational ecology (for example, Hannan and Freeman 1977). In this chapter, we argue that the sociological rational choice approach could contribute much to our understanding of the antecedents and consequences of organizational change as well. The further study of organizational change is promising, and highly needed. Notwithstanding the continuous flow of new research devoted to organizational change, important puzzles remain at the micro level of analysis. First, a

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comprehensive contingency theory of organizational change is still missing (Van Witteloostuijn and Boone 2004): what types of organizational change are beneficial from the organization’s perspective under which conditions, both in terms of environmental characteristics and organizational features? Second, the organizational change literature has a strong bias toward the micro level. It focuses on the antecedents or consequences of organizational change for individual organizations, or groups (industries or populations) of specific individual organizations. In this chapter, we offer a plea to shift attention to the macro level of analysis: what societal antecedents drive societywide organizational change patterns, how can societal organizational change trends over time be explained, and what might be the consequences of these trends for society at large? By way of steppingstone, we point to five trends that we think dominate modern capitalist societies. The first trend relates to organizational size. We argue that at the top of the organizational size pyramid in modern capitalist societies, the trend is clearly toward bigger organizations. This is not to say that below this top smaller enterprises cannot and will not flourish—they do (Boone, Carroll, and Van Witteloostuijn 2002). And this is not to say that large organizations never downsize—they do (Cascio 2002). Rather, our argument is that within the top, say, 5 percent, average organizational size increases over time. This gives: Trend 1 (size)— In modern capitalist societies, the average size of large commercial enterprises increases over time.2 This can be illustrated with data from the Compustat data set, which includes annual report information of the world’s largest commercial enterprises. In terms of the number of employees, the top 1 percent of enterprises employed, on average, about 204,000 people in 1993, which increased to approximately 264,000 in 2003. These figures are 87,000 (1993) and 108,000 (2003) for the top 5 percent, and 56,000 (1993) and 77,000 (2003) for the top 10 percent.3 The second trend involves commercial merger and acquisition (M&A) activities (Pryor 2001a,b,c; Andrade, Mitchell, and Stafford 2001; Brakman, Garretsen, Van Marrewijk, and Van Witteloostuijn 2006). M&As reflect a prominent route to organizational growth. As Andrade et al. (2001) and many others before and after them have observed, M&A activity comes in waves, with each next wave surpassing the previous wave in terms of the number of deals and the value involved. By engaging in M&A activity, an organization can grow quickly by amalgamating with another organization. This provides: Trend 2 (amalgamation)— In modern capitalist societies, the frequency and magnitude of M&A activities in the world of large commercial enterprises increase over time. The third trend focuses on the rhythm of organizational change. Aggregate data on the frequency of organizational change, worldwide or per country, are not available. However, studies on specific types of change in specific national or international industries abound (Sorge and Van Witteloostuijn 2004, 2007), reporting an increasing organizational change frequency over time in modern industries (for example, Axelsson 2010). This suggests:

558 Rafael Wittek and Arjen Van Witteloostuijn Trend 3 (change)— In modern capitalist societies, the rhythm of organizational change in the world of large commercial enterprises speeds up over time. The fourth trend relates to the work floor. The rhetoric is that so-called highperformance human resource management practices are increasingly introduced for the very reason of their positive impact on organizational performance (Pfeffer 1998). The evidence, though, goes against this claim (Knoke 2001). Rather, we witness: Trend 4 (work floor)— In modern capitalist societies, the spread of high-performance human resource management practices in the world of large commercial enterprises does not increase over time. The fifth trend has to do with the total compensation packages for the chief executive officers (or more broadly, top executive managers) of large commercial enterprises. In modern capitalist societies, the corporate elite’s income is clearly on the rise, and sharply so (Hall and Murphy 2003;Van der Laan,Van Ees, and Van Witteloostuijn 2008). This is true in terms of a series of elements of such remuneration schemes, from fixed salaries to option packages, as well as for the total sum (Frydman and Saks 2007). This results in: Trend 5 (income)— In modern capitalist societies, the income of the corporate elite in the world of large commercial enterprises increases over time. Together, these five trends may well have far-reaching consequences for society. Two potential consequences are particularly worth mentioning. First, Trends 1 to 3 might imply that citizens face larger and larger commercial organizations, on average, which change more and more often. As a result, the cognitive distance between citizens and organizations increases over time. This triggers feelings of alienation. Modern large commercial enterprises transform into anonymous bureaucracies, with advertising-driven brand name images that are far remote from the organization’s actual behavior. To the best of our knowledge, systematic evidence on this development is missing, although anecdotal “evidence” of citizens lost in the labyrinth of large commercial enterprises abounds. Second, Trends 4 and 5 in combination reveal a widening income gap between the corporate elite and the work floor. Indeed, income inequality in modern capitalist societies has increased ever since the 1980s (OECD 2007). Although country differences are substantial, an increase in inequality can be witnessed in all twenty countries. Clearly, a societal divide between the not-so-rich, on the one hand,4 and the extremely rich, on the other hand, is emerging in modern (and transition) capitalist societies. Both alienation and divide are key sociological issues. Our logic suggests that both may well be driven by trends related to organizational change in the world of large commercial enterprises. If so, the study of organizational change is also important from a macro perspective, next to the traditional micro angle. In this chapter, we will propose a sociological rational choice explanation, emphasizing that the corporate elite seeks to maximize power and income.

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However, this cannot be more than a suggestion, as a sociological rational choice study of organizational change is, to date, nonexistent. Therefore, our argument comes in three steps. First we will discuss a series of rational choice models from other traditions than rational choice sociology—that is, neoclassical economics and organizational ecology. In both fields, formal models have been developed that inform our issue of the antecedents and consequences of organizational change. Then we will review the available evidence. Here we decided to focus on three issues: strategic change, corporate restructuring, and workplace transformation research in business and economics. Following this we develop the contours of what might become a sociological rational choice approach to organizational change. We will explore the extent to which the sociological rational choice approach may help to solve remaining puzzles, with an emphasis on macrolevel issues. In so doing, we will explore explanations of the five trends by focusing on the development of a sociological rational choice model of the behavior of the corporate elite in modern capitalist societies. Finally, we conclude with an appraisal.5

Economic Rational Choice Models of Organizational Change The explicit modeling of organizational change from a rational choice perspective is close to nonexistent. A related modeling literature that oftentimes implicitly has something to say on organizational change, though, can be found in organizational economics. The agency perspective is at the heart of what has become known as organizational economics, a blend of neoclassical microeconomics that models issues of organizational authority and hierarchy. By its very nature, organizational economics takes a rational choice perspective. The core of organizational economics’ models tends to be economic agents and principals maximizing their private utility, often specified as monetary benefits B minus some costs C. However, from the current chapter’s perspective, the extant organizational economics literature goes only halfway for two reasons. First, the organizational economics literature tends to ignore sociological perspectives, rather emphasizing “pure” economic calculus—that is, maximizing B minus C by each individual decision-maker, often in combination with profit at the level of the organization, being defined as a group of hierarchically linked principals and agents. Second, organizational change is not explicitly modeled, but is rather implicitly addressed by the comparison of different outcomes under different sets of conditions. In the context of the current chapter, a “quickand-dirty” overview of this literature must suffice, just to make clear how our contribution relates to this modeling tradition. After we have done that, we will briefly discuss the few models inspired by organizational economics that do deal explicitly with the organizational change issue. Roughly, the organizational branch of microeconomics models imperfect relationships between principals (say, owners or managers) and agents (say, managers or workers).6 Assume a simple two-person setting, with a principal i and an agent j. Each party involved in the organization maximizes her private utility, U, which is B – C. For principal i, B might entail firm profit and C monitoring activity; for agent j, B may be her remuneration and C the cost of effort. An essential pair of assumptions is that (a) the utility function of

560 Rafael Wittek and Arjen Van Witteloostuijn the principal i is different from the utility function of agent j, and (b) the principal j is not perfectly informed about agent i’s behavior and performance. For example, an agent would like, ceteris paribus, to minimize effort cost Ci, but principal j’s payoff is an increasing function of Ci. The modeling exercise then focuses on features of the organizational design (for example, a manager’s span of control) and human resource policies (such as the bonus system) that maximize the principal’s utility (for example, firm net profit). As a result of (a) conflict of interest and (b) information imperfection, all kinds of subtle tradeoffs determine the payoff-maximizing organizational form and practices from the perspective of the principal. By far the majority of the papers in this tradition focus on two organizational forms, inspired by Chandler (1962) and Williamson (1975), the M- and UForm (see below for a more detailed description of the differences between the two forms). For instance, if the organization becomes larger, a multidivisional (M) form will outperform the unitary (U) form because, for example, the MForm bypasses part of the information asymmetry bottleneck by introducing yardstick competition (for recent examples of this type of modeling, see, for example, Hart and Moore, 2005; Inderst, Müller, and Wärneryd 2007). In this modeling tradition, imperfection of information is key: transmission of information from agent to principal cannot be perfect (for example, Maskin, Qian, and Xu 2000), and may even be manipulated by the agent in the context of rent-seeking behavior (for example, Milgrom and Roberts 1990) and power struggles (for example, Rajan and Zingales 2000). Of course, changes made by principals to improve effectiveness can pay off, at least for a while. In organizational economics, examples of such changes abound, all being based on comparative statics—that is, if a key parameter’s value goes up or down, the “optimal” organizational form may switch from M to U or vice versa. After all, “[D]ifferent organizational forms give rise to different information on which incentives can be based” (Maskin, Qian, and Xu 2000: 363). For instance, after a comparative statics exercise like this, Aghion and Tirole (1995: 441) conclude that “[e]xogenous changes in the firm’s environment induce a restructuring of its activities. For instance, growth raises the headquarters’ overload and may force the firm to spin off activities to refocus on its core competencies . . . and to abandon some marginal activities.” However, in so doing, these organizational economics’ models do not explicitly specify the costs and benefits of change as such. We know from the large organizational change literature that organizational change is anything but costless (see below for an overview of this literature). In fact, at the heart of the organization sciences literature is a debate as to whether organizational change is, on average, a good or a bad thing, depending upon the nature of change and the associated contingencies, with organizational ecology offering the counterpoint. A limited number of formal rational choice models have been developed to relate to precisely this issue: the “optimality” of organizational change as such. Here, by way of illustration, we briefly discuss two of them. First, Van Witteloostuijn (1998) adopts an agency argument in the context of a traditional Cournot duopoly competition model, seeking to model organizational decline. Following the delegation games literature, as originally developed by Vickers (1985), Fershtman (1985), and Fershtman and Judd (1987),

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he assumes that a principal-owner of firm i hires an agent-manager to run his firm, as does the principal of a rival firm j.7 The principal-owner’s objective is to maximize his firm’s profit, whereas the manager’s utility is a combination of profit and sales. In principle, this may introduce a conflict of interest. A manager’s utility function is specified as u = π + αs,

(1)

where u is utility, π is profit, α is a weight parameter, and s is sales. This α can reflect either a manager’s intrinsic preference for sales or an element in the manager’s bonus contract. With α, the issue of organizational change is introduced. That is, the lower αi, the higher the likelihood that the firm headed by manager i will downsize in response to a sales expansion by rival j. So a manager with a low α is associated with downward organizational size flexibility, and a manager with a high α with downward organizational size inertia. Modeling Cournot duopoly competition between i and j assuming 0 ≤ αi < αj reveals that the inert firm j outcompetes the flexible rival i. That is, organizational change is counterproductive, being associated with lower performance. This result offers formal support for organizational ecology’s claim that organizational inertia is positively associated with the likelihood of organizational survival (Hannan and Freeman 1977), and that organizational change increases the likelihood of organizational mortality (Hannan and Freeman 1984). Under certain conditions, this “inertia outperforms flexibility” result holds true even if the inert rival j is less efficient than the flexible rival i (that is, if ci < cj, where c is unit production cost). Second, Van Witteloostuijn, Boone, and Van Lier (2003) add to Van Witteloostuijn (1998) a model with production adjustment cost. Production adjustment cost is specified as a = βΔq, where a is adjustment cost, q is the quantity produced, Δq = qt – qt–1, and β is an adjustment cost parameter. Of course, if β > 0, changes in q are associated with inertia. With a higher β, adjusting the production volume is more costly, making the firm more inert. Assuming 0 ≤ βi < βj gives similar results as in Van Witteloostuijn (ibid.): the inert firm j (with the high βj) outperforms the flexible rival i (with the low βi) in a declining market. Of course, this model and the one of Van Witteloostuijn (ibid.) deal only with a specific type of organizational change: downsizing and upsizing. In this context, both models offer an explanation for Trend 1. Where does all this leave the rational choice modeling of organizational change? We believe that three observations are worth making. First, organizational economics offers the toolkit to do precisely this: to develop formal rational choice models of organizational change. Second, the extant literature models organizational change only indirectly, with the exceptions of Van Witteloostuijn (ibid.) and Van Witteloostuijn, Boone, and Van Lier (2003). Third, none of the existing models is really sociological in nature. In essence, all are in the economic rational choice domain. The latter observation is particularly important, as it points the way to future sociological rational choice work in the area of organizational change. The key concept here is power.

562 Rafael Wittek and Arjen Van Witteloostuijn Power certainly is part of organizational economics’ habitat (Inderst, Müller, and Wärneryd 2007).8 After all, the very idea of principal-agent relationships is that principals carry formal power over agents. This defines the authority associated with hierarchies. However, as we will argue below, a sociological rational choice perspective would treat power as an element of the principal’s utility function, rather than as a boundary condition or a manipulation instrument. But before spelling out this logic in detail, we first offer an overview of the empirical literature on organizational change.

Trend Hypotheses and Stylized Facts The following review is limited to studies that explicitly or implicitly make use of rational choice reasoning. It focuses on three types of organizational change underlying the above-mentioned trends: strategic change, corporate restructuring, and workplace transformations. Issues concerning mergers and acquisitions (Trend 2) are at the core of the literature on strategic change; research on changes in organizational size (Trend 1) and the speed of change (Trend 3) can be found in the literature on corporate restructuring; the debate about the spread and consequences of “high-performance” human resource management (Trend 4) and increases in the remuneration of top managers (Trend 5) is part of the literature on workplace transformations. strategic change Hypotheses Organizational strategies are “basic long-term goals and objectives of an enterprise and adoption of courses of action necessary for carrying out these goals” (Chandler 1962: 13). A key idea of (corporate) strategy research is that diversification can help to realize economies of scope.9 All economic rational choice explanations of strategy choice agree that management will opt for (de-)diversification if the expected performance benefits outweigh the costs of implementing strategic change. They come to different predictions for the performance benefits of different types of diversification (for an overview of theories of strategic change, see Hoskisson and Hitt 1990), in particular a related versus an unrelated diversification strategy. According to the resource-based view, diversification is a viable strategy if it builds on available surplus or underutilized resources (Penrose 1959), in particular managerial time and skills. By implication, there will be a trend toward related rather than unrelated diversification, because it allows the firm to build optimally upon existing capabilities and exploit complementarities provided by newly acquired resources. In addition, unrelated diversifiers such as conglomerates will also perform worse because the head office consumes too many of the valuable resources. Agency and transaction cost theory both predict an increase of both related and unrelated diversification through time.Transaction cost theory sees synergy benefits as the major rationale for diversification. By creating an internal capital market, a firm can allocate capital more efficiently than it could on the external capital market, as long as transaction costs with other firms are higher than transaction costs within the firm (Williamson 1975). Since there are limits to

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the exploitation of synergy benefits even in firms with related diversification— intrafirm exchanges will be impeded by communication problems and incentive distortions due to intrafirm competition—related diversification will not yield performance benefits. Agency theory assumes that market and firm imperfections in combination with managerial motives play a role in diversification decisionmaking. It offers three major rationales for diversification, all of them based on the assumption that managers will pursue their self-interest at the expense of stockholders (Martin and Sayrak 2003: 40). First, managers with large firmspecific investment in human capital have an incentive to diversify in order to protect their investment and make their position more secure (Shleifer and Vishny 1990). Second, managers might attempt to reduce firm risk through diversification (Amihud and Lev 1981). Third, since diversification usually results in an increase in firm size, and managerial pay tends to increase with the size of the firm (Jensen and Murphy 1990), managers have an incentive to diversify their firms. Agency and transaction cost approaches also provide a rationale for the massive refocusing trend since the 1980s. Pointing to government policies as important external constraints, transaction cost theory sees refocusing as triggered by deregulation in many industries. During the 1980s, global competition began to increase considerably, and tax and antitrust policies were relaxed, facilitating mergers in related businesses (Hoskisson and Hitt 1990, 1994). Consequently, firms will get rid of units that are not related to their core business. Agency theorists argue that diffuse ownership increased the chances of governance failure: lacking appropriate control, managers used available financial assets to expand, but without increasing firm value. The resulting overdiversification was corrected during the 1980s.10 Stylized facts Overall, for large firms, the available evidence shows a trend toward increasing diversification through time. This holds for the United States and other industrialized countries alike (Itoh 2003; Claessens et al. 2003; Whittington and Mayer 2000). For the United States, four phases of merger and acquisition waves need to be distinguished (Golbe and White 1993; Shleifer and Vishny 1990). They coincide with changes in antitrust legislation, supporting the transaction and agency cost reasoning about the importance of external constraints. The last wave started in the 1980s, when the Reagan administration relaxed antitrust enforcement. A massive refocusing movement started: management increasingly dropped the firm-as-portfolio philosophy and concentrated on their “core competencies.”This resulted in a trend toward divestitures of unrelated businesses and acquisitions within the same industry (refocusing). This wave lasted until the early 2000s (Pryor 2001d). In 1992, two-thirds of Fortune 500 companies were actively involved in five or more distinct business lines (defined by four-digit SIC codes) (Montgomery 1994). And between 1986 and 1990, about 15 percent of the Fortune 500 firms made conglomerate acquisitions (Davis, Diekmann, and Tinsley 1994). In fact, in the period between 1990 and 1996, about 50 percent of employment in the United States was provided by diversified firms, which also owned about 60 percent of the total assets of publicly traded firms (Martin and Sayrak 2003: 38). Mergers

