The Indian Economy Blog

July 25, 2007

Expectations Matter

Filed under: Basic Questions — Atanu Dey @ 10:41 am

George Akerlof’s seminal contribution to economic theory is in the area of information imperfection and how it affects markets. Information asymmetry between the buyers and sellers of used cars (very poor quality used cars are the lemons that Akerlof talks about) leads to that specific market failure. The role of expectations is critical in that specific case. In fact, I am persuaded that expectations play a very important role in how human systems behave dynamically.

The most important advance in the economics toolkit in the past century is undeniably game theory. Game theory informs economics because economics studies what happens when economic agents behave strategically. That is, the result of the “game” of human activity is not chosen by any economic agent. Like in those activities that are games (sports such as football, or board games such as chess and checkers), formal games model how the outcome emerges from the interaction of the choices that individuals make motivated by their own self-interest. The strategic part lies in how a player chooses to do something that is based on his expectation of how the others players will respond to his move.

Once you start thinking about expectations, it is surprising how pervasive the role of expectations in outcomes is. There is a definite and positive link between expectations and results. Personal anecdotal evidence is persuasive. I have noticed that I generally aim to achieve that is expected of me. Some of my mentors cleverly used that tendency. Whenever I am expected to be good at something, I try hard to be good at it; if I am expected to be lazy and unproductive, I usually am.

In the US, I noticed that Americans of African descent do much worse than Americans of Jewish descent in most spheres. Jews are expected to be good at whatever they do, whether scholarship or the arts, while blacks are expected to generally drop out of school, engage in crime and end up in jail. I believe (and this is a conjecture only) that from early childhood, people understand what is expected of them and they do as the script dictates. We are prisoners of our own expectations, expectations that get communicated to us by our families and by the environment that we are immersed in.

We behave to a large extent on how others expect us to behave.

It is interesting to understand how expectations are formed. Within a closed system, expectations are endogenous by definition. In open systems, at least part of the expectations must be exogenous. Since individuals are not closed systems – that is, they are influenced by events and things outside of themselves – there is a role for others to influence the expectations that individuals have. For now, I will not go into how expectations are formed. I am only asking how the aggregation of individual behavior influenced by expectations gives rise to macro phenomenon.

People expect trash on the streets in India. That is they expect others to throw trash. That expectation allows them to feel free to add their own (small amount of) trash. Aggregated over many people over an extended period of time, the trash accumulates as the expectation itself gets reinforced. Eventually you have Singapores and Mumbais.

People expect the politicians to be crooks. Their expectation of a lower moral standard allows the politicians to be immoral scum. The immorality of politicians is widely known. The pile of immoral acts grows and at any time there is an average level of depravity. The next politician seeing the huge pile, feels free to add to the heap and indeed goes a little deeper in the depravity department. The average sinks further and people adjust their expectations downwards even more and the vicious cycle continues.

Take a publication such as The Times of India. There is an average quality of the articles. Then it accepts a very low quality article. This brings down the average very slightly in the short run but can have a large negative effect in the long run through the mechanism of expectations.

Assume that in general, writing articles that are above the average at any particular time is more costly than writing below average articles. The publication of a very poor quality article expands the range of articles that are accepted for publication. So the average creeps downwards as more below the current average articles are submitted. The submission is based on the expectation that it will be accepted as was demonstrated by the very poor quality article. As the average creeps downwards, the quality of the readership changes to reflect the poor quality of the publication, and the good writers move on.

I believe that revolutionary change at its core is the raising of expectations of the people far above the prevalent average. It takes leadership, courage, vision, and heaps of chutzpah. Which, in our case, we do not have. But imagine if we did. Imagine that somehow our expectations were raised sufficiently that we would not tolerate crooks and criminals in high office. Imagine that there would be revolt in the streets when we find that the highest political offices are held by murders and embezzlers. Would not that change the political climate, would that not allow the good guys to hold office in India?

Links: The wikipedia on The Market for Lemons.

8 Comments »

  1. I see at least two factors impacting expectations from people/communities -

    - Communication medium – Internet, Television, Radio allow individuals to think outside their circle of reference and impacts their aspirations and expectations

    - Role models and pioneers – People who succeed in breaking stereotypes are a huge influence on their communities. Whether it’s Jesse Owens winning Gold medals in Hitler’s era or Tiger Woods defying Jack Nicklaus’ argument or Narayan Murthy turning from a middle class and honest background to a multimillionaire…similar achievers have reversed negative stereotypes.

    I also believe community size matters. If there were a billion jewish people as opposed to only 10 million or so in this world, their track record and hence expectations would be different.

    Comment by ashutosh — July 25, 2007 @ 2:40 pm

  2. That’s quite true. Expectations do play a very important role in shaping lives and communities.

    Comment by Amogh — July 25, 2007 @ 3:01 pm

  3. Atanu, great idea but I think you made a large leap from the game theory premise to establishing “We behave to a large extent on how others expect us to behave”. Not that I disagree with you though.

