PART IV

Marketing and Interdependent behaviour

 CHAPTER 19

Engendering Change

Joshua S. Gans

When the decentralized decisions of individual agents in the economy lead

to two or more equilibria that can be Pareto-ranked, the problem of
coordination failure is possible. The economy could be trapped at a low
efficiency equilibrium requiring the government, or some other external
party, to intervene in an attempt to coordinate the actions of agents to reach
a more efficient equilibrium.1 Recently, such situations have been given
renewed interest in formal economic theory (see Cooper and John 1988;
Gans 1991). While this literature has been able to characterize the economic
conditions that lead to coordination failure, and, hence, the need for
intervention, virtually no attention has been given to what this need entails
theoretically. It is the goal of this paper to make a start at addressing
theoretically the particulars of facilitating transition between equilibria.
To restate: in its coordinating role, a government needs to convince
individuals to change their behavior in order to facilitate an escape from a
low equilibrium trap. A low efficiency equilibrium is a problem because it is
stable, but unlike, for example, the equilibrium in a pure public goods
problem, it is not globally stable. This means that if individuals can be
persuaded to change their behavior by a sufficient amount, the conditions for
a successful escape can be met and a virtuous cycle can begin. But changing
individual behavior to provide the basis necessary for escape involves
1
The problem of coordination failure is related to the more familiar public goods
problem. In those situations, the equilibrium outcome of interactions of agents
may not coincide with the Pareto optimal resource allocation. In such a situation,
it is the role of government to establish an equilibrium that yields the Pareto
optimal allocation. In contrast, the role of government in the presence of
coordination failure is to facilitate a movement from one equilibrium to another
which is Pareto superior. Both types of problem share in common the notion that
payoffs and decisions of self-interested agents are effected by the actions of other
agents through nonmarket interaction.
390
 Engendering Change 391

changing their expectations and beliefs. These very beliefs have

accommodated to the lower equilibrium leading individuals to take actions
reinforcing those beliefs. Thus, the goal of government policy is to break the
hold of accommodation by enough to form the basis for an escape.2
While escape, once begun, involves no additional role for the
government, breaking the hold of accommodation of individuals involves
substantial cost. These costs rise with the number of individuals who need to
be targeted for change and with the degree to which they have to change
their behavior. Thus, the optimal policy choice (i.e.., the one that minimizes
transition costs) often involves choosing between attacking on a wide front
or storming the hill. The choice depends on how far one has to push on the
front and how significant the hill is. And, in the context of game-theoretic
models with multiple Pareto-rankable equilibria, it will be seen that the
nature of accommodating beliefs can be the critical variable in the decision
equation.
In order to motivate my analysis, in the next section, I describe the
problem of discrimination in the labor market that possesses many of the
characteristics of coordination failure problems. Section 2 will then discuss
the dynamics of escape and what precisely needs to be done to generate
upward momentum. Section 3 turns to consider the alternative (balanced
and unbalanced) mechanisms for achieving individual change and some of
the difficulties involved in the context of statistical discrimination. The
economic characteristics that can drive the government’s choice of
mechanism are analyzed and discussed in Section 4. Section 5 concludes by
addressing unresolved issues and directions for future research.
1 Specific Example: Discrimination in the Labor Market
To analyze the policy choices facing governments in their coordinating role,
it helps to have a specific context in mind. As a motivating context, I choose
the situation of statistical discrimination in the labor market. Models of such
situations have the quality that there can exist both discriminatory and
non-discriminatory equilibria. Thus, the overall policy goal for the
government would be to facilitate a transition away from discrimination. As
such, the class of models I am examining are in the spirit of Arrow (1972a,
1972b, 1973) and Phelps (1972). According to these theories, discrimination
is the result of self-fulfilling prophecies on the part of employers and
potential workers, rather than being embedded in tastes per se (cf., Becker
1957). Looking to this type of statistical discrimination allows us to focus on

2
The terminology of “accommodation” and “escape” I borrow from Myrdal (1957)
and Galbraith (1979).
392 Joshua S. Gans

some of the economic tradeoffs one would expect to confront a government

in its coordinating role.
Although more complete analyses are present in the literature, in this
paper I will only highlight the important qualitative properties of statistical
discrimination models. As such, it is convenient here to focus attention on
the discriminated against group which I assume is small relative to the labor
market. This means that the labor market equilibrium for other groups need
not be considered explicitly. In addition, for analytical and notational
convenience, I assume that workers in the discriminated against group are
drawn from a set L h [0, 1] , a continuum.
Worker i receives a wage, wi, and has marginal product qi. However,
this marginal product can be improved by investing in education or other
personal factors, for example, “the habits of action and thought that favor
good performance in skilled jobs, steadiness, punctuality, responsiveness,
and initiative.” (Arrow 1972a: 105) Each worker chooses a single
dimensional investment level, xi, from a compact strategy space X i _ · (as
in Kremer 1993). The payoff to worker i is assumed to be, J i = J i (wi , x i ) ,
with J i1 > 0 and J i2 < 0 . So while additional investment is costly to
workers, they do benefit if this results in a greater wage.
The insight of models of statistical discrimination is that if the marginal
product of an individual worker is observed imperfectly, then it is possible
that information concerning the productivity of other members of the group
they belong to may influence the wage they receive.3 Thus, the return a
worker receives on their personal investment is dependent on the
investments other workers from their group make. For example, often the
labor market and final product market is assumed to be competitive with
workers receiving their expected marginal product leading to the wage
schedule, w i = E[q i ¸ i ] .4 In such models, the expectation of a worker’s
marginal product is based on the beliefs of employers who use information
(¸ i ), a composition of two types: (i) a test of the worker’s ability; and (ii) the
knowledge of the societal group the worker belongs to and a point estimate
of the general investment level of a worker in that group, x. Here it is
3
As Arrow (1972a, 1972b) notes, the force of the imperfect information argument
relies on employers making some specific investment in workers before they can
observe their true productivity.
4
See, for example, Arrow (1973), Lundberg and Startz (1983) and Kremer (1993).
An alternative way of describing the problem of discrimination would be to
assume that a worker’s observed ability affected their job placement. Thus, the
returns to personal investment would take the form the quality of the position a
worker received. Models along this line include Milgrom and Oster (1987), Coate
and Loury (1993), and Athey et. al. (1993).
 Engendering Change 393