564 Rafael Wittek and Arjen Van Witteloostuijn and acquisitions reached $2.3 trillion in 1999, with a 20 percent average annual growth rate in the number of mergers between 1985 and 1999. Studying diversification in France, the UK, and Germany from 1983 to 1993, Whittington and Mayer (2000) conclude that these countries, by and large, support the trend hypothesis, postulating a gradual increase of diversified firms. Overall survival rates of related diversifiers and conglomerates do not differ significantly: unrelated diversifiers are not poor performers. In all three countries and across both time periods, tightly integrated, related diversifiers show consistently superior financial returns. This finding comes closest to the predictions made by the resource-based view. In sum, the available evidence, by and large, supports the postulated trend toward amalgamation (Trend 2). On a general level, economic rational choice theories of strategy choice are able to account for this trend. However, as soon as different types of diversification strategies are distinguished, economic rational choice theories produce contradicting claims. More specifically, the increase and good performance of unrelated diversifiers like conglomerates challenge the resource-based view. corporate restructuring We distinguish three types of corporate restructuring: changes in organizational form, size, and structure (Johnson 1996).These three dimensions are highly correlated, and are seen as elements of organizational complexity (Hall and Tolbert 2005: 27–62). In the introduction, we proposed that the average size of large commercial enterprises increases over time (Trend 1). Organizational size has several dimensions (Kimberly 1976) and should therefore be conceived broadly.We focus on two dimensions of size: the number of employees, and the number of divisions or units of a firm.11 The latter is an aspect of organizational form. It reflects horizontal differentiation, and is also a measure of organizational complexity. Change in organizational form Hypotheses. The term restructuring is usually used to denote the addition or deletion of divisions from an organization. Change in structural-relational form comes in four types, depending on the degree of centralization of (a) strategy and (b) operations. In the Functional or Unitary Form (U-Form), both strategy and operations are centralized.The heads of functionally defined departments, like sales, marketing, or production, are responsible for the operations in their departments, and at the same time are members of the top management team, where they are involved in formulation of strategy for the whole company (Rumelt 1974: 33). The major characteristic of the Multidivisional Form (M-Form) is the centralization of strategy and the decentralization of operations: the heads of the divisions are not involved in the process of strategy formulation. The latter is done by a group of top managers at the headquarters, who are supposed to ensure the survival and growth of the company as a whole. The Holding Form (H-Form) or conglomerate consists of almost completely autonomous subunits, with very little management and strategic control from the center: both strategic decision-making and operational control are decentralized. Conglomerate

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mergers, for example, are defined as any purchase in which both the acquiring and target firms operate in unrelated industries (Knoke 2001: 118). Why do firms change their form, and which trends can be expected? Economic rational choice accounts offer two explanations. According to transaction cost approaches, the structural-relational M-Form is likely to follow on the strategic choice of a company to diversify. As Chandler argues, once a firm had diversified, structured reforms were necessary in order to enable a more efficient use of resources (“structure follows strategy”). Firm strategies involving high-volume production, vertical integration of technically complex functions, geographic dispersion, and entry into diverse new product lines put pressure on management in the classical U-Form, and can be carried out more efficiently within the M-Form. Moreover, the U-Form will suffer cumulative loss effects, as Williamson argues (1975: 133). Increasingly diverse and complex decision-making by top management results in monitoring, coordinating, and control problems. Functional managers in the top management team favor their own division’s short-term interests, losing sight of the more general organizational goals. Separation of strategy and operation solves this problem, reduces transaction costs, and relieves managers from information and decision overload. The so-called M-Form hypothesis states that “the organization and operation of the large enterprise along the lines of the M-Form favors goal pursuit and least-cost behavior more nearly associated with the neoclassical profit maximization hypothesis than does the U-Form organizational alternative” (Williamson 1970: 134).12 According to Chandler, the H-Form does even worse than the U-Form, since top management in the H-Form tends to be “blind, weak, confused or partisan” (Whittington and Mayer 2000: 70): headquarters lack adequate information systems to monitor (financial) performance of its subsidiaries, and the top managers of the different business units of the holding tend to push the interest of their units rather than pursue the welfare of the holding as a whole. Consequently, rational choice scholars consider both types of holdings as traditional phenomena, which came into being mainly as a response to severe antitrust policies. Hence, given the superior performance of the M-Form, the relative proportion of divisionalized and diversified firms in a country should increase through time, and the decision to implement a multidivisional structure should be taken after the decision to diversify. The strong version of this hypothesis assumes that this trend should hold independently of institutional context. It is a universalistic statement, predicting that, in the long run, organizations all over the world will converge toward adopting this superior M-Form. The second explanation is rooted in the principal-agent approach. Unlike transaction cost explanations, it emphasizes managerial motives and information asymmetries rather than efficiency advantages as the major trigger behind the spread of the M-Form.13 According to agency theory, the rise of the M-Form is due to shifts in the power distribution between owners, financial institutions, and top managers. Whereas at the beginning of the twentieth century power rested mainly with owner-entrepreneurs and families, the demand for capital resulting from expansion into wider national and international markets resulted in a gradual shift of power toward large numbers of shareholders, and consequently to a dispersion and weakening of the position of owners.

566 Rafael Wittek and Arjen Van Witteloostuijn This enabled top management to use their information advantage for seizing effective control of the company and its strategies. Similarly, banks and lending institutions increasingly gained in power. From an agency and resource dependence perspective, the M-Form hypothesis needs to be refined and restricted in scope. For example, one prediction following from this perspective is that firms in which ownership is concentrated in the hands of families or banks will be less likely to divisionalize than management-controlled companies (Palmer et al. 1987). Family-based coalitions can more easily control the day-to-day operations of a (local) UForm, compared to the operations in an (often geographically dispersed) M-Form. Family ownership also facilitates the implementation of strategies enhancing the realization of short-term profits for the owners, because a small coalition of family owners can effectively limit management’s discretion to engage in long-term strategies designed to increase market share (Knoke 2001: 105). With regard to bank-controlled firms, it has been argued that banks tend to discourage divisionalization because the resulting centralization would negatively affect the demand for financial expertise provided by banks (Palmer et al. 1987). Stylized facts. Already by the early 1920s, a handful of large U.S. corporations— General Motors, Du Pont, Standard Oil of New Jersey, Sears Roebuck—started to diversify their production and to switch from a unitary functional to an MForm (Chandler 1962).These changes in strategy (diversification) and structure (divisionalization) marked the birth of the Multidivisional Firm, which soon would grow to become the dominant type of business organization in the industrialized world. Whereas only 1.5 percent of the one hundred largest U.S. firms had adopted the multidivisional form in 1929, that figure has risen to 84.2 percent in 1979 (Fligstein 1985). Further analyses (ibid.: 386) also confirm Chandler’s argument that industries where product-related strategies dominate (for example, machinery, chemical, and transportation industries) would adopt a multidivisional form earlier than vertically integrated industries (such as mining, metal, lumber and paper, and petroleum industries). Although starting later, a similar trend toward diversification and divisionalization can be observed for France, Germany, and the United Kingdom (Whittington and Mayer 2000). The M-Form is less prevalent among the largest Japanese firms, where it was adopted by only 59.8 percent of the largest firms in 1980 (Itoh 2003: 54). The overall picture emerging from these empirical investigations seems to support the M-Form hypothesis: until the 1980s, there was a clear trend toward divisionalization. The spread of the M-Form slowed down during the 1980s, when many multidivisional firms started to “refocus” their businesses by divesting some of their divisions. Estimates mention that in the period between 1981 and 1987, 20 to 50 percent of the Fortune 500 firms refocused, compared with 1 percent during the 1960s and 1970s (Markides 1995). This wave of corporate restructuring aimed at downscoping and dediversifying. It resulted in 55,000 mergers and acquisitions worth about $2 trillion and 2,540 leveraged buyouts worth $297 billion. In 1986 alone, firms completed more than 1,200 divestitures worth $60 billion (Jensen 1993). Despite all this supportive evidence, some caution is necessary with regard

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to the efficiency argument underlying the M-Form hypothesis. Freeland’s detailed reconstruction (2001) of the implementation of the M-Form at General Motors—one of the textbook cases for the M-Form hypothesis— shows that GM’s CEO Sloan deliberately violated the fundamental principles of the multidivisional form by blurring the boundaries between strategy and operations. This was also GM’s most successful period, though it sparked intensive conflict with corporate owners, who favored a stricter separation between strategy and operations. Freeland shows that the implementation of the M-Form depends on the relative power distribution between management and owners. It also raises some doubts about the assumed performance advantages of the multidivisional form, since the decentralized structure it implies may undermine cooperation and lead to organizational decline. In sum, though the available evidence tends to support the trend hypothesis concerning the increase in the number of multidivisional firms, it still remains unclear to what degree multidivisional firms comply to their key principles (for example, separation of strategy and operations), and to what degree their rise is due to efficiency advantages rather than the successful management of internal power struggles. Changes in organizational structure Hypotheses. The majority of the literature on corporate restructuring addresses firm-level activities, such as divisionalization through mergers and acquisitions, as they were discussed in the previous section. Changes in organizational structure—that is, internal reorganizations like delayering—represent the most recent and least explored domain in the field of research on organizational change.14 Delayering is defined as “planned vertical compression of managerial levels of hierarchy, involving the wholesale removal of one or more layers of managerial or supervisory staff from the organization’s payroll” (Littler, Wiesner, and Dunford 2003). The depth of delayering refers to the number of levels— intermediary positions between a CEO and the lowest managers—that are cut out. The breadth of delayering captures changes in the span of control of the CEO, and is defined by the decrease in the number of positions directly reporting to the CEO (Rajan and Wulf 2006). Rajan and Zingales (2001a) provide a formal model of internal organizational structure (see also Hart and Moore 2005, for a general model of optimal hierarchical structure). More generally, rational choice theories of delayering point to four possible reasons for firms flattening their hierarchies (Rajan and Wulf 2006). First, increasing competition in product markets pressures firms toward quicker decision-making. This can be achieved by cutting down layers in the hierarchy, because delegating decision authority further down the hierarchy would imply loss of top management control. A related argument is that competition increases the complexity of decisions. Tall hierarchies are less suited to handle complex decisions, are likely to result in distorted upward information flows, and reduce managers’ incentives to collect information. Second, agency theorists argue that inadequate monitoring of management resulting from failing governance mechanisms resulted in empire building and hiring of middle managers. With the number of small-scale shareholders

568 Rafael Wittek and Arjen Van Witteloostuijn decreasing and large institutional shareholders becoming more important since the 1980s, governance and control of management improved, forcing top management to eliminate “unproductive” layers of middle managers. The third possible reason for delayering is changes in information technology. Previous theorizing produced contradicting claims on the impact of information technology. One line of reasoning suggested that information technology allows top managers to bypass middle managers in both upward and downward communication. Since middle managers are assumed to have mainly informational roles, in this scenario they become increasingly obsolete. A second line of reasoning posits the opposite. Here, the role of the middle managers is not restricted to an information broker, but extends to important coordination, interpersonal, and decision tasks. Changes in information technology will increase organizational complexity and the need for coordination, thereby resulting in an increase in the number of middle managers. Sociological research points to the fourth possible reason for delayering: the neglected role of intraorganizational power relationships. Pinsonneault and Kraemer (1997) argue that a decrease in the number of middle managers is contingent upon the degree of centralization of decision authority over computing and organizational issues in general. Where decision authority is centralized, information technology will result in a decreasing number of middle managers. The argument rests on a reinforcement politics perspective, which assumes that the dominant coalition in an organization will use information technology to reinforce its own interest. The dominant coalition can be formed by different kinds of actors, such as members of the managerial or technocratic elite. Maintaining and enhancing efficiency is assumed to be (among) top management’s interests. Where decision control is centralized in top management, middle management will fulfill mainly routine, informational, and highly structured tasks. Hence, top management has an incentive to use information technology to replace middle managers. Where decision control is decentralized, middle managers’ role is more complex, and will be more difficult if not impossible to computerize. Information technology will, however, enable middle managers to perform their tasks more efficiently, leaving them more room to dedicate themselves to more complex decision-making, and to improve their position in the organization. In sum, the overarching trend hypotheses with regard to changes in organizational structure states that power will tend to be concentrated at the top of the organization, which among others should lead toward an overall decrease of middle-management functions. Stylized facts. For the United States, delayering was studied by Rajan and Wulf (2006). Based on a sample of more than three hundred publicly traded firms over the years 1986 to 1998, covering a variety of industries, their overall conclusion is that “firms are becoming flatter, the CEO span is broader, intermediate managers are being dispensed with, and divisional managers are getting more authority, higher pay, and greater incentive pay as they come closer to the CEO” (ibid.: 772). They find strong evidence that the depth of hierarchies decreased (by approximately 25 percent, from an average of 1.58 managers between the CEO and the division manager in 1986, to 1.18 in

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1998), and the span of control of CEOs increased (by roughly 50 percent, from an average 4.46 in 1986 to 6.79 in 1998). Their statistical tests rule out several potential alternative explanations, such as the argument that these effects could be the result of profit center responsibility being taken away from smaller units, firms becoming bigger through natural growth or mergers, or creation of new positions. Similar conclusions could be drawn by a study of delayering in Australia, New Zealand, and South Africa (Littler, Wiesner, and Dunford 2003). In sum, the available evidence on delayering for several countries supports the claim of a power shift toward the top of the organization. Changes in organizational size Hypotheses. Changes in firm size are the third major element of corporate restructuring, and Trend 1 postulates that the average size of large commercial enterprises is on the rise. Although models of firm size changes cover both increases and decreases in headcount, downsizing received disproportionately more attention than upsizing (for reviews, see Datta et al. 2010; Gandolfi and Hansson 2011). Downsizing is defined as “a strategy implemented by managers that affects the size of the firm’s workforce and the work processes used” (Freeman and Cameron 1993: 12). Downsizing is intentional, involves reductions in personnel, attempts to improve efficiency or effectiveness, and usually affects work processes. Downsizing differs from organizational decline, nonadaptation, growth-in-reverse, and layoffs (Freeman and Cameron 1993). Reductions in firm size can be brought about by a variety of strategies, ranging from natural attrition and involuntary redeployment to layoffs with or without outplacement assistance (Greenhalgh, Lawrence, and Sutton 1988; Wagar 1997). Probably the most comprehensive theoretical and empirical study on downand upsizing has been carried out by Baumol, Blinder, and Wolff (2003). Their major argument is that technological change favors smaller enterprises, and that faster technological innovation will lead to more labor market “churning” (that is, the replacement of lower skilled by higher skilled employees). A model of firm size needs to be able to account both for down- and upsizing.They predict different patterns for different industries, for two reasons. First, “technological change can sometimes promote larger average firm size and at other times promote smaller firms” (ibid.: 8). Second, they argue that average firm or establishment size will co-vary with total employment size in an industry: “[W]hen industries grow (or shrink), they tend to grow (or shrink) more by increasing (or decreasing) firm size than by adding (or subtracting) firms” (ibid.: 123). In the manufacturing sector, technological developments will instigate a regression to the mean—that is, small firms will upsize and large firms will downsize. The advances in information technology and computerization significantly increased the flexibility in the production process—for example, by facilitating switches in built-to-order production and “mass-customization.” Standardization and long production runs—once the advantage of large firms— no longer were necessary preconditions for cost-efficient production. With the resulting decrease in the profitability of mass production, the advantages of large firms in the manufacturing sector started to dwindle, too (ibid.: 78).

570 Rafael Wittek and Arjen Van Witteloostuijn In the retailing sector, technological developments made larger retailing firms more profitable than they had been before, because information technology reduces coordination, communication, and record-keeping costs. Smaller retailing firms, therefore, will gradually lose the cost advantages they had over larger firms because of their lower coordination and communication costs. The overall trend resulting from these two opposing developments should be firm sizes regressing to the mean: large firms getting smaller while small firms increase in size. Stylized facts. With regard to changes in organizational size, the general trend hypothesis posits a tendency of firms to become larger. This claim contradicts common wisdom, according to which the past decades represent the age of downsizing. For example, a frequently cited New York Times feature, published in 1996, reports that since 1979, 43 million jobs were eliminated, with yearly job loss rates reaching a peak of 3.4 million in 1992. Downsizing indeed has been common since 1967 (Baumol, Blinder, and Wolff 2003), and has intensified since the 1980s, when many firms started to refocus and dedivisionalize. In the United States, an estimated 10 million employees lost their jobs as a result of downsizing operations in the 1980s and early 1990s (Budros 1999: 69). Whereas these figures seem to support the popular credo on the decades of downsizing, a completely different picture emerges from research that simultaneously studies down- and upsizing. Baumol, Blinder, and Wolff (2003: 119–30) report that downsizing took place mainly in the manufacturing sector in the period from 1972 to 1992, with the exception of the period between 1982 and 1987. The trade and service sectors upsized during the past forty years, whereas there is a trend for neither up- nor downsizing in the remaining sectors (construction, mining, and transport). Their econometric analysis on the determinants of downsizing yields the following general picture (ibid.: 133). First, as predicted, changes in industry total employment correlate highly with firm size, and this pattern is most pronounced in the manufacturing sector, where 87 percent of employment changes result from changes in firm size, compared with 55 to 58 percent in other industries. Second, since 1967, technology indeed favored smaller businesses. Third, firms experiencing a fall in profits are more likely to downsize. Fourth, incidence of downsizing increases with intensification of foreign competition on export markets. In sum, the data lend support to their major hypotheses, according to which the major short-run determinant of downsizing is industry growth or decline, whereas technological change exerts the major long-term influence on changes in firm size. Baumol, Blinder, and Wolff ’s empirical investigation provides one of the rare occasions in which upsizing is modeled. They find that the set of factors explaining downsizing in the manufacturing sector also explain upsizing in the retail and service sector, though in some cases with the signs of the effects pointing in the opposite direction (ibid.: 181–93). More specifically, they draw four major conclusions. First, the more rapid industry growth (as measured by total employment), the higher the degree of upsizing. Second, the stronger competition with imports in an industry, the more likely upsizing. Third, the more export-oriented an industry, the less likely firms will upsize. Finally, the lower the profitability of a firm, the more likely upsizing becomes.