    My game theory might be a little rusty but lose lose outcomes are also plausible in scenarios even when players “raise expectations … far above the prevalent average” as a strategy. Am I right? It is possible that a simultaneous move (or moves) has the unknown effect of dominating the final outcome?

    In India’s case a noble strategy of removing illnesses and death had the unintended effect of a massive population boom that wreaked havoc on the economy. Still strategies of education and food production paid out as we use the outcomes of these to leverage the economy back into shape with IT. As the game continues supposed setbacks become strengths as our lower costs and population leverages the BPO industry with manufacturing soon to follow.

    In game theory at least, the expectations are not always what we expect them to be. In a finite game length with a time frame of the last two decades “we lost” but in an infinite play (with an unknown end date) it looks like we have the strategies and outcomes to win.

    Comment by Nikhil — July 25, 2007 @ 11:33 pm

  4. More than couple of things I don’t know

    1. I don’t know what information imperfection has to do with expectations. Its like saying this “The real estate market in Bombay is unorganised. Hence, there is no readily-available data on property price trends.”

    2. I don’t know what game theory has to do with expectations. Its like saying this “I went searching for a house in Dharavi. I expect prices to be low out there”.

    3. I don’t know what expectations have to with anecdotal evidence. Its like saying this “I met with a few people in Dharavi. They were short, black, dirty. They were like tribal pygimes”.

    4. I don’t know what anecdotal evidence has to do with what people think of me. Its like saying this “Everyone hates tribal pygmies. To belong, even I must hate tribal pygmies”.

    5. I don’t know what people’s expectations of me has to do with the company I keep. Its like saying this “I hate tribal pygmies. And so do all my friends”.

    6. Finally, I don’t know what the company I keep has to do with causing a revolution. Its like saying this “Well, the real estate market in Bombay can change a tribal pygmy’s life”.

    Comment by Sivaji — July 27, 2007 @ 10:55 am

  5. Atanu,
    Thinking of similar topics, I came across these papers a few months ago:

    http://www.arts.cornell.edu/econ/CAE/06-06.pdf

    http://www.econ.upf.edu/docs/seminars/oxoby.pdf
    These are a bit technical for me. There is also the work of Hoff and Pandey:
    http://sticerd.lse.ac.uk/dps/bpde2004/hoff.pdf
    I wonder whether thiese are related to your ideas. Regards,
    Swarup

    Comment by gaddeswarup — July 27, 2007 @ 2:56 pm

  6. Expectations are self-fulfilling. But one follow on issue is the institutionalisation and incumbency of such thoughts and expectations.

    Because we expect politicians to be corrupt, we do not reform the systems that may faciliate this as assidiously as we would otherwise. We are, consequently, more indifferent to morally offensive political scandals.

    Institutions are infamous for taking a long time to reform. If only one person revises his expectation that “political corruption is bad and I’m going to do something about it”, that’s not enough. EVERYONE has to be on board for changes to happen – this is where marketing comes in.

    A lesson for economists from the management consultancy sphere: “it’s 80% about delivery, 20% about content”.

    Comment by pratiksrandomwalk — July 27, 2007 @ 3:40 pm

  7. Guys, Krish in Politics is a retard. What is he ranting on about? Dey is not a professor and neither did he claim to be one. As far as his post goes, he is expression an opinion that expectations matter. That is not revolutionary. And he just illustrates it with a few examples. Lighten up! This is a blog not an academic publication.

    Comment by Alok Prakash — July 27, 2007 @ 9:15 pm

  8. Atanu – You make a great point on expectations. However, I wish you had also talked about the role of institutions on the performance-expectations link. I am sure you will touch upon this in a later post, but I wanted to make a few observations. It is also important to realize how individuals reset their expectations.

    When performance of a particular entity does not meet one’s expectations, disconfirmation occurs. Individuals look either within themselves or in the environment to locate the reasons for this disconfirmation. When they do figure out the cause of the lower performance and hence the disconfirmation, they learn how to deal with it. Absent the role of institutions or their effectiveness, the ability of an individual to seek redress in such scenarios is severely hampered. It is not just about raising expectations, but also developing a process through which individuals can seek redress. It is not that individuals have lower expectation in India, it is that they don’t know or do not seek redress.

    Comment by Girish — July 29, 2007 @ 2:47 am

  9. atanu

    surely your mentors don’t hold high expectations in areas where your potential is low? There has to be latent talent for expectations to make a real difference. Admittedly almost everyone has the talent to not litter, demand for ethical behavior etc. So for some types of activities, expectations will matter. For others (sports, arts, science) talent assuredly matters and there is a wide distribution across individuals and groups.

    Comment by sriram — July 29, 2007 @ 8:09 am

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