Does exposure to markets make us more, or less, rational?

We know that people are not fully rational - they try, but they are subject to predictable cognitive biases. These biases form the basis of behavioural economics.

One of these biases is the endowment effect. The classic experiment that demonstrates this effect was run by Daniel Kahneman, Jack Knetsch, and Richard Thaler. Kahneman describes the results in his book (Thinking, Fast and Slow):

Mugs were distributed randomly to half the participants. The Sellers had their mug in front of them, and the Buyers were invited to look at their neighbor's mug; all indiated the price at which they would trade. The Buyers had to use their own money to acquire a mug. The results were dramatic: the average selling price was about double the average buying price, and the estimated number of trades was less than half of the number predicted by standard theory.

Rational decisionmakers, who are willing to pay up to $10 to gain an item, should also be willing to sell that same item for $10. So, on average we would expect buying and selling prices not to diverge greatly. But they do, as shown in the experiment (and in a great many other experiments besides).

There are several explanations for this, but I will concentrate on one in particular - loss aversion. In general, people are loss averse because we value losses more than we value gains. Gaining $10 makes us happier, but losing $10 makes us unhappier to a greater extent than gaining $10 makes us happier. How does this relate to the endowment effect? Using the experimental example above, the sellers have a coffee mug, which they own. Let's say that they would have been willing to pay $10 to get their mug. Giving up their mug creates a loss (they lose their mug), and because of loss aversion they value that loss at more than $10. So, they would only be willing to sell their mug for some amount that is more than $10.

Other experiments have demonstrated that the endowment effect reduces as people gain more experience at trading in the market. The work of John List (surely a future Nobel prize winner) in the markets for baseball cards demonstrates that endowment effects reduce with trading experience (see here for a nice summary, or the gated article here). Given that these results show that market experience reduces the endowment effect, a commonly held belief among economists is that exposure to markets makes us more rational.

Which brings me to this paper from last year, by Coren Apicella and  Eduardo Azevedo of the University of Pennsylvania, James Fowler of UC San Diego, and Nicholas A. Christakis of Harvard University. The paper is described in lay terms in some detail here, so I will forego a long explanation. Essentially, in this paper the researcher describe an experiment where they tested for the presence of the endowment effect among one of the few remaining hunter-gatherer societies in the world - the Hadza Bushmen of northern Tanzania. They exploited the fact that some Hadza live close to tourist trails and interact with tourists and guides, while others live further away and have fewer contacts with outsiders. Those who have had more interactions were hired as guides, sold bows and arrows, etc. In other words, they engaged in more market transactions. What the researchers found was that the Hadza who lived in the most isolated villages did not display endowment effects, while those who had engaged in more market transactions (because they lived closer to the tourist trails) did exhibit significant endowment effects. Based on these results then, exposure to markets makes us less rational.

How can markets make us simultaneously more rational and less rational? The apparent paradox is troubling, but consistent with the old proverb that a little knowledge is a dangerous thing - a little bit of market experience may reduce rationality, until we become experienced enough in market transactions to overcome the endowment effect. Alternatively, Apicella and friends give some potential explanations for their results, including exposure to "concepts of ownership, selling and purchasing of goods, and payment for labor, all of which could be driving the group’s preference for owned items". I'm left wondering if it's the concept of ownership that leads to the endowment effect. I imagine that hunter-gatherers have quite a different conception of ownership than we do in the western world (the Apicella and friends paper notes that "While the Hadza do own some items, such as knives, bows and arrows, and animal skins, ownership is limited to what can be carried"). Exposing the Hadza to markets may broaden their conception of ownership, and more importantly to the loss of ownership. I wonder if there are any plans to test whether loss aversion is present amongst this group?