supposed that, x = f({x i } icL ) , where f is some aggregator function that is

nondecreasing in each worker’s investment. Its value influences the wage a
worker from that group receives. As long as the test of a worker’s ability is
an imperfect indicator of marginal product, it can be shown that it will be
optimal for employers to rely on their knowledge of x in addition to the test
(Phelps 1972; Kremer 1993). However, if the test provides some information
to employers as to workers’ individual productivities, their wages will be
influenced, albeit imperfectly, by their own personal investment.
By undertaking personal investment, workers can be viewed as
contributing to a public good, x, that improves everyone’s payoffs. This is
because a higher x results in higher wages for everyone in the group. What
distinguishes this from a pure public good problem is that workers also
receive a private benefit from their own personal investment, as a result of
the use of an individual test by employers. Thus a worker’s payoff becomes
J i = J i (w(x i , x), x i ) , where w is nondecreasing in both its arguments. Under
certain conditions, however, the wage function can have the quality that the
marginal impact of individual personal investment on wages is
nondecreasing in the aggregate investment, x (Arrow 1974 and Kremer
1993). In such situations,
¹Ji ¹w
¹w ¹x i
¹J i is nondecreasing in x.
¹x i

This condition is implies the definition of strategic complementarity as

used by Milgrom and Shannon (1994).5 For what follows I will assume this
condition on payoffs.
Strategic complementarity present in worker’s payoffs means that their
best response correspondences are monotone nondecreasing in x (Milgrom
and Shannon 1994). In notation, let
B i (x) h x i c X o i (x i , x) m o i (x i , x), ¼x i g x i denote the best response set
5
In actuality, this game should probably be referred to as a game with aggregate
strategic complementarities. This is because the strategies of other workers are
embodied in the point estimate employer belief regarding the average level of
worker education. This, in turn, is an aggregate of worker investments. Thus, it
shares a common link with many applications of games with strategic
complementarities (e.g., Cooper and John, 1988; Murphy, Shleifer and Vishny,
1989), but it is distinguished slightly from the game-theoretic literature on the
subject (e.g., Milgrom and Roberts, 1990). In a technical appendix note
reproduced here (Gans, 1994) I find the conditions under which games with
aggregate strategic complementarities are a special case of games with strategic
complementarities. The most important condition to note here is that the
aggregator function be nondecreasing in each x i .
394 Joshua S. Gans

for worker i when x is produced. If B i is single valued for worker i, this

monotonicity is depicted in Figure 1. Thus, as other workers raise their
personal investments, this raises x, which in turn raises the optimal
personal investment for an individual worker.

z
x

x
Figure 1. Multiple Equilibria
What are the possible equilibria of this type of game? To simplify
matters, I will assume for the rest of the paper that all workers have the
same underlying economic characteristics (although their observed
characteristics may ultimately differ in equilibrium) and focus my attention
on pure strategy symmetric Nash equilibria (SNE). As such, I will suppress
the worker subscript in what follows. x̂ is, therefore, a SNE strategy profile
for the discrimination game if (i) x̂ c B(x), ¼i ; and (ii) x = f({x̂}; h ). Thus, in
equilibrium, workers choose levels of investment that maximize their
payoffs, and the aggregate level of education used by employers is consistent
 Engendering Change 395

with these maximal choices, capturing the notion of a self-fulfilling

prophecy.
Strategic complementarities mean that there is the possibility of
multiple equilibria (see Figure 1). There could be a low investment
equilibrium with associated strategy profile, y, where workers invest little
reinforcing low employer expectations regarding the level of productivity of
a worker from the group. In addition, there could also be a high equilibrium,
with strategy profile z>y, where workers invest high amounts in their
productivity generating high employer expectations of the marginal product
of individual workers from the group. And since o(x, x) is nondecreasing in
x, the highest equilibrium will always be preferred by workers (Milgrom and
Roberts 1990, Theorem 6). In order to focus discussion on transition issues,
in what follows I will assume that there are only two stable SNEs
corresponding to strategy choices, y < z. Equilibria with higher outcomes are
preferred by workers and since they are paid their marginal products,
employers presumably prefer higher outcomes as well. Thus, it is a desirable
policy goal for the government to facilitate a transition to the high
equilibrium.
Much attention has been given to modeling how multiple equilibria can
arise in a model of statistical discrimination6 than what are the general
tradeoffs a government faces in coordinating economic change. This is not
to say that policy matters have not received attention. Indeed, the opposite is
certainly true. Questions of differing policy goals and instruments under a
taste-embedded versus a statistical discrimination setting have received
much attention. In addition, throughout the social sciences there have been
many empirical studies into the successes or otherwise of affirmative action
policies and the like (e.g., Sowell 1983). However, in formal economics,
there has been little synthesis and focus on the important considerations
entering into government decision-making in the face of multiple equilibria
6
There have been numerous models within economics similar to the one sketched
here. Gunnar Myrdal (1944) clearly had some notion that a positive feedback and
complementarity between worker action and employer expectations lay at the
heart of the discrimination problem. But it was not until Arrow (1972a, 1972b,
1973) and Phelps (1972) that the idea of modeling discrimination as a statistical
phenomenon with multiple potential equilibria in the labor market was developed.
Both of those theories emphasized imperfect information as lying at the heart of
the problem, in that employers would find it advantageous to use group
information in employer evaluations and that this could generate self-fulfilling
prophecies and negative stereotypes. More recently, there has been a revival in
such models focusing on discrimination within organizations that leave the
observed wage schedule unaltered (Milgrom and Oster, 1987; Coate and Loury,
1993; Athey, Avery and Zemsky, 1994).
396 Joshua S. Gans