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The overall picture emerging from empirical research on firm size changes is that downsizing tends to be restricted to the manufacturing sector, whereas firm size in other sectors tends to increase. workplace transformation Hypotheses. High-performance human resource management (HRM) is one of the managerial buzzwords of the past decade. The term describes a bundle or cluster of interrelated workplace practices with the common denominator that they increase the involvement and intelligent effort of employees (Appelbaum and Batt 1994; Baron and Kreps 1999). Although there still is no agreement in the literature about which types of practices should be considered as belonging to the bundle of high-performance human resource management practices (Delaney and Huselid 1996; Sun, Aryee, and Law 2007), the following key aspects are generally considered as being part of it (Appelbaum and Batt 1994: 57): “[T]he use of flexible technologies; some form of worker participation or teamwork; substantial worker education and training; the flexible deployment of workers; a commitment to employment security; a narrowing of the gap between workers and managers, as evidenced by education levels and worker involvement in managerial decision making; quality consciousness; and an active role for unions and representative employee committees in achieving performance gains in the production process.” The rationale behind adopting a related set of practices rather than single practices only is that they mutually support and enhance each other’s functioning, thereby helping to resolve free-rider problems (Kandel and Lazear 1992), focus attention to tasks that are important for performance but difficult to measure (Baker, Gibbons, and Murphy 1994), and elicit information of employees (Milgrom and Roberts 1995). The formal basis behind the idea of (Edgeworth) complementarity was elaborated by Milgrom and Roberts (1990, 1995). In their words, complementarity is given if “doing more of one thing increases the returns to doing (more of) the others” (Milgrom and Roberts 1995: 181). A formal model of the adoption of HRM bundles or clusters has been developed by Ichniowski and Shaw (1995), who conceive the adoption as an investment decision into a managerial innovation. In sum, due to their assumed superior incentive and motivational effects, there should be a general trend toward the adoption of high-performance human resource management practices over time, and firms that introduced such practices should outperform organizations that do not have such practices, or introduced only some, but not all of its elements. Our Trend 4 hypothesis contradicts this argument. Stylized facts. For the United States, the 1996 National Organization Study, based on 1,002 establishment interviews (Kalleberg et al. 2006) gives insight into the distribution of high-performance HRM practices in for-profit, public, and nonprofit organizations. They distinguish three types of practices: team features, multiskilling, and incentive practices. Teamwork for core workers is practiced in about 40 percent of all establishments, ranging from 37 percent in for-profit establishments to more than 60 percent in nonprofit organizations. Of the three types of incentive practices investigated (group incentives, pay

572 Rafael Wittek and Arjen Van Witteloostuijn for learning new skills, and profit sharing or bonus programs), the latter was practiced by one-third of the for-profit organizations, but only by 13 percent of public and 2.6 percent of nonprofit organizations. Finally, of the three multiskilling practices (cross-training, job rotation, and transfer to other job family), cross-training is clearly the most used practice, with two-thirds of the for-profit and public organizations, and 76 percent of nonprofit ones making use of it. Sectoral differences in the adoption of high-performance HRM were found for the use of self-directed teams and offline committees, which were more prevalent outside the for-profit sector, and the use of output-related incentives, which were more frequent in for-profit organizations. No sectoral differences were found for multiskilling practices. For Europe, data from the Cranet-Survey (Brewster, Mayrhofer, and Morley 2004)15 show a clear decrease in the proportion of employees in the HR department, and clear increases in the percentage of annual salaries spent on development and training, the incidence of management communication of financial performance and firm strategy to employees, and the use of performance-related and variable elements of compensation systems. Somewhat weaker evidence was obtained for the use of flexible working practices (for example, part time work) with statistically significant increases in seven—mostly Northern European—countries, and about one-third of the countries making less use of such practices. A comparative analysis of changing human resource management practices in China, Japan, and South Korea (Rowley, Benson, and Warner 2004) shows that HRM practices tend to resemble the Western HRM model rather than exhibiting a specifically Asian version. Taken together, the available empirical evidence indicates that highperformance HRM practices still are far less common than one would expect based on their assumed performance-enhancing effects. Several empirical studies based on surveys came to the conclusion that the number of firms using more than one high-performance HRM practice is “surprisingly low” (Appelbaum and Batt 1994: 63).16 Knoke (2001: 194) concludes that “high performance work practices were neither alternatives to conventional bureaucracy nor incompatible with its survival. Indeed, establishments deploying elaborate bureaucratic personnel systems seemed more prone to implement innovative work practices than were workplaces with absent or weakly developed FILMs [Firm Internal Labor Markets] and formalization.” Management’s reluctance to adopt high-performance HRM might also be due to uncertainty with regard to their expected performance effects, which actually seem to be far less evident than the optimistic conclusion prevailing in the literature. Here, the current wisdom on performance effects is that “a large majority of published studies find an association between HR practices and firm performance, regardless of whether they are cross-sectional or longitudinal, whether conducted at establishment or company level, whether based on strong performance data or subjective estimates, whatever based on, whatever operational definition of HRM is used and wherever they are conducted” (Guest et al. 2003: 294). Recent critics are less convinced, pointing to a variety of serious shortcomings in previous research: the majority of studies are limited to the United States, do not distinguish between industries (Guest et al. 2003), do not control for reverse causality (Wright et al. 2005), use different measures

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of HRM practices, and do not disentangle individual HRM practice effects from combined effects (Wall and Wood 2005). This skepticism receives further support from several recent large-scale and meta-analytic studies with true predictive longitudinal research designs. All of them cast serious doubt on an overly positive conclusion about performance effects of high-performance HRM (Guest et al. 2003; Wall and Wood 2005; Wright et al. 2005). Based on their meta-analysis of twenty-five studies, Wall and Wood (2005: 454) conclude that “it is premature to assume that HRM initiatives will inevitably result in performance gains, either in all situations or even where deemed appropriate by contingency arguments.” Another review based on sixty-six studies of large food service corporations in the United States concludes that “results provide just as much support for the proposition that performance causes commitment and HR practices as it does the reverse” (Wright et al. 2005: 412). Wright et al.’s findings mirror the results of an earlier longitudinal study, based on a sample of 366 companies in the UK (Guest et al. 2003). Using both subjective and objective performance measures, and applying both crosssectional and longitudinal tests, their findings point toward reverse causality— that is, high profitability increasing the likelihood for high-performance HRM, rather than vice versa.The point that all these recent critics make is that available research lacks sufficient rigor to convincingly show that the introduction of high-performance HRM in a firm leads to a subsequent increase in performance (Wright et al. 2005: 410). To sum up, as postulated in Trend 4, the empirical evidence does not show an increase in the implementation of high-performance HRM practices.

A Sociological Rational Choice Theory of Organizational Change Economic rational choice models overemphasize micro or mesolevel antecedents and consequences of organizational change, as witnessed by the extant business, economic, and sociological literatures. In this section, we develop a complementary sociological macro perspective. Key is, we believe, to introduce a “classic” sociological concept: power. As our review of the empirical literature has shown, the focus on efficiency within current economic rational choice explanations of organizational change, in particular in the context of transaction cost economics, is incomplete. The reviewed empirical literature contains some evidence that power issues frequently interfere with or dominate over efficiency-related motives. Some of the research inspired by agency theory already points to the potential role of power in a theory of organizational change: if control fails, managers can exploit information asymmetries, and can design strategic and structural change for the sake of empire building. The starting point is a sociological rational choice specification of a top manager’s utility function. An example is Ui = fU (Ii, Pi),

(2)

where U denotes utility, I income, P power and i individual manager i, and with ∂Ui/∂Ii > 0 and ∂Ui/∂Pi > 0.17 With income I, we add a utility component that is well studied in managerial economics, with agency theory and delegation games as two modern off-springs (see above). With power P, we

574 Rafael Wittek and Arjen Van Witteloostuijn introduce a key concept from sociology. Although power is related to financial economics’ concept of hubris,18 we move beyond the current state of the art by introducing this very sociological aspect of human motivation and behavior in the context of communities as an element of the (top) manager’s utility function. In isolation, power is a nonissue. In interaction with other people in social communities, such as commercial enterprises and society at large, power may well be a utility-providing component in and of itself. The acquisition of status and prestige has been identified as an important instrumental goal for the production of social well-being (see Lindenberg’s contribution on social rationality in this volume), and formal power is one of the major means to produce status. This argument is a well-established insight in sociology, but not so in economics (but see Niskanen 1971; and Frank 1985 for insightful exceptions). Hence, utility function (2) clearly reflects an example of sociological rational choice modeling. To make our illustration more concrete, the following additive utility function19 can be specified: Ui = αiI + βiP, with αi and βi > 0.

(3)

A manager derives utility from both income and power. The extent to which one dominates over the other is reflected in the weight parameters αi and βi: if αi > βi, the income motive is dominant; but if αi < βi, power is more important. Moreover, either managerial heterogeneity (αi, βi ≠ αj, βj) or homogeneity (αi, βi = αj, βj) can be assumed (with i ≠ j). Already this simple managerial utility function (3) implies a series of interesting research questions. What drives the relative importance of income vis-à-vis power? To what extent can managerial heterogeneity be observed in practice? What can explain differences across settings such as countries and industries? How does competition evolve in different income-power “regimes”?, and so forth. For the sake of brevity, we refrain from reviewing the business, economic, psychological, and sociological literatures that relate to these questions, but rather suffice with references to two observations. First, particular types of managers tend to be selected into top positions precisely because they like to execute power (see, for example, Boone, van Olffen,Van Witteloostuijn, and De Brabander 2004). Second, although the corporate governance regimes within which top managers have to operate vary from one country to the other, issues of power are central to all of them (see, for example, Aguilera and Cuervo-Cazurra 2004). By way of further illustration, we would like to set a few additional steps in the sociological rational choice modeling exercise. For one, we assume that income is positively affected by power: the powerful are more successful in their rent-seeking behavior (Acemoglu and Robinson 2008). This suggests an income-power function Ii = fP(Pi),

(4)

with ∂Ii/∂Pi > 0. Again, an example of a simple specification is Ii = γiP, with γi > 0.

(5)

Secondly, power is positively associated with organizational size: the larger the organization a CEO is heading, the more powerful his or her reputation in the

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outside world. This gives the size-power function Pi = fs(Si),

(6)

where Si is the size of the organization headed by top manager i, and with ∂Pi/∂Si > 0. Again, a straightforward specification is Pi = ηiSi, with ηi > 0.

(7)

Substituting Eqs. (5) and (7) into Eq. (3) produces Ui = λiSi, with λi = αiγiηi + βiηi.

(8)

Since αi, βi, γi, and ηi are all positive, λi > 0. Hence, a top manager’s utility is positively associated with organizational size, which offers a straightforward sociological rational choice explanation for Trend 1.The implications of Eqs.(1) to (6) are summarized in the twofold Proposition 1. Proposition 1 (size, power, and income): (a) Top managers of large organizations have more power than those heading small organizations, and (b) top managers of larger organizations earn higher incomes than their counterparts in smaller organizations. Indeed, ample evidence indicates that organizational size is the key determinant of a top manager’s income (see, for example, Gibbons and Murphy 1990). Given Proposition 1, it is in the top manager’s direct self-interest to increase the size of the organization s/he is heading.The next question therefore is what this top manager can do to increase organizational size. Clearly, the quick route to organizational size is external growth. As explained in economics’ agency theory and by finance’s hubris notion, top managers seek quick growth by M&A activities because this enhances their income and power. So this suggests the acquisition function (from now on suppressing subscript i, for convenience’ sake) S = fA(A),

(9)

where A is acquisitive activity and with ∂S/∂A > 0. For example, S = φA with φ > 0.

(10)

Eq. (9) in combination with Eq. (7) explains Trend 2. Proposition 2 offers a summary. Proposition 2 (M&A strategies and size): Top managers launch M&A strategies to increase the size of their organization, and so their income and power. Proposition 2 is associated with the implicit assumption that top managers are in control: they can do what they think is in their self-interest, as reflected in utility function (8). The modern literature on corporate governance suggests that this is indeed often the case. For a modern top manager, it is instrumental to stay in control, to be able to engage in effective rent-seeking behavior. We claim that much organizational change serves precisely this very aim of keeping control. Organizational change programs are launched to sustain control (see Van der Mandele and Van Witteloostuijn 2013 for a similar argument).Without

576 Rafael Wittek and Arjen Van Witteloostuijn such change, control-eroding forces would have the time to gain momentum. This implies a control function C = fC(O),

(11)

where C denotes the top manager’s control and O organizational change. Our logic implies that ∂C/∂O > 0. For instance, C = θO with θ > 0.

(12)

Control is needed to sustain power. This serves a dual goal. First, power is a source of managerial utility in and of itself (see Eqs. 2 and 3). Second, power is a prerequisite for managerial rent-seeking behavior (see Eqs. 9 and 10). That is, Eq. (6) must be extended to P = fsc(S,C),

(13)

which is, for instance, reflected in P = ηS + C with η > 0 and > 0.

(14)

This logic relates to Trend 3, and is summarized in Proposition 3. Proposition 3 (control and power): Top managers frequently initiate organizational change programs to develop and sustain control and power.20 This is only one side of the coin. The other side relates to avoiding that other organizational members gain power. Managerial control and power decrease with increasing workforce’s countercontrol and counterpower. This is why top managers tend to pay only lip service to employee empowerment, participation, and other high-performance human resource management (HRM) practices. Notwithstanding ample evidence that high-performance HRM practices are positively associated with organizational performance, the introduction of such practices is relatively rare (see, for example, Becker and Huselid 1998; and Pfeffer 1998). This is certainly true for the explicit introduction of power-sharing mechanisms in the form of organizational democracy (see, for example, De Jong and Van Witteloostuijn 2004; Van den Berg, Grift and Van Witteloostuijn 2011). The implication of this argument is that Eqs. (11) and (12) have to be extended with a negative empowerment component E, which gives C = fOE(O,E),

(15)

with ∂C/∂O > 0 and ∂C/∂E < 0, which can be specified as, for example, C = θO – τE with θ,τ > 0.

(16)

Eqs. (15) and (16) are reflected in Proposition 4. Proposition 4 (empowerment): Employee empowerment through high-performance HRM practices reduces managerial control, and so managerial power. This provides a sociological rational choice explanation for Trend 4. With control and power in place, top managers can boost their income directly by negotiating attractive remuneration packages, and indirectly, by

Rational Choice and Organizational Change 577

engaging in size-increasing strategies. Substituting Eqs. (9), (13), and (15) into income function (4) gives I = γP = ηS + C = φA + θO – τE.

(16)

This offers a sociological rational choice theory explanation of Trend 5, as all parameters are positive (see above). In Proposition 5, we summarize this logic. Proposition 5 (income): A top manager’s income is positively associated with the organization’s size, change rhythm, and M&A activities, as well as with managerial control and power, and negatively with employee empowerment. This closes the circle of our rudimentary sociological rational choice theory of organizational change, offering ultimately a managerial power explanation of the five societal trends listed in the Introduction. Of course, the above is only a skeleton of a sociological rational choice model of organizational change. Much future work is needed to fine-tune the model’s specification, to carry out robustness analyses, and to derive novel propositions. Particularly, we would like to put the above managerial decision-making model in a competitive context in which different managers/organizations interact. Economics’ delegation games, as reviewed above, offer a nice toolkit to do precisely this. This would require adding two elements to the above sociological rational choice imaginary of top managerial decision-making: (1) a first stage in which the top managers as agents negotiate a governance and remuneration deal with owners as principals; and (2) a third stage in which competition among a set of top managers and their organizations evolves. The above decision-making model would be part of this overall setup as the second stage. In the first stage, the owners/principals can try to manipulate, indirectly, the top managers’ utility function by defining the rules that will, after the third stage, determine their top managers’ incomes. In the third stage, actual competition among organizations will fix the organization’s size and the top manager’s income. In such a setting, the robustness of the propositions suggested here can be put to the theoretical test by changing the rules of the competitive game, introducing different mixtures of top manager features, associating organizations with different sets of characteristics, and so forth. For now, though, the above skeleton of the second stage must suffice, serving two purposes. First, it illustrates what the microfoundation of a sociological rational choice theory of organizational change could look like. Second, it offers a stepping-stone to formulate a series of tentative propositions, exploiting the model’s underlying logic. It is this to which we turn now. In Figure 16.1, we summarize our set of five propositions schematically, representing the underlying relationships in an overarching framework that binds key concepts together. Note that we have added a few additional hypothesized linkages, which could be integrated in the model—that is, we suggest that acquisition activities have a positive impact on the frequency of organizational changes and a negative effect on the implementation of high-performance HRM practices. Of course, future theoretical work is needed to substantiate or refute this set of eleven relationships, and to add many other alternatives. Also, empirical

+

+

+

+

Managerial control

–

Organizational size

+

Acquisition activities

+

+

–

High-performance HRM practices

Managerial income

–

figure 16.1. A microfoundation of a sociological rational choice theory of organizational change

Managerial power

+

Organizational changes

Rational Choice and Organizational Change 579

contributions are required to build up a stock of evidence, helping sociological rational choice theory to refocus on the study of the macrolevel antecedents and consequences of organizational change.

Conclusion This chapter has sketched a sociological rational choice model of organizational change, and provided an overview of available research in this field. We started with describing five major trends related to organizational change. We proceeded with the observation that there are no sociological rational choice models of organizational change, and that the available economic models are couched in a comparative statics framework, rather than addressing change as such. We then provided a short overview of the key assumptions of economic rational choice models of change. Focusing on strategic change, corporate restructuring, and workplace transformation, we then summarized the major trend hypotheses following from available economic rational choice reasoning, and assessed to what degree the available empirical evidence supports their claims. We come to a mixed overall assessment.While some of the trend hypotheses find support in the data, many inconsistencies remain. These inconsistencies not only contradict current popular wisdom about corporate restructuring and workplace transformation but sometimes also run counter to economic reasoning. For example, high-performance human resource management still is far less common than one would expect based on its assumed performance advantages; conglomerates are far more widespread than one would expect based on the efficiency loss that some rational choice models predict for unrelated diversification; most firms tend to upsize rather than downsize; a textbook multidivisional firm like General Motors performed best during a period when it systematically violated the core principles of the multidivisional form. In addition, many organizational changes do not achieve the goal of improving performance or the internal processes leading to it, but often have detrimental effects. We contend that these inconclusive results can be resolved by introducing power into models of organizational change, and sketch the microfoundations for a sociological rational choice theory of organizational change in which the acquisition and maintenance of power is integrated into managerial decisionmaking as an objective in itself, rather than just a means. We also believe that this framework is better able to account for macroeffects of organizational change on society—an issue that up until now has been largely neglected. Although preliminary, it opens up several areas for future research. We would like to conclude our contribution with briefly sketching some of them. First, a crucial assumption in our reasoning is that organizational change is a means to increase managerial control. An implication of this assumption is that managerial control should increase after restructuring, independently of the type of governance structure that is implemented as a result of the change. That is, power can have a variety of different bases, and centralization is not the only way for management to increase control. Indeed, many firms go

580 Rafael Wittek and Arjen Van Witteloostuijn through a series of restructurings, with their governance structures oscillating between centralization and decentralization. Our framework would imply that independently of the form that such changes take, they would lead to an increase or at least stabilization of managerial control. We are not aware of any large-scale studies on this link. Indirect evidence comes from employee survey research investigating trends in workplace innovation in Europe. It shows that both task discretion (Gallie, Felstead, and Green 2004) and job control (Gallie 2005) decreased through time. In addition, case study research (Prechel 1994; Vallas 1999) provides evidence that managerial control increases even if organizational change results in decentralization. Such findings run counter to current flexibility arguments, which postulate that restructuring of modern firms follows a trend toward more autonomy for employees and middle managers. Yet such an argument “does not acknowledge that decentralization entails more precise controls at the point of production to ensure concomitant standardization of social action and product quality” (Prechel 1994: 741). Second, our framework further implies the need to have a closer look at organizational processes that lead to an erosion of managerial power and control loss. Control loss may be due to increases in organizational size (Williamson 1967), design complexity and incomplete contracting, and communication imperfection (Van der Mandele and Van Witteloostuijn 2013). Hence, the increase of a top manager’s power base through upsizing at the same time bears the seeds for the erosion of managerial power. Similarly, complexity-increasing strategies such as M&As might lead to future control losses.This type of reasoning suggests that, in the end, power-promoting strategies might well lead to loss of control, and hence power, in the longer run. More generally, analyzing these kinds of topics implies that rational choice models of organizational change should also explore issues of feedback loops and intertemporal sustainability. A third area for future research is related to the distinction between de facto and de jure power (Acemoglu and Robinson 2008) or formal and real authority (Aghion and Tirole 1997), a distinction neglected in our model. For example, building on sociological ideas on the emergence of oligarchy, Acemoglu and Robinson (2008) show that changes in the allocation of de jure power might result in elites intensifying their investments in de facto power. Applied to organizations, this finding implies that, for example, attempts to limit top management’s formal power is likely to spark top managers’ attempts to increase their real power toward organizational stakeholders. Finally, with our model being developed for business firms, we did not address the question of to what degree our claims also hold for organizational change in public and semipublic organizations. We believe that many of the above arguments apply equally well in the domain of nonprofit organizations. However, there are differences, too. For instance, most nonprofit organizations are not engaged in competition in the marketplace, and some nonprofit managers may be characterized by a utility function that includes a component reflecting the desire to contribute something to public service. In future work, these and other features specific to the nonprofit sector can be added to the type of organizational change models introduced above. Organizational change takes many forms, and there are no signs that its incidence will decrease in the coming decades, leaving social scientists with

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the challenge of explaining its antecedents, processes, and outcomes, including its societal consequences. We hope that the rudimentary sociological rational choice framework sketched in this contribution will prove a useful tool for that purpose.

