Collective action

What Is Collective Action?

Collective action refers to the efforts of a group of individuals to pursue a common objective or achieve a shared benefit that would be difficult or impossible for any single individual to attain alone. In the realm of economics and behavioral finance, collective action often addresses situations where individual rational choices may lead to a suboptimal outcome for the entire group. This concept is fundamental to understanding how groups, ranging from small investor coalitions to large national and international bodies, attempt to overcome obstacles and coordinate their behavior to produce what are often considered public goods or to address shared challenges.

The core challenge in collective action lies in aligning individual incentives with group welfare. Even when all members of a group stand to benefit from a collective outcome, individual members might be tempted to avoid contributing to the effort, hoping to "free-ride" on the contributions of others. This tension between individual self-interest and collective good is a central theme when examining collective action.

History and Origin

The modern understanding of collective action is largely attributed to the work of American economist Mancur Olson Jr. His seminal 1965 book, "The Logic of Collective Action: Public Goods and the Theory of Groups," challenged prevailing assumptions that groups would naturally act to achieve their common interests⁶. Olson argued that in large groups, individuals have little incentive to contribute to a collective good because their individual contribution would have a negligible impact on the overall outcome, and they would still benefit if others contributed. This phenomenon is known as the free-rider problem.

Olson's theory highlighted that for collective action to occur, especially in large groups, there often need to be "selective incentives" – benefits or punishments that apply only to those who contribute or fail to contribute, respectively. His insights have profoundly influenced not only economics but also political science, sociology, and other social sciences, providing a framework for analyzing cooperation and conflict within groups.

Key Takeaways

• Collective action involves multiple individuals coordinating to achieve a shared goal that benefits the group.
• The free-rider problem is a significant hurdle to successful collective action, as individuals may benefit without contributing.
• Collective action is crucial for providing public goods and addressing issues like market failures.
• Mechanisms like selective incentives, coercion, and strong institutional frameworks are often necessary to overcome collective action problems.
• Successful collective action can lead to outcomes that improve overall welfare, especially in financial markets and regulation.

Interpreting Collective Action

Interpreting collective action involves understanding the underlying motivations and constraints that drive or hinder group cooperation. In financial contexts, this often means evaluating how different stakeholders, such as investors, regulators, or even nations, come together to address common concerns like financial stability or systemic risks.

For instance, when a financial crisis looms, the ability of central banks and governments to coordinate monetary policy and fiscal policy is a critical example of collective action. The successful interpretation of the need for collective action often leads to policies that prevent broader economic contagion, whereas a failure to do so can exacerbate crises. The degree to which divergent interests or information asymmetries exist within a group will significantly influence the ease or difficulty of achieving a collective outcome.

Hypothetical Example

Consider a publicly traded company where a significant portion of its value is tied to a single, environmentally unsustainable practice. A diverse group of shareholders, including small retail investors and large institutional investors, believes that shifting to sustainable practices would enhance long-term value and reduce regulatory and reputational risks. However, individually, no single shareholder has enough voting power to force this change.

This situation presents a collective action problem. To address it, these shareholders might form a coalition, pooling their proxy votes and advocating for a shareholder activism campaign. They could propose a resolution at the company's annual meeting, urging the board to adopt a comprehensive sustainability strategy. Even if the resolution is non-binding, the collective voice of a substantial shareholder group can pressure management and the board to respond, demonstrating how coordinated effort can lead to a significant shift in corporate governance.

Practical Applications

Collective action is evident in various aspects of finance and markets:

• Shareholder Activism: As seen in the example above, shareholders often engage in collective action to influence corporate policies, executive compensation, or environmental, social, and governance (ESG) initiatives. This is facilitated by mechanisms like shareholder proposals, which allow investors to communicate their collective views to the board. ⁵The U.S. Securities and Exchange Commission (SEC) regulates the shareholder proposal process, providing a framework for such collective efforts. Rule 14a-8, for example, outlines the conditions under which companies must include shareholder proposals in their proxy materials.
  ⁴* Regulatory Coordination: International bodies and national regulators frequently engage in collective action to address global financial risks, such as preventing money laundering, ensuring cross-border financial stability, or establishing common standards for risk management. For instance, after the 2008 financial crisis, there was a concerted international effort to improve the global financial infrastructure through initiatives like the Legal Entity Identifier (LEI) system, which aims to provide a unique identification for parties to financial transactions, thereby enhancing transparency and understanding of systemic risk.
  ³* Bondholder Committees: In sovereign debt restructuring, bondholders often form committees to collectively negotiate with debtor nations, aiming to protect their interests while facilitating an orderly resolution of the debt crisis.
• Industry Standards and Associations: Financial industry associations often act collectively to set best practices, advocate for favorable regulations, or develop common technological infrastructure that benefits all members, even though individual firms might be tempted to let others bear the cost of developing these standards.

