Melberg, Hans O., Norms and Capitalism

_{[Note for bibliographic reference: Melberg, Hans O. (1996), Norms and Capitalism:
How norms of fairness may inhibit economic growth, http://www.oocities.org/hmelberg/papers/960820.htm]

Norms and Capitalism:

How norms of fairness may inhibit economic growth

by Hans O. Melberg

The starting point of this observation is an episode I witnessed this summer. A tourists
at a campground wanted to buy a newspaper, but he was complaining about the price of the
paper. The price of this paper was usually 8 NOK (a bit more than $1), but at this
particular place they were charging 10 NOK (a bit less than $2). It was this price
difference which made the man so angry. This episode made an impression on me because it
demonstrated how norms of fairness could prevent an otherwise profitable trade.

First, one should note that there was an opportunity for a profitable trade. The man
wanted the paper and he would be willing to pay 10 NOK if this had been the standard
price. Furthermore, the people selling papers were willing to sell for 10 NOK. It seems
like we have a perfect example of how both parties could be made better off (a Pareto
improvement) by a trade.

Yet, the trade failed to take place. Why? The answer is that the man felt that he would be
unfairly taken advantage of if he paid more than the "normal" price. Even if the
paper was worth 10 NOK, he was not willing to pay this amount when the "normal"
price was 8 NOK. His behaviour was motivated by a norm - do not pay more than the standard
price - and not by rational maximization of utility.

The above episode illustrates a wider and much more important problem: That economic
growth and efficiency may be inhibited by some kinds of norms of fairness. Economic
efficiency requires free price formation. Hence, the "correct" price is that
price which makes demand equal to supply, not the price which appears to be fair.

An application of this could be to the current situation in Russia. The Russian culture
may have norms of fairness which prevent profitable trades from taking place. This, in
turn, may be a part of the explanation of why capitalism is developing so slowly (if at
all) in Russia. One could then try to examine whether the culture of the rich world is
different from Russia in that people are more willing to accept the price given by supply
and demand as the fair and/or acceptable price.

Needless to say this last paragraph must be examined empirically. One might use
experiments to see whether the Western norms of what constitute an acceptable price is
more influenced by demand/supply considerations than the Russian norms. (One might also
use empirical methods to investigate whether capitalism is really growing at a slow speed.
Some might argue that the low growth figures neglect the large growth in the black
economy).

Lastly one may speculate how these norms are formed. It is my suspicion (and experience)
that people tend to accept the price given by demand and supply as fair as long as it does
not change dramatically (there are a number of significant exceptions such as the price of
medical services and baby food. Also the fairness of a price tends to be coloured by some
other factors such as the necessity of it (again: baby-food) and the cost of producing
it). Hence, I would suggest that in a market economy people's views of a fair price is
determined (in the long run) by the market price. I qualify this by adding in the long run
because large price increases, even when given by the forces of supply and demand, are
often viewed as unfair (My personal experience of this is with the price of renting huts.
People tend to accept small price increases, but not big ones even if the increase is
determined by a rise in demand. However, if the same price had been brought about by small
yearly increases it would have been accepted. Also, a large price rise tends to be
forgiven over time. People get used to the new price level and accept is as the
"fair" price. If I am allowed a last speculation I may argue that this
"irrational" formation of norms is caused by the mechanism of cognitive
dissonance reduction. It is difficult to pay a price which one does not think is fair and
at the same time think that one is a reasonable person. A reasonable person would only
accept a fair price. Through this mechanism our views of what constitute a fair price may
be coloured by the actual market price).

In conclusion, I believe this is an issue which deserves further empirical investigation.
As mentioned one could design experiments to examine the argument in more detail - for
example by observing the degree to which "unfair", but profitable, exchanges
fail to occur in a given experimental situation. One might also use questionnaires to
reveal the factors that determine people's perception of a fair price. If we discover that
the Russian culture is very different from the Western culture in this aspect, one might
then come one step closer to explaining why the free market system in Russia did not have
the effects predicted by many economists. These predictions were based on the assumption
that people behave rationally, while in fact people are often motivated by norms such as
not accepting a trade if it is perceived as unfair (even if it increases utility).

_{[Note for bibliographic reference: Melberg, Hans O. (1996), Norms and Capitalism: How
norms of fairness may inhibit economic growth, http://www.oocities.org/hmelberg/papers/960820.htm]}}