The cultural foundations of economic failure: A conceptual toolkit

This paper proposes a framework for integrating mental constructs into economic analysis. It considers three types of belief: identities, narratives and norms. Identities influence preferences; narratives influence how causal relationships are (mis)understood; norms determine self-imposed constraints. The beliefs are acquired pre-rationally, through participation in social networks which are initial endowments; subsequent choice of network participation is path dependent. Actors rationally maximize their utility subject to these beliefs, but the beliefs themselves are contaminated by these endowments of irrationality. In equilibrium, beliefs and networks are locally stable and constitute a ‘culture’: the culture can be that of an organization, an entire society, or a family. Local stability is achieved partly through interactions between the three types of belief, and partly through the interaction of beliefs and networks. A dysfunctional culture generates behaviour that yields bad outcomes. If these forces are strong, Bayesian updating from mistakes can be frustrated: dysfunctional cultures can be traps. Principals can use various control variables to improve (or preserve) outcomes by targeting beliefs. The framework enables a systematic approach to dysfunctional cultures.