Notes Both authors contributed equally. Rafael Wittek gratefully acknowledges funding from the Netherlands Organization for Scientific Research, NWO (Grants 016-005052 and 400-05-704). 1. U.S. Census Bureau (http: //www.census.gov/csd/susb/susb04.htm). 2. We focus on private enterprises only. An interesting question is to what extent the arguments presented here also apply to public, semipublic, and voluntary organizations (Nieto Morales, Wittek, and Heyse 2012). 3. Of course, this ignores fluctuations over time. Basically, these numbers tend to decrease in times of economic downturn. For example, after the Internet bubble burst, the number of average employees in the top 1 percent decreased from approximately 250,000 in 1999 to about 213,000 in 2000. It can be expected that the upward trend is disrupted in the present financial crisis period, too, as it is for average M&A activity (Trend 2) and top remuneration (Trend 5). 4. For the poor, similar statistics could be presented. What is striking is the detour of the middle class. 5. Our treatment of the organizational change literature is biased and incomplete, given our “ultimate” focus on rational choice and societal issues. For those interested in reviews of this literature from other angles, we refer to the relevant chapters in Baum (2002). 6. There are other microeconomics’ literatures that relate to issues of organizational change in a similarly indirect way. For instance, the industrial organization literature on multiactivity, multiasset, or multiproduct firms specifies production functions that reflect scope economies (or, in modern jargon, complementarities), implying that the costs or benefits of having two or more assets, activities, or products under a single organizational roof are lower or higher, respectively, than in single-activity, asset or product organizations. The extent and nature of such scope economies then imply an “optimal”—that is, cost-minimizing or profit-maximizing—activity, asset, or product mix. Examples of this tradition are Rubin (1973); Panzar and Willig (1977 and 1981); Bailey and Friedlaender (1982); Milgrom, Qian, and Roberts (1991); and Milgrom and Roberts (1995). Again, comparative statics imply organizational change. A shift in scope economies will trigger a change in the optimal activity, asset, or product mix. For the sake of brevity, we limit attention in the main text to contributions that relate more closely to issues of internal organizational change. 7. Delegation games combine agency with industrial organization theory, modeling the interaction of principal-agent arrangements with competition in the marketplace (for recent examples, see Jansen,Van Lier, and Van Witteloostuijn 2007;Van Witteloostuijn, Jansen, and Van Lier 2007). 8. Actually, power is a key concept in economics at large, as is clear from the many models on market power in industrial organization and state power in institutional economics. 9. Scope means that the value created by the joint production of two outputs is greater than if the two outputs were produced separately. Economies of scope can be realized if the total cost (C) of producing two products Y1 and Y2 in one firm is lower than the combined cost of producing both products separately (Helfat and Eisenhardt 2004: 1218): C (Y1, Y2) < C(Y1, 0) + C(0, Y2). Formal models of diversification based on

582 Rafael Wittek and Arjen Van Witteloostuijn this reasoning were developed by Panzar and Willig (1981); Rubin (1973); and Bailey and Friedlander (1982). 10. Of course, our review cannot discuss the many intricate debates and subtle arguments that abound in the literature. For instance, recent insights have emerged arguing that conglomerates experienced a comeback in the 2000s in the form of private equity funds (Van Witteloostuijn 2007). 11. The other dimensions constitute the firm’s physical capacity (for example, number of airplanes), organizational in- or outputs (such as number of passengers served), and the discretionary resources available to the organization (for example, net assets). 12. For formalization of some of these arguments underlying the M-Form hypothesis, see Aghion and Tirole (1995); Rotemberg (1999); Maskin, Qian, and Xu (2000); Itoh (2003); and Inderst, Müller, and Wärneryd (2007). These models of the choice between M-Form and U-Form focus on three mechanisms (Itoh 2003): control benefits, improved incentives, and internal capital markets. 13. The reasoning is, in fact, consistent with sociological accounts formulated in the context of resource dependence theory (Pfeffer and Salancik 1978). 14. Three types of internal reorganizations have attracted attention during the past decade: reconfiguration/recombination of units within the firm, charter change, and de- and relayering. Given the paucity of empirical research on reconfiguration and charter change, both of which are relatively recent areas of investigation, we focus on delayering. 15. See http: //www.cranet.org/: “During the first 5 years of the survey (1990– 1995) the questionnaire was distributed to between 25,200 and 33,100 organizations each year and received between 5,000 and 6,500 responses. This is a response rate of 16.6–22.5%, varying between countries. . . . In 1999 the survey was distributed to over 50,000 organizations and received 8,050 responses, giving a total response rate of 15%.” 16. Appelbaum and Batt (1994: 173–90) provide a succinct summary of twelve surveys on workplace practices, carried out in the United States during the late 1980s and early 1990s. 17. For the sake of parsimony, we ignore the time dimension here. This is an important issue, though, as the time horizon of the manager (and other stakeholders, for that matter) is an important determinant of decision-making, as is clear from standard game theory and the literature on modern shareholderism;Van Witteloostuijn 2007). 18. In the microeconomics of competition, called industrial economics or industrial organization, the concept of market power is critical. This relates to another level of analysis, though—the firm rather than the manager. 19. We could introduce more complex functional specifications (say, of the CobbDouglas type). We decided not to do so, to keep the argument as simple as possible. That is all we need in the context of this chapter, where our model serves illustrative purposes only. 20. Strictly speaking, Proposition 3 is silent about the argument reflected in Trend 3 as to the increased rhythm of organizational change over time, as suggested in the management hype literature (Sorge and Van Witteloostuijn 2004). In future work, a sociological rational choice model may be developed that focuses on this very rhythm issue.

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Index

Aarts, Olav, 338 Abbink, K., 45 Abbring, J. H., 494 Achen, Christopher H., 153, 165 Actor-based statistical models, 262–65, 272–73 Addiction, 291–93 Adolescents, see Youth Adverse selection, 482, 489–90, 493–94 Affection, need for, 77, 78–79 Afghanistan war, 414–15, 417 Africa: postcolonial state formation, 455, 456, 457–58, 463nn28–29; Zulu kingdom, 461n8 Agency costs, 530 Agency theory, see Principal-agent theory Agentic ability, 80–81, 93. See also Selfregulation Agentic needs, 77–78 Agentic self, 97 Agents, see Principal-agent problem Agneessens, F., 272 Air pollution, see Clean Air Act; Pollution Akerlof, George A., 309 Alba, Richard, 356, 358, 369, 370 Albert, R., 256–57, 266 Alchian, Armen A., 527, 529–30, 533, 534 Alexander, Jeffrey C., 367 Alliances, of firms, 136, 253, 254, 255, 266, 268 Al Qaeda: in Afghanistan, 401, 414–15, 417; diffusion effects of attacks, 398; goals, 382, 389, 390; members, 386; 9/11 attacks, 381, 390 Altruism: Dictator Game, 43–44; preferences, 387–88 Altruistic punishment, 53–57, 54 (fig.), 59 Ambiguity aversion, 289 Ames, Edward, 451, 452 Anarchists, 388, 389, 390 Anderhub,Vital, 131, 132

Anderson, C. M., 57 Anderson, Elijah, 314 Anderson, James C., 193 Andrade, G., 557 Andreoni, James, 44 Anthropology, state formation theories, 445–47 Antitrust regulation, 538, 563 Ao, Dan, 231, 237 Arce, Daniel G., 402, 403 Arnott, R., 494 Arousal, need for, 77 Arrow, K., 478, 479, 527, 528 Asada, T., 480 Asian-Americans, 226, 356, 362, 368–69. See also Minorities Asset specificity, 533–34, 535 Assimilation of immigrants: boundaries and, 367–70; causal mechanisms, 360–61, 362, 372; collective action, 361, 364, 372–73; definition, 358; empirical research, 359–60, 370–72; ethnic identity preservation, 358, 369, 371; in Europe, 359–60; by group, 355; individual level, 361–63, 368, 372–73; institutional mechanisms, 365–67, 372, 373; intergenerational, 357, 361, 372; languages, 362, 371; mainstream culture and, 358–59, 362–63; network mechanisms, 360, 363–64, 372–73; of nonwhite immigrants, 355–56; purposive action, 19, 360, 361–63, 372; rational choice analysis, 359–60, 373; resistance to, 368, 369; of second generation, 362, 370–72; social mobility, 364; straightline models, 357; theories, 356–58. See also Immigrants Assurance games, 304, 315n12 Asymmetric information, see Information asymmetries Atomic bombs, 383 Atomized interactions, see Isolated encounters

590 Index Auctions: Internet, 137; second-bid, 397. See also eBay Audience costs, 421–22, 425, 427, 435–36, 438–39n7 Authority: centralized, 365–66, 450, 452; charismatic, 297; control of behavior, 297; costs of exercising, 522; in hierarchies, 562; managerial, 521–22, 529, 534, 544n6; norms and, 295. See also Power Autocracies: audience costs, 425, 438–39n7; formation, 447; leaders, 419, 426, 431, 433, 436, 447, 448, 449; repression, 425; wars, 426, 433, 434, 436, 437 Automobiles, lemons market, 308–9 Autonomy, 76, 99, 227, 387 Avery, C., 497 Axelrod, Robert, 124, 254 Azam, Jean-Paul, 387 Azzi, Corry, 332 Background goals, 84–86 Bainbridge, William S., 322, 323, 332, 344 Bakan, David, 77 Baker, George, 522, 537 Bala,Venkatesh, 261, 264 Bandura, Albert, 298 Barabási, A. L., 256–57, 266 Bargaining: among states, 411, 415, 420; during wars, 427–29 Bargaining games, center-periphery, 457 Bargaining stage: coalition building, 154, 163–64; dominant processes, 171–72; issue specification, 160–61; models, 156, 156 (table), 157, 174–75; policy positions, 153, 161, 163–64; voting positions, 153, 155–56. See also Enforcement; Logrolling; Persuasion Bargaining theories: commitment problems, 417; in economics, 415; maximal outcome, 415; reasons for failures, 416–17; reservation points, 415, 416, 420–21, 423–24, 427–28; risk-return tradeoff, 416; separation of types, 416, 420, 421; wars as bargaining failures, 411, 414–17, 424, 427; zone of agreement, 415, 424, 428, 439n10 Barker, George R., 538 Barkow, Jerome H., 78 Baron, James N., 243 Barro, Robert J., 338 Barzel,Yoram, 449, 450 Basque Fatherland and Freedom, see ETA Batenburg, Ronald S., 135, 140 Bates, R., 450 Bates, Robert H., 458 Baum, J. A. C., 256 Bauman, Karl E., 267 Baumeister, Roy F., 79 Baumer, Eric P., 297

Baumol, W., 569, 570 Bean, Richard, 451 Bearman, Peter, 205, 206–7 Bearman, P. S., 257 Beccaria, Cesare, 283–84 Becker, Gary S., 240, 285–86, 291–92, 323 Behavioral confirmation, 79, 80 Behavioral economics, 33, 37 Beliefs, 34 Belleflamme, P., 266 Bellemare, C., 48 Benard, S., 268 Bennardo, A., 493 Bennett, D. Scott, 431–32, 434 Bentham, Jeremy, 283 Berardo, R., 272–73 Berg, Joyce, 48 Berger, Peter, 335, 337–38, 345, 348n20 Berger, Philip G., 540 Berle, Adolph A., 530 Berlyne, D. E., 77 Berman, Eli, 399–400 Bernasco, Wim, 240 Bernholz, Peter, 387 Berninghaus, S. K., 261 Berveling, Jaco, 155 Bienenstock, Elisa Jayne, 200–201 Blainey, Geoffrey, 415, 417 Blau, Peter M., 185–87, 188, 195–96, 201, 203, 206, 301 Blinder, A., 569, 570 Bloch, F., 259–60, 266 Blockmans, Willem, 448 Bloom, Mia, 400 Blumberg, Boris F., 135 Boehnke, Klaus, 297 Bohnet, Iris, 49 Boissevain, Jeremy, 226 Bolton, Gary E., 61, 63, 133 Bonacich, Phillip, 200–201, 270 Boone, C., 561 Borch, Casey, 198 Boundaries, social: assimilation of immigrants and, 367–70; blurred, 367–68; bright, 367– 68, 369; definition, 359 Bounded rationality: assimilation of immigrants, 359; assumptions, 3–4, 7; in organizational economics, 523, 533, 535–36, 540–41, 543, 545n19; trust and, 120 Bourdieu, Pierre, 226, 228, 230, 235, 296 Bowlby, J., 78–79 Bowles, Roger, 290 Bowles, S., 475 Boxman, Ed, 228 Brand names, 332 Brandts, Jordi, 131, 132 Brashears, M. E., 238, 253

Index Brass, D. J., 242 Brechet, T., 489 Britain: bureaucracy, 453, 454; religious participation, 339, 343. See also English Parliament Broken windows hypothesis, 299–300 Bruce, Steve, 333, 334, 335–36, 339 Brustein, William, 451 Buch, R., 478 Bueno de Mesquita, Bruce, 157, 159, 286–87, 290–91, 425–26, 433, 435–36, 438 Bueno de Mesquita, Ethan, 386, 393, 395, 401, 405n5 Bunderson, J. S., 91 Bureaucracy: monitoring capacity, 453; public, 538; war and, 453–54 Bureaucratic states, 21, 450, 451, 452–54, 459, 463n30 Burger, M. J., 262 Burt, R. S., 143, 222, 223, 227, 255, 266 Business cycles, 480 Business networks, 193, 257–58 Buskens,V., 129, 133–34, 135, 136, 259, 261, 262, 266, 272 CAA, see Clean Air Act Cacioppo, J. T., 79 Camerer, Colin F., 131, 132 Campa, Jose Manuel, 540 Canonical rational choice model, see Rational choice model Capital, religious, 328, 332. See also Human capital; Social capital Capitalism, 224–25, 437, 529 Capital markets, 539, 562–63 Caplan, A., 489 Carbon dioxide, see Kyoto Treaty Carmichael, Lorne, 541 Carpenter, J. E., 44 Carroll, Glenn R., 341 Casanova, José, 336 Casciaro, T., 254 Catholic Church, 331, 347n14 Catholics: commitment levels, 328; in Europe, 329, 344; in Northern Ireland, 328, 397, 400; socialization, 334; in United States, 355, 369 Catholic schools, 88, 239–40, 369 Cela-Conde, Camilo J., 270 Centeno, M. A., 456 Center-periphery bargaining games, 457 Certification, 489–92 Chain Store game, 397 Chaloupka, Frank J., 292 Chandler, A. D., Jr., 544n9, 560, 565, 566 Chapman, Ralph B., 538 Charness, Gary, 63

591

Chaves, Mark, 338 Chestnut, L. G., 484 Cheung, Stephen S. N., 529 Chevalier, Judith A., 540 Chiappori, P. A., 493–94 Chiappori, P. H., 494 Chicago, migration to, 356–57 Chicago School of Sociology, 356–58, 373 Chicken game, 212n17, 397 Child-centered social control, 299 Childe, Gordon V., 445 Children: attachment, 78–79; bonding with, 74; competition in families, 239; selfformation, 94; self-regulation development, 87–88, 89; in single-parent families, 240; in social networks with adults, 299, 304. See also Education; Families;Youth China: air pollution, 483–84; bureaucracy, 454; greenhouse gas emissions, 163, 173; social capital, 231 Chiozza, Giacomo, 436 Christianity, see Catholic Church; Religions Chung, S. A., 254 Churchill, Winston, 424 Cigarettes, 292–93 Cities, see Urban areas Civil Rights Act of 1964, Title VII, 365–67 Civil wars, 384, 412, 414 Claessen, Henri J. M., 447 Clark, K., 51 Clean Air Act (CAA), 484–85, 488 Clearinghouses, 494, 495–97, 496 (table) Clergy, see Religious leaders Climate change, see Copenhagen climate meeting Coalition formation: in exchange networks, 200–201; exchange theory, 192–93, 198; by stakeholders, 154, 163–64, 170 Coalitions: building, 154, 163–64; in coercive structures, 198; electoral, 419–20, 426, 431, 436, 437; rationality, 200–201 Coase, R. H., 481, 517, 525–26, 527, 529, 532 Coase theorem, 518 Cochard, Francois, 132–33 Coclanis, P., 477 Coercion, 365. See also Terrorism;Violence Cognition: of agents, 523, 541; anomalies, 3; in decision-making, 4–5 Cognitive limitations, 479. See also Bounded rationality Cohen, Jacqueline, 288 Cohen, Lawrence E., 286–87, 290–91 Cohen, Michael D., 254 Cohesion: of exchange relations, 190; relational, 190, 194, 204 Coleman, J. S., 10, 87–88, 114, 117, 119, 155, 223, 226, 227, 228, 229, 232, 233, 234, 237,

592 Index 239, 241, 255, 285, 294, 296, 298, 300, 302, 307, 517 Coles, Catherine M., 299–300 Collective action: in centralized networks, 257; of immigrants, 361, 364, 372–73 Collective action problems: in counterterrorist policy, 382; generalized exchanges, 205, 209; reaction functions, 391–92, 392 (fig.); state formation and, 445–46, 449. See also Free riders; Public goods Collective decision-making: contexts, 154; formal rules, 156, 157, 158, 171, 174; future research directions, 171, 175; gametheoretic models, 156, 156 (table); interest alignment, 154, 173; issues, 153, 160–63; as joint production, 153–54, 157; model elements, 158; outcome predictions, 158, 169, 171–72, 174, 175–76n2; power and influence, 151–53, 154; preferences in, 153, 154; stages, 153; strategic intervention, 172–74. See also Bargaining stage; Decisionmaking;Voting stage Collective efficacy: crime and, 299–300; definition, 298; of neighborhoods, 298–301, 300 (fig.), 304; social capital and, 298–301, 302–7 Collective goods, religious, 333 Colonialism, 455–56, 457 Comfort, need for, 77 Commitment, in interfirm relations, 195 Commitment problems: in bargaining, 417; terminating wars, 429–30, 432; war aims and, 430–31; before wars, 423–24, 427, 430 Commodities, named and contingent, 481 Communist countries: corruption, 308; efforts to destroy religion, 344; social capital, 234– 35. See also Eastern Europe; Soviet Union Communities, 13. See also Neighborhoods Competence, 76, 81 Competition: among terrorist organizations, 390, 400; rational choice analysis, 27–28; religious, 324–26, 327–30, 334–35, 340–42; for resources, 187. See also Markets Complete contracts, 39, 47, 59, 528, 536 Concentration camps, 235 Conference of Parties (COP), see Copenhagen climate meeting Conflicts, see Religious conflicts; Wars Conflict theories, 445, 446, 447, 461n13 Conglomerates, 529, 540, 562, 563, 564–65, 570, 582n10. See also Mergers and acquisitions Consensus norm, 157, 158, 169, 171–72 Constraints, 34–35, 72–73 Contagion models, 154–55 Contracts: bilateral, 115; complete, 39, 47, 59, 528, 536; costs, 481; employment, 45–47,

