THE THEORY OF INCENTIVES I : THE PRINCIPAL-AGENT MODEL (original) (raw)
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principle will also prove useful in that, because of its roots in an older tradition of interpretive sociology, it will allow us to connect some intriguing new developments in behavior and cognition with a recognizable version of economic explanation. By thus walking both very old and very new ground, I hope to delimit a trail that others may find attractive. As I have argued elsewhere, Popper's principle is ultimately part of a larger European tradition associated with names like Max Weber and Alfred Schütz (Langlois 1986b, 1990). In that tradition, one analyzes social processes by assuming that agents (1) act appropriately or reasonably in the situation in which they find themselves. Put his way, the method of situational analysis, as it is called, is a broad and widely applicable one. Popper (1966, 1967) embraces a version of situational analysis as an antidote to what he calls psychologism, the view that one can explain all social processes solely by reference to the psychological states of individuals. (2) By contrast with psychologism, says Popper, situational analysis is able to explain "the unintended social repercussions of intentional human actions" (Popper 1966, p 95). Unlike psychology, economics and kindred social sciences are not about explaining the behavior of individuals; rather, they are about how individual behavior leads to larger social patterns and institutions, an idea that goes back at least to Smith and the Scottish Enlightenment. Understanding-or predicting, if one really believes that possible-the behavior of the agent is thus a means to an end rather than an end in itself. Moreover, for Popper, one benefit of situational analysis is that knowledge of the agent's situation can compensate in large measure for detailed knowledge of the agent's psychology: the "logic of the situation" may largely dictate behavior, and the psychology-or even the "rationality"-needed to make sense of the agent's actions (as one element in the explanation of unintended social phenomena) may be "trivial" (Popper 1966, p. 97). Notice, however, that, although both the situation and the theory of behavior needed to make sense of action in the situation may indeed be trivial, they also may well not be trivial. In the hands of Alfred Schütz and his followers (Schütz 1967; Schütz and Luckmann 1973), the approach from situational analysis often implies quite complex situations. In economics, however, it moved in a rather more narrow direction. Neoclassical rationality. Popper contended (e. g., 1966, p. 97) that situational analysis is in fact the method of economics. I return to this claim below. What is indisputable, however, is that there has long been in economics a tendency to see rationality as a logical rather than a psychological principle. Although we may trace this tendency to Menger (McCulloch 1977), it was probably Lionel Robbins's Nature and Significance of Economic Science (1932) that fully ensconced in the minds of economists the idea that their science is about the logic of means and ends rather than about the psychology of utility. Given a framework of means and ends, the agent's behavior reflects the solution to a logical problem of allocation. It was not a difficult leap to associate this logical problem with the mathematical problem of optimization, a leap that Walras and his followers had in fact already made. (3) The neoclassical rationality assumptions are well known, and it may seem unnecessary even to repeat them. I propose, however, to recast my description in a rather idiosyncratic way that will help highlight certain criticisms on which I want to focus below. The basic neoclassical model, I argue, combines the following four elements. Self-interest. Omniscience ("complete information"). Conscious deliberation (or an "as if" equivalent). The representative agent. The first two of these are much discussed; the third and forth elements are less often noticed. Self interest. The assumption of self-interest has come under intense criticism, traditionally from outside economics, although increasingly from within as well. In my view, however, self interest is a red herring. By self-interested behavior one really means purposeful behavior. And, as Viktor Vanberg points out,