of the kind faced here. So while these models have, in the past, pointed out
the need for change, there has been little discussion of what alternative
mechanisms would be best for actually engendering change.
2 Dynamics of Escape
Gunnar Myrdal was the first economist to recognize the possibility that a
virtuous circle could break the equilibrium of discrimination. Having
outlined the feedbacks generating the problem, Myrdal continued,
White prejudice and low Negro standards thus mutually “cause” each other. If at a
point of time things tend to remain about as they are, this means that the two forces
balance each other: white prejudice and the consequent discrimination against the
Negroes block their efforts to raise their low plane of living; this, on the other hand,
forms part of the causation of the prejudice on the side of whites which leads them to
discriminatory behavior.

Such a static “accommodation” is, however, entirely fortuitous and by no means a

stable equilibrium position. If either of the two factors should change, this bound to
bring a change in the other factor, too, and start a cumulative process of mutual
interaction in which the change in one factor would continuously be supported by the
reaction of the other factor and so on in a circular way. The whole system would
move in the direction of the primary change, but much further. Even if the original
push or pull were to cease after a time, both factors would be permanently changed,
or the process of interacting changes would even continue without any neutralization
in sight. (Myrdal 1957: 16-17)
Myrdal seems here to be implying that a virtuous circle could arise quite
easily. However, as Swan (1962) points out, the notion of complementarity
between the beliefs of employers and minority workers could also lead to
vicious circles as well. It is the goal of this section to formalize and make
precise such notions of circular and cumulative causation and in the process
examine the requirements for a successful escape.
The hold of accommodation will be broken if the workers can be
persuaded that it is worth their while to undertake personal investments in
their productivity. In the situation described in Section II, the greater are the
observed expectations of employers regarding the investment level of a given
worker from the group, the larger will be an individual worker’s investment.
Nonetheless, the danger is that if these observed employer beliefs are not
high enough, the resulting investment will not justify even those beliefs and
they will fall back to their low equilibrium levels. As it turns out, however,
under certain dynamic assumptions, there does exist a critical level of
aggregate employer beliefs such that, if those beliefs are generated, the
process will not unravel and the hold of accommodation will be broken.
 Engendering Change 397

In showing how this is so, the first order of business is to make some
assumptions about how beliefs evolve over time. It has already been assumed
that employer beliefs about a worker’s investment are some nondecreasing
function of the current actual education investments of the group, i.e..,
x = f({x i } icL ) . What is crucial, however, is that workers be persuaded to
change their behavior. This will depend on their expectations regarding
what the future level of employer beliefs will be. To see this, observe that at
time t, each worker solves, max xi,t cX o(x i,t , x t ). Here, each worker maximizes
their payoff contingent upon their expectation regarding the aggregate
employer beliefs in that period. The dynamic sequence of observation and
action is depicted in Figure 2. For simplicity, it is assumed that when there
are multiple best responses to a set of beliefs, then the highest strategy is
chosen. Note, however, that is possible that sophisticated agents forming
rational expectations could, even at strategies close to the high equilibrium,
form expectations that drive them back to the low equilibrium. Thus, some
restrictions on how workers use past observations of the aggregate to form
their expectations are required to ensure that an escape, once begun, will
continue.

workers employers workers

choose and workers receive
observe
xt xt wt
Figure 2. Time Line

Given this, how might workers adjust their expectations over time? x t is
considered to be the state variable in the analysis that follows. Consider the
following very weak definition of adaptive expectations.

Definition. Suppose that a worker’s conditional probability density function

of current employer beliefs is g(x t x t−1 ) . Expectations are adaptive if
398 Joshua S. Gans

g(x t x t−1 ) satisfies the (generalized) monotone likelihood ratio property in

x t−1 , for any history {x t−2 , x t−3 , ...} .7
The (generalized) monotone likelihood ratio property used in this way
means that if the past aggregate estimate of worker education is higher, then
the probability that this period’s education aggregate exceeds any given level
is greater. This merely says that if the previous period’s personal
investments for all workers improve, then so will their expectations
regarding what this period’s personal investment will be. If workers use only
the immediate past observation of employer beliefs to form their
expectations, i.e.., setting o(x i,t , x t ) = o(x i,t , x t−1 ) and maximize that function,
then the resulting dynamics are Marshallian or best reply dynamics. Thus, it
can be seen that this often used adjustment dynamic is a special case of the
definition of adaptive expectations given here.