59, 532, 537; enforcement, 480, 481; gametheoretic models, 523; market, 529, 532; optimal design, 538; relational, 474, 537; transaction costs, 481; trust and, 134–35. See also Incomplete contracts Control: informal social, 299, 302, 304–5, 307; by managers, 575–76; organizational, 544n1; organizational change and, 575–76, 579–80; residual rights, 534–35, 539 Control mechanism, embeddedness effects, 122–27, 123 (table), 131 (table), 132–34, 136, 137, 139, 140–41 Cook, J. M., 254 Cook, Karen S., 187, 188, 190–91, 194–95, 205, 208 Cooperation: altruistic punishment, 53–57, 54 (fig.), 59; conditional, 58–59, 122–23; enforcement, 170–71; motives, 58; in networks, 269–71; Prisoner’s Dilemma Game, 49–52, 50 (fig.), 198, 254, 270–71; social preferences and, 59; strategic gains, 51. See also Public Goods Game Cooperative exchange relations, 187 Cooperative games, 200, 213n21 Cooperative models, of collective decisionmaking, 156 (table), 156–57 Coordination, within firms, 532 Coordination games, 38, 271–72, 524 Copenhagen climate conference, 158–60, 160 (table), 162 (fig.), 163, 167–68, 168 (table), 172–74 Core theory, 200–201, 213n19 Corporate governance, see Organizational governance Corporate restructuring, 564–69, 579–80. See also Firms Correlates of War (CoW) dataset, 412–13 Corruption, 308, 314 Corten, Rense, 272 Corts, Kenneth S., 135 Counterterrorist policy: budgets, 393; collective action dilemmas, 382; defensive, 401–3; free riders, 402; game-theoretic models, 402 (fig.), 402–3; information problems, 395, 397, 398; negative incentives, 382, 401; positive incentives, 382, 401; proactive, 401–2, 403, 406n17; public goods and, 393–95, 401–2; raising cost of attacks, 401; war on terror, 395 Cox, James C., 49 Crawford, Robert G., 533, 534 Credence goods, 489, 502n60 Credible commitments, 366, 367, 444, 449, 459, 530 Credit rating agencies, 492 Crime: collective efficacy and, 298–301, 300 (fig.), 304; empirical research, 287–90;

Index 593 identity theft, 492; individual-level model, 285, 287–90; marriage and, 90; opportunities for alternatives, 286–87; organized, 307–8, 314, 447; policies aimed at reducing, 286, 287, 291; rational choice analysis, 283, 284–91, 313; social capital and, 297, 307; social organizations against, 295–307; social organizations in favor, 295, 307–13; sociological analysis, 284; youth, 90, 288–89, 298, 304–5, 314 Criminal justice system, 283–84, 290 Crises, international, 413 Crocker, Keith J., 538 Crockett, Alasdair, 339, 341, 343 Cronshaw, M., 489 Crowding out hypothesis, 234, 237 Cultural clarity, 96 Cultural competence, 362 Culture: change in, 367; impact of immigration, 357. See also Assimilation of immigrants Cyert, Richard, 544n9 DAA, see Deferred Acceptance Algorithm Daenell, E., 477 Dahl, Robert A., 151 Davis, Douglas D., 40, 41 Davis, James A., 255 Debreu, J., 478, 527, 528 Decision-making: cognitive factors, 4–5; democratic, 152, 154; in firms, 568; individual, 4–5; political, 152, 153, 157. See also Collective decision-making Decision-Making in the European Union (DEU), 175 Decision theory, in rational choice model, 34 Deferred Acceptance Algorithm (DAA), 496 (table), 497 De Graaf, Nan Dirk, 238, 334, 337, 340, 341, 342, 343–44, 345 De Graaf, Paul, 228, 240 Delayering, 567–69 Delegation games, 560–61, 573, 577, 581n7 Democracies: decision-making, 152, 154; leaders, 425–26, 436; opposition parties, 425; political control of leaders, 419–20; terrorist groups, 392; wars, 417, 424–27, 433–34, 437 Democracy: organizational, 576; transitions to, 234, 237 Democratic peace, 424–27 Demsetz, Harold, 527, 529–30 Desch, Michael C., 433 Deterrence: nuclear, 384; punishment as, 284, 286, 287–88, 289–90 Detroit Area Study, 236

DEU, see Decision-Making in the European Union Dickhaut, John, 48 Dictator Game, 43–44 Differential social organization, 295, 313–14 Dijkstra, Jacob, 169, 172 Dijkstra, J. K., 267, 272 Discriminating alignment, 518, 533–34 Discrimination, 365–67, 371 Disequilibrium models, 500n27 Distributive justice, 195 Dobbin, Frank R., 243 Doebler, Stephanie, 344 Donnelly, Shawn, 208 Downs, George W., 436 Downsizing, 569, 570–71 Drugs: dealers, 310, 314; rational addiction theory, 291–93 Dufur, Mikaela, 242 Dufwenberg, M., 64 Dumin, M., 228 Dunbar, Robin, 73, 342–43 Durkheim, Emile, 77, 115–16, 206 Durkin, John T., 332 Durlauf, Steven N., 301 Dyadic embeddedness: assumptions, 11; control effects, 122, 123 (table), 123–25, 126, 131 (table), 132–33, 140, 141; definition, 122; empirical evidence, 131–33, 134–35, 136; learning effects, 123 (table), 129–30, 131 (table), 132–33, 134, 140, 141 Earls, Felton, 298–99, 300 Eastern Europe: Catholics, 329; Orthodox Church, 334, 344, 369; postcommunist states, 237, 344, 455, 457; religious participation, 344; state formation, 455, 456, 457 eBay, 113–14, 120, 122, 137, 492 Eckel, Catherine C., 45 Ecological rationality models, 7 Economic sociology, 193 Economic transactions, 115–16. See also Isolated encounters; Trust problems Economies of scope, 539, 562, 581n6, 581– 82n9 Education: Catholic schools, 88, 239– 40, 369; college rankings, 492; of immigrants, 362, 369, 370; medical, 495–97; parental involvement, 226, 242; religious participation and, 336; in scientific worldview, 336; self-regulation development and, 87–88; signaling function, 309; social capital and, 239–40 EEM, see Externality Exchange Model Egas, Martijn, 57

594 Index Egoism, assumption, 8 Eguìluz,Victor M., 270 Ehrenberg, Ronald G., 332 Ehrhart, George C. M. A., 269 Ehrhart, K.-M., 261 Ehrlich, Isaac, 287–88 Ekeh, Peter, 185, 195, 205, 207 Elementary theory, 192, 197–98 Elites: corporate, 558, 559; marriages, 235; social capital, 230–31. See also Status Ellison, Christopher G., 323 Embeddedness: institutional, 10, 23–24, 25; as social capital, 142; structural, 11. See also Dyadic embeddedness; Network embeddedness Embeddedness effects: control mechanism, 122–27, 123 (table), 139; disentangling, 123, 142, 143; empirical research, 130–41, 138 (table), 142–44; experimental evidence, 130–34; future research directions, 142–44; game-theoretic models, 123–30, 142; hypotheses, 131 (table); learning mechanism, 123, 123 (table), 139; negative, 143; on social dilemmas, 117; survey evidence, 134–39; vignette experiments, 139–41 Emerson, Richard M., 186, 187–88, 189, 190– 91, 192, 194, 195, 196–97, 204, 254 Emission Trading Scheme (ETS), European Union, 483, 486 (fig.), 487 Emotions: in exchange relations, 204; regulation, 86, 94; social, 80 Employees: belonging to firm, 537; differences from independent contractors, 532, 535; effort and wages, 45–47, 59; empowerment, 576; high-performance human resource management, 558, 571–73, 576, 579; incentives, 571–72; training, 572; unpaid overtime, 91–92. See also Labor markets; Organizational governance Employment contracts, 45–47, 59, 532, 537 Enders, Alter, 402 Enforcement, 154, 164 (table), 165–66, 170–71 Engel, C., 44 Engelmann, Dirk, 63, 131, 132 Engels, Friedrich, 445 Engle-Warnick, Jim, 132 English Parliament, 448, 449, 461–62n16 Ennettt, Susan T., 267 Ensel, Walter M., 226, 230 Entrepreneurs, 23, 498, 542 Environmental pollution, see Pollution Environmental Protection Agency (EPA), 484, 485 Epstein, S., 477 Equilibria: definition, 35; market, 35, 40, 478;

mixed strategy, 42; in network games, 259– 60; optimality, 38; Pareto-efficient, 478, 482; payoff dominance, 125; reaching, 37–38; strategic, 35–36 Erdös, P., 257 Ermisch, John, 48 Ertman, T., 451–52 Esser, Hartmut, 171, 359–60 ETA (Basque Fatherland and Freedom), 384, 389, 396, 405n5, 406n15 Ethnic identity, 358, 369, 371 Ethnic minorities: boundaries, 359; enclaves, 360–61, 370–71; immigrants, 355–56, 362; norms, 363–64; social mobility, 369; social networks, 362. See also Immigrants; Minorities Ethnic stratification, 358 Europe: assimilation of immigrants, 359–60; medieval, 339, 448, 449–50, 461n13; social networks, 236, 237; state-making, 448–52, 457–58, 459, 461n13. See also Eastern Europe; World War I; World War II European Union (EU): bargaining processes, 171–72; Copenhagen climate conference, 160, 168, 173; decisionmaking process, 157, 158, 171–72, 175; Emission Trading Scheme, 483, 486 (fig.), 487; implementation of decisions, 171; predicting decision outcomes, 158, 169, 171–72; procedural rules, 156 Evans, Goeffrey, 344 Evolution: goal-frames and, 85; religious functions and, 342–43; of self-regulation, 73–74, 98; of social needs, 77–78 Evolution theory, conflict with religion, 322 Exchange models, 155–56 Exchange networks: connection types, 189; core theory, 200–201, 213n19; general equilibrium analysis, 201; negative and positive connections, 187, 189; norms, 206; overlapping, 209; power inequalities, 187, 191; relative positions, 191, 192; structural changes, 210; structures, 191, 196; uncertainty and risk, 194–95 Exchange relations: behaviors and outcomes, 188–89; bilateral, 294; cohesion, 190; commitments, 194–95, 203; cooperative, 187; dependence, 186, 187–88, 190, 200; dyadic, 207; emotions in, 204; equality, 185; externalities, 294, 297; future research directions, 208–11; generalized, 204–9; information asymmetries, 301–2; integrative outcomes, 202–4; latent, 192; in markets, 13, 473; negotiated, 165, 166, 172, 201, 203, 213n21; norms, 195–96; punishment, 201, 202; reciprocal, 190, 201–3, 213n21, 296, 301–2; rewards, 186, 201, 202; as

Index social capital, 301–3; solidarity, 204, 206–7; trust in, 194–95, 203, 302, 315n7; utility maximization, 301–2. See also Power inequality in exchanges Executive compensation, 558, 576–77 Expectation status theory, 159 Expected utility, of criminal behavior, 286 Expected Utility model, 157 Expected-value theory, 200, 212n18 Experience goods, 489, 502n60 Experiments: advantages, 42; laboratory, 42– 43, 130–34, 190; standards, 42–43; vignette, 131, 139–41, 289–90 Externalities: correlated, 489; definition, 501n36; examples, 483–84; in exchange relations, 294, 297; market solutions, 484– 89; negative, 482; positive, 482; regulation, 482. See also Pollution Externality Exchange Model (EEM), 169 External markets, 475–76 Fafchamps, Marcel, 301 Fairbanks, A., 497 Fairness, 194, 195–96, 202, 206, 290–91 Falk, Armin, 64 Families: intergenerational relations, 208; kinship networks, 473; religious socialization, 334, 342; social capital, 229, 230, 234, 239–40; social resources, 239. See also Children; Parents Family-owned firms, 566 Farrelly, Matthew C., 292 Fascist terrorism, 390–91 Fatton, Robert, 455 Fearon, James D., 398, 417 Fehr, Ernst, 45, 47, 48, 53–54, 55, 61–63 Ferrero, Mario, 388 Feudalism, 450, 451, 462n19 Fichman, Mark, 195 Figueras, Neus, 131, 132 Filson, Darren, 428 Finke, Roger, 322, 327, 330, 334, 336, 338, 341, 342, 344–45 Firm, theories of, 528 (table); agency, 527, 530–32, 559–62, 563, 565–66; changing meaning, 524–25; development, 526–27; economic, 523–24; efficiency, 542–43; evolutionary, 527; incomplete contracts, 525, 527–28, 533–36, 537; new property rights approach, 534–36, 537; nexus-ofcontracts view, 527, 528–30; transaction costs, 525, 526, 562–63, 565. See also Organizational governance Firms: agency problems, 522; classical capitalist, 529; conglomerates, 529, 540, 562, 563, 564–65, 570, 582n10; demand information, 479; distinction from markets,

595

529, 534; diversification, 539–40, 562–64, 566, 581–82n9; downsizing, 569, 570–71; executive compensation, 558, 576–77; family-owned, 566; holding (H) form, 564, 565; internal capital markets, 539, 562–63; mergers and acquisitions, 522, 539, 557, 563–65, 575; multidivisional (M) form, 560, 564, 565, 566–67; multinational, 478; number in United States, 556; organizational structures, 567–69; restructuring, 564–69, 579–80; sizes, 522, 557, 558, 564, 569–71, 574–75, 581n3; team production, 529, 530; unitary (U) form, 560, 564, 565, 566. See also Organizational change; Organizational governance Firms, relations among: alliances, 136, 253, 254, 255, 266, 268; commitment, 195; joint production, 539; networks, 193, 257–58; price wars, 396; trust problems, 134–37 Fischbacher, Urs, 48, 58, 59, 62–63, 64 Fischer, Claude S., 227–28, 236, 239, 343 Fisher, F., 479 Fisheries, see New Zealand fishing market Flache, A., 268, 271 Flap, Henk, 228, 232–33, 237, 239 Fong, Christina M., 62–63 Ford, M. E., 77 Foreign policy: principal-agent problem, 418– 20; public goods, 426. See also Wars Forsythe, Robert, 43–44, 45 Fortna,Virginia Page, 435 Foss, Kirsten, 522 Foss, Nicolai J., 522, 542 Fox, Jonathan, 338–39 France: Estates-General, 449; monarchy, 438; national market, 477 Frank, Robert H., 78 Fréchette, G., 497 Freeland, R. F., 567 Free riders: in counterterrorist policy, 402; in generalized exchanges, 206; in public goods games, 58; punishing, 53–57, 62; in religious communities, 347–48n17; in religious organizations, 333; in social networks, 303, 305; in terrorist organizations, 385–86, 399 Fried, Morton H., 445, 446 Friedkin, Noah E., 200 Friedman, James W., 125 Froese, Paul, 344 Fry, M., 78–79 Full rationality models, 6–7 Functionalism, 445, 460–61n7 Gächter, Simon, 53–54, 55, 58, 59 Gain goal-frames, 83, 85–86 Gale, D., 497

596 Index Gambetta, Diego, 285, 307, 308, 309, 310, 311, 312, 313 Game theory: experiments, 38; generating testable hypotheses, 119, 120 (fig.); interdependence of actors, 116; social dilemma analyses, 116. See also specific games Gardner, Roy, 53 Gargiulo, M., 136, 255, 262 Gastroenterology Fellows (GIF), 497 Gat, Azar, 437 Gautschi, Thomas, 132 GEA, see General equilibrium approach Gelissen, John, 237 Gelman, A., 253 Gelpi, Christopher, 426 General equilibrium approach (GEA), 201, 479–80, 493, 494 Generalized exchanges: definition, 204–5; fairness, 206; future research directions, 208–9; intergenerational, 208; Kula ring, 185, 205–6; online, 208; solidarity, 206–7; types, 205 General Motors (GM), 566, 567, 579 General Social Survey (GSS), 236, 238, 297 Gerbasi, Alexandra, 195 German Democratic Republic (GDR), 234–35 Germany: Nazi regime, 424, 429; World War I, 429, 432, 436 German Youth Institute, Family Survey, 239 Gestsdottir, S., 89 Ghoshal, Sumantra, 541 Giant components, 257–58 Gibbons, Robert, 522, 537 GIF, see Gastroenterology Fellows Gift Exchange Game, 43, 45–47, 46 (fig.), 59, 144n7 Gigerenzer, G., 7 Gilles, R. P., 259 Gillespie, James J., 241 Gillespie, Patsy, 400 Ginkel, John, 392 Gintis, H., 36, 38, 480 GM, see General Motors Goal-frames: background goals and, 84–86; balance of, 86; definition, 82; evolution and, 85; gain, 83, 85–86; hedonic, 82–83, 85, 86; normative, 83–84, 85–87 Goal-related self-regulation, 81–93 Goals: activation, 82; definition, 81; focal, 82, 84; general human, 224–25; meaningful need states, 91–93; overarching, 82, 84 Goemans, H. E., 429, 436 Goeree, J. K., 261–62, 266 Goffman, E., 98 Goldthorpe, John H., 2, 5, 116, 323 Gonzalez, M., 273

Goods: credence, 489, 502n60; experience, 489, 502n60; religious, 326, 330–31, 332– 33, 345, 347n5; search, 489, 502n60. See also Public goods Gordon, Milton, 357, 358, 370 Gorski, Philip S., 336, 338 Gould, R.V., 254 Governance: forms, 13; mechanisms, 516, 517; structures, 515–17. See also Organizational governance Governments, see Bureaucracy; Regulation; States Goyal, Sanjeev, 259, 261, 264, 266, 271 GPI, see Graph-theoretic Power Index Graham, John R., 540 Grandori, Anna, 516, 517 Granovetter, M. S., 117, 222, 223–24, 255, 296–97, 311 Graph-theoretic Power Index (GPI), 193, 197 Greeley, Andrew M., 332, 342, 344 Green, D., 2–3 Greenwood, R., 478 Greif, A., 25, 366 Grieco, Joseph M., 426 Grossman, Philip J., 45 Grossman, Sanford, 534, 535 Group-generalized exchanges, 205, 209 Group of 77 (G77), 159, 168 Groups: behavioral confirmation, 79, 80; collective goods, 73; exclusion, 99; influence, 74, 87; normative goal-frame, 83–84; norms, 206, 363–64; peers, 87; status differences, 78. See also Immigrants; Minorities Gruber, Jonathan, 292–93 GSS, see General Social Survey Guerra, G., 491 Guest, A. M., 327 Guilt model, 121 Guisinger, Alexandra, 422 Gulati, R., 134, 136, 253, 255, 262, 266, 268 Güth, Werner, 44–45, 131, 132 Hadaway, C. Kirk, 334 Hagan, John, 297 Hahn, F., 479 Håkansson, Håkan, 193 Haller, Max, 236 Hamas, 389, 395 Hamberg, Eva M., 327, 329, 335, 338, 343 Handcock, M. S., 257 Hannan, Michael T., 243 Hanseatic League, 477 Hansen, M. N., 228 Harlow, H. F., 78 Harmony, of selves, 96–97 Harrison, Glenn W., 40, 41