Limitations and Criticisms

Despite its importance, collective action faces significant limitations, primarily rooted in the free-rider problem and the complexities of coordinating diverse interests. Mancur Olson's theory highlights that in large groups, the individual incentive to free-ride often outweighs the perceived benefit of contributing, leading to a suboptimal provision of public goods. This can result in:

• Under-provision of Public Goods: If too many individuals free-ride, the collective good may not be provided at all, or it may be provided at a level far below what is socially optimal. This is a common issue in areas requiring widespread cooperation, such as combating climate change or ensuring global financial stability.
  ²* High Coordination Costs: Bringing together a large number of diverse actors, each with their own interests and priorities, can incur substantial negotiation, communication, and enforcement costs. These costs can sometimes outweigh the benefits of collective action, making it impractical.
• Information Asymmetries: Unequal access to information among participants can hinder collective action. Some parties may exploit information advantages, making others less willing to cooperate or contribute. This is particularly relevant in financial markets where the principal-agent problem often arises.
• Divergent Interests: Even when a common goal is identified, the specific methods or the distribution of benefits and costs may lead to disagreements that prevent a unified approach. As observed during past financial crises, overcoming discord and delay in coordinated responses can be extremely challenging due to divergent national interests and ideologies.
  ¹

Collective Action vs. Free-rider Problem

While closely related, collective action and the free-rider problem represent distinct concepts. Collective action describes the act of a group working together to achieve a shared outcome. It is the collaborative effort itself. In contrast, the free-rider problem is a barrier or challenge to successful collective action.

The free-rider problem arises within the context of collective action, specifically when the benefits of a collective good are non-excludable—meaning individuals cannot be prevented from enjoying the good even if they don't contribute to its provision. An individual, acting rationally in their self-interest, might choose to withhold their contribution, assuming others will bear the cost. If many individuals choose to free-ride, the collective action may fail, and the shared good will not be produced or will be under-provided. Therefore, while collective action is the goal, the free-rider problem is a common impediment to reaching that goal, necessitating strategies to incentivize participation or enforce contributions.

FAQs

What is the primary goal of collective action in finance?

The primary goal of collective action in finance is to achieve outcomes that benefit a group of market participants or the broader financial system, which individual actions alone cannot accomplish. This can include ensuring financial stability, influencing corporate governance through shareholder activism, or coordinating regulatory responses to crises.

Why is collective action often difficult to achieve?

Collective action is often difficult to achieve due to the free-rider problem, where individuals benefit from the collective effort without contributing. Other challenges include high coordination costs, information asymmetries among participants, and divergent interests within the group, which can make reaching a consensus or enforcing contributions problematic.

How does collective action relate to public goods?

Collective action is essential for the provision of public goods. Public goods are non-rivalrous (one person's consumption does not reduce another's) and non-excludable (it's hard to prevent people from using them once they exist). Because individuals can't be easily excluded, they have less incentive to pay for them, leading to the need for collective effort or government intervention to ensure their provision.

Can collective action apply to individual investors?

Yes, collective action can apply to individual investors, especially when they pool their resources or voices to influence a company or market trend. While a single individual investor might have limited impact, forming an investment club, joining a shareholder activism group, or participating in proxy voting mechanisms allows them to exert a collective influence that can impact asset allocation strategies or corporate behavior.

What role does game theory play in understanding collective action?

Game theory is a powerful tool for analyzing collective action problems. It models strategic interactions between rational decision-makers, illustrating scenarios like the Prisoner's Dilemma, where individual rational choices lead to a collectively suboptimal outcome. This helps in understanding why cooperation might fail and how incentives can be structured to encourage collective behavior.