Theorem 1 (Momentum). Consider any game with aggregate strategic

complementarities. Suppose that players adjust their strategies optimally
(i.e.., play highest best responses) using adaptive expectations. Then if
x t m x t−1 for some t, x s [ x s+1 [ ... for all s > t. And if x t [ x t−1 for some t,
then x s m x s+1 m ... for all s > t.
This definition allows a variant of a theorem from Milgrom, Qian, and
Roberts (1991) to be stated for multiperson decision contexts and
games—their Momentum Theorem deals with adjustment processes in
certain contracting problems.

7
A probability density function, g(x; l) satisfies the monotone likelihood ratio
g(x;l)
property (MLRP) in a parameter l if g(x;lÂ) is monotone nonincreasing in x for
all l < l . If G(x; l) is the probability that the random variable exceeds x, then
the MLRP implies thatG(x; l) [ G(x; lÂ) , for all x. This definition does not,
however, allow for comparisons when changes in the parameter ,l, alter the
support of the density. Suppose that x c · , and let S(l) h x g(x; l) > 0 .
Then g(x; l) satisfies the (generalized) MLRP if given any x c S(l) and
g(x;l)
y c S(lÂ) , (i) min[x, y] c S(l) and max[x, y] c S(lÂ) ; (ii) for all l < l , g(x;lÂ)
is monotone nonincreasing in x for all x c S(l) 3 S(lÂ) . The (generalized)
MLRP is shown by Athey (1994) to be equivalent to Ormiston and Schlee’s
(1993) definition of MLR dominance. She also shows that the MLRP is a special
case of the (generalized) MLRP. I allow for the more general definition here to
allow for the possibility that agents’ expectations put unit one mass on a single
level of x, something essential in game theoretic contexts. This definition is also
applied in Gans (1995).
 Engendering Change 399

Proof. Since this is a game with strategic complementarities, p satisfies

the single crossing property in (x t ; x t ) . Moreover, by Theorem 5.1
of Athey (1994), since g(x t x t−1 ) satisfies the (generalized) MLRP in
x t−1 , E[p] satisfies the single crossing property in (x t ; x t−1 ) .
Consequently, workers’ best response correspondences are
monotone nondecreasing in x t−1 at each t (Milgrom and Shannon
1994). Suppose that x t m x t−1 , we can conclude that x t m x t−1 , since
f is monotone in each worker’s strategy. Then since each player’s
best response, at time t+1, is nondecreasing in x t , x t+1 m x t . The
theorem then follows by induction. The proof of the second part is
analogous to the first.
Theorem 1 captures Myrdal’s intuition that a virtuous cycle or escape,
once begun, will have a momentum of its own. If ever there is a time such
that workers wish to adjust their optimal investment upwards, that will
feedback on itself to generate employer beliefs that continue to be justified
by further upward movements in education for all workers. Note, however,
that the theorem relies on expectations being adaptive. If expectations were
not so then, in this general formulation, it could not be guaranteed that an
upward cycle once begun would sustain its upward momentum.8
The above results shows that there exists some critical level of employer
beliefs such that if, by intervention, a government can generate those beliefs,
upward momentum will be generated and an escape from the trap of the low
equilibrium will have been achieved. This critical level is defined, in the
myopic best reply dynamic case, by,
(1) f & = arg min x f( B(x) ) m x
If this critical level is generated, in the absence of any other shock, the
state of play will not return to the discriminating equilibrium. What it does
not say, however, is how far the escape will go. Under best reply dynamics,
the outcome of play of the game will converge to the high static equilibrium.
In other cases, the conditions of the theorem do not place enough restrictions
to allow us to predict where play might converge to. For instance, the
outcome of the path could be a Nash equilibrium or indeed, the state played
could keep rising indefinitely, past the level of the high equilibrium.

8
Note also, that if agents were forward looking and maximized the present value of
payoffs this period, i.e.., solved max {xi,t } S smt d s−t o(x i,s , x s ), 0 < d < 1 ,
Theorem 1 would continue to hold. In addition, allowing for heterogeneous
payoffs does not alter the momentum result if the player set is assumed to be
finite. In that case, the result would state that if ever there was a time that a single
worker adjusted optimal investment upwards, systemic momentum would follow.
400 Joshua S. Gans

Continued momentum, is, of course, desirable from a welfare point of view

because the state, x, enters positively into all worker’s payoffs.
In order for the government to intervene and generate a level of the
aggregate that escapes the basin of attraction of the low equilibrium, the
adjustment process must be, in some sense, path dependent. That is, the
adjustment path taken depends more on the history of past play than other
factors (e.g., future expectations). Adaptive expectations have this property
although convergence could be to an outcome other than the high static
equilibrium. Best reply dynamics possess both an adaptive quality and
predict convergence to some equilibrium9. Other dynamic adjustment
processes that would also converge to some Nash equilibrium rely on more
sophisticated expectations formation, but lose the path dependence that
would prevent adjustment after intervention from returning play to the low
equilibrium—e.g., rational expectations. If, however, one were to suppose
that there were costs to the upward adjustment of strategies then it is
possible that even under sophisticated expectations formation some
separation of the basins of attraction of the high and low equilibria is
possible.
There have been two general approaches to incorporating adjustment
costs to analyze the transition between equilibria in games. In a series of
papers, Matsuyama (1991, 1992) has analyzed dynamics in models with
multiple equilibria where agents are only able to adjust their strategies
intermittently. In addition, he assumes perfect foresight on the part of agents
as to the future paths of states. What prevents dynamic paths from
potentially returning to the low equilibrium is that, if the probability that an
agent would be able to alter their strategy in any given period is low enough,
the possible future paths for the state are constrained. Thus, if agents’
discount rates are sufficiently high and if the initial condition of the system
was above a critical state, then even if all other agents who were able to
change used low strategies, it would still be optimal for any agent to play a
high strategy. The intermittent adjustment process puts some lower bound
on feasible paths for the state which in turn constrains even paths of rational
expectation.
It would be beyond the scope of this paper to explore such adjustment
dynamics in detail. In all other applications using this method to date, the
strategy choice of agents is binary and the aggregate of concern is additively
separable in each individual’s strategy, for instance, some average.
Nonetheless, if we were to view the government as intervening to change
initial conditions, then the Matsuyama dynamic seems to imply that there
9
Indeed, support for this type of adjustment behavior is part of the experimental
literature (see Meyer et. al., 1992; Van Huyck, Cook and Battalio, 1992)
 Engendering Change 401