Index Hart, Oliver, 517, 521, 525, 533, 534–35, 536 Hayek, Friedrich von, 10, 514 Haynie, Dana L., 267 Health, social capital effects, 220, 242 Health maintenance organizations (HMOs), 491–92 Hebb, D. O., 77 Hechter, Michael, 33–34, 323, 330, 451 Hedonic goal-frames, 82–83, 85, 86 Heider, Fritz, 223 Heifetz, A., 491 Heller, W., 483 Helpman, E., 494 Herbst, Jeffrey, 455, 456, 457–58 Herfindahl index of religious concentration, 340–41, 344, 346 Hierarchies: authority in, 562; delayering, 567–69; goal-setting, 170; governance structures, 515–16, 534; network structures, 192–93 High-performance human resource management, 558, 571–73, 576, 579 Hill, Jonathan P., 333 Hinz, Thomas, 239 Hirschman, Albert O., 127 Hispanic Americans, 356. See also Ethnic minorities; Immigrants; Minorities Historical institutionalism, 25 Historical sociology, 451 Hitler, Adolf, 424 HMOs, see Health maintenance organizations Hobbes, Thomas, 115, 225, 460n6 Hoffer, T., 87–88 Hoffer, Thomas, 239 Hoffman, Bruce, 387, 400 Holdaway, Jennifer, 370–72 Holland, P. W., 255, 263 Höllinger, Franz, 236 Holme, P., 268, 269 Holmes, Stephen, 389, 395 Holmström, Bengt, 482, 531, 532 Homans, George C., 185, 187, 195, 359 Homophily: coevolution models, 268–69; in networks, 254, 267–69 Hormones, 74 Hout, Michael, 343 Huberman, B. A., 78 Huizinga, David, 288–89 Human capital: crime reduction and, 291; of immigrants, 361, 362, 372; inalienability, 537; religious, 332; social capital and, 228, 237–38. See also Education Human resource management, see Employees; High-performance human resource management Hume, David, 313 Hunter, Floyd, 151

597

Hurwicz, Leonid, 519 Hvide, H. K., 491 Iannaccone, Laurence R., 322, 323, 324–26, 328, 332, 333, 339, 340, 342, 344, 399 ICB, see Interstate Crisis Behavior data set Ichniowski, C., 571 Identity: clarity of, 96; ethnic, 358, 369, 371; religious, 329. See also Self Identity theft, 492 Immerfall, Stefan, 236 Immigrants: families, 226, 240; as rational actors, 356, 359, 361–62; self-interest, 361–62; social mobility, 369, 371–72; social networks, 240, 362, 363–64; in United States, 355–56; in urban areas, 356, 360–61. See also Assimilation of immigrants Impossibility Theorem, 482 Impression management, 98 Income inequality, 337, 558 Incomes: executive compensation, 558, 576–77; poverty, 291; power and, 574–75, 576–77. See also Socioecononomic status Incomplete contracts: Durkheim on, 115; employment contracts, 45, 47, 59; organizational governance and, 517–18, 519–21; theory of firm, 525, 527–28, 533–36, 537 Individualism: assumptions, 9–11; institutional, 10; methodological, 9–11, 25, 26, 38, 300, 523; ontological, 25; in rational choice approach, 9; structural, 10–11, 15 Individual Transferable Quotas (ITQ) System, 483, 485–87 Industrialization: power of state and, 423; war and, 437 Industrial organization, 498, 527, 581n6 Inequality: income, 337, 558; in networks, 257; religious participation and, 337; social, 230; state formation and, 445. See also Power inequality in exchanges Inequity aversion, 61–64, 121, 361 Influence: access, 152; activities, 522; in collective decision-making, 154; definition, 152; distinction from power, 152, 153; measurement, 151–52, 159; networks, 155; potential, 153; social, 154–55; of stakeholders, 151–53, 159; status, 199. See also Power Informal social control, 299, 302, 304–5, 307 Information: private, 416, 421, 429; as public good, 127, 137–39; as resource, 152; as social capital, 296–97, 311; trustworthy, 165. See also Learning mechanism Information asymmetries: adverse selection effects, 482, 489–90, 493–94; in

598 Index counterterrorist policy, 395, 397, 398; in exchange relations, 301–2; in firms, 530–31; lemons market, 308–9, 312–13; market design for, 489–92; in markets, 308–9, 312–13, 481; moral hazard, 482, 489, 493–94, 530–31; on personal characteristics, 492–94; on product quality, 308–9, 312–13, 482, 489–92; in protection rackets, 309–11; signaling as solution, 309 Information technology, 568, 569–70. See also Internet; Technology Informativeness principle, 531 Inglehart, Ronald, 336–37, 346 Institutional embeddedness, 10, 23–24, 25 Institutional individualism, 10 Institutionalism, 25. See also New institutional economics Institutions: assimilation of immigrants and, 365–67, 372, 373; change in, 366–67; distinction from organizations, 514–15; failures, 22; formation, 443; legal, 365–67; market, 39–40; social capital and, 231, 234– 36; state, 365–67. See also Markets; Political institutions; State-making Insurance: incentives and, 530–31; markets, 493–94 Insurance model, 332–33 Intangible resources assumption, 8 Interests: alignment, 154, 173; conflicting, 154, 173; shared, 154, 164–65 Intergenerational closure of networks, 299, 304 Internal markets, 476–77 International Social Survey (ISSP), 236 International trade, 477 Internet: exchange relations, 208, 209–10; fraud, 492; generalized exchanges, 208; network embeddedness, 136–37; reputation scores, 113, 137, 210; social interactions, 233–34. See also eBay Interstate Crisis Behavior (ICB) data set, 413, 436 Investment Game, 119, 120, 125, 132–33 IRA, see Irish Republican Army Iraq, 420, 430–31 Irish Republican Army (IRA), 389, 396, 397, 400 Islam, in Western societies, 346 Islamist terrorist groups, 389, 390. See also Al Qaeda Isolated encounters: trust problems, 113–14, 118–19, 120–22. See also Embeddedness Israel, 389, 395, 399, 401, 402, 420 ISSP, see International Social Survey Issues: salience, 153, 161, 163, 169, 173; specification, 161 Italy: market for protection, 308; Sicilian

Mafia, 308, 309–13; social capital, 241; terrorism, 390–91 ITQ, see Individual Transferable Quotas System Jackson, M. O., 259–60, 265, 266 Janky, B., 271 Japan: national market, 477; Pearl Harbor attack, 423, 424 Japanese Red Army, 406n17 Jennings, Devereaux, 243 Jensen, Michael C., 528–30 Jews: Hasidic, 360; in United States, 355, 369 Jin, G. Z., 490, 491, 492 Johanson, Jan, 193 Joint production: collective decisions, 153–54, 157; by firms, 539 Jolls, C., 497 Jones, J., 257 Jongman, Albert J., 383 Joshi, Sumit, 259, 266 Justice: criminal justice system, 283–84, 290; distributive, 195. See also Fairness Kahneman, D., 265 Kalmijn, Matthijs, 236 Kalyvas, Stathis, 384, 399, 404 Kanazawa, Satoshi, 33–34 Kaplan, Edward H., 402 Kasinitz, Philip, 370–72 Kato, A., 490, 491, 492 Katok, Elena, 133 Katz, E., 223 Kaufman, J., 273 Kedia, Simi, 540 Kelley, Jonathan, 337, 341, 342, 345 Kelling, George L., 299–300 Kerr, S., 485–87 Keser, C., 261 Kiecolt-Glaser, J. K., 79 King, Martin Luther, Jr., 367 Kirchsteiger, G., 45, 64 Kiser, Edgar, 449, 450, 452 Kitts, J., 268 Klein, Benjamin, 533, 534, 537 Klein, P. G., 538, 540, 542 Kleinberg, J., 266 Knetsch, J., 265 Knez, Marc, 143 Knight, Frank H., 517, 525 Knoke, D., 572 Koçak, Özgecan, 341 Kochen, M., 258 Kocher, Martin, 48 Kogut, B., 257–58 Kollock, Peter, 132, 137, 194 Köpetz, C., 84

Index Kosfeld, M., 261 Köszegi, Botond, 292–93 Krackhardt, D., 255 Kraemer, K. L., 568 Kramer, Roderick, 195 Kreager, Derek A., 288–89 Kreps, David M., 124, 532 Kröger, S., 48 Krueger, Alan B., 386 Kula ring exchange system, 185, 205–6 Kurizaki, Shuhei, 422 Kwan, Kian, 357–58 Kydd, Andrew H., 389–90 Kyoto Treaty, 158–59, 162 (fig.), 163, 173 Labianca, G., 242 Labor markets: antidiscrimination laws, 365–67; closed-shop agreements, 538; demographic change and, 369–70; education credentials as signals, 309; ethnic enclaves, 370–71; information asymmetries, 493, 494–95; internal, 243; matching, 494– 97, 496 (table), 498 (table); migration and, 361, 363–64; occupational prestige ladder, 228, 242; social networks and, 220, 222, 230–31, 232, 235–36, 237–38, 242, 363–64; technological change and, 569–70 Laffont, J. J., 494 Laitin, David, 399–400, 457 Lalman, David, 438 Lambrecht, S., 489 Lang, Larry H., 540 Lapan, Harvey E., 397 Latin America: internal conflicts, 457; state formation, 455–56, 457, 458; terrorist groups, 383, 385 Laub, J. H., 90 Laumann, Edward O., 236 Lawler, Edward J., 194, 203–4 Law of Demand, 57 Laws: Civil Rights Acts, 365–67; Clean Air Act, 484–85, 488 Lazarsfeld, P. F., 254 Leaders, political: audiences, 421–22; autocrats, 419, 426, 431, 433, 436, 447, 448, 449; decisions to go to war, 421; in democracies, 425–26, 436; effects of war, 435–36; political control of, 418; principal-agent problem, 418–20; reputations, 422; selfinterest, 411; war aims, 430–31 Leaders, religious, see Religious leaders Learning mechanism: embeddedness effects, 123, 123 (table), 131 (table), 132–33, 134, 136, 137, 139, 140, 141; in Trust Game, 123, 129–30, 133 Learning models, 7, 38, 130 Leary, M. R., 79, 80

599

Lechner, Frank J., 339–40 Lederman, Daniel, 297 Ledyard, J., 487 Lee, K., 254 Leenders, Roger Th. A. J., 155 Leffler, Keith B., 537 Legal system, see Criminal justice system; Laws Leifer, Eric M., 223 Leik, Robert K., 193 Leinhardt, S., 255, 263 Lemmon, Michael L., 540 Lemons market, 308–9, 312–13 Lenaerts, Tom, 271 Lerner, R. M., 89 Leslie, P., 490 Levento lu, Bahar, 422, 430 Levi, Primo, 235 Levinthal, Daniel A., 195 Levi-Strauss, Claude, 185, 206 Levitt, Steven, 288 Levy, Jack S., 414 Lewis, K., 273 Lien, D., 450 Liggett, Thomas M., 270 Lin, Nan, 226, 228, 230, 231, 237 Lindenberg, S., 7, 10, 15–16, 26, 78, 171, 232, 265 Linked utility assumption, 8 Linton, April, 452 List, J., 490, 491 Litwak, Eugene, 233 Lizzeri, A., 491 Loayza, Norman, 297 Lobo, M. S., 254 Loch, C. H., 78 Lochner, Lance, 289 Logrolling: conditions conducive to, 165–66, 168–69; externalities, 167, 169; negotiated exchanges, 165, 166, 172; networks, 154, 164 (table); position exchanges, 166–69, 167 (fig.) Los Angeles County hygiene report cards, 490–91 Loughran, Thomas A., 289 Louis XI, King of France, 477 Lucking-Reiley, David, 137 Lyons, Bruce R., 134–35 M&A, see Mergers and acquisitions MacDonald, K., 79 MacLeod, W. Bentley, 541 Macy, M. W., 268 Mafias, 307, 308, 309–13, 383 Mair, Christine A., 238 Malik, A., 488 Malueg, D., 488 Managers: authority, 521–22, 529, 534, 544n6;

600 Index compensation, 558, 576–77; control, 575–76; interventions, 522; middle, 567–68, 580; power, 574–77, 579–80. See also Highperformance human resource management; Principal-agent problem March, James G., 514, 544n9 Marijuana, 292. See also Drugs Market contracts, 529, 532 Market design: for asymmetric information, 489–92; challenges, 478; citizen involvement, 488–89; correcting market failures, 474–75, 482, 497–98; example, 482–83; for externalities, 487–89; matching markets, 494–97, 496 (table), 498 (table); popularity, 498; rational choice analysis, 23; for timing problems, 494–97 Market failure: conditions, 481–82, 483; contracting problems, 481; market power, 481–82, 488, 491; solutions, 474–75, 482, 497–98, 517, 527. See also Externalities; Information asymmetries Market power, 481–82, 488, 491 Markets: atomized interactions, 117; bypassing, 497–98; cognitive limitations of participants, 479; competitive, 39, 62, 478–79, 481; completeness, 481; definition, 473; distinction from firms, 529, 534; efficient allocations, 518; equilibria, 35, 40, 478; establishment and evolution, 474, 475–78, 476 (fig.); exchanges in, 13, 473; general equilibrium model, 479–80; institutions, 39–40; for lemons, 308–9, 312– 13; neoclassical model, 117, 478–79, 481; perfect competition, 478–79, 481; prices, 479–80; regulation, 474–75, 498; selfregulation, 475, 477; social dimension, 474; state formation and, 450; strong rationlity in, 4; supply-demand models, 39–42, 41 (fig.); transactions, 115 Markovsky, Barry, 197, 198, 199 Markus, Hazel, 96 Marler, Penny L., 334 Marriage: among elites, 235; crime reduction and, 90; divorce, 240; exchange theory, 212n15; generalized exchange systems, 205, 207; religions of spouses, 334, 346; social capital, 240. See also Significant others Marschak, Jacob, 527 Marsili, Matteo, 269 Marwell, G., 257 Marxism, 445, 450–51. See also Communist countries Maskin, Eric, 536 Maslow, A., 76, 77, 78 Mass markets, 477 Matching markets, 494–97, 496 (table), 498 (table)

Materialism assumptions, 8–9, 19 Matsueda, Ross L., 288–89 Matsusaka, John G., 540 Matthew effect, 230, 256 Mauss, Marcel, 205, 206, 229 Mayer, A., 267 Mayer, M., 564 McAdams, Richard H., 290 McAndrew, Siobhan, 336 McCabe, Kevin, 48 McCarthy, Bill, 290 McCleary, Rachel M., 338 McCormick, Gordon H., 387, 391, 398, 400 McDonald, Steve, 238 McKay, Henry D., 298 McLanahan, Sarah, 240 McPherson, M., 238, 253, 254 Mead, George Herbert, 306, 358 Meaningful need states, 91–93 Means, Gardiner C., 530 Meckling, William, 528–30 Menegahn, Elizabeth G., 242 Menéndez, Ana Maria, 297 Menirav, J., 476 Menzel, H., 223 Mergers and acquisitions (M&A), 522, 539, 557, 563–65, 575 Merkens, Hans, 297 Merton, R. K., 254, 256, 294 Messner, Steven F., 297 Methodological individualism, 9–11, 25, 26, 38, 300, 523 MIDs, see Militarized interstate disputes Milgram, S., 258 Milgrom, Paul, 522, 531, 532, 543 Militaries: battles, 428, 429; capabilities, 421, 429; expanson, 437–38, 439n14; power, 384; standing armies, 438; technology, 451; weapons, 429. See also Wars Militarized interstate disputes (MIDs), 413 Miller, John H., 44 Mills, C. Wright, 151 Mills, D. M., 484 Minorities: downward mobility, 364, 371; ethnic, 355–56, 359, 360–61, 362, 363–64, 369, 370–71; race relations cycle, 357; religious, 360, 369; segregation and exclusion, 360, 372; social distance, 358, 362; in urban areas, 356–57. See also Immigrants Miwa,Y., 477 Mobility: economic, 364, 369, 371–72; intergenerational, 364; non-zero-sum, 369–70 Modernization: inequality and, 337; secularization and, 322, 335, 336, 337, 338 Moerbeek, Hester, 242

Index Moffiet, Terrie E., 73 Mollenhorst, Gerald, 232–33, 239 Mollenkopf, John, 370–72 Molm, Linda D., 187, 188, 190, 195, 201–3 Monarchies: absolute, 437, 450, 451; representative voting institutions and, 448–49, 461n13; standing armies, 438; supporters, 419, 437. See also Autocracies Monitoring: of agents, 453; in firms, 529, 530; of youth, 304–6 Monopolies, see Market power Moody, J., 257 Mookherjee, Sujoy, 541 Moore, John, 517, 535, 536 Moral hazard, 482, 489, 493–94, 530–31 Moran, Peter, 541 Moreno, J. L., 253 Morenoff, Jeffrey D., 299 Morgenstern, Oskar, 286 Motivation: extrinsic and intrinsic, 541; in organizations, 523–24, 541–42; of terrorists, 381, 385–88 Mouw, Ted, 238 Mullins, Nicholas C., 221 Multinational corporations, 478. See also Firms Murphy, Kevin J., 522, 537 Murphy, K. M., 291–92 Nagin, Daniel S., 290 Nash Bargaining Solution (NBS), 164–65, 166, 167 (fig.), 168, 169, 173 National Committee for Quality Assurance (NCQA), 491–92, 503n69 Nationalist terrorist organizations, 382, 389, 396–98 National markets, 477 National Organization Study, 571–72 National Resident Matching Program (NRMP), 495 Nations, see States Natural methodological individualism, 10 NBS, see Nash Bargaining Solution NCQA, see National Committee for Quality Assurance Nee,Victor, 356, 358, 370 Need, Ariana, 242, 334, 344 Need-related self-regulation, 75–81 Needs: affection, 77, 78–79; behavioral confirmation, 79, 80; definition, 75; multifunctional satisfaction, 81; physical, 75, 77; social, 75, 77–78; social production function theory, 76–77; status, 77, 78, 79 Negotiated exchange relations, 165, 166, 172, 201, 203, 213n21 Negotiation, see Bargaining Neighborhoods: collective efficacy, 298–301, 300 (fig.), 304; disorder, 298; ethnic

601

enclaves, 360–61; informal social control, 299, 302, 304–5, 307; monitoring and sanctioning youth, 304–6; organizations, 306; social capital, 298–306; social networks, 226–27, 233, 234, 239–40, 298, 299, 301–4 Neighborhood watches, 306 Neoassimilation theory, see Assimilation of immigrants Neoclassical economics: assumptions, 3, 10, 117; atomized interactions, 117; markets, 117, 478–79, 481 Neral, John, 131, 132 Netherlands: pillarization, 330, 339–40; religious participation, 339–40, 343–44, 348–49n28; religious switching, 334, 348n19; secularization, 340; social networks, 233–34, 239, 242, 243–44; unpaid overtime, 91–92 Network dynamics: coevolution with behavior, 267–73; experimental results, 261–62, 265–66; future research directions, 273; game-theoretic models, 258–62, 265– 66, 269–72, 273; statistical models, 262–65, 272–73; utilities, 265–67 Network embeddedness: assumptions, 11; control effects, 122–23, 123 (table), 126–27, 131 (table), 133–34, 136, 137, 140–41; definition, 122; empirical evidence, 133–34, 135–39; information sharing, 126–27; learning effects, 123 (table), 129–30, 131 (table), 133, 136, 137, 140, 141; organizational governance and, 23; sociograms and sociomatrices, 221 (fig.), 221–22, 222 (fig.) Network Exchange Models, 155–56 Network exchange resistance theory, 197–98 Network Exchange Theory (NET), 189–90, 192, 193, 198, 199–200. See also Exchange networks Network extension, 188, 193 Network-generalized exchanges, 205 Network identities, 193 Network models, 155–56 Networks: business, 193, 254, 257–58; centralization, 256–57; characteristics, 253–58; closed, 227, 256; components, 257–58; connectedness, 257–58; density, 127, 141, 226–27, 232; enforcement, 154, 164 (table); of ethnic minorities, 362; formation, 142–43, 231–32, 259, 260–62, 302–3, 473–74; homophily, 254, 267–69; of immigrants, 240, 360, 362, 363–64, 372–73; individualist view, 223–24; influence, 155; intergenerational closure, 299, 304; kinship, 473; labor markets and, 220, 222, 230–31, 232, 235–36, 237–38, 242, 363–64; logrolling, 154, 164 (table); meeting places

