The research described in this proposal seeks an understanding of the role and importance of relationships in allocating resources. People often work without using contracts, prices, legal devices, or markets in their economic affairs, even when such means are available. Instead, they rely on relationships. A relationship is a continuing interaction between identified (rather than anonymous) agents, with current incentives created by adjusting future payoffs rather than making current transfers, and with these future payoffs ensured by creating the appropriate future incentives rather than by writing contracts. For example, firms who regularly deal with one another often pay no attention to the contracts governing their interactions, if they bother with such contracts at all, responding to imbalances with an unspecified "we'll make it up next time." Without some imperfection, there would be no role for relationships, in the narrow sense in which this term is used here, in allocating resources. Commodities would take the form of complete conditional contracts, specifying an outcome for every current and future contingency, and would be be traded in an Arrow-Debreu market at prices that support an efficient allocation. Once we move away from this ideal, however, the door opens for all sorts of supplementary mechanisms to improve market performance. Given that it is especially difficult to write complete contacts over future events -- few would be able or willing to commit to every detail of their future career, even on a contingent basis, when entering the labor force -- relationships quite naturally come into play.
The proposed research has three components. The first is the study of the circumstances under which prices or markets might not be effective in allocating resources. This research will assume that the usual sources of market failure -- imperfect competition, externalities, and private information -- do not arise, in order to focus on the role of investments that are required for market participation. The second component, centered around models based on repeated games, will study the role of relationships in allocating resources. The third will bring an evolutionary perspective to bear on some of the basic difficulties that arise when working with models based on repeated games.
The intellectual goal of the proposed research is a better understanding of economic behavior. A running theme will be that we can often expect prices and markets to play a key role in allocating resources, but can also often expect them to be supplemented with less formal means organized around relationships. The proposed research will be theoretical, but with an eye toward providing foundations for more applied work.
The broader impact of the proposed research will include contributions to our understanding of effective economic policies and institutions. The work will strengthen ties between evolutionary work in economics, psychology and biology and will provide support for graduate students doing research on related topics.
