"Identity economics" explains why people don't always make selfishly rational economic decisions.

Nobel laureate in economics George Akerlof and Rachael Kranton have a new book, Identity Economics: How Our Identities Shape Our Work, Wages, and Well-Being, which they summarize here.  They note that real people in large numbers often confound mainstream economists by making decisions contrary to obvious economic incentives measured in money. That basic insight is not new; it is central to “behavioral economics” and assumed by sociologists, psychologists, and political scientists. Still, it’s interesting when one of the high priests of economics joins in pulling away the homo economicus foundations of the mainstream economics theory temple.  This paragraph encapsulates the authors’ explanation for these common but economically irrational behaviors: 

When we examine people’s decisions from the perspective of their individual identities and social norms, we get new answers to many different economic questions. Who people are and how they think of themselves is key to the decisions that they make. Their identities and norms are basic motivations. We call this approach identity economics.

They provide several examples of behavior that cannot be explained by mainstream economic theory and then suggest how to get employees and students to be productive and successful without traditional economic rewards. 

Men and women in the United States smoked cigarettes at vastly different rates at the beginning of the twentieth century, but these rates largely converged by the 1980s. Women now smoke just as much as men. 

Overall military pay is relatively flat—that is, it does not go up and down depending on performance, and it is also lower than for comparable positions in civilian firms. Nothing in standard economic analysis can make sense of such a pay structure—or of the rituals that are central to military tradition.

. . . .

In organizations that function well, employees identify with their work and their organizations. If employees feel more like insiders—a key purpose of military rituals—there is little need for incentive pay or pay-for-performance schemes. The military changes the identity of its recruits, inculcating in them values such as duty and service. In the civilian world, too, the most important determinant of whether an organization functions well is not the monetary incentive system, as standard economic models would imply, but whether its workers identify with the organization and with their job within it. If they do not, they will seek to game the incentive system, rather than to meet the organization’s goals.

Likewise, good schooling occurs not as a result of monetary rewards and costs—the stock-in-trade of conventional economics—but because students, parents, and teachers identify with their schools, and because that identification is associated with learning. Moreover, whether students identify with being in school becomes the major determinant of whether they stay or drop out.

Given this, education policy should look at what some successful programs have done to establish a school identity that motivates students and teachers to work according to a common purpose. If we focus on training teachers in how to inspire their students to identify with their school—rather than teaching students to take standardized tests—we just might be able to reproduce these schools’ great results.

Update on Saturday, June 19, 2010 at 03:23PM by Skeptic

This NYT article from Mumbai Deciphering the Cause of Human Motivation draws on the work of other authors arguing that there is an over-emphasis on rewards and accountability, which is based on a misunderstanding about what motivates humans. Hat tip to Christine for the link.