will exist some critical level of the aggregate such that if this is generated all
future paths will converge to the high equilibrium.10
The other method by which one could incorporate more sophisticated
expectations formation assumptions into adjustment dynamics and still
guarantee convergence to the high equilibrium, is if the use of government
policy actually eliminated the low equilibrium. Milgrom and Roberts (1991)
have analyzed learning and adjustment processes in games. They define a
class of learning processes that includes best reply dynamics and more
sophisticated types of dynamics—such processes are consistent with
adaptive learning. If educational changes were irreversible to some degree,
then intervention may remove the low equilibrium. Then, as Milgrom and
Roberts (1991) have shown, play will converge to the unique higher
equilibrium regardless of the dynamic process assumed—whether
sophisticated or merely adaptive. Gans (1994) demonstrates this process in
more detail and the circumstances under which it might be relevant.
In summary then, a necessary element of any successful government
policy to engender change is to ensure a sustained escape. Indeed, it could be
argued that when considering policy in the face of coordination failure, it is
critical that the details of the situation at hand imply some dynamic
adjustment behavior that is path dependent for the government to intervene
successfully. However, in situations where the dynamic permits a significant
role for history, the goal of the government is to lift the aggregate of
employer beliefs above some critical level, f &. Beyond that level, transition
will be completed by the adjustment behavior of individual workers. But
generating that critical level depends on changing individual behavior
already in the grip of accommodation. In order to avoid adding complicating
conditions to the following analysis, I will suppose that the expectations of
workers only depend on the immediate past level of aggregate employer
beliefs. This removes any additional difficulties in generating the critical
aggregate caused by long-standing low expectations since expectations will
evolve in a similar manner to best reply dynamics. If this were not the case
then, regardless of the dynamics adjustment behavior assumed, a
government may have to intervene for longer periods of time in order to
convince workers to improve their education in the face of greater employer
beliefs. The other issues involved in achieving the critical aggregate are the
subject of the next section.

10
For an excellent discussion of the roles of history and expectations along these
lines see Krugman (1991)
402 Joshua S. Gans

3 Changing Individual Behavior

Given the discussion in the previous section, the transitional sub-goal of the
government is clear: to generate the critical level of employer beliefs. One
way to do this would be to intervene and change the beliefs of employers.
But changing beliefs requires evidence and this is a scarce commodity in a
world of self-fulfilling prophecies. Alternatively, one could legislate directly
to avoid discrimination through an affirmative action policy. That is, one
could move to equalize (observable) outcomes between groups. But recent
theoretical discussions cast doubt on the effectiveness of outcome-based
affirmative action policies because of enforcement difficulties (Lundberg
1991) and the potential for patronization of minority workers (Coate and
Loury 1993).11 Empirical doubts along similar lines are given by Sowell
(1983) and Steele (1992).
Thus, the likely candidates for agents of change are the
discriminated-against workers themselves. Since all workers contribute to
generating employer beliefs, changing their incentives to invest in their
productivity possesses the same qualities as getting individuals to contribute
to the provision of a public good. The problem is that each worker perceives
losses as a result of greater educational investment, although others making
investments would enhance their own expected payoff. Given that we are
currently at the low equilibrium, this means that to change an individual
worker’s behavior is bound to be costly. For instance, one possible
mechanism for individual change would be to subsidize all workers for their
expected ex ante losses on their educational return. But regardless of the
actual mechanism, changing individual i’s investment from its low
equilibrium value y to another value x entails a cost which I write as c i (y, x) .
This is the individual transition cost. So if the government were to push on a
wide front in a balanced way, then, it needs to incur the individual transition
costs of ensuring that all workers invest an amount x & , where x & satisfies
f & = f({x & } icL ). Thus, the total cost of this transition mechanism would be
1
(2) TC b = ° c i (y, x & )di = c(y, x & )
0
This is the sum of all the individual transition costs.
But a balanced mechanism targeting all workers equally for change is
not the only way a government could generate the critical level of employer
beliefs. A myriad of unbalanced mechanisms could be imagined where only
a subset of workers are targeted. For simplicity, suppose that when the
11
Schelling’s (1978) discussion of the losses incurred by groups in transition also
provide another set of arguments that diminish the desirability of outcome based
affirmative action policies.
 Engendering Change 403