602 Index and, 231–33, 254; in neighborhoods, 226– 27, 233, 234, 239–40, 298, 299, 301–4; node centrality, 256–57; norms, 236, 363–64; outdegree, 127, 261; path lengths, 258; patronage, 223, 227; persuasion, 154, 164 (table); power in, 152; reciprocity in, 253– 54; religious socialization and, 337, 341–42, 345; research on, 220, 221–24, 227, 252, 273; self-regulation and, 98; sizes, 253; as social capital, 224, 225; stability and change, 238–39, 259, 260; structural holes, 222–23, 227, 240–41, 255, 266; structuralist view, 221–23; structures, 226–27; survey data, 236–37, 238–39; transitivity, 254 (fig.), 254– 56, 258; weak ties, 222–23, 234–35, 297. See also Exchange networks; Social capital Newell, R., 485–87 New institutional economics, 10, 25, 156, 527 Newman, David, 157, 159 Newman, M. E. J., 257, 268, 269 New property rights approach, 534–36, 537 New York City, second-generation immigrants, 356, 370–72 New Zealand fishing market: exports, 501n46; Individual Transferable Quotas System, 483, 485–87, 501n47 Nguyen Van, Phu, 132–33 Nichols, C. W., 77 Niederle, M., 494–95, 497 Nikiforakis, Nikos, 57 Nisbet, R., 446 Nohria, N., 253, 266, 268 Noncooperative games, 213n21 Noncooperative models of collective decision-making, 156 (table), 156–57, 170 Nonprofit organizations, 571–72, 580 Normann, Hans-Theo, 57 Normative goal-frames, 83–84, 85–87 Norms: authority, 295; conjoint, 304, 305, 315n11; definition, 363–64; enforcement, 303–4, 315n9, 363–64; in gain goal-frame, 83; informal, 314; internalization, 305–6; neighborliness, 303; reciprocity, 206, 302; social, 82, 83–84, 85–86, 88, 115, 196; as social capital, 297; social networks and, 236, 363–64 Norris, Pippa, 336–37, 346 North, Douglass C., 447, 451, 458 Northern Ireland, 328, 384, 389, 395, 397, 406n15. See also Irish Republican Army NRMP, see National Resident Matching Program Nuclear deterrence, 384 Ochs, Jack, 131, 132 Ockenfels, Axel, 61, 63, 133 Ofek, Eli, 540

Oligopolies, 330 Oliver, P. E., 257 Olson, Daniel V. A., 327–28, 329, 333, 341, 344 Olson, Mancur, 403, 447, 450, 458 Önçüler, A., 78 Opportunism, 8, 533, 541–42 Organizational change: average firm sizes, 557, 558, 564, 569–71, 575, 581n3; control motives, 575–76, 579–80; economic rational choice models, 559–62, 573; empirical research, 562–73, 580; forms, 564–67; frequency, 557–58; future research directions, 579–81; human resources practices, 571–73; rational choice analysis, 24; research on, 556–57; societal antecedents, 557; sociological rational choice theory, 558–59, 573–80, 578 (fig.); strategic, 562–64; trends, 557–58, 562, 579 Organizational control, 544n1 Organizational ecology, 560 Organizational economics: applications, 538– 40; assumptions, 523–24, 540–41; bounded rationality, 523, 533, 535–36, 540–41, 543, 545n19; debates, 540–43; empirical research, 539–40, 543; entrepreneurship, 542; games, 524; governance structures, 515–17; methodological individualism, 523; rational choice models, 523, 559; research in, 525– 28, 528 (table). See also Firm, theories of Organizational governance: agency costs, 530; classical capitalist firms, 529; critiques of rational choice approaches, 514, 543; definition, 513–14; dispute resolution, 534; emergence, 517–21; empirical research, 540; incentives, 521, 524, 531–32, 537; problems, 521–22; rational choice analysis, 23, 513–14, 515, 517–19, 523–24, 543; research on, 515, 536–37. See also Firm, theories of Organizational sociology, 193–94, 514, 518 Organizations: definition, 514–15; distinction from institutions, 514–15; motivation in, 523–24, 541–42. See also Firms Organized crime, 307–8, 314, 447. See also Mafias Ostrom, Elinor, 53 Other-regarding preferences, 36, 43, 121–22 Ott, Marion, 261 Overgaard, Per B., 397 Owen, Guillermo, 391 Ownership rights, see New property rights approach Pacheco, Jorge M., 271 Palestinian terrorists, 386, 387, 389, 395, 399, 400 Pape, Robert A., 387, 389, 406n13

Index Papua New Guinea, 205–6 Parcel, Toby L., 242 Parents: affection, 79; bonding with children, 74, 79; help with children’s schoolwork, 226, 242; influence, 87–89; single, 240; social networks, 226–27, 233, 234, 239–40. See also Families Pareto-efficiency, 478, 482 Park, Juyong, 257 Park, Robert Ezra, 357 Parsons, Talcott, 115 Party Groups, Copenhagen climate meeting, 159, 160, 160 (table), 163, 167–68, 168 (table), 172–74 Path dependence, 455, 457, 542 Pathologies of Rational Choice Theory (Green and Shapiro), 2–3 Patronage networks, 223, 227 Pattison, P., 258 Peace: democratic, 424–27; duration, 434–35; negotiated settlements, 427–28, 430, 434. See also Wars Pearanson, E., 497 Pearson, M., 272 Pemantle, R., 269–70 Pendell, S. E., 78 Perfect competition, 478–79, 481 Perl, Paul, 333 Persuasion: conditions conducive to, 164 (table), 165; models, 175; Nash Bargaining Solution, 164–65; networks, 154, 164 (table); strategies, 164 Peru, Shining Path, 383, 385 Peterson, Gretchen, 195, 202 Pettersson, Thorleif, 327, 329, 335, 338, 343 Pfaff, Steven, 344 Physical well-being assumption, 8–9 Piliavin, Irving, 288 Pinquet, J., 494 Pinsonneault, A., 568 PIRA, see Provisional Irish Republican Army Pluralism, see Religious pluralism Poggi, Gianfranco, 448 Police: deterrent effects, 288, 289; Mafias and, 312; neighborhood watches and, 306. See also Criminal justice system Policy positions, in bargaining stage, 153 Political decision-making, 152, 153, 157 Political institutions: democratic, 425–26; formation, 443; representative voting, 448– 50, 456, 461–62nn16–17; war and, 411, 425–26. See also States Political leaders, see Leaders, political Political resources, 225 Pollution: as externality, 483–84; markets for, 483, 484–85, 487, 488–89; regulation, 482, 484–85, 488

603

Portes, Alejandro, 307, 364 Positivity, 97 Posner, R., 497 Poverty, 291 Powell, Robert, 417, 423, 424, 429 Power: administrative, 452; average total, 190; decision-making and, 94–95, 568; de facto and de jure, 580; distinction from influence, 152, 153; elitist-pluralist debate, 151; employee empowerment, 576; to hurt, 384; incomes and, 574–75, 576–77; local, 151; of managers, 574–77, 579–80; measurement, 151–52, 159, 191; military, 384; network determinants, 190–92; in networks, 155; potential, 153, 189; in principal-agent relationships, 561–62, 565–66, 567; punishment, 202; relational, 189, 190, 209; of stakeholders, 165; in state formation, 448–50; of states, 423, 424; strong and weak, 198; structural, 189; voting, 152–53. See also Influence Power-at-a-distance, 199 Power-dependence theory, 186, 187–88, 189, 190–94 Power inequality in exchanges: access to resources, 187, 189, 190–91; balancing mechanisms, 186, 188, 192–93, 194–95, 209; differentiation, 185–86; dynamics, 192–95; emergence, 186, 187, 207; empirical research, 189–92, 193–95, 197–98, 204; equi-dependence principle, 191; expectedvalue model, 200, 212n18; fairness and, 194, 195–96, 202; future research directions, 208–9, 210–11; game-theoretic models, 198, 200–201; indirect power, 199; network exchange resistance theory, 197–98; relative positions, 192; sanctions, 202; status and, 199; strains, 192; structural factors, 187, 189–90 Pradiptyo, Rimawan, 290 Prahl, R., 257 Preference assumptions, 7–9, 36, 61. See also Selfishness assumptions Preferences: altruistic, 387–88; in collective decision-making, 153, 154; consistency, 35, 36; definition, 34; other-regarding, 36, 43, 121–22; rationality assumptions, 35; risk, 286; social, 43, 59–61, 64, 65 Prescott, E., 494 Prestige, 386. See also Reputations; Status Price, Derek de Solla, 256, 266 Prices, 396, 479–80 Prieur, F., 489 Principal-agent problem: incentives, 521; influence activities, 522; moral hazard, 530–31; in organizations, 521, 530–31; power and, 561–62, 565–66, 567; of states, 411, 418–20

604 Index Principal-agent theory: in bureaucratic states, 21, 452–54, 459, 463n30; of firm, 527, 530–32, 559–62, 563, 565–66 Prisoner’s Dilemma Game: cooperation, 49– 52, 50 (fig.), 254; in networks, 198, 270–71; power structures, 198; results, 49–52, 50 (fig.) Private benefits, 419–20, 426 Procedural models, 156, 158 Procedural rationality models, 7 Product quality, asymmetric information, 308–9, 312–13, 482, 489–92 Propaganda by the deed, 390 Property rights, see New property rights approach Prosocial behavior, 42, 60. See also Altruism; Cooperation Protection rackets: demand and supply, 308, 309–10, 312–13; externalities, 310; information asymmetries, 309–11; microfoundations, 307–13; use of violence, 311–12. See also Mafias Provisional Irish Republican Army (PIRA), 384 Public goods: counterterrorism policy, 393–95, 401–2; definition, 52; in foreign policy, 426; information as, 127, 137–39; problems, 115; provision, 419, 431, 445–46; war aims, 431 Public Goods Game: cooperation, 52–56, 58–59; description, 52; micromotives and macrobehavior, 57–59; Perfect Stranger design, 55 (fig.), 55–56; with punishment, 53–54, 54 (fig.), 55–57, 56 (fig.), 59; results, 52–55, 53 (fig.); use of, 43 Puller, S. L., 267 Punishment: altruistic, 53–57, 54 (fig.), 59; demand for, 57; deterrence, 284, 286, 287– 88, 289–90; effectiveness, 57; in exchange relations, 201, 202; perceived risk, 288–89; power and, 202; by state, 283; in wars, 431–32 Putnam, Robert D., 228, 234, 241–42, 295–96 Putterman, L., 57 QAD, see Quantitative analysis of data Qaeda, see Al Qaeda Quality, see Product quality Quantitative analysis of data (QAD), 116–17 Rabin, Matthew, 63, 64 Rabushka, Alwin, 157, 159 Race, 299, 315n13, 365–67, 368. See also Minorities Race relations cycle, 357 Radner, Roy, 527 Rajan, R. G., 537, 567, 568 Ramseyer, J. M., 477

Rapoport, Anatol, 114 Rapp, Richard, 451, 452 Rational action theory (RAT), 116 Rational addiction theory, 291–93 Rational choice approach (RCA): applications, 33, 38–39; assumptions, 5–11; competition and cooperation, 27–28; criticism of, 2–3, 35, 37, 284, 323; definition, 5; development phases, 26–27; future research directions, 24–28; implicit use of, 443–44, 445–46; limits, 37; microfoundations variations, 5–11, 6 (table), 24; strengths, 1–2 Rational choice institutionalism, 25 Rational choice model (canonical): assumptions, 35; description, 34–36, 35 (fig.); empirical success, 33–34, 37, 38–39, 42, 61, 65; example, 39–42, 41 (fig.); methodological remarks, 36–38; predictions, 37; selfishness assumptions, 36; theoretical success, 38 Rational choice paradox, 1–2 Rationality: assumptions, 6–7, 15–16, 18, 20, 21–22, 24, 35, 37, 117, 119; coalition, 200– 201; group, 201; individual, 200–201. See also Bounded rationality; Social rationality Raub, W., 10, 133, 134, 135, 136, 140, 258 Raudenbush, Stephen W., 298–300 RCA, see Rational choice approach Real IRA, 406n15 Reciprocity: dyadic, 253–54; in exchange relations, 190, 201–3, 213n21, 296, 301–2; indirect, 203, 254; in networks, 253–54; norms, 206, 302; positive, 43, 45–47, 46 (fig.); strong, 60, 123; theories, 64; weak, 122–23 Regulation: antitrust, 538, 563; demand for, 498; of externalities, 482; of markets, 474–75, 498; of pollution, 482, 484–85, 488; of restaurant hygiene, 490–91. See also Selfregulation Reiter, Dan, 430, 432, 433 Relational cohesion, 190, 194, 204 Relational contracts, 474, 537 Relational power, 189, 190, 209 Religions: functions, 342–43; minority, 360, 369; sociology of, 322, 323; strictness, 333; terrorism motives and, 387. See also Catholic Church; Islam; Jews Religious capital, 328, 332 Religious conflicts, 328, 329, 340 Religious goods: collective, 332–33; definition, 326; individual, 332–33, 347n5; inscrutable, 330–31, 332, 345; production, 326–27, 332; social, 347n5 Religious identity, 329 Religious leaders, 331, 345

Index Religious markets: compared to other markets, 329–32, 346; competition, 324–26, 327–30, 334–35, 346; demand, 342–44, 345; monopolistic, 324–26, 327, 341, 347n14; oligopolistic, 330; state regulation, 327, 330, 338, 339; symbols, 331; violations of rational choice assumptions, 330–31 Religious markets, supply-side approach: assumptions, 324, 342, 345; competition, 327–29; constant demand and supply, 343; cost-benefit analysis, 324, 334; criticism of, 334, 339, 344–46; development, 322; empirical evidence, 338–42, 344–45; neglect of nonreligious population, 345–46; propositions, 325 (table), 326–28; as rational choice approach, 345, 347n9; religious socialization levels, 342; secularization theory and, 335–38, 339–40, 344, 345; stable preferences, 342; submarkets, 328, 338 Religious opposition, 329 Religious participation: cohort effects, 340, 343, 348n27; commitment levels, 328, 329, 333; competition and, 341; demand side, 329; empirical research, 323–24, 338–42, 343–44, 348n22, 348–49n28; faith decisions, 332–33, 334; future research directions, 345, 346; household production model, 332; life-cycle effects, 340, 348n27; macropropositions, 327; microfoundations, 19, 325 (table), 326–27; monetary contributions, 333; pluralism and, 338, 339, 344; rational choice analysis, 322–24, 326, 335, 345; revivals, 322; sacrifices, 399; signaling function, 347n15; switching, 334–35, 338, 346, 348n19; variations over time, 336 Religious plausibility structures, 337–38, 345 Religious pluralism: competition and, 327–28, 330, 340–42; measurement, 340–41, 346, 349n31; participation and, 338, 339, 344; regulation and, 327; secularization and, 337–38 Religious socialization, 334, 337, 341–42, 345 Remington, Thomas F., 456 Rent-seeking, 522, 538 Rényi, A., 257 Representative voting institutions, 448–50, 456, 461–62nn16–17 Repression, 385, 392–95 Reputations: brand names and, 332; of firms, 331; inscrutable goods and, 331–32; of Mafias, 311, 312; of political leaders, 422; of religious leaders, 331, 345 Reservation points, 415, 416, 420–21, 423–24, 427–28 Resnick, Paul, 137

605

Resource dependence theory, 193–94, 566, 582n13 Resources: availability, 188, 189, 190–91; competition for access to, 187; economic, 225; political, 225; social, 226, 229, 239; of stakeholders, 151–53, 159; symbolic, 225; value, 188, 189 Restaurant hygiene regulations, 490–91 Revolutionary terrorist organizations, 382, 389, 390, 391–92 Reynolds, Kenneth J., 538 Rice, Eric R. W., 195 Riedl, A., 45, 57, 261–62, 266 Riolo, Rick L., 254 Risk: in exchange networks, 194–95; investment, 539; pooling, 545n17; preferences, 286; of punishment, 288–89; tradeoff with returns, 416. See also Insurance Roberts, John, 522, 543 Robins, G. L., 258 Robinson, David T., 136 Rocke, David M., 436 Rogers, B. W., 266 Role models, 87, 96. See also Significant others Rooks, Gerrit, 136 Rosenbladt, Bernhard von, 48 Rosenfeld, B., 476 Rosenfeld, Richard, 297 Ross, S., 531 Roth, A., 474, 478, 488, 494, 495–97 Ruiter, Stijn, 238, 337 Russia: Duma, 456; organized crime, 308; Orthodox Church, 330, 344. See also Soviet Union Russian Federation, 457, 458 SA, see Strategic approach Safety, need for, 76 Salanié, B., 493 Salganik, M. J., 253 Sampson, R. J., 90, 288, 298–300 Sánchez-Cuenca, Ignacio, 399 Sanchirico, J., 485–87 Sanctions, 304–6. See also Punishment Sandler, Todd, 393–95, 397, 402, 403 Sanfey, Alan G., 45 San Miguel, Maxi, 270 Santos, Francisco C., 271 Sartori, Anne E., 422 Sawyer, R. Keith, 294 Saxenian, Annalee, 361 Scheepers, Peer, 234, 237 Schelling, Thomas C., 381, 383, 384, 391 Schinkel, M., 479–80 Schmalensee, R., 484, 485 Schmid, Alex P., 383

