Values, Mechanism Design, and Fairness

Abstract:     
The popular understanding of "free enterprise" has focused all too often on the importance of self interest. A better description gives prominence to the psychology of values. The recognition of the character of consenting players by other consenting players assists humans in taking part in productive, consensual interactions. Classical economic modeling gave insufficient attention to the structural requirements of trade and cooperative interaction. A combination of game theory and institutional economics helps us to redress the balance, and leads us to the conclusion that values play an important role in many kinds of institutions, and are of fundamental importance in interactions that are not subject to complete structuring through such alternatives as law, physical mechanisms, or institutionalized markets. Values such as honesty and trustworthiness can be very effective in transactional contexts, helping in the restructuring process of mechanism design and changing the dominant solutions in interactions from those with poor cooperative outcomes to those with higher mutual potential. Fairness, by contrast, often plays a different role. It can be viewed, at least in part, as a measuring process in which we decide whether participation in the game as designed is "individually rational," i.e. desirable as a matter of uncoerced choice. The pay-off structures set in place by a bargaining system based on the marginal utility of the players may not match up with their fairness pricing, a problem which could lead to instability in the system. This instability can be resolved by adding an appropriately calibrated redistribution rule to the overall game, whether in a dyadic paring, a firm, or in society as a whole.

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