government targets some workers, it tries to induce them to change their

strategy choices by the same amount. The balanced mechanism is a special
case of this type of mechanism with all workers being targeted to change
their strategy to x & . Since f is nondecreasing, any mechanism that targets
some subset of workers must necessarily induce those workers to change
their strategy choice to some x̃ > x & . Thus, for any given target choice of
strategy, x̃, some critical mass of workers would need to be targeted for
change to x̃ in order to generate the critical aggregate. The critical mass
when workers are induced to invest x̃, k & (x̃) , is determined by
k & (x̃) c k ` L f & = f(({y} i"k , {x̃} ick )) . All mechanisms targeting some
subset of workers, i.e.., k & (x̃) < 1 , are called unbalanced transition
mechanisms, with mechanisms with a lower k & (x̃) being described as more
unbalanced.
Of course, inducing individual workers to change to some x̃ > x & is a
harder task than getting them to change to x & , and, therefore, more costly.
Thus, I suppose, quite naturally, that c(y, x) is increasing in x. The total
transition cost for any given unbalanced mechanism is,
k & (x̃)
(3) TC u (x̃) = ° c i (y, x̃)di = k & (x̃)c(y, x̃)
0
Note that the definition of an unbalanced mechanism makes some
implicit assumptions about the nature of the interaction between the
government and employers. When the government intervenes to change the
beliefs of employers by altering the investments of a group of workers, it is
assumed that employers cannot distinguish between those workers who were
targeted for change and those who were not. If they were able to make such
a distinction then this might mean that employers separate their beliefs
about targeted and non-targeted workers. In this case, the positive benefits of
intervention will not spillover to the workers not targeted harming the
possibility of an escape. Therefore, given the large set of workers, for
analytical convenience this possibility is assumed away.
Therefore, as remarked upon earlier, the choice for the government is
between moving a small amount on a wide front versus large pushes on
limited fronts. To be sure, all mechanisms, balanced or unbalanced, will be
sufficient to achieve a successful escape. Each breaks the hold of
accommodation to the low equilibrium trap. But each mechanism may entail
very different costs on the part of the government. As such, this will be its
crucial dimension in the choice of alternative mechanisms. Having
identified the important decision element for a government interested in
engendering change, the rest of this paper will be directed towards
identifying characteristics that will guide that choice.
404 Joshua S. Gans

4 Characterizing the Optimal Policy Choice

In choosing the scope of its policy, i.e.., the number of workers it targets, the
government faces a tradeoff between the costs of targeting an additional
worker and the costs of greater individual transition costs to change
behavior by a greater amount. This tradeoff exists because, in order to
ensure escape, any policy choice pair (x̃, k & ) is constrained to lie within the
set, G h (x c X, k _ L) f({y} i"k , {x} ick ) m f & . Thus, the policy choice of the
government in its coordinating role is determined by the optimization
problem, min (x,k) kc(y, x) subject to (x, k) c G . In general, however, there is
no guarantee that the functions and sets involved in this minimization
problem are convex or even continuous. Thus, in order to say something
more about what determines the optimal choice of the government, we need
to adopt some parameterization of the relevant aggregate and of the
transition costs.
Let me begin with the aggregate. Returning to the discrimination
context, the relevant aggregate was employer beliefs regarding the average
level of personal investment of the group of workers. Thus far, I have only
assumed that employer beliefs could be represented by some function,
x = f({x i } icL ), that is nondecreasing in each worker’s actual investment. It
has not been necessary to ascribe a functional form for f for any of the
results presented in the sections above. When it comes to analyzing the
relative costs of balanced and unbalanced transition mechanisms, however,
assuming specific functional forms becomes crucial.
Here I introduce a simple functional form as a description of how
employers form their beliefs on the basis of observed educational levels of
workers from the group. Employer beliefs regarding x are determined by,
1
1 a

(4) x = f({x i } ) = ° x ai di ,a > 0

0
This is the commonly used CES aggregator (see Cornes 1993)12 To see
its properties observe that if a = 1, we have the ordinary mean of the
1
investment levels, ° x i di. In this case by investing more, each worker
0
contributes precisely that amount to the generation of improved employer
beliefs. On the other hand, as α approaches 0, employer beliefs becomes a
1
geometric average, exp ° ln x i di . Here, an investment by a worker contributes
0
12
This function form is a symmetric CES production function or the generalized
mean of Hardy, Littlewood, and Polya (1952). It has been used in various forms in
economics, recently, by Dixit and Stiglitz (1977), Romer (1987), and Cornes
(1993).
 Engendering Change 405

a lower amount to employer beliefs if their investment is greater than that of

other workers, but a greater amount if it is smaller than others’
investments—so bad apples tend to spoil the bunch. Finally, observe that as
α approaches infinity, x approaches the max[{x i } ] . In this case, the worker
with the greatest education level determines employer beliefs.
The parameter, α, is, in this model, a measure of the flexibility of
employer beliefs. If α is high, employer beliefs adjust relatively easily to
improvements in a number of workers’ education levels. On the other hand,
if α is low, employer beliefs are relatively harder to change and
improvements rely increasingly on the simultaneous improvement of many
workers’ education.
What considerations justify this parameterization of employer beliefs?
One possible justification is that inflexibility (low α) describes a situation
(i.e.., type of labor market) where employers are more inherently prejudiced.
This would result in a model that combines aspects of taste generated and
statistical discrimination, although here inherent prejudice is embedded in
the determinants of beliefs rather than in utility functions. Nonetheless, such
an explanation might beg the question of why competition does not eradicate
those employers holding such beliefs. This was the original motivation
behind developing models of statistical discrimination in the first place (see
Arrow 1972a).
That beliefs are rigid might originate in optimizing behavior. For
example, as Kremer (1993) argues, employers may be using a production
technology where the marginal product of workers of a given ability is raised
by having co-workers of greater ability—the so-called “O-Ring” production
function. In that case, employers would find it optimal to match workers of
equal ability. The CES aggregate, therefore, represents what employers care
about. Indeed, it is often a stated element of statistical discrimination that
there are gains to the division of labor, i.e.., complementarities, that
preclude discriminated against workers from forming their own firms to
compete with discriminating employers (see Arrow 1972b).13
Regardless of the explanation underlying it, with this specification for
employer beliefs, one can see how flexibility, α, will be critical in
13
An alternative explanation, based on an observation of Meg Meyer, is that the
information employers receive about the group’s aggregate ability comes from
information sources that are unreliable and that alternative information sources
that are more reliable are prohibitively costly for employers to acquire. The
expected gains from having a reliable source of information do not outweigh the
additional costs associated with sampling from that source. Of course, it would be
beyond the scope of this paper to explore in detail this alternative explanation for
statistical discrimination.
406 Joshua S. Gans

determining the relative costliness of balanced and unbalanced mechanisms.