606 Index Schmidt, Klaus M., 61–62, 63 Schmittberger, Rolf, 44–45 Scholz, J. T., 272–73 Schools, see Education Schultz, Kenneth A., 425 Schumpeter, Joseph A., 10, 152 Schwarze, Bernd, 44–45 Schweinberger, Michael, 272 Science, religion and, 335, 336 Scott, W. Richard, 194 Seabright, Mark A., 195 Seabright, Paul, 478 Search goods, 489, 502n60 Secularization theory: acceptance, 322; criticism of, 335–36, 339; doubts, 322; empirical evidence, 338; hypotheses, 335, 336; predictions, 19, 336, 337, 343; rational choice approach in, 19, 335–36; supply-side approach to religion and, 335–38, 339–40, 344, 345; versions, 336–37 Security: constraint on terrorism, 398, 399, 400, 405–6n9; need for, 76; religious participation and, 336–37 Security analysts, 500n20 Sefton, M., 51 Selectorate theory, 419–20 Self: affirmation, 97; clarity, 96; development, 93, 94; evaluation, 97–98; harmony of partial, 96–97; importance, 93–94; invulnerability, 94–95; positive view, 97; threats, 95 Self-categorization, 97 Self-defense, 95, 97 Self-discipline, 86 Self-efficacy, 298 Self-interest, of political leaders, 411 Selfishness assumptions: experimental evidence, 33, 34, 42, 59–60, 65; justifications, 36; in market models, 478, 479; in rational choice model, 7–8, 21–22, 36; relaxing, 14, 15–16, 61, 121; in terrorism, 387; violations, 37, 42, 59–60 Self-regarding preferences, see Selfishness assumptions Self-regulation: capacities, 73, 89–90; constraints, 72–73; development, 87–88, 89, 90; evolution of, 73–74, 98; functions, 73; goal-related, 81–93; higher-order, 74–75, 80–81, 86, 95–97, 99; influence of others, 88–90, 98–99; lower-order, 74–75, 80, 81–82, 94–95, 99; of markets, 475, 477; meaningful need states and, 91–93; needrelated, 75–81; processes, 74, 75 (fig.), 98; self-related, 93–98 Self-schema, 96 Sen, Amartya, 35 Servaes, Henri, 540

Shadow of the future, 124, 125, 165, 229, 230 Shah, J., 89 Shapiro, I., 2–3 Shapley, Lloyd S., 474 Shapley, S., 497 Sharing, see Ultimatum Game Shaw, Clifford R., 298 Shaw, K., 571 Shelanski, Howard A., 538 Sherkat, Darren E., 323 Sherman, Lawrence W., 289 Shibutani, Tomatsu, 357–58 Shining Path, 383, 385 Sicilian Mafia, 308, 309–13 Signaling: costly, 347n15; of cultural competence, 362; as solution to information asymmetries, 309; with violence, 392; in wars, 421–23, 425, 428–29 Significant others: imitation of, 74; influence, 79, 88–90, 92–93, 96; perspective taking, 94 Silva, E., 489 Simmel, G., 255 Simon, Herbert A., 514, 532, 533, 544n9 Singh, H., 254 Singh, Jasjit, 135 Siqueira, Kevin, 393–95 Siverson, Randolph M., 435 Skalnik, Peter, 447 Skvoretz, John, 197, 198, 209 Skyrms, B., 269–70 Slantchev, Branislav L., 429, 430, 432, 433 Slonim, Robert L., 132 Small world, 258 Smith, Adam, 224, 324–26, 450, 478, 480 Smith, Alastair, 312, 392, 422, 428, 429 Smith, Christian, 338 Smith, John Maynard, 396 Smith, Steven S., 456 Smith,Vernon L., 39–40, 41 Smith-Lovin, L., 238, 253, 254 Smoking, 292–93 Snijders, Chris, 121, 135, 137, 140 Snijders, T. A. B., 262–63, 264, 265, 267, 272 Social action, 116 Social boundaries, see Boundaries Social brain, 73, 74, 75, 77, 79, 98. See also Self-regulation Social capital: acquisition, 229; ascribed, 229; as club good, 315n10; collective, 241–42, 244–45; collective efficacy and, 298–301, 302–7; criminal behavior and, 297, 307; crowding out hypothesis, 234, 237; decline in, 234, 238–39, 243; definition, 227, 295–96; distribution, 230–31; elements, 226–27, 296; exchange relations as, 301–3; expected value of future support, 229, 230; goal-specific, 242; of immigrants, 364;

Index individual view, 296, 300–302; information as, 296–97, 311; institutional influences, 231, 234–36; international differences, 236–37; investments, 142–43, 225, 229–30, 238; of Mafias, 307, 310, 311; measurement, 227–28, 234, 237, 297; negative ties, 242; networks as, 224, 225; norms as, 297; relationship to other resources, 228; resources, 226–27, 296; returns on, 142–43, 229; structural change and, 232; technology and, 233–34; threshold model, 303; uses, 307 Social capital research: future directions, 243, 244–45; hard core, 225; international comparative, 234, 236–37; investment hypothesis, 225, 229–30, 238, 244; new issues, 241–43; questions, 225–31, 233–36; social resources hypothesis, 225, 226–27, 230, 237–38; surveys, 236–37, 238–39 Social choice theory, 527 Social comparison, 97 Social contract, 283 Social dilemmas, 114–15, 116, 205. See also Trust problems Social disorganization, 298, 299–300 Social embeddedness, see Embeddedness Social exchange relations, see Exchange relations Social goals, 9 Social imitation, 74 Social methodological individualism, 10 Social mobility, see Mobility Social networks, see Networks Social orders, 13 Social organizations: appropriated for other purposes, 307; against crime, 295–307; differential, 295, 313–14; in favor of crime, 295, 307–13 Social preferences: cooperation and, 59; experimental evidence, 43, 59–60, 61, 65; rational choice models, 60–61, 64. See also Selfishness assumptions Social production function (SPF) theory, 76–77 Social rationality: assumptions, 8–9; microfoundations, 4–5, 25; models, 7; proponents, 4. See also Self-regulation Social resources hypothesis, 225, 226–27, 230, 237–38 Social well-being assumption, 9 Socioecononomic status: elites, 230–31, 235, 558, 559; mobility, 364, 369–70, 371–72; self-regulation development and, 88, 89–90. See also Incomes Sociology: Chicago School, 356–58, 373; historical, 451; micro-macro linkages, 9, 20, 293 (fig.), 293–95, 300–301; organizational, 193–94, 514, 518

607

Solidarity: among terrorists, 387; assumptions, 8; in exchange relations, 204, 206–7; organic, 206 Solnick, Steve, 457 Song, Lijon, 231, 237 Sorensen, A., 492 Sorensen, Olav, 266–67, 268, 273 South Korea, student activism, 307 Soviet Union, 308, 456, 457. See also Russia Spence, Michael, 309 Spencer, Herbert, 446 SPF theory, see Social production function theory Srole, Leo, 357, 370 Stakeholders: coalition building, 154, 163–64, 170; cooperation, 170–71; definition, 159; influence, 151–53, 159; interests, 154, 164–65, 173; issue salience, 161, 163; policy positions, 153, 161, 163–64, 171; power, 165; resources, 151–53, 159; trust of, 165. See also Collective decision-making Stam, Allan C., 429, 431–32, 433, 434 Stark, Rodney, 322, 323, 326, 327, 328, 330, 332, 334, 336, 337, 338, 339, 340, 341, 342, 343, 344–45 Starrett, D., 483 State-making: in contemporary era, 455–58, 459, 463n28; initial, 445–48, 458, 460n6, 461n10; in medieval and early modern Europe, 448–52, 457–58, 459, 461n13; national languages, 457; path dependence, 452, 455, 457; research methods, 460n3; variations, 454; war and, 446, 450–52, 453– 54, 456, 462n20 State-making models: agency theory, 452–54, 459, 463n30; center-periphery bargaining games, 457; conflict theories, 445, 446, 447, 461n13; ecological factors, 446, 455, 457–58; functionalist/integrationist, 445– 46, 460–61n7; microfoundations, 444, 447; power/conflict, 448–49; rational choice, 21, 444, 447, 449, 451, 452, 458–59; zero-sum or positive-sum games, 21, 444, 449–50 States: bargaining among, 411, 415, 420; breakdowns, 458; bureaucratic, 21, 450, 451, 452–54, 459, 463n30; centralized authority, 365–66, 450, 452; coercion by terrorists, 382; as corporate actors, 411, 417–20; decentralization, 457, 463n30; definition, 20, 444; disputes, 413, 420, 421, 426–27; dyadic conflicts, 412, 413; modern, 448–50; monopoly on violence, 396; patrimonial administrations, 451–52, 453, 454, 457, 462n19, 462n21; postcolonial, 455–56; power, 423, 424; principal-agent problem, 411, 418–20; repression, 385, 392–95; taxation, 292–93, 365, 448, 449, 452–53,

608 Index 458, 461–62n16; use of terror, 383, 385. See also Wars State-sponsored terrorism, 385 Status: ascribed, 199; differentiation, 186, 187; expectation status theory, 159; need for, 77, 78, 79; self-regulation and, 89–90. See also Socioecononomic status Status influence, 199 Status value, 199 Stavins, R., 484, 485, 488 Steglich, C. E. G., 272 Steverink, N., 78 Stiglitz, J., 494 Stimulation, need for, 77 Stockholm Environment Institute, 159 Stokman, F. N., 153, 155, 166, 169, 172, 267 Stolte, John F., 191, 195–96 Stovel, K., 257 Strategic approach (SA), 493 Strategic change, 562–64 Strategic equilibria, 35–36 Strategic-form games, 519 (fig.), 519–21 Stratification: economic, 445; ethnic, 358. See also Inequality Strobel, Martin, 63 Strogatz, Steven H., 258 Strong rationality, 3–4 Structural embeddedness, 11 Structural-functionalism, 357 Structural individualism, 10–11, 15, 19, 21. See also Collective decision-making Structuralist view of networks, 221–23 Structure, need for, 76 Stuart, Toby E., 136, 266–67, 268, 273 Stulz, René M., 540 Substitution effects, 134 Suicide attacks, 386–88, 399–400, 406n13 Supply-side approach to religion, see Religious markets, supply-side approach Sutherland, Edwin, 285, 295 Sutter, Matthias, 48 Swaray, Raymond B., 290 Swedberg, R., 475, 476, 477 Szakaly-Moore, K., 487 Tabory, Ephraim, 338–39 Takács, K., 271 Takahashi, Nobuyuki, 195, 202, 206, 209 Taliban, 414–15, 417 Tangible resources assumption, 8 Tarar, Ahmer, 422 Tazelaar, Frits, 136 TCE, see Transaction cost economics Teachman, Jay, 432 Technology: change in, 451, 453, 568, 569–70; military, 451; networks, 257; social capital and, 233–34. See also Internet

Teece, David J., 539 Te Grotenhuis, Manfred, 234, 237, 340, 343–44 Terror, state use of, 383, 385 Terrorism: civilian deaths, 398–99; costs, 396; definitions, 383–84, 385; domestic, 384, 403; future research directions, 405; game-theoretic models, 397–98; individual motivations, 381, 385–88; international, 384, 401–2; length of conflicts, 398; rational choice analysis, 381–83, 386–88, 393–94, 400, 404–5; state-sponsored, 385; suicide attacks, 386–88, 399–400, 406n13. See also Counterterrorist policy Terrorist organizations (TOs): attrition strategy, 382, 389, 396–98; characteristics, 384–85; competition among, 390, 400; constraints, 398–400, 405–6n9; decisionmaking process, 400; empirical research, 386, 387, 404; failures, 392; free riders, 385– 86, 399; goals, 382, 388–90, 396; Islamist, 389, 390; mass attacks, 398; mobilization strategy, 382, 389, 390–95; nationalist, 382, 389, 396–98; popular support, 398–99, 400, 406n10; resources, 397, 398; revolutionary, 382, 389, 390, 391–92; tactics, 384, 385, 398–400; targets, 383–84, 399–400, 402. See also Al Qaeda Thaler, R., 265 Thick rational choice models, 25 Thies, Cameron, 456 Thomas, Jeremy N., 333 Thompson, J. A., 91 Thye, Shane, 199 Tilly, Charles, 438, 448, 451 Tirole, J., 489, 536 Tobacco, 292–93 Todd, P., 7 Tomz, Michael, 422 TOs, see Terrorist organizations Townsend, R., 494 Tragedy of the commons, 38, 115 Transaction cost economics (TCE), 515–16, 528, 535–36, 538, 543, 562–63 Transaction costs, 481, 517, 525, 526, 534, 536, 540 Travers, J., 258 Treisman, Daniel, 457 Triads, 254 (fig.), 254–55 Trust and trustworthiness: collective efficacy and, 298, 299; crime rates and, 297; in exchange relations, 194–95, 203, 302, 315n7; in Investment Game, 119; measuring in Trust Game, 48–49; rights protection and, 309; social capital and, 234; in social networks, 227; of stakeholders, 165; symbols representing, 331

Index Trust Game: communication in, 143–44; with complete information, 127–28; control effects, 122; description, 48, 118, 118 (fig.); with dyadic embeddedness, 122, 123–25, 126, 130–32; equilibria, 118, 118 (fig.), 125, 128–29; finitely repeated, 128–30, 131–32, 133–34; with incomplete information, 128–30, 143; indefinitely repeated, 123–27, 132; learning effects, 123, 129–30, 133; with network embeddedness, 122, 126–27, 133–34; one-shot, 118, 120–22, 133; with other-regarding preferences, 121–22; results, 48–49, 120; use of, 43, 48 Trust problems: among firms, 134–37; examples, 113–14; in isolated encounters, 113–14, 118–19, 120–22; as social dilemmas, 114–15 TSMM, see Two-sided matching markets Tuinstra, J., 479–80 Two-sided matching markets (TSMM), 494–95 Uchino, B. N., 79 Udehn, L., 9, 10, 164 Ukraine, 456 Ule, A., 261–62, 266 Ultee, Wout, 240, 334 Ultimatum Game, 43, 44–45, 62–63 Unanticipated consequences of action, 294, 314n4 Uncertainty, 194–95, 256, 309. See also Risk United States: Afghanistan war, 414–15, 417; civil rights laws, 365–67; Clean Air Act, 484–85, 488; climate treaty negotiations, 160, 163, 173–74; healthcare system, 491– 92, 495–97; Iraq war, 420; power elite, 151; racial and ethnic diversity, 231, 355–56, 358, 370; religious groups, 355, 369; religious participation, 322, 340, 341, 343; religious switching, 334, 348n19; social capital, 234, 239–40, 242; social networks, 236, 238–39; war on terror, 395. See also Assimilation of immigrants University of Chicago, 356–57 Ünver, M., 497 Urban areas: ethnic neighborhoods, 360–61; immigrants, 356, 360–61; medieval towns, 448, 461n13; migration to, 356–57; planning, 232; secularization, 339 Urso, P., 257–58 U.S. News and World Report (USNWR), 492 Utilitarianism, in criminal justice system, 283–84 Utility: linked, 8. See also Expected utility Uunk, Wilfried, 236 Uzzi, Brian, 241

609

Van Assen, Marcel A. L. M., 169, 172 Van Busschbach, Jooske, 238 Van de Bunt, G. G., 265, 267 Van den Bos, Jan M. M., 153 Van de Nouweland, A., 260 Van de Rijt, Arnout, 259, 261, 266 Van der Meer, Tom, 234, 237 Van der Veer, Joris, 133, 134, 136 Van Duijn, M. A. J., 265, 267 Van Lier, A., 561 Van Oosten, Reinier C. H., 166 Van Tubergen, Frank, 337 Van Witteloostuijn, A., 560–61 Varese, Federico, 308, 312 Vasquez, José, 522 Vaughn, John C., 226, 230 Vega-Redondo, F., 256, 266, 269, 270, 271 Verbrugge, Louis M., 232–33 Vermeulen, D., 479–80 Vermeulen, P., 478 Vignette experiments, 131, 139–41, 289–90 Villalonga, Belén, 540 Violence: informal norms, 314; Mafia use of, 311–12, 383; mobilization goal, 390–96; political, 381; of protection rackets, 311–12; rational choice analysis, 381; state monopoly, 396; threshold model, 294, 391; youth, 90. See also Terrorism; Wars Voas, David, 336, 341, 343, 344 Vogt, Bodo, 261 Völker, Beate, 228, 232–33, 237, 239 Von Neumann, John, 286 Voting institutions, see Democracy; Representative voting institutions Voting positions, 153, 155–56 Voting power, 152–53 Voting stage, 153, 156, 156 (table), 157–58 Vuchinich, Samuel, 432 Wagner, R. Harrison, 428, 429 Walker, G., 257–58 Walker, James M., 53 Wall, T. D., 573 Walras, L., 478, 479 Walter, Barbara F., 389–90 Wang, Lihua, 134 Warburton, D., 476 Warner, W. Lloyd, 357, 370 War on terror, 395. See also Counterterrorist policy Wars: aims, 430–31; of attrition, 396–98, 431–32; bargaining during, 427–29; as bargaining failures, 411, 414–17, 424, 427; bureaucracy and, 453–54; civil, 384, 412, 414; commitment problems and, 417, 423–24, 427, 429–31, 432; costs, 428–29; data on, 412–13; democratic peace, 424–27;

610 Index domestic politics and, 411, 417–20, 422, 425, 434; duration, 414, 431–34; escalation stage, 426–27; fatalities, 414, 414 (table); frequency, 413–14, 414 (table), 427, 437; hazard rates, 432, 435, 439n11; interstate, 412; leaders and, 411, 435–36; long-term trends, 413–14, 427, 437–38; military strategies, 431; mobilization, 422–23, 428–29; negotiated settlements, 427–28, 430, 434; outbreak stages, 420–23; outcomes, 432–34; principal-agent theory, 418–20; signaling resolve, 421–23, 425, 428–29; state-making and, 446, 450–52, 453–54, 456, 462n20; terminating, 429–30, 432, 433–34; territorial disputes, 384–85; theories, 412, 427; threats, 420–21, 422, 425 Watabe, Motoki, 194–95 Waters, Mary C., 370–72 Watts, Alison, 264 Watts, Duncan J., 258 Weak rationality, see Bounded rationality Weber, Max, 10, 78, 85, 116, 297, 324, 336, 443–44, 448, 454 Weesie, J., 135, 137, 258, 272 Weigelt, Keith, 131, 132 Welfare economics, fundamental theorems, 478–79, 481, 518 Welfare states, social networks and, 234, 237 Well-being, 8–9, 343. See also Self-regulation Werner, Suzanne, 428, 434, 435 White, Harrison C., 221, 223 Whittington, R., 564 Willer, David, 189, 192, 196, 197, 198, 199, 209 Williams, Arlington W., 40, 41 Williamson, O. E., 8, 481, 515–16, 518, 521, 522, 525, 526, 527, 533–34, 535–36, 538, 539, 541, 542–43, 544n9, 560, 565 Willinger, Marc, 132–33 Wimer, C., 90

Wintrobe, Ronald, 387 Wippler, R., 10 Wittek, R. P. M., 272 Wittman, Donald C., 427–28 Wöhler, Thomas, 239 Wolf, Jack G., 540 Wolff, E., 569, 570 Wolinsky, Asher, 259, 260, 265, 266 Woller, Gary, 435 Wood, S. J., 573 Woolcock, J., 258 Work, see Employees; Labor markets Workplace transformation, 571–73, 580. See also High-performance human resource management World Values Survey, 297, 337, 346 World War I, 429, 432, 436 World War II, 383, 423, 424, 429, 431 Wright, P. M., 573 Wulf, J., 568 Xing, X., 495–97 Yamagishi, T., 53, 191, 194–95, 205, 206, 209 Yariv, L., 494–95 Yates, A., 488, 489 Yoon, Jeongkoo, 204 Young, Lawrence A., 323 Youth: crime, 90, 288–89, 298, 304–5, 314; marijuana use, 292, 293; norms, 88, 314; self-regulation, 90. See also Children Yuen, Amy, 435 Zaheer, A., 253, 266, 268 Zeckhauser, R., 137, 497 Zeggelink, E. P. H., 155, 267 Zheng, T., 253 Zhou, Min, 364 Zimmerman, Martin G., 270 Zingales, L., 537, 567 Zulu kingdom, 461n8