Fairness and Retaliation: The Economics of Reciprocity

This paper shows that reciprocity has powerful implications for many economic domains. It is an important determinant in the enforcement of contracts and social norms and enhances the possibilities of collective action greatly. Reciprocity may render the provision of explicit incentive inefficient because the incentives may crowd out voluntary co-operation. It strongly limits the effects of competition in markets with incomplete contracts and gives rise to noncompetitive wage differences. Finally, reciprocity it is also a strong force contributing to the existence of incomplete contracts. This paper is part of the MacArthur Foundation Network on Economic Environments and the Evolution of Individual Preferences and Social Norms. Some research reported in this paper has also been funded by the EU-TMR research network ENDEAR (FMRX-CT98-0238). We are very grateful for helpful comments by Alan Krueger, Timothy Taylor and Bradford De Long, as well as by Ken Binmore, Iris Bohnet, Terence Burnham, Colin Camerer, Gary Charness, Jim Cox, Vince Crawford, Armin Falk, Urs Fischbacher, Diego Gambetta, Robert Gibbons, Herbert Gintis, Felix Oberholzer, Larry Samuelson, Rajiv Sethi, Herbert Simon, Vernon Smith and Frans van Winden. We regret that – in view of the very large number of comments we received – we could not do justice to all of them. § Ernst Fehr is Professor of Economics and a Core Member of the MacArthur Foundation Network on Economic Environments and the Evolution of Individual Preferences and Social Norms. Simon Gächter is Professor of Economics. Addresses: University of Zurich, Institute for Empirical Research in Economics, Blümlisalpstrasse 10, CH-8006 Zurich. Email: [email protected] and University of St. Gallen, FEW-HSG, Dufourstrasse 50B, CH-9000 St. Gallen. [email protected].