As before, suppose there are two Pareto rankable equilibria, with all workers
investing y and z, respectively, with y<z. There exists a critical level of the
aggregate, f &, that is the policy-maker’s goal. The critical strategy for the
balanced mechanism, x & , is determined by,
1
1 a

(5) f =
& ° x di &a
e x& = f &
0
Note that x & does not depend upon α, due to the (assumed)
homogeneity of the employer belief function. The critical mass for any
unbalanced mechanism with target worker investment, x̃, is determined by,
1
k & (x̃) 1 a
f & a −y a
(6) f & = ° x̃ a di + ° y a di g k & (x̃) = x̃ a −y a
0 & k (x̃)
Under this parameterization, therefore, k & (x̃) is a continuously
differentiable function from X into [0,1].
If c(y,x) is also smooth we can represent the government’s transition
minimization problem as in Figure 3. The curve g represents the function
c(y, x̃(k & )) , where x̃(k & ) is the inverse of k & (x̃) . This inverse exists because
k & is monotonically decreasing in x̃. A simple check also verifies that so
long as c(y,x) is not too concave in x, g is convex. The curve TC represents
the total transition cost function,
(7) c(y, x̃) =
TC
k & (x̃)
Figure 3 depicts the types of optimal policies that are possible. In (a),
the balanced mechanism minimizes transition costs, whilst in (b) an interior
solution is depicted. In Figure 3 (c) targeting a small number of workers to
use a high strategy is optimal.
 Engendering Change 407

(a )
c ( y ,x ) g

T C

*
c (y , x )

1 k
*

(b )
c (y ,x ) g
T C

c ( y , x̃ )

*
c (y , x )

k
*
( x̃ ) 1
(c )
c ( y ,x )

T C
*
c (y ,x )

1 k
*

Figure 3. Optimal Policy Choices

What is of interest, however, is how different levels of a change the
optimal policy choice of the government. In general, c(y,x) will not be
smooth and may be concave or convex. Nonetheless, even without such
408 Joshua S. Gans

restrictive assumptions, the following comparative statics result is still

available.14

Theorem 2. In symmetric games with aggregate strategic complementarities

and a CES aggregator, the degree of unbalance in the cost minimizing
transition policy is nondecreasing in a.
Proof. First, observe that k & is decreasing in a and that it is
¹k & (x̃)
submodular in (x̃, a) . We need to show that ¹a c(y, x̃) is
decreasing in x̃. That this is so follows from the submodularity of k &
and the assumption that c is increasing in x. Thus, total transition
costs are submodular in (x̃, a) . By Topkis’ Monotonicity Theorem
(Milgrom and Shannon 1994), the optimal choice of x̃ is increasing
in a. The theorem follows from the fact that k & is decreasing in x̃
The above theorem identifies the characteristics of employer beliefs as a
significant determinant of the government’s cost minimizing choice of
transition mechanisms. In situations where beliefs are relatively inflexible,
in order to generate the critical aggregate in a cost effective manner,
resources have to be spread thinner with the mechanism being more
balanced. Thus, the particular transition policy may differ across different
labor markets and even different regions. For example, in some markets
(e.g., popular music performers), beliefs may be fairly flexible, whilst in
others (e.g. CEO positions for women), beliefs could well be extremely rigid.
But the overriding conclusion is that, regardless of other potential
characteristics of payoff functions, the more inflexible beliefs are, the wider
the front one has to push to generate the critical aggregate and break the
hold of accommodation.
Parameterizations of the aggregate aside there are other characteristics
of economic significance that could influence the nature of the transition
mechanism chosen by the government. For example, the actual level of the
critical aggregate, while the target of all transition mechanisms, could
influence the relative costs of mechanisms. Indeed, it is simple to check that
the cost minimizing target strategy is nondecreasing in f & and hence, a
higher critical aggregate implies a more unbalanced mechanism.
What factors might cause the critical aggregate be greater? The
Matsuyama adjustment process discussed in Section III and the analysis of
Krugman (1991a), are suggestive of the notion that as agents become more
farsighted or as the ability to adjust strategy choices becomes greater, the
14
The homogeneity of the aggregator is not critical for this result and the theorem
would still hold if x = ° 0 x ai di .
1
 Engendering Change 409

