THE AMERICAN ECONOMIC REVIEW SEPTEMBER /999 rate schedules(Robert Gibbons, 1987), regulation of Several conclusions can be drawn from our natural monopolies(Michael A. Crew, 1994), and experimental data, At a general level, in all procurement contracting (Jean-Jacques Laffont and versions of the game, and with all subject pop- Jean Tirole, 1993) ulations, there is a strong initial tendency for In this paper, we report an experiment which high-productivity firms to ignore the strategic addresses several open questions about the de- implications of the ratchet effect. Only gradu velopment of the ratchet effect in centrally ally(and incompletely)does play converge to planned economies and, more generally, about pooling equilibrium. This replicates results the evolution of strategic play in games. We from other signaling game experiments Jord study a game that captures the essential features Brandts and Charles A. holt 1992; Zeinab Pa of the strategic interactions between planners tow and Andrew Schotter, 1993; Cooper et al and firms in a centrally planned economy. In all 1997a, b), indicating that this general pattern of equilibria of this game, a ratchet effect emerges play is unaffected by culture, subject popul ith high-productiy tion and incentiv productivity types, thereby resulting in a pool This general pattern of play also suggests ar answer to an important question about the We compare the dynamics of adjustment to ratchet effect: Why should the ratchet effect equilibrium between: (1)standard"versus sub- ever be observed in field settings? If high stantially increased monetary incentives, (ii)the productivity firms anticipate that planners will standard" experimental subject population ratchet up their production targets and therefore students) and an"expert"subject population imitate low-productivity types, central planners with extensive field experience with the ratchet should also anticipate firms' mimicry and select effect (managers and white-collar workers in incentive schemes that do not elicit this strate state enterprises in the Peoples Republic of (for example, precommiting to a long-term con- China), and (ii) experimental sessions con- tract). Our results show that incentive schemes ducted"in context"versus a"generic"setting. that eventually produce the ratchet effect may The latter is no doubt the most novel of our actually work quite well initially for the central experimental treatment conditions, and there- planners, with inefficiencies arising only grad fore warrants further explanation ually over time as high-productivity firms learn For sessions played in context, the language to imitate low-productivity types. It has been is deliberately designed to relate to subjects suggested that, One possibility [why a planne field experi vith similar games For exam- might not precommit to a long-term contract], ple, we refer to subjects as"planners"and of course, is that the central planner is not aware managers"with"planners deciding what kind of the benefits of commitment"(Xavier Freixas of production target to assign to managers- et al., 1985). Our results suggest a different easy or tough. To the extent that the laboratory explanation: the planner may not precommit game and its equilibria are similar to experi- because initially there are minimal benefits to ences outside the laboratory, the use of context commitment may make subjects more sensitive to the strate ing at the detailed pattern of play, sev- gic implications of the game, facilitating con- eral interesting observations emerge. First, in vergence to the pooling equilibrium. In contrast, creasing payoffs for People's Republic of China in generic sessions, the language is kept delib-(PRC)students induced substantially higher erately abstract with firm managers referred to pooling rates by high-productivity firms in early as"A"players and planners referred to as"B" plays of the game(students in standard-pay players, with B players deciding between sessions only caught up after 20 or more repe- and"Y"( tough or easy contracts)in response to titions of the game). That is, more money in- A players"choices. The generic language is duced heightened initial levels of strategic play intended to minimize any relation to subjects suggesting that money can serve as a partial field experiences and may be expected to reduce substitute for experience. This provides some of consistent with the intuition of most theorists