The idea that people have moral values is of course not new. However, the analysis of such values as endogenous to the environment of the agent is relatively recent. Bowles (1998) provides an excellent and wide-ranging survey of what is known about the effects of economic institutions, and especially markets, on preferences.
Recently, researchers have started to investigate the effects of deterrent strategies on values using evolutionary models. In general, these studies model how institutions affect the payoffs of ‘cooperative’ types vis-`a-vis the payoffs of selfish types, and derive the evolutionary success of these types. That is, one uses version of evolutionary theory, the so-called indirect evolutionary approach, in which evolution impacts on preferences, rather than strategies. In an evolutionary approach, agents are rational optimizers but evolution selects the preferences that are best suited to the environment. Note that the term ‘evolutionary’ does not necessarily refer to a biological selection process, since this could take place only over a time span in which institutions cannot be reasonably be held constant. Rather it refers to a process of cultural evolution, where preferences spread by imitation and education.
Huck (1998) presents an evolutionary model where legal institutions have a positive effect on preferences for remorse from cheating in bilateral exchange. One party is in the position to cheat on the other party, which can observe cheating at a cost. Under exogenous preferences, penalties need to be very high to deter cheating if there is zero remorse. However, under
endogenous preferences, penalties on cheating hurt selfish individuals more than remorseful individuals, who will always comply. Thus remorse becomes an evolutionary stable trait. This in turn causes the optimal sanctions to be lower in the long run.
All other papers in this literature have focussed on negative impact of sanctions. Bar-Gill and Fershtman (2004) model the evolution of preferences for fairness in the population as a function of the contract enforcement strength of the legal system. They show first that fairness concerns will be widespread in an exchange economy if legal enforcement is weak. The reason is that preferences for fairness gives sellers a good bargaining position. If an unexpected rise in performance costs occurs, they can credibly threaten not to service the contract unless they get a higher price. However, when the buyer has legal options to enforce the original contract, she may prefer litigation to renegotiation with fair types. Thus, under strong enforcement, fair preferences provide less bargaining benefits, and evolution leads to lower fairness concerns. Another mechanism by which legal enforcement can discourage the spread of virtuous character traits is given in Bohnet et al. (2001) and Bar-Gill and Fehrstmann (2005). The general idea is that there are two types, virtuous and selfish, which are perfectly observable. In the absence of enforcement, people will trustful only towards virtuous types. (Probabilistic) enforcement may make it worthwhile to trust also low types, so that the latter are better off and increase their share in the population.
In the model of Bohnet et al. (2001) the two types play a standard trust game, in which the receiver can decide to cheat or be trustworthy. Under endogenous preferences, there are potentially negative long run effects of a (probabilistic) enforcement of trustworthy behavior by third parties. If the contract is enforced by the third party, the cheater induces a cost (fine, legal costs). When the probability of enforcement is in an intermediate range, the trustors may be inclined to trust even if the trustee is a low type. This raises the payoffs of the cheaters and increases their share in the population. In the long run, only low types remain. Low enforcement on the other hand leads trustors to be more careful and only trust honest types. This means that honest types will eventually take over in the population. The authors test their result by means of an experiment, in which subjects are randomly matched to play the trust game. In all sessions, the last six interaction rounds featured low enforcement probabilities. In the first rounds, enforcement probabilities varied between high, low and medium. In accordance with their hypothesis, the authors find that trustees who interacted only in the low enforcement regime tended to be more trustworthy.
Bar-Gill and Fehrstmann (2005) model a similar logic in the context of a social dilemma game. In their model some agents care for status (high types) and others don’t (low types). Agents match randomly in a 2 × 2 prisoners dilemma game. A decision to cooperate is a public good in the sense that everybody profits from the average amount of cooperation in society. Status can be acquired by contributing to the public good, and the amount of status increases in the
average cooperation level in society. The authors show that in the evolutionary equilibrium the high types cooperate with each other if their preference for status is strong enough. The low types defect. If a high type meets a low type, the low type defects and the high type is indifferent between cooperating or not. The unique evolutionary stable equilibrium is one where a fraction of high types cooperate with the low types. The authors now consider the effect of a small subsidy on cooperation. They show that in the short run, the subsidy raises the fraction of high types who cooperate. However, this raises the evolutionary payoffs of the low types, causing their presence to increase. In the long run, this effect dominates, and the subsidy lowers contributions in equilibrium.
This logic depends on the strong assumption that types are observable. G¨uth and Ocken- fels (2005) show that when this assumption is dropped, legal institutions that punish non- cooperation become central to the evolution of cooperative preferences. Obviously, the reason is that cooperation can no longer be conditioned on type, and so private punishment of cheaters is impossible. As a consequence, cheaters will always be at least as well off as non-cheaters. In summary, sanctions may decrease the relative payoffs of selfish types, which decreases the equilibrium level of such types and decreases cheating. However, countervailing dynamics exist. When types are observable, sanctions on defection or subsidies on cooperation may increase cooperation with selfish types. In the long run, the result is a larger share of such types which lowers aggregate cooperation levels. These are suggestive results with potentially important policy implications. However, they are largely derived in an empirical vacuum, given the almost complete lack of data on the long-run effect of sanctions.