basin of attraction of the high equilibrium shrinks. This means that the
critical aggregate that ensures convergence a successful escape is greater
and hence, a more unbalanced mechanism will be preferred.
Another potential influence on the choice of mechanism is the level of
individual increasing returns. If the total costs associated with raising
personal investment rise at a slower rate, then the marginal increase in
individual transition costs associated with a higher target strategy could be
lower. This could be the case because of initial startup costs in improving
human capital. Thus, we could imagine individual transition costs to be
some function c(y,x;b) where b parameterizes the marginal cost increase of a
higher x. It is straightforward to show that lower levels of b imply a greater
target strategy and hence, a more unbalanced mechanism. Thus, greater
individual returns to scale of investment will tend to cause the government
to favor a more unbalanced mechanism.
In summary, in this section, it has been shown that the government will
find a more unbalanced mechanism to be cost minimizing the more flexible
are employer beliefs, the higher the critical aggregate is, and the more
personal investment is characterized by individual increasing returns to
scale. Indeed, for a resource starved policy-maker, paying attention to these
economic characteristics may determine what type of successful escape is
feasible at all.
5 Conclusions and Extensions
The particular policy choices facing a government in its coordination role
have been neglected by economists until now. This paper has highlighted,
within the context of a model of statistical discrimination in the labor
market, some of the issues confronting governments attempting to change
an economy or game from one equilibria to another. In so doing, the
possibility of escape (under adaptive expectations) was identified. Moreover,
the notion that individual agents need to be convinced to change their
behavior by a sufficient amount to break the hold of accommodation was
emphasized. In such situations, the policy choices facing a government
involve how best to change individual behavior to move them out of the
basin of attraction of the low equilibrium. Note though that these
considerations apply to many models with public good elements that exhibit
strategic complementarities, beyond the application discussed here.
Given these findings, this paper has turned to focus on whether a
government should target a small number of individuals for change or adopt
a wider coverage. In the context of discrimination in the labor market, the
flexibility of employer beliefs and individual returns to scale were singled
out as critical determinants of whether a balanced or unbalanced mechanism
was cost minimizing. But the assumptions of the game presented abstract
410 Joshua S. Gans

from other factors that might affect the choice of balanced or unbalanced
change.
First, the worker’s strategy choice is currently assumed to be
unidimensional. One could imagine that it is more complex than this.
Indeed, it may be multidimensional taking into account differing aspects of
education and other investments that improve productivity. Much of the
analysis will continue to hold if vector of strategy variables available to an
agent were in turn complementary with one another (Milgrom and Roberts
1990). If this is the case, one could then expand the range of mechanisms
available for change. For instance, one might have unbalanced mechanisms
that attempt to change an individual’s behavior on all dimensions or perhaps
target some variables by a large amount, leaving the rest to adjust by later
momentum.
Second, the game as presented is symmetric in that all workers possess
the same payoff functions, face the same aggregate and have the same
impact on the aggregate. Introducing heterogeneity complicates matters by
making the definitions of balanced and unbalanced mechanisms less clean.
Suppose, however, that agents only differed in their costs of investment.
That is, o i = w(t, x) − c i x , where c i is the individual investment cost. In that
case, since all agents make the same contribution to aggregate employer
beliefs, it is clear that the definition of a balanced mechanism remains the
same, while the least cost unbalanced mechanism would have those with the
lowest investment costs being targeted first. This would continue to be the
case if those with the lowest costs also had the greatest impact on the
aggregate. However, if this were not the case, then a tradeoff between low
costs and greater contributions to the aggregate exists. Nonetheless, a
complete analysis of the issues of the optimal composition of a critical mass
lie beyond the scope of the dissertation.
Throughout the paper the government was assumed to be a purely
external facilitator of change and to possess an external source of resources.
Government intervention did not change, permanently, the best response
correspondences of agents or if it did, it did so positively. But it is well
documented from social psychology that social interventions can have
unintended negative feedback effects. In the 1930s, what has become known
as the Cambridge-Somerville experiments were conducted in impoverished
neighborhoods near Boston. The idea was to take a selection of children
from these neighborhoods and devote (virtually) unlimited social work and
other resources to helping them escape poverty traps. Thus, education and
health care were provided. Regular visits, monitoring and counseling was
provided by social workers. Basically, all the ingredients that one could hope
for. Nonetheless, years later, the basic social statistics for measuring an
 Engendering Change 411

enhanced socioeconomic condition showed little improvement and, on some

dimensions, a worsening of children’s situations. A suggested reason for the
failure of the intervention was an unintended effect: children receiving aid
suffered from isolation from their peers. The negative effects of this were
enough to cancel the positive benefits of the intervention.15
Such considerations, also documented in the case of discrimination by
Steele (1992), were not part of the above analysis. In the analysis of this
paper, all costs of achieving individual change were subsumed in the
function c(y, x) . Negative feedbacks would enter into these costs and their
identification can be of considerable importance for achieving a successful
transition. In addition, the discussion in this paper assumes individual
transition costs to be independent of the actions of other agents. Fruitful
extensions would include relaxing this assumption.
Finally then, the government is currently assumed to know with
certainty the critical aggregate, strategies and masses to provide the basis of
escape and the real individual transition costs. As is indicated by the
previous paragraphs, an interesting and important extension would be to
explore more completely relaxations of this assumption and this might
change the choice between balanced and unbalanced mechanisms.
By examining the flexibility of employer beliefs, this paper has
highlighted the degree of substitutability of individual workers’ investments
in altering employer beliefs as determining how widespread a government’s
policy to eliminate discrimination ought to be. This is because, regardless of
how they are achieved, once employer beliefs reach some critical level, the
discrimination will be removed by a momentum of attrition of stereotypes
and of improvements in workers’ incentives to take investments that
improve their own marginal productivity. Therefore, the costs and tradeoffs
associated with changing the behavior of workers to raise employer beliefs to
this critical level is the appropriate focus of the government. Such issues are
also present in other situations of coordination failure and the choices facing
policy-makers in facilitating transition are, in that respect, similar.
Nonetheless, this paper represents only a first step in understanding policy
in the face of multiple equilibria and in other economic contexts, the critical
variables driving choices may well be different and more complex.
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