2.

3 Reciprocity and Inequity Aversion When analysing consumer incentives and human motivation, economists have often in the past failed to look beyond monetary incentives (Fehr & Falk 2002). The vacuum left when using a narrow monetary scope has been filled by psychological and social motivation theories. This report focuses on two highly influential social preference theories; reciprocation and inequity aversion. These two theories help explain why socially responsible consumers are willing to incur a higher price for products that incorporate social goals as part of the value bundle (Becchetti & Rosati 2007, p.802). The idea of social interactions influencing social preferences within markets has been most recently influenced by work associated with Ernst Fehr (Fehr & Schmidt 1990, Fehr & Falk 2002, Fehr & Fischbacher 2002). According to this literature, material self interest on its own fails to explain consumer motivations, and thus a social preference theory is needed to fill this gap. Particularly harsh criticism is given to economics which Fehr and Fischbacher (2002, C1) describe as a dismal science because economists routinely make worst case assumptions regarding peoples motives. Social preference is defined as the propensity to take into account the material resources allocated to relevant reference agents rather than solely from the perspective of self interest. It is based largely on the concept of reciprocation, where according to the models put forward by Rabin (1993), a consumer will act kindly to a perceived kind action and with hostility to a perceived hostile action. In short, under reciprocation, people like to help those who are helping them and to hurt those who are hurting them (Rabin 1993, p.1281). Rabin uses a game involving two people to demonstrate, where player one is given a small sum of money to divide with player two. For player one to claim any share of the money, player two must accept the terms of the divide. If we were to only take into account self interest measured by a perfect sub-game Nash equilibrium, player one would offer the lowest possible amount to player two such that player two would always accept. However Rabins experiments resulted in equitable divisions which would typically end with a 50/50 split. This demonstrated that while self interest theory would look for player one to offer player two the lowest possible value and for player two to accept, what actually happened was that player one offered a perceived fair value and player two accepted in kindness. To further the point, according to self interest theory player two should have accepted any value, including the lowest possible value. However they would only do so if the offer was perceived to be fair, i.e. player two would rather have left the negotiation with nothing at all than to be left with an inequitable value. While Rabins experiment uses a small reward/risk using only $10, other experiments have raised the stakes of the game and this has changed the outcome. Slonim and Roth (1998) noticed that after a learning period where the game was played several times, a higher stake resulted in a lower frequency of rejections from player two. Therefore a greater convergence towards the perfect sub-game Nash equilibrium, a lower level of reciprocation and less impact of social preference becomes evident. Schervish and Havens (1998, cited in Nelson 2001 p. 1182) using extremely high stakes actually reversed the trend, noticing that equity increased when extraordinary high values were used. This implies that there is a U-shaped quadratic relationship between the level of equity and the values involved such that low values are equitable, a high value is less equitable, and extremely high values again become more equitable: Figure 2, taken from Schervish and Havens (1998, cited in Nelson 2001), the U shaped quadratic relationship has serious implications when applied to consumer products. It would suggest that

the value of a product is a strong influence when considering the effect of social preferences during the purchasing decision, and should be taken into account when analysing Fairtrade Certified products. A criticism of Schervish and Havens study is that it is taken from data on charitable donations rather than the controlled experiments used by Rabin (1993), and Slonim and Roth (1998). This puts into question whether the relationship really is quadratic, or whether it is limited to being negatively linear. A second type of social preference is inequity aversion. Supported by Fehr and Schmidt (1999), the inequity aversion concept states that someone who has inequity aversion is preferable to an equitable distribution of material resources. This is not just limited to the desire to bring someone up to the equitable level, but also wishing that those above that level are brought back down. In its simplest form, inequity aversion is the drive for equality. Reciprocity and inequity aversion are similar in that they are both based on a notion of fairness (Fehr & Fischbacher 2002, p.C3), and the models for reciprocity capture the effects of inequity aversion. This report will therefore not attempt to distinguish between the two when applied to Fairtrade consumers, but instead analyse the extent of social preference theory in the purchasing decision.

3.1.5 Legal The UK government has embraced CSR initiatives; however it still largely believes it is the responsibility of individuals and companies to determine their own approach (Department of Business Skills & Innovation 2004, p.8). Much of the current policy framework sets basic levels of CSR practise in the fields of health and safety, environmental impact and employment practises, combined with incentives for the private sector to incorporate greater socially responsible corporate policies above the minimum legal standard (Department of Business Skills & Innovation 2008, p.5). Part of this was the 2006 Companies Act which introduced statutory requirements for directors to publish reports on environmental, employee, social and community matters. However as already mentioned, firms do not have to go above minimal legislative standards. Environmental Sustainability has received increasing attention over recent years from the business press and as a result, manufacturers are taking this on board (Luchs et al 2010, p.18). This cultural trend towards sustainability has been fully embraced by Fairtrade (FLO 2010, p.26): The community must recognise that part of its future success will depend on how well it can collaborate with the rest of the sustainability standards movement to achieve common sustainable development objectives FLO must remain among the leading initiatives for sustainable trade The drive for sustainability is much more than a modern marketing tool; when fully implemented, sustainability improves the bottom line by saving costs, reaching new customer groups and contributes towards a human resource strategy that gains and keeps creative talent (Werbach 2009, p.74). The trend towards greater sustainability puts Fairtrade in a strong position over its value chain strategy. Environmental concerns are prevalent in the social attitudes of British consumers; however this has changed in a similar fashion to attitudes towards corporate responsibility during the recent recession. In 2007, Ipsos MORI (2009) report that just less than 20% of the British public considered the environment to be Britains most pressing issue and around 13% considered the

economy to be most important. However at the beginning of 2009, the environment scored below 10% and the economy jumped to 70%. Such a dramatic shift reflects public concern over the recession, at the cost of